Wednesday, 20 May 2009

Can corruption be a public good?

I'm reading Dani Rodrik's "One Economics, Many Recipes" which sheds interesting light on the understanding of developing-country growth and its causes.

Chapter one focuses on the idea that there are basic principles behind economic development (indeed, economic activity in general): property rights, sound money, fiscal solvency, and market-oriented incentives. The exact policies which result in these outcomes are not necessarily those from the standard (Washington Consensus) list: privatisation, tariff reduction, etc. Instead, the universal principles need to be achieved with policies that are tailored to the country in question.

There's one point he makes in passing which struck me as fundamental. From p38 (of the 2007 edition):
"...policy changes at the outset have been typically modest...[South Korea's] military government led by Park Chung Hee that took power in 1961 did not have strong views on economic reform, except that it regarded economic development as its key priority...as these instances illustrate, an attitudinal change on the part of the top political leadership toward a more market-oriented, private-sector-friendly policy framework often plays as large a role as the scope of policy reform itself. Perhaps the most important example of this can be found in India: such an attitudinal change appears to have had a particularly important effect in the Indian takeoff of the early 1980s, which took place a full decade before the economic liberalization of 1991."

Why would this be? There's an ongoing debate (mostly between economists and sociologists) about how much importance to ascribe the influence of culture in prosperity. Economists traditionally say that choices arise from the incentives that individuals face - for instance if they get to keep and spend the profits of hard work, they're more likely to work hard and invest; while sociologists talk about culture and how that influences the behaviour of a population (for instance would you say that German culture encourages hard work and saving more than, say, Portuguese? Are American people more entrepreneurial than French?)

As with many interdisciplinary debates, this is a false dichotomy - where culture does influence people's behaviour, it probably happens through incentives, which can be social or psychological as well as material. And this is my explanation for the effect that Rodrik describes - specifically the fact that the incentives provided by new policy measures are highly uncertain. Especially if your government has been inconsistent in the past (or previous governments have not managed to stay in power long enough to be consistent), you may not trust the new institutional arrangements to last. And if you think your property rights are only here until the politicians change their mind, you may not act any differently than if you had no property rights at all.

What's more, policy changes are needed as circumstances change, or when the results of experiments have played out. And as I've mentioned before, it's hard to distinguish between a change in policy which is genuinely intended as an improvement, and one which is a disguised way of backing off from a commitment. Thus, if the government is not entirely credible, it may get stuck with suboptimal policies to avoid giving the impression of a lack of will.

In these cases, the attitude of your leaders to business is a key indication that private-sector-friendly policies will continue, regardless of the details of individual policies.

So a visible and credible commitment to the principle of an economy with a strong private sector may act as a signal that policies will be sustained - and may allow a government to optimise its policies over time without investors losing faith.

An important question - not answered in detail in the book - is: how can leaders signal such a commitment?

Sometimes, institutional mechanisms work, and this is the main theme of the rest of Rodrik's text. These are most successful in mature democracies - for instance the constitutional protection of private property in the United States is not seriously doubted by businesspeople there, because they know and trust the structures by which it will be enforced, and there is wide agreement among participants in the political, justice and enforcement communities about how these things work. But in a young or unstable society these tacit agreements may not exist, and institutions can always be overthrown.

A potential solution, then: Corruption, at the highest level possible. Specifically, crony capitalism of the sort that used to be familiar in East Asia.

The way to ensure commitment to business-friendly policies is to give political leaders an incentive to help businesses be successful. An excellent way to do this is to choose leaders who own businesses and make sure they keep hold of them during their term in office. They're likely to create an environment that imposes few barriers to doing business, with a low chance of asset confiscation by government. And, crucially, if they are allowed to align government policy with the interests of their own firm - provided their firm is not fully dominant within the economy - it will be in the interests of the private sector in general. Even if they decide to support their own businesses directly with government resources, at least that is likely to keep demand circulating within the domestic economy.

Growth in almost every country has been driven by private sector development and encouraging it in this way is likely to outweigh the welfare disadvantages - even in the short term - of more unequal wealth distribution and the economic rents extracted by politicians.

Of course there are caveats. One is that this is a completely unsustainable model and cannot be the basis of long-term development. Rodrik draws the distinction between igniting growth and sustaining it, and this feel much more like an ignition tactic than a sustenance strategy. The other is that not all businesses are equal: a corrupt leader may divert resources to his or her own businesses at the expense of others. To discourage this, leaders should be chosen whose businesses are closely embedded in trading networks with others.

Where has this worked? I probably have to be careful in what I say here, so I'll just suggest you look at the recent history of some East Asian economies. Certainly some smaller countries have been able to take advantage of the signalling value of having an industrialist in charge. I wouldn't know whether there is actually corruption in such places, but Belize is probably regarded as more business-friendly due to its government's relationship with Michael Ashcroft ("The billionaire who bought Belize"). And Italy is arguably considered a better place to do business under Berlusconi than under previous governments.

I hasten to note that this conclusion is not drawn from (or even implied by) Dani Rodrik's book. And of course it is a rather tongue-in-cheek idea.

But before dismissing it, let's remember one situation that is comparable: the principal-agency model of investment bank compensation. Under this theory, bankers decide to pay each other an amount of shareholders' money which is well above their marginal productivity (some have even claimed that such bonuses are 'corrupt'). The idea is that this reduces their incentive to take actions that are against the shareholder's interests. Is it really any different in a political system?

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