Why Is Development Blocked?

SECTION 6

Why Is Development Blocked?
Raj Nallari

There are several reasons why growth and development have been uneven
across countries and over time: high income inequality; state capture by
elites and powerful groups; weak state and private institutions related to
perennial problems of corruption, rule of law, property rights, and capacity
to formulate and implement policies; and “lack of a regional growth pole.”
Several of these factors are interrelated. For example, high income inequality could coincide with higher state capture and higher levels of perceived
corruption. These bottlenecks to development are detailed below.

Regional Growth Pole Helps Spur Development
Akamatsu (1962), the Japanese scholar, developed the “Flying Geese Paradigm” to explain technological development in Southeast Asia. Embraced
also by Kojima (2000), the paradigm views Japan as a leading power—the
lead “goose” with the other countries in the region aligned in a “wild
geese” pattern, based on their differing stages of growth. As the lead
nation moves out of labor-intensive production to capital-intensive production, its low-productivity production moves down the hierarchy and
the pattern repeats itself. This model of comparative advantage described

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Figure 6.1

Regional Growth Poles

Newly
industrializing
economies

Japan

Association of
Southeast Asian
Nations

China

Vietnam

Source: Author’s illustration.

the economic development of Japan, the second-tier of nations consisting
of the new industrializing economies of the Republic of Korea; China;
Taiwan, China; Singapore; and Hong Kong SAR, China, followed by the
main countries of the Association of Southeast Asian Nations (the Philippines, Indonesia, Thailand, and Malaysia, with China and Vietnam at the
rear) (figure 6.1). The paradigm depended on the catalytic role of Japan as
the lead nation. It is difficult to identify lead nations in other developing
regions of the world.

High-Income Inequality Constrains
Economic and Political Development
There is now enough evidence that in a country with relatively higher
income and wealth inequality, the incumbent government (1) resorts to
redistributive policies to maintain political and social stability; and (2) is
faced with credit market imperfections as powerful groups corner the credit
flows, thus impeding the formation of both physical and human capital
among the have-nots. For example, Sachs (1989) finds that Latin American
and Caribbean countries have higher income equality than other regions,

and this is deterring their economic development. Persson and Tabellini
(1994) find that, indeed, a relatively equal distribution does have a positive
impact on economic growth in democratic countries.

Poor Institutions
To trace the variety of institutions prevailing in postcolonial nations, Acemoglu, Johnson, and Robinson (2002) estimate the effect of institutions on
economic performance, based on differences in European mortality rates.
Where Europeans faced high mortality rates, due to an adverse climate or
disease environment, institutions tend to be extractive. Colonizers were

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unable to settle in these areas and thus concentrated on extracting as
much and as many of the resources as possible, without developing institutions to protect property or to limit government expropriation. In
areas where climate was favorable and the disease environment was
manageable, colonizers facing lower mortality rates had incentives to
develop institutions that protected property rights and enforced checks
and balances on government.
Europeans settled in large numbers in the United States, Canada, and
Australia, where climate was favorable. Institutions conducive to growth
evolved. The fate of much of Africa was very different, however. Even after
the demise of colonialism, extractive institutions prevailed. In a separate
article, Acemoglu, Johnson, and Robinson (2002) note the exceptional case
of Botswana, where due its unfavorable geographic location, the colonial
masters did not tamper with the local tradition of checks and balances. This
fostered democracy and sustained economic growth.
According to North and Weingast (1989), British institutions were better

in fostering growth because of superior commercial law. Consequently,
British settler-colonies fared better eventually. Latin America was a Spanish
and Portuguese colony. Similar to their colonial masters, these nations had
regulatory monopolies, which prevailed well into current times and
impeded growth. Despite the same initial advantage during 19th century,
each continent was led to a different predicament during the next 100 years
or so.

Formal Rules Are Required for Development
During the 11th century, the West was far behind in almost all dimensions, compared with Islamic and Chinese civilizations; but industrialization took place in Great Britain and not elsewhere. Greif (1989, 1994)
makes a compelling argument that juxtaposes the individualistic nature
of the West with the collaborative nature of the East. Contracts in the
West were mostly bilateral, compared with multilateral contracts in the
Muslim world. Even though initially efficient, multilateral contracts prevented the formation of formal legal institutions. The absence of formal
legal institutions forced trade to take place within a certain community.
This curtailed the growth of exchanges farther afield. Bilateral transactions did not enforce communal ties; therefore, the society had greater
need to build formal laws and regulations that eventually fostered economic growth.

Why Is Development Blocked?

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Perennial Crisis in Governance
Destabilizes Development
What do we learn from the troubles of modern-day corporations? These
are the most sophisticated corporations ever formed, yet they are victims
of their own governance failures. Public sector governance problems are
known from time immemorial. The first description of state governance
problems in the form of bribery, corruption, and other misgovernance is

attributed to Patañjali, who lived in India around 53 CE. Conversely, corporate governance problems are relatively recent. With the industrial revolution came the need for a corporation to organize and manage capital
and labor. The board of directors, by law, is given full authority in a corporation. In the initial days of industrialization, the family-owned corporation had family members on its board. However, as the corporations
became more complex over time, the board has occupied more a role of
overseeing the management team (comprising chief executive and financial officers). This is the problem of principal-agent, where the agent
(management team) usurps power from the principal (board of directors
and shareholders). The oversight function has been diluted further, owing
to the complexity of business transactions and the managers often providing obfuscation. In addition, more and more boards are stacked with insiders and friends. As a result, we have reached a stage in several big and small
corporations where there is a crisis in corporate governance. The recent
financial crisis is but one manifestation of this corporate crisis, where
complexity is deliberately created in the name of financial innovation that,
in turn, obfuscates information given to the board of directors, stakeholders, and the public.
The crisis in corporate governance is compounded by public sector governance where politicians and bureaucrats are influenced by the large corporations. State capture is defined by Hellman et al. (2000) as the “propensity
of firms to shape the underlying rules of the game by ‘purchasing’ decrees,
legislation, and influence at the central bank, which is found to be prevalent
in a number of transition economies” (p. i). This “shaping” may be done not
only by the private firms or richer elites (top 20 percent on the income distribution scale), but also by ethnic groups or powerful economic groups in
some countries. As such, to fully understand the dynamics of state capture,
the analysis must be based on winners and losers—not only in terms of
income groups, but also in terms of powerful groups and vested interests
(including bureaucracy). In almost all the countries, this argument of state
capture by a small group of corporations or elites appears to hold because
these elites have been colluding with politicians and, with the help of
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bureaucracy, extracting rents rather than investing in productive activities
(which Eifert and Gelb 2005 call “low-level political equilibrium”). Private
investment and growth are higher in stronger states than in weaker states,

and garnering of subsidies by the elites is relatively lower.
Countries that are “highly captured” may exhibit capture of all or most
institutions—such as parliament, political parties, the executives (including
ministries and public enterprises), judicial courts, and bureaucrats. Firms
and groups that cannot compete with favored firms or accommodated
groups will go under or have no choice but to resort to “informality” or
“unofficialdom” and a “shadow financial system.” By choosing to be in the
shadows, these informal enterprises are able to circumvent government
regulations relating to property rights, labor laws (such as minimum wages
and workers’ safety restrictions), environmental regulations, price controls,
and licensing and to avoid taxes and fees. To avoid the costs arising from
detection and punishment for operating informally (usually illegally), the
big corporations and informal enterprises operate through “trust” in the
form of transactions, based on reputation, among closed networks of customers and suppliers.
Political development is blocked by the elites and powerful groups.
Acemoglu and Johnson (2007) studies a number of countries and finds
that the movement from dictatorship or authoritarianism to democracy
is blocked by groups that benefit from the status quo. In such societies,
the reward structure favors the elites. Only when there is outside pressure (for example, from donors) or when the vast majority of citizens
take to the streets will there be some concessions made to ease restrictions, reduce rent-seeking, and change the reward structure to promote
incentives for the many—not just the few. There has to be a continuous
pressure exerted on closed regimes to provide more equitable services
and develop institutions that provide incentives. Enlightened leadership
and coalition building in civil society (that emphasizes social accountability) can bring forth change agents and place a country on a path of
gradual reforms and opening up.

In Conclusion
Growth and development have been uneven over time and across countries.
Some of the issues considered here—high income inequality, state capture
by elites and powerful groups, weak state and private institutions, and the

“lack of a regional growth pole”—highlight this disparity in growth and
development.
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References
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