DM Study Guide

Development management
J-P. Faguet
DV3165, 2790165
2011
Undergraduate study in
Economics, Management,
Finance and the Social Sciences
This subject guide is for a 300 course offered as part of the University of London
International Programmes in Economics, Management, Finance and the Social Sciences.
This is equivalent to Level 6 within the Framework for Higher Education Qualifications in
England, Wales and Northern Ireland (FHEQ).
For more information about the University of London International Programmes
undergraduate study in Economics, Management, Finance and the Social Sciences, see:
www.londoninternational.ac.uk
This guide was prepared for the University of London International Programmes by:
Dr Jean-Paul Faguet, Development Studies Institute & STICERD, The London School of
Economics and Political Science.
This is one of a series of subject guides published by the University. We regret that due
to pressure of work the author is unable to enter into any correspondence relating to, or
arising from, the guide. If you have any comments on this subject guide, favourable or
unfavourable, please use the form at the back of this guide.
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Reprinted with minor revisions 2011
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Contents
Contents
Introduction ............................................................................................................ 1
Aims and objectives of the course .................................................................................. 1
Learning outcomes ........................................................................................................ 2
Syllabus......................................................................................................................... 2
How to use this subject guide ........................................................................................ 3
Structure of the guide .................................................................................................... 4
Essential reading ........................................................................................................... 6
Further reading.............................................................................................................. 7
Online study resources ................................................................................................... 9
Journals ...................................................................................................................... 10
Other resources .......................................................................................................... 11
Examination structure .................................................................................................. 11
Examination advice...................................................................................................... 12
List of abbreviations used in this subject guide ............................................................. 12
Part 1: Theoretical background ............................................................................ 13
Chapter 1: Institutions, organisations and development management ............... 15
Aim of the chapter....................................................................................................... 15
Learning outcomes ...................................................................................................... 15
Essential reading ......................................................................................................... 15
Further reading............................................................................................................ 15
Works cited ................................................................................................................. 15
Introduction ............................................................................................................... 16
Institutions and organisations ...................................................................................... 17
Complexity .................................................................................................................. 20
Why they matter: incentives ......................................................................................... 20
Organisational and institutional change ....................................................................... 21
Conclusion: the meaning of development management ................................................ 22
A reminder of your learning outcomes.......................................................................... 23
Sample examination questions ..................................................................................... 23
Part 2: Governance .............................................................................................. 25
Chapter 2: Political accountability and public action ........................................... 27
Introduction and aims of the chapter ........................................................................... 27
Further reading............................................................................................................ 28
Democracy and voting ................................................................................................. 28
An empirical study: local government at the extremes .................................................. 33
A simple model of government .................................................................................... 37
Chapter 3: Democracy and decentralisation ........................................................ 41
Aims of the chapter ..................................................................................................... 41
Further reading............................................................................................................ 42
i
165 Development management
Introduction ................................................................................................................ 42
Arguments for and against decentralisation ................................................................. 45
Decentralisation in Bolivia and Colombia ..................................................................... 47
The Colombian decentralisation programme ................................................................. 48
Chapter 4: International aid and international governance ................................ 55
Learning objectives ...................................................................................................... 55
Essential reading ........................................................................................................ 55
Further reading............................................................................................................ 56
Works cited ................................................................................................................. 56
Introduction ................................................................................................................ 56
The origins of international development...................................................................... 57
Development institutions – how do they work? ............................................................ 59
The development of development: physical capital and the financing gap ..................... 61
Integrated rural development ....................................................................................... 63
Structural adjustment .................................................................................................. 65
Human capital formation and good governance ........................................................... 67
Progamme lending, SWAPs and GBS ............................................................................ 69
Has aid worked?.......................................................................................................... 70
Institutions, incentives and aid ..................................................................................... 74
Part 3: Private provision ....................................................................................... 79
Chapter 5: Hierarchy, cooperation and incentives in private firms ...................... 81
Essential reading ........................................................................................................ 81
Further reading............................................................................................................ 81
Introduction ................................................................................................................ 81
The traditional capitalist firm (late nineteenth century) ................................................. 83
The modern firm (ca. 2008).......................................................................................... 84
The neoclassical view of the firm .................................................................................. 86
The new institutional economics view of the firm.......................................................... 87
Chapter 6: Real firms, small firms:
microentrepreneurs and the informal sector ....................................................... 93
Aim of the chapter....................................................................................................... 93
Further reading............................................................................................................ 93
Additional resources .................................................................................................... 93
Introduction ................................................................................................................ 94
Definition and evolution of the idea ............................................................................. 97
Formal, informal and illegitimate income opportunities ................................................. 98
Analysis of key differences ......................................................................................... 100
De Soto’s The Other Path (1987) ................................................................................ 101
The possibility of reform............................................................................................. 102
ii
Contents
A reminder of your learning outcomes........................................................................ 104

Sample examination questions ................................................................................... 104
Chapter 7: Managing common resources: private solutions for
collective action ................................................................................................. 105
Aims of the chapter ................................................................................................... 105
Learning outcomes .................................................................................................... 105
Essential reading ....................................................................................................... 105
Further reading.......................................................................................................... 106
Introduction .............................................................................................................. 106
Theoretical models of collective action ....................................................................... 108
The government solution ........................................................................................... 113
Solutions from real life ............................................................................................... 113
Part 4: Empirical studies of transformation and decomposition........................ 117
Chapter 8: Geography, values, factor endowments, institutions ....................... 119
Aim of the chapter .................................................................................................... 119
Further reading.......................................................................................................... 120
Internet resources ...................................................................................................... 120
Introduction .............................................................................................................. 120
Some simple growth empirics .................................................................................... 121
Geography ................................................................................................................ 123
Culture (values) ......................................................................................................... 126
Factor endowments ................................................................................................... 128
Institutions ................................................................................................................ 131
Conclusions ............................................................................................................... 134
Chapter 9: Analytical narratives of development failure ................................... 137
Aim of the chapter..................................................................................................... 137
Further reading.......................................................................................................... 138
Internet resources ...................................................................................................... 138
Introduction .............................................................................................................. 138
Analytical narrative 1: Venezuela ................................................................................ 141
The explanation ......................................................................................................... 144
Analytical narrative: Zimbabwe .................................................................................. 145
Analytical narrative: Pakistan ..................................................................................... 148
Some preliminary lessons of failure ............................................................................ 149
Chapter 10: Analytical narratives of development success................................ 151
Further reading.......................................................................................................... 151
iii
Introduction .............................................................................................................. 151

Analytical narrative: Botswana ................................................................................... 153
Analytical narrative: China ......................................................................................... 156
Lessons of success ..................................................................................................... 159
Deeper lessons .......................................................................................................... 160
Chapter 11: Towards a theory of development management ............................ 163
Essential reading ...................................................................................................... 163
Further reading.......................................................................................................... 163
Introduction .............................................................................................................. 164
Institutions for development ...................................................................................... 165
Explaining underdevelopment .................................................................................... 167
Development functions and institutional tools ............................................................ 168
Endogenous institutional emergence .......................................................................... 171
The development manager’s toolkit............................................................................ 172
Appendix 1: Sample examination paper ............................................................ 175
Appendix 2: Guidance on answering the sample examination paper................ 177
General remarks ........................................................................................................ 177
Section A ................................................................................................................... 178
Section B ................................................................................................................... 179
iv
Introduction
Introduction
Development management is a ‘300’ course offered on the Economics,

Management, Finance and the Social Sciences (EMFSS) suite of
programmes.
It is a subject which provides insights and understanding of the institutional
drivers of economic and social development, as well as economic and social
decomposition. It trains students to manage processes of change in the
direction of increasing prosperity and freedom. Many students approach
this course with the idea that development management is primarily about
administering aid projects. Common misunderstandings are that countries
develop as the direct result of international donor and NGO activities, and
hence that by better administering the aid projects of such organisations,
societies can become richer and more free. Such a view is rooted in a myth
of charity which holds that people become more developed through the
efforts and resources of others. This course will provide ample empirical
and historical evidence to show that in fact societies develop as a result
of deep changes in the way they organise key sets of rules by which they
operate, such as the economy, government, and the system of justice.
These sets of rules define their institutions, and hence development can be
viewed as a process of transformation from less effective to more effective
institutions. Outsiders, such as NGOs and international agencies, can
play a crucial role in nudging societies towards such transformations, and
advising national actors once change is under way. But the fundamental
responsibility lies within developing societies. What you should take
away from this course is an understanding of the role of institutions and
organisations in developmental and anti-developmental processes, and
strategies for fomenting the former and discouraging the latter.
It is a particularly relevant course for those of you who want to go on to
careers in developing country governments, multilateral organisations
such as the World Bank, United Nations, and regional development
banks, development NGOs, CSOs and advocacy groups, and private firms
working in developing countries, as the way it looks at development
is central to the core tasks and problems that such organisations face.
I teach a similar course at LSE, which is the core course of our MSc in
Development Management. My particular interests are in decentralisation,
local government effectiveness, the political economy of insurgency and
violence, and the institutional roots of comparative development. My
background is split between political science and economics, and hence my
work tends to lie on the frontier between those two disciplines.
This course complements a number of other International Programmes
courses, most obviously 26 International political economy,
96 Economic history in the twentieth century, 108 Political
analysis and public choice, 44 Economics of development and
164 Economic geography. I hope that you enjoy studying this course.
Aims and objectives of the course

This course uses an institutional approach to examine the development
process and analyse the roots of developmental and anti-developmental
experiences in countries, regions and organisations. The approach draws
on institutional theories from political science, sociology and the new
institutional economics. 1
The objectives specifically include:

• to explain institutions and organisations as theoretical concepts
• to analyse the development implications of different organisational
forms
• to examine coordination in the increasingly complex institutional
systems that characterise the most advanced countries
• to explore how characteristics of this complex interdependence are
related to the persistence of high and low states of development.
Learning outcomes
At the end of the course and having completed the essential reading and
activities you should be able to:
• explain the role of incentives in political behaviour and economic
performance
• map the links from different organisations and institutions to the
incentives they put in place
• compare and contrast why certain organisations are better suited to
certain types of services and/or environments than others
• map the links from incentive systems to micro and macro-level
economic performance
• discuss what stable institutional constellations comprise, how they
come about, and under which conditions they perish.
Syllabus
Part 1: Theoretical background
Institutional theories of development: Institutions, organisations
and development management; the importance of managing the
transformation from less to more effective institutions.
Part 2: Governance
Political Accountability and Public Action: The nature of
democracy; voting as a means of achieving voice and exit; the roles
of information and accountability; theoretical models of voting, and
of their problems; empirical studies of government at the extremes of
performance; a simple model of government that integrates economic
structure, political party system, and the structure and dynamics of civic
organisations.
Democracy and decentralisation: Fiscal architecture, hierarchical
relations within government; government responsiveness; residual
power; interest groups vs. civic groups; organisation, voice and political
representation.
International aid and international governance: Aid,
conditionality and national sovereignty; the concept and limitations of
‘global governance’; its effects on trade and aid flows; their ultimate effects
on countries’ development prospects.
Part 3: Private provision: the market and beyond
Hierarchy, cooperation and incentives in private firms: Pure
market exchange; the theoretical origins of firms; the role of hierarchy in
efficiency and coordination.
2
Introduction
Real firms, small firms: microentrepreneurs and the informal

sector: Theory of the firm applied to real, third-world market conditions;
the origins of the informal sector; prospects for its development.
Common resources and private solutions for collective
action: The economic characteristics of common property resources;
the pervasiveness of Tragedies of the Commons and environmental
degradation in LDCs; implications for efficiency; possibilities for private
solutions and collective action; empirical examples from LDCs
Part 4: Empirical studies of transformation and decomposition
Institutions vs. Geography vs. Values: Why are some countries rich
and others poor? Competing theories of the determinants of development;
empirical evidence for each.
Analytical narratives of development failure: Why do some
countries ‘de-develop’? The cases of Venezuela, Zimbabwe and Pakistan;
cross-country evidence of development failure.
Analytical narratives of development success: Why do some
countries succeed? Can their success be replicated? The cases of China and
Botswana; cross-country evidence of development success.
Towards a theory of development management: A synthesis of
the theory of parts 1 and 2 with the evidence presented in part 3; the
determinants of development success; successful management of the
transition to a rapid development process.
How to use this subject guide

The aim of this subject guide is to help you to interpret the syllabus. It
outlines what you are expected to know for each area of the syllabus, and
suggests relevant readings to help you understand the material. There
are four set textbooks which you must read for this course, but you will
find that much of the information you need to learn and understand is
contained in examples and activities within the subject guide itself. If
you are to succeed in this course, it is important that you complete the
essential readings; the adjective ‘essential’ is not accidental.
I would recommend that you work through the guide in chapter order,
reading the essential texts beforehand. The activities provided will help to
strengthen your understanding of key concepts, and to link them together.
You may wish to supplement your studies by reading among the further
references provided in each chapter.
Where appropriate, useful internet resources are provided which you
may take advantage of. These provide data which you can use to explore
particular topics further, case studies that illustrate specific points, or
links to important organisations and research groups working on relevant
issues.
It is important that you appreciate that different topics are not self-
contained. There is a degree of overlap between them, and you are guided
in this respect by the cross-referencing between different chapters. In
terms of studying this subject, the chapters of this guide are designed as
self-contained courses of study, but for examination purposes you need to
have an understanding of the subject as a whole.
At the end of each chapter you will find a checklist of your learning
outcomes, which is a list of the main points that you should understand,
once you have covered the material in the guide and the associated
readings.
3
Structure of the guide

Chapter 1 begins by asking: Why are some countries rich and others
poor? Why are the citizens of some countries more free to realise their
potential than others? Why are some organisations more effective
and efficient at what they do than others? Development management
is concerned first of all with analysing the role of institutions and
organisations in the process of development. Development management
also seeks to go beyond understanding and analysis, to the active
management of organisational and institutional transformation, in ways
that promote increased levels of growth, development, and freedom. To do
this, we must first understand what institutions and organisations are, and
what they are not. In North’s (1990) famous characterisation, institutions
are the ‘rules of the game’, and organisations are the teams that operate
within those rules. Institutions and organisations matter because they
create incentives, and these incentives regulate human behaviour. Hence,
institutional variation is not arbitrary, and its significance goes well
beyond ‘local colour’. Understanding how institutions and organisations
work requires a grasp of complexity. Institutions do not operate as
islands, but overlap and interlink. And any given organisation, whether
a firm, a government department, or a household, functions under a set
of incentives created by multiple institutions, all of which affect their
behaviours.
To become development managers, we must go beyond a static
understanding of these relationships, to a dynamic understanding of
how organisations and institutions change. Institutional change can
occur through the gradual accretion of small changes over time, or via
sudden exogenous shocks. Both kinds of change can be either positive or
negative, leading to higher or lower levels of efficiency and effectiveness.
Development management is about actively fomenting institutional and
organisational changes that increase human freedom and wealth, and
hence society’s level of development.
Chapters 2, 3 and 4 comprise a module on ‘Governance’. Although a
country’s institutions are not limited to its government, the state does hold
a privileged position in that it not only operates within the institutional
context, but is also in many ways its shaper and guardian. We begin with
the question of public order, exploring the origins and role of the states
in historically-informed theoretical terms. But much more is required
of modern states, and especially developmental states. Thus we explore
the question of political accountability, and the role that voting and
elections play in generating it. We then turn to the question of hierarchical
relations within government, and the possibility of reform that increases
government responsiveness to citizens’ needs. The most popular such
reform worldwide is decentralisation, which we explore theoretically and
empirically. The decentralisation literature is ambiguous about the likely
effects of reform. We explore the sources of this ambiguity, and propose
a theory of residual power that explains both why empirical results are
not more clear-cut, and why decentralisation reforms are more often
proclaimed than implemented. In Chapter 4 our gaze turns to the question
of international aid and international governance. Foreign aid is often
criticised for subverting national sovereignty. If so, it is quite likely that
aid undermines government accountability to its citizens. We analyse the
question of conditionality and aid effectiveness, both theoretically and
empirically, and explore whether reforms to the aid architecture might
improve countries’ development prospects.
4
Introduction
Chapters 5, 6, and 7 comprise a module on ‘private provision’. The

most common type of private provision of goods and services is by firms
operating in the market. But why do we need firms? Why not just pure
market exchange? This is an important question, as the answer has
deep implications for organisational theory in general, and especially
for the question of non-state provision. We rely on Coase, Alchian and
Demsetz, and others to show that firms arise within the market in order
to minimise transaction costs, and to solve the monitoring and efficiency
problem. Hierarchies exist within the decentralised market mechanism
because they are efficient. But taking this model of firms and markets to
a developing-world context requires us to relax a number of assumptions
about the institutional context. When an economy is marked by high levels
of inequality, weak or unenforceable property rights, an untransparent
and inefficient judiciary, and poor legislative oversight, economic activity
will have strong incentives to ‘go underground’, and hence the informal
economy will bloom. When the institutional context is distorted in these
and other ways, informality emerges as an efficiency device for small and
medium-sized firms for whom the costs of formality far outweigh the
benefits. But the costs to society of informality are also significant, and
include lower wages, lower health and safety standards, weak workers’
and consumers’ rights, low investment, and low levels of productivity. A
number of reforms intended to reduce informality have been attempted
in recent decades, and some of these have proved notably effective. We
explore these measures, and suggest institutional reforms that can both
reduce informality, and raise efficiency and productivity in the economy.
The implicit objects of our analytical gaze thus far are private and public
goods. A third category not yet addressed is common property resources,
which are both conflicting and non-excludable (e.g. a common pasture).
For such goods, the market solution tends strongly towards degradation
and resource collapse, while public provision is costly and very often
ineffective, due to incentive incompatibility of the principal actors
involved. But other private, non-market type of solutions are feasible. We
explore a number of these which experience has proved successful, and
derive broader theoretical implications for this class of goods.
Chapters 8, 9, and 10 comprise the last module, ‘Empirical studies of
transformation and decomposition’. This module attempts to synthesise
the key lessons learned so far regarding institutions, organisations, and the
characteristics of state, market, and non-market private provision through
a set of quantitative and qualitative empirical studies of development
success and failure. We begin with broad approaches to the question of
why some countries are rich and others poor. Competing theories centre
on the role of institutions, geography, or culture/values in explaining
development success and failure. We dissect such theories down to first
principles, and explore their internal coherence and plausibility. We
then test such theories with broad, cross-country empirical evidence.
This evidence finds greater support for institutional approaches, and
least support for culture, with geography playing a non-trivial mediating
role. But to understand development, we must go beyond the correlates
of development success and failure, to understand the dynamics of the
developmental, and anti-developmental, processes themselves. Thus we
turn to qualitative evidence, and to analytical narratives of development
failure. The cases of Venezuela, Zimbabwe and Pakistan are three diverse,
rich, and telling examples of development gone awry. In each case,
favourable initial conditions and strong signs of early success turned into
development tragedy, followed by economic and social decomposition. We
explore the causes and dynamics of these failures, and attempt to draw
5
lessons from them. These lessons are tested against cross-country evidence.
We then turn to analytical narratives of development success, and the
cases of China and Botswana. As recently as 1970, the economic and social
prospects of each country seemed bleak, and yet today each country has a
strong claim to be a clear development success. We explore the causes and
dynamics of these successes, and attempt to draw lessons from them as
well. These lessons are also tested against cross-country evidence.
Chapter 11 synthesises the theory of modules 1 and 2 with the
evidence and lessons presented in module 3, in an attempt to construct
a theory of progressive institutional transformation, and hence a
theory of development management. We bring together a knowledge
of the determinants of development success provided above, with an
understanding of the dynamics of institutional transition, to outline a
theory of how development managers can catalyse rapid development
processes in less-developed countries.
Essential reading
Detailed reading references in this subject guide refer to the editions of the
set textbooks listed below. New editions of one or more of these textbooks
may have been published by the time you study this course. You can use
a more recent edition of any of the books; use the detailed chapter and
section headings and the index to identify relevant readings. Also check
the VLE regularly for updated guidance on readings.
You should purchase:
North, D. Institutions, Institutional Change and Economic Performance.
(Cambridge: Cambridge University Press, 1990) [ISBN 9780521397346].
Brett, E.A. Reconstructing Development Theory. (Basingstoke: Palgrave-
Macmillan, 2009) [ISBN 9780230229808].
Putnam, R.D. Making Democracy Work: Civic Traditions in Modern Italy.
(Princeton: Princeton University Press, 1993) [ISBN 9780691037387].
Rodrik, D. (ed.) In Search of Prosperity: Analytical Narratives on Economic
Growth. (Princeton: Princeton University Press, 2003)
[ISBN 9780691092690].
Each chapter of the subject guide starts by identifying the appropriate
chapters from these textbooks. In instances where the textbooks are
inadequate or simply do not cover a particular topic, additional readings
are listed under both ‘essential’ and ‘further’ headings.
You are also required to read a number of articles which are available
in the University of London Online Library. (See Online study resources
below.)
Acemoglu, D., J.A. Robinson and S. Johnson ‘The Colonial Origins of
Comparative Development: An Empirical Investigation’, American Economic
Review 91(5) 2001, pp.1369–401.
Alchian, A. and H. Demsetz ‘Production, information costs and economic
organization’, American Economic Review 62(5) 1972, pp.777–95.
Banerjee, A.V. and M. Ghatak ‘Symposium on Institutions and economic
performance’, Economics of Transition (13) 2005, pp.421–25.
Bauer, P.T. Equality, the Third World, and Economic Delusion. (London:
Weidenfeld and Nicolson, 1981). Read two chapters: ‘Western guilt and
Third World Poverty’, available at: www.valt.helsinki.fi/atk/gpe/texts/
bauer.htm and ‘Foreign Aid and Its Hydra-Headed Rationalization’.
Brett, E.A. ‘State Failure and Success in Uganda and Zimbabwe: The Logic of
Political Decay and Reconstruction in Africa’, Journal of Development Studies
44(3) 2008, pp.339–64.
6
Introduction
Coase, R.H. ‘The Nature of the Firm’, Economica (4) 1937, pp.386–405.
Faguet, J.P. and F. Sánchez ‘Decentralisation’s Effects on Educational Outcomes
in Bolivia and Colombia’, World Development (36) 2008, pp.1294–316.
Available at: http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_
id=260795
Gallup, J.L., J. Sachs, and A. Mellinger ‘Geography and Economic
Development’, International Regional Science Review (22) 1999,
pp.179–232.
Glaeser, E., R. La Porta, F. Lopez de Silanes and A. Shleifer ‘Do Institutions
Cause Growth?’, Journal of Economic Growth 9(3) 2004, pp.271–303.
Ray, D. ‘Annual World Bank Conference on Development Economics: Lessons of
Experience 2005’, American Economist (44) 2000, pp.3–16.
Semler, R. ‘Managing without managers’, Harvard Business Review 67(5)
Sep/Oct 1989, pp.76–84.
Sen, A. ‘Just Deserts’, review of Bauer’s Equality, the Third World, and Economic
Delusion, New York Review of Books, 4 March 1982.
You also need to read a number of papers or reports which are available
online:
DiJohn, J. ‘The Political Economy of Industrial Policy in Venezuela’,
unpublished manuscript, University of London, 2007. Available at: www.
cid.harvard.edu/events/papers/0604caf/DiJohn.doc
You may also be interested in the skypecast interview with DiJohn at:
http://caracaschronicles.blogspot.com/2006/07/skypecast-jonathan-
dijohn-casts-doubt.html.
Faguet, J-P. ‘Governance From Below: A Theory of Local Government With Two
Empirical Tests’, STICERD Political Economy & Public Policy Discussion
Paper No. 12, 2005. Available at: www.scholarship.org/uk/item/3gp422c9
Hardin, G. ‘The tragedy of the commons’, Science, (American Association for the
Advancement of Science) 162, 1968, 1243–48 download at: www.lrainc.
com/swtaboo/stalkers/gh_tragc.html), also Hardin’s follow-up at:
www-physics.ohio-tate.edu/~wilkins/sciandsoc/commons_extension.html
Ranis, Gustav ‘The Evolution of Development Thinking: Theory and Policy’
in Francois Bourguignon and Boris Pleskovic, (eds), Annual World Bank
Conference on Development Economics: Lessons of Experience (2005),
pp.119–40, also Growth Center Discussion Paper, No. 886, (Yale University,
2004).
Stern, N. The Economics of Climate Change: The Stern Review. (Cambridge:
Cambridge University Press, 2006). Read Executive Summary (long
version), available here: www.hm-treasury.gov.uk/independent_reviews/
stern_review_economics_climate_change/stern_review_report.cfm
World Bank. Informality: Exit and Exclusion. (Washington, DC: The World
Bank, 2007). Read overview, available at: http://siteresources.worldbank.
org/INTLAC/Resources/CH0.pdf
Further reading
Please note that as long as you read the Essential reading you are then free
to read around the subject area in any text, paper or online resource. You
will need to support your learning by reading as widely as possible and by
thinking about how these principles apply in the real world. To help you
read extensively, you have free access to the virtual learning environment
(VLE) and University of London Online Library (see below).
Other useful texts for this course include:
Acemoglu, D., S. Johnson and J.A. Robinson ‘An African Success Story:
Botswana,’ in D. Rodrik, (ed.) In Search of Prosperity: Analytical Narratives
on Economic Growth. (Princeton: Princeton University Press, 2003) [ISBN
0691092680] Chapter 4.
7
Amsden, A.H. Rise of ‘The Rest’. (New York, NY: Oxford University Press, 2003).
[ISBN 0195170598].
Bardhan, P. ‘Institutions matter, but which ones?’, Economics of Transition (13)
2005, pp.499–532.
Bardhan, P. and D. Mookherjee ‘Decentralisation in West Bengal: Origins,
Functioning and Impact’ in Bardhan, P. and D. Mookherjee
(eds) Decentralisation and Local Governance in Developing Countries:
A Comparative Perspective. (Cambridge, MA: MIT Press. 2006)
[ISBN 9780262524544] pp.203–22.
Bates, R.H. Prosperity and Violence: The Political Economy of Development.
(London: W.W. Norton, 2001) [ISBN 0393050386] Chapter 4.
Bonin, J. et al, ‘Theoretical and empirical studies of producer cooperatives’,
Journal of Economic Literature, 31(3) 1993, pp.1290–320.
Boone, P. and J. Faguet. ‘Multilateral Aid, Politics and Poverty: Past Failures
and Future Challenges’, in R. Grant and J. Nijman (eds) The Global Crisis in
Foreign Aid. (Syracuse, New York: Syracuse University Press, 1998)
[ISBN 9780815627715].
Brett, E.A. ‘Understanding institutions and organisations’ in D. Robinson et al.
Managing development: Understanding inter-organisational relationships.
(London: Sage, 1999) [ISBN 9780761964797] pp.17–48.
Cleaver, F. ‘Moral Ecological Rationality, Institutions and the Management of
Common Property Resources’, Development and Change, 31(2) 2000,
pp.361–83.
De Soto, H. The Other Path. (Perseus Books Group, 2002) [ISBN
9780465016105]. Foreword, Preface, and Conclusion pp.231–61
Diamond, J. Guns, Germs and Steel. (London: Jonathan Cape, 1997) Chapters
4, 5 and 6. [ISBN 9780224038096].
Douglas, Mary How institutions think. (New York: Syracuse University Press,
1986) [ISBN 9780815602064].
Easterly, W. The elusive quest for growth: economists’ adventures and
misadventures in the tropics. (Cambridge, MA: MIT Press, 2001 [ISBN
026205065X] Chapters 2 and 6.
Easterly, W. ‘The Political Economy of Growth without Development: A case
study of Pakistan’ in D. Rodrik (ed.) In Search of Prosperity: Analytical
Narratives on Economic Growth. (Princeton: Princeton University Press,
2003) [ISBN 0691092680] Chapter 14.
Esman, M.J. ‘State, Society and Development’ in M.J. Esman, Management
Dimensions of Development: Perspectives and Strategies. (Connecticut:
Kumarian Press, 1991) [ISBN 9780931816642] pp.5–25.
Hausmann, R., F. Rodríguez, and R. Wagner. ‘Growth Collapses’, CID Working
Paper No. 136. (2006) (www.cid.harvard.edu/cidwp/136.htm)
Hausmann, R., L. Pritchett and D. Rodrik ‘Growth Accelerations’, Journal of
Economic Growth, 10 2005, pp.303–29.
Ian, Y. ‘How Reform Worked in China.’ in D. Rodrik (ed.) In Search of
Prosperity: Analytical Narratives on Economic Growth. (Princeton: Princeton
University Press, 2003) [ISBN 0691092680] Chapter 11, pp.297–333.
Knight, J. Institutions and social conflict. (Cambridge: Cambridge University
Press, 1992) [ISBN 9780521421898] Chapters 1, 2 and 4.
Kohli, A and V. Shue ‘State power and social forces: on political contention and
accommodation in the third world’ in J. Migdal et al. State Power and social
forces: Domination and Transformation in the Third World. (Cambridge:
1994) [ISBN 9780521467346] Chapter 11.
Litvack J., J. Ahmad and R. Bird, 1998. ‘Rethinking decentralisation in
developing countries’, World Bank Sector Studies Series, 21491.
MacGaffey, J. The Real Economy of Zaire. (Oxford: James Currey, 1991)
[ISBN 9780852552131] Chapters 1 and 2.
McArthur, J. and J. Sachs ‘Institutions and Geography: Comment on AJR’ NBER
Working Paper 8114, 2000.
8
Introduction
Moe, T. ‘The Politics of Structural Choice: Toward a Theory of Public

Bureaucracy’ in O.E. Williamson (ed.) Organization Theory. (Oxford: Oxford
University Press, 1995 ed.) [ISBN 0195098307] pp.116–53.
Olson, M. ‘Dictatorship, democracy and development’ in M. Olson, and S.
Kahkonen A Not-so-Dismal Science: a Broader View of Economies and
Societies. (Oxford: Oxford University Press, 2000) [ISBN 9780198294900]
pp.119–38.
Ostrom, E. et al. ‘Decentralized institutional arrangements’ in Institutional
Incentives And Sustainable Development. (Boulder, Westview, 1993)
[ISBN 9780813316192] Chapter 8.
Ostrom, E. Governing the commons. (Cambridge: Cambridge University Press,
1990) [ISBN 9780521405997] Chapters 1, 6 and notes.
Portes, A. and R. Schauffler ‘Competing Perspectives on the Latin American
Informal Sector,’ Population and Development Review (19) 1993, pp.33–60.
Rigobon, R. and D. Rodrik ‘Rule of law, democracy, openness, and income.
Estimating the interrelationships’, Economics of Transition (13) 2005,
pp.533–64.
Rodrik, D. ‘Why Is There Multilateral Lending?’, 1995 ABCDE paper available
at www.nber.org/papers/w5160.pdf
Sokoloff, K.L. and S.L. Engerman ‘History Lessons: Institutions, factor
endowments, and paths of development in the New World’, Journal of
Economic Perspectives 14, 2000, pp.217–32.
Tarrow, S. ‘Making Social Science Work Across Space and Time: A Critical
Reflection on Robert Putnam’s Making Democracy Work’, American Political
Science Review, 90(2) 1996, pp.389–97.
Wade, R. Governing the Market: Economic Theory and the Role of Government
in East Asian Industrialization. (Princeton, NJ: Princeton University Press,
1990) [ISBN 069104242X] Chapter 11: ‘Conclusions (2): Lessons From
East Asia’.
Wade, R. Village republics: economic conditions for collective action in South
India. (Cambridge: Cambridge University Press, 1988)
[ISBN 9781558153875] Chapter 10.
Williamson, O. The economic institutions of capitalism. (New York, Free Press,
1986) [ISBN 9780029348215] Chapter 10.
Online study resources

In addition to the subject guide and the Essential reading, it is crucial that
you take advantage of the study resources that are available online for this
course, including the VLE and the Online Library.
You can access the VLE, the Online Library and your University of London
email account via the Student Portal at:
http://my.londoninternational.ac.uk
You should receive your login details in your study pack. If you have not,
or you have forgotten your login details, please email uolia.support@
london.ac.uk quoting your student number.
The VLE
The VLE, which complements this subject guide, has been designed to
enhance your learning experience, providing additional support and a
sense of community. It forms an important part of your study experience
with the University of London and you should access it regularly.
The VLE provides a range of resources for EMFSS courses:
• Self-testing activities: Doing these allows you to test your own
understanding of subject material.
• Electronic study materials: The printed materials that you receive from
9
the University of London are available to download, including updated

reading lists and references.
• Past examination papers and Examiners’ commentaries: These provide
advice on how each examination question might best be answered.
• A student discussion forum: This is an open space for you to discuss
interests and experiences, seek support from your peers, work
collaboratively to solve problems and discuss subject material.
• Videos: There are recorded academic introductions to the subject,
interviews and debates and, for some courses, audio-visual tutorials
and conclusions.
• Recorded lectures: For some courses, where appropriate, the sessions
from previous years’ Study Weekends have been recorded and made
available.
• Study skills: Expert advice on preparing for examinations and
developing your digital literacy skills.
• Feedback forms.
Some of these resources are available for certain courses only, but we
are expanding our provision all the time and you should check the VLE
regularly for updates.
Making use of the Online Library

The Online Library contains a huge array of journal articles and other
resources to help you read widely and extensively.
To access the majority of resources via the Online Library you will either
need to use your University of London Student Portal login details, or you
will be required to register and use an Athens login:
http://tinyurl.com/ollathens
The easiest way to locate relevant content and journal articles in the
Online Library is to use the Summon search engine.
If you are having trouble finding an article listed in a reading list, try
removing any punctuation from the title, such as single quotation marks,
question marks and colons.
For further advice, please see the online help pages:
www.external.shl.lon.ac.uk/summon/about.php
Journals
There are a number of journals which will form the basis to lists of
suggested readings and which provide useful up-to-date materials.
They are:
American Economic Review
American Political Science Review
Development and Change
Economics of Transition
Journal of Development Economics
Journal of Development Studies
Journal of Economic Growth
Journal of Economic Perspectives
Journal of Public Economics
Public Administration and Development
World Development
10
Introduction
Other resources
Unless otherwise stated, all websites in this subject guide were accessed in
May 2008. We cannot guarantee, however, that they will stay current and
you may need to perform an internet search to find the relevant pages.
Angus Maddison’s database: www.ggdc.net/Maddison/
Centre for Global Development (CGD): www.cgdev.org/
Conference Board and Groningen Growth and Development Centre, Total
Economy Database, November 2007: www.conference-board.org/
economics/database.cfm
Development Studies Institute (DESTIN, LSE): www.lse.ac.uk/collections/
DESTIN/
Initiative for Policy Dialogue (IPD): www.gsb.columbia.edu/ipd/
PNUD República Dominicana: portal.onu.org.do/interfaz/main.asp?Ag=2
Roubini Global Economics Monitor: www.rgemonitor.com/
Suntory and Toyota International Centres for Economics and Related
Disciplines (STICERD, LSE): sticerd.lse.ac.uk/
UK Department for International Development (DFID): www.dfid.gov.uk/
UNDP: www.undp.org
World Bank: www.worldbank.org/
Examination structure
Important: the information and advice given in the following section
is based on the examination structure used at the time this guide
was written. Please note that subject guides may be used for several
years. Because of this we strongly advise you to check both the current
Regulations for relevant information about the examination, and the VLE
where you should be advised of any forthcoming changes. You should also
carefully check the rubric/instructions on the paper you actually sit and
follow those instructions.
Remember, it is important to check the VLE for:
• up-to-date information on examination and assessment arrangements
for this course
• where available, past examination papers and Examiners’
commentaries for the course which give advice on how each question
might best be answered.
The examination paper for this course is three hours in duration and you
are expected to answer three questions, from a choice of 10. The Examiner
attempts to ensure that all the topics covered in the syllabus and subject
guide are examined. Some questions could cover more than one topic from
the syllabus since the different topics are not self-contained. A sample
examination paper appears as an appendix to this guide, along with
guidance on answering the sample examination paper.
The Examiners’ commentaries, which are available on the VLE, contain
valuable information about how to approach the examination, so you
are strongly advised to read them carefully. Past examination papers and
the associated commentaries are valuable resources in preparing for the
examination.
11
Examination advice
When approaching an examination for this type of subject, the most
important thing to remember is that even if you know and fully
understand the material, you must clearly convey this to the examiner
in order to do well. You need to be able to show that you have covered
the syllabus and read widely, and that you can go beyond repeating the
arguments you have read to construct your own.
Good practical advice for achieving this includes: write legibly and
express yourself clearly. No matter how brilliant your answer may
be, it is of no use if the examiner cannot read it. You should begin each
examination by reading all the questions on the examination paper, and
deciding which ones you will answer. Read each question carefully, and get
a good sense of what the question is specifically asking for. Once you have
decided which questions you will answer, write an outline of each answer
before you begin the essay proper. A good rule of thumb for a three-hour
examination is to spend 10–15 minutes on each outline, and 45 minutes
writing each essay.
Think of your answers in terms of building an argument. Each answer
should begin with definitions and first assumptions, and then build up
an argument logically to conclusions that directly answer the question
posed. Your answers should synthesise the ideas developed in the
subject, and will often include evidence. ‘Evidence’ refers to examples,
case studies, or statistical information gleaned from subject readings, or
from other sources that you know about. Do not worry too much about
bibliographical references in your answers. When dealing with major ideas
or contributions from subject readings, it may be useful to cite relevant
author(s). But you are not expected to know precise dates, and you are
not expected to cite references for all the ideas you use in your essays. For
example, when referring to ‘the invisible hand of the market’, you could
reference ‘(Adam Smith)’ or just ‘(Smith)’.
Examination questions will require you to synthesise material across
several chapters in order to provide complete answers. But in many cases,
different combinations of material from different chapters can provide
answers that are equally good and complete. For the most part, it will not
be the case that a specific example question refers to a specific chapter.
Remember, it is important to check the VLE for:
• up-to-date information on examination and assessment arrangements
for this course
• where available, past examination papers and Examiners’
commentaries for the course which give advice on how each question
might best be answered.
List of abbreviations used in this subject guide

CSO Civil Society Organisation
GDP Gross Domestic Product
LSE The London School of Economics and Political Science
NGO Non-Governmental Organisation
12
13
Notes
14
Chapter 1: Institutions, organisations and development management
Chapter 1: Institutions, organisations

and development management
Aim of the chapter

The aim of this chapter is to introduce you to institutions and
organisations as theoretical concepts, and outline the overarching
argument of this course: the problem of development implies a move
from less effective to more effective institutions and organisations.
The challenge of development management is to serve as a catalyst for
institutional transformations of this nature.
Learning outcomes
By the end of this chapter and having completed the essential readings
and activities, you should be able to:
• explain what institutions are, and give examples
• explain what organisations are, and give examples
• identify the main ways in which institutional and organisational change
comes about
• discuss how institutional change can drive the development process.
Essential reading
Brett, E.A. Reconstructing development theory. (Basingstoke: Palgrave-
Macmillan, 2009) Chapter 1.
North, D. Institutions, Institutional Change and Economic Performance.
(Cambridge: Cambridge University Press, 1990) Chapter 1.
World Bank, Equity and development. World Development Report 2006,
Washington: World Bank, 2006. Chapter 6. ‘Equity, institutions and the
development process.’
Further reading
Brett, E.A. ‘Understanding institutions and organisations’ in D. Robinson et al.
Managing development: Understanding inter-organisational relationships.
(London: Sage, 1999) [ISBN 9780761964797] pp.17–48.
Douglas, Mary How institutions think. (New York: Syracuse University Press,
1986) [ISBN 9780815602064].
Esman, M.J. ‘State, Society and Development’ in M.J. Esman Management
Dimensions of Development: Perspectives and Strategies. (Connecticut:
Kumarian Press, 1991) [ISBN 9780931816642] pp.5–25.
Knight, J. Institutions and social conflict. (Cambridge: Cambridge University
Press, 1992) [ISBN 9780521421898] Chapters 1, 2 and 4.
Works cited
Sen. A. Development As Freedom. (Oxford: Oxford University Press, 1999).
15
Introduction
Why are some countries rich and others poor? Why are the citizens of
some countries more free to realise their potential than others? Why are
some organisations more efficient and effective at what they do than
others? This subject develops a political economy approach to examining
the institutional roots of developmental and anti-developmental processes.
We begin with the basic theoretical tools of institutions and organisations,
and analyse the implications of different organisational forms. We examine
coordination in the increasingly complex, multilayered systems that
characterise the most advanced countries. And we explore whether this
complex interdependence is merely a correlate of development, or a cause,
or both.
Activity 1.1
Consider Germany and Spain and Ghana and Sri Lanka. Why are the citizens of Germany
and Spain richer and more free than those of Ghana and Sri Lanka? Is it because the
former are more intelligent? Because they work harder? Because they are morally more
just?
Write down what you think are the three most plausible causes of the different levels of
development that these countries exhibit.
Consider the development transitions of the United Kingdom, the United

States, Germany, the Netherlands, and Korea. Economic historians
commonly estimate that the UK’s industrialisation process took about
150 years. The Industrial Revolution began in the UK, and so it is
understandable that many mistakes, dead ends, and simple bad luck
contributed to a longer process in the country that essentially invented
industrialisation. The next country to follow, the US, learned from the
UK’s many examples of both success and failure, and so was able to
complete the transition in about half that time – some 80 years. Using
very round numbers, Germany, the Netherlands, and other northern
European economies took between 50 and 80 years to industrialise. The
country that holds the world record for transition from a low productivity,
largely agricultural economy, to a fully industrialised, sophisticated, high-
technology, high-productivity economy, with high levels of fixed capital
and a highly trained labour force, is South Korea. The Korean transition is
commonly thought to have taken about 30 years, although some scholars
put the number below 20 years. In the context of economic history, this
is a miracle. The developmental processes put into place by South Korea
from the 1960s onwards transformed its economy and society out of all
recognition. They lifted an entire nation out of poverty and deprivation,
and put South Koreans on the path to prosperity and freedom.
The goal of development management is to generate such miracles,
not in isolated cases, but across the developing world. Our approach to
development is premised on the notion that institutions are crucial to
explaining not only development success but also development failure.
Institutions are meta-phenomena; they are deeply set, and they have
powerful effects on human incentives and hence human behaviour. But
they are also susceptible to human action. Institutions can be changed.
Learning to do so in the interest of accelerating development is the goal of
development management.
Before continuing, it is important to establish what this subject is not.
This is not a subject which teaches students hands-on, practical tools
that they are likely to use immediately upon completion, in their work as
16
development professionals. This subject will not teach students how to

draw up logical frameworks, calculate an internal rate of return, estimate
project timelines, or budget project costs, to name just a few. It does
not familiarise students with software packages that they are likely to
use in the professional world, nor does it make much effort to acquaint
students with practical jargon, acronyms, and other professional minutia
of the development field. A number of courses at other universities do
these things, and some of those are available through external study.
Such practical, vocational training has a useful place in the educational
spectrum.
Many people consider development management to be mainly
about administering aid projects. They assume that the study of
development management should primarily train students to work in
NGOs or multilateral agencies. Such views are rooted in a common
misunderstanding that countries develop as the direct result of
international donor and NGO activities, and hence that by better
administering the aid projects of such organisations, societies can become
richer and more free. Such a view is rooted in a myth of charity which
holds that people become more developed through the efforts and
resources of others. This is not a view that we espouse in this subject
guide, for reasons that are developed in the chapters that follow.
Before moving deeper into development management, we must first define
‘development’. There are a number of definitions, with some of which you
are no doubt familiar. For many, development is more or less synonymous
with GDP per capita. For others, development implies industrialisation,
especially the growth of manufacturing and heavy industries. Still others
use the word development to refer to individual freedoms, and extensive
civil and political liberties. Arguments over the definition of development
are often rich and interesting. But it is important to realise that, strictly
speaking, they cannot be resolved. The meaning of the word ‘development’
is essentially a value judgment, and thus something about which well-
informed people can legitimately differ.
In this subject, we will by-and-large adopt the definition of Amartya
Sen, who defines development as that which increases human freedom.
Freedom to do what? In Sen’s formulation, the object of freedom is to
maximise individual potential. Hence, increasing income is developmental
because greater resources provide the means for an individual to reach
her human potential. More wealth can make you more free. But freedom
has many other dimensions as well, which are only indirectly related
to income and wealth: spiritual and religious freedom, for example;
freedom of speech; human security; freedom of association; and many
others. Income often serves as a convenient shorthand for measuring
development, as it is an input for many of the things that help people to
realise their potential: food, shelter, education, etc. Hence income (and
wealth) can serve as a proxy for development. But it is important to note
that income and development are not substantively the same.
Institutions and organisations

Institutions
The concept of institutions is at the centre of this subject, and hence it
is important that we understand what is meant by the term ‘institution’
before continuing. The academic literature on institutions is deep and
17
rich, covering sociology, economics, political science, and anthropology,

amongst other things. We draw on all of these traditions in this subject,
but root ourselves most strongly in the political economy tradition,
especially the New Institutional Economics. The New Institutional
Economics is, according to Clague (1997a):
…a kind of “expanded economics”. Like standard economics, it

focuses on the choices people make in their lives. But it enriches
the simple rational choice model by allowing for the pervasiveness
of information problems and human limitations on processing
information, the evolution of norms, and the willingness of people
to form bonds of trust. The NIE seeks to explain not only individuals’
choices with a given set of institutions but, more important, the
way that individuals’ beliefs and choices affect the evolution of the
institutions themselves.1 1
p.16.
We follow Clague (1997a) and Olson and Kahkonen (2000) in construing

the NIE broadly to include the economics of transaction costs, institutional
innovation and efficiency, property rights, collective action, and the
evolution of cooperation and norms.2 Note that some of the foremost 2
See Clague (1997) pp.17–23 for
exponents of some of these subjects might well disagree with so broad a a discussion of these
definition (see North (1990) and Williamson (1995a)). Our purpose here components. Good alternative
is not to give a comprehensive account of the NIE, but rather to highlight definitions include Bardhan
useful concepts in a framework which can be employed to analyse local (2000), Moe (1995), Williamson
government. (1995a), and Williamson (2000).
According to Williamson (1995a), the NIE insists on realistic, commonly

verifiable instead of analytically convenient, behavioral assumptions:
(i) opportunism, and (ii) bounded rationality. Opportunism does
not assume that all people are always dishonest, but rather that ‘some
individuals are opportunistic some of the time and that it is costly to
ascertain differential trustworthiness ex ante.’3 Opportunism thus prompts 3
p.190.
agents to seek credible commitments before executing transactions. The
concept of bounded rationality was proposed by Simon (1957) as
behaviour that is ‘intendedly rational, but only limitedly so’.4 It arises 4
Simon (1957) in Williamson
because people are limited in the information they possess and in the (1995a), p.178.
computational skills they bring to bear in making choices. ‘The capacity
of the human mind for formulating and solving complex problems is very
small compared with the size of the problems whose solution is required
for objectively rational behavior in the real world.’5 Bounded rationality 5
Ibid., p.179.
makes the mind itself a scarce resource.
Closely related to bounded rationality is what Douglass North (1990) calls
imperfect subjective mental models. This relates to the implicit
behavioural assumption of the rational choice and neoclassical economics
schools that:
actors possess cognitive systems that provide true models of

the worlds about which they make choices or, at the very least,
that the actors receive information that leads to convergence of
divergent initial models. This is patently wrong for most of the
interesting problems with which we are concerned. Individuals
make choices based on subjectively derived models that diverge
among individuals and the information the actors receive is so
incomplete that in most cases these divergent subjective models
show no tendency to converge.6 6
p.17.
Imperfect mental models interact with and reinforce the bounded nature
of human rationality to create significant obstacles to efficiency in
transactions.
18
Bounded rationality and imperfect mental models, combined with

uncertainty, imply that ‘all complex contracts are unavoidably incomplete’.7 7
Williamson (1995a), p.179.
Modern complex contracts are both multidimensional and extend over
time. Agents’ limited mental abilities imply that parties to a contract will
be unable to specify all possible future contingencies. Parties will thus
deliberately leave possible unknowns unspecified, rendering contracts
incomplete. Instead they delegate the resolution of disputes which may
arise to some third party, which accounts for the rise of certain institutions,
to which we turn presently.
A fifth idea central to the NIE is costly transactions, pioneered among
others by Coase (1937). North expands on this theme:
The costliness of information is the key to the costs of

transacting, which consists of the costs of measuring the
valuable attributes of what is being exchanged and the costs of
protecting rights and policing and enforcing agreements. […]
Commodities, services, and the performance of agents have
numerous attributes and their levels vary from one specimen or
agent to another.8 8
North (1990), p.27−29.
Ascertaining the level of these attributes, protecting rights, and policing

and enforcing agreements makes transactions costly.
With these tools in hand, we can now turn to the structural characteristics
of society. Consider first institutions and organisations.
Activity 1.2
Define ‘institution’. Write down your definition.
Write down five examples of institutions that you know of.
What is an institution? North (1990) defines institutions pithily as the

‘rules of the game’. He uses a football analogy, where the game of football
is the institution (i.e. the rules of football), and teams of players are
the organisations that compete within this institutional context. These
definitions are compelling, and you should keep them in mind. In this
subject guide we use a different definition, which is quite similar in spirit,
but slightly more comprehensive. Institutions are systems of rights and
obligations in the form of recognised, formal or informal, but enforceable
rules that enable individuals to cooperate to achieve common purposes by
creating regularised role relationships. Examples of institutions are: the US
Constitution, the global market economy, Islam, football, marriage, and
the Mafia.
Organisations
Activity 1.3
Define ‘organisation’. Write down your definition.
Write down five examples of organisations with which you are familiar.
Organisations are the teams of people operating within the rules set by
institutions to achieve particular goals. They are agencies that facilitate
cooperation among individuals in the name of these goals, on the basis
of rules, authority, and incentives. Examples of organisations are: the
Democratic Party, Toyota Motor Corporation, a mosque, Manchester
United (a football team), and a gang.
Institutions and organisations involve implicit contracts between agencies
and recipients, in which the former supply services in exchange for
19
appropriate awards. The terms on which these are supplied (the balance
of powers between service provider and recipients) determine the political
social and economic impact of any system of institutional arrangements.
Institutions can be more or less formal, conscious and visible.
Formalisation tends to increase with development. Institutional contexts
may change significantly over time, but formal and informal, new and old,
institutions will continue to exist.
Activity 1.4
Your answers to the previous two learning activities were your ‘naïve views’. Now that
you are properly equipped, repeat both exercises. Write down your answers. These are
your theoretically informed views. Remember them.
Complexity
There is no clear, linear progression from nation to institutions to
organisations. Institutions and organisations overlap to an extent that
North’s football analogy somewhat obscures. If institutions are the ‘rules
of the game’, and organisations are the ‘teams’ that operate within those
rules, then it is important to note that most ‘teams’ that we can think of
operate and are significantly affected by different coherent sets of rules,
and hence different institutions. For example a family – a particular kind
of organisational unit – will operate under the institutions of marriage, the
constitution, property rights, the market, etc. The same is true of a firm or
NGO.
Furthermore, within any category, or sector, organisations engaged in
substantively similar activities may have very different structures and
levels of efficiency and effectiveness. The garment manufacturing sector,
for example, is populated by a large number of firms. Some of these are
huge, multinational concerns, and others are small and highly local.
Some invest heavily in research and product development and are capital
intensive, while others mainly copy external designs and are labour-
intensive. Hence institutional systems are characterised by complexity.
Why they matter: incentives

Institutions and organisations are important because they generate
incentives that govern human behaviour. But what are ‘incentives’?
Incentives are rewards and punishments that accrue to individuals (or
groups of people) due to certain actions or behaviours. A salary is an
incentive, as is the possibility of promotion, or of gaining the favour of
a superior. These are all positive incentives. Negative incentives include
fines, the possibility of losing one’s job, loss of reputation, and physical
punishment, amongst others.
Different institutions create different incentives. This, in turn, means that
variations in institutions and organisations are not arbitrary, and their
significance goes well beyond ‘local colour’. The particular institutions and
organisations that society is endowed with critically affect the incentives
that permeate that society, and hence what sorts of activity are promoted
or encouraged. The way organisations are structured, and the way they
operate, directly affect how well they achieve their organisational goals,
and with what levels of efficiency.
Activity 1.5
Consider two identical twins separated at birth. Both have grown up to become inventors.
One lives in a country with a private market economy populated by firms and individual
20
agents. The other lives in a country with a collectivised, socialist economy composed
entirely of cooperatives.
Which twin has stronger incentives to invent and innovate? To engage in research and
development activities? To pursue ideas? To be curious?
Keep in mind that the question is not which twin will invent more in any given period, but
rather which faces stronger external (i.e. to herself) incentives to invent.
For example, in the 1950s and 60s rocket scientists in the United States
and Soviet Union faced similarly strong incentives to develop more and
more powerful rocket engines, and to do so quickly. But although they
had similar effects, these incentives took very different shapes in the
two countries, and were embedded in radically different organisational
structures and institutional contexts. The Soviet space programme
operated as a silo, physically and institutionally disconnected from the
rest of the economy. By contrast, the American space programme was
deeply connected with its leading universities, and with private sector
aerospace firms. As a result, the brilliant technical advances of the Soviet
space programme remained mostly isolated from the rest of the economy,
which in fact was starved of resources and expertise for the sake of the
space effort. The American space programme, by contrast, benefited from
the dynamic efficiencies generated elsewhere in the economy. As a result,
more scientific and engineering know-how filtered back into private sector
aerospace and manufacturing firms.
Organisational and institutional change

Organisations change over time. They change because they learn to
execute core functions more efficiently, or with greater precision or
quality, because they invent new technologies of production, they develop
new products or services, or they learn to organise themselves better.
Hence automobile manufacturers may learn to build cars with fewer
raw materials or fewer workers, they may learn to build cars with fewer
defects, they may develop machines which save materials or labour in
the production process, they may invent a new kind of engine that gives
their cars a competitive advantage, or they may reorganise their supply
chains or distribution networks in ways that save money. Alternatively,
organisations and organisational performance can deteriorate in any or all
of these ways as well.
Likewise, institutions become more (or less) efficient and effective as the
rules that comprise them are modified or replaced in ways that promote
greater (or less) human productivity and freedom. Increasing levels of
public education in the West, for example, were often portrayed at the
time as a question of human rights, or a moral imperative. But a more
educated population also increased levels of human capital in the labour
force, boosting productivity, innovation, and facilitating the development
of a more sophisticated, higher value-added economy. Such institutional
changes are often prodded by changes in the organisations that
operate under institutions, or broader social or cultural changes, whose
proponents gain sufficient political power to ‘institute’ changes beneficial
to themselves. Hence the extension of civic and political rights down
the social ladder in late medieval Europe was at least partly prompted
by outbreaks of plague, which decimated the population, increasing the
value of rural and urban labour. Amongst the peasant masses, those who
survived found themselves in a much better bargaining position, and so
able to extract concessions from landowners, lords, princes and priests.
21
Conclusion: the meaning of development management

Development management is about actively fomenting institutional
and organisational changes that increase human freedom and wealth,
and hence the level of development. It is the opposite of a laissez-faire
approach, which waits for change to happen autonomously, with no
attempt at coordination or catalysis. It is, instead, the deliberate, conscious
and informed attempt to move institutions and organisations towards
higher levels of efficiency and effectiveness in a way which is faster than
their autonomous rate of progressive change, and – to the extent that this
is possible – more coordinated.
How do we know what sorts of institutions development managers should
work towards? Five criteria are commonly used to differentiate better from
worse institutions:
1. Efficiency and growth. Better institutions are more complex, larger
scale, cost minimising, and tend to increase growth. Efficiency stems
from institutions that maximise rational planning and the role of
science by encouraging free experimentation and merit-based selection,
and eliminating inherited monopoly power.
2. Autonomy and freedom. Better institutions allow people the ‘freedom
to choose’ by basing control over resources on competition and free
discussion, rather than a monopoly on physical or moral coercion. This
requires institutions that create formal equality of access (democratic
states, free-market economies, gender equality, religious and ethnic
tolerance), rather than those based on dictatorship, command
planning, patriarchy, or ethnic or religious discrimination.
3. Diversity and pluralism. Better institutional systems use different kinds
of agency to provide political, economic, or social services, and to meet
the needs of people with different cultural dispositions and different
levels of skill and social capital. This increases complexity and choice.
4. Equity and justice. Better institutions create equality of opportunity,
ensure that rewards are directly tied to performance, and minimise
exclusion and insecurity. Development requires systems that create
incentives that tie rewards to performance, and use accountability
mechanisms that enable recipients to exercise effective leverage over
those who provide them with their services.
5. Connectedness and voluntary cooperation. Better institutions increase
the range of autonomous interdependence, and therefore our capacity
to cooperate freely with each other. This requires systems that are
based on reciprocity and interdependence. No one should be able
to use their personal power to exploit anyone else – to extract resources
from them without providing an adequate return.
We know that progressive institutional transformation can be done,
because it has been done in a number of countries. More often it has
failed. But where it has succeeded, good development management has
transformed people’s lives, and lifted entire nations out of poverty in
as little as one lifetime. The difficulties development managers face are
enormous, and the risk of failure is high. But the benefits to society of
success are even greater, and all the more worth the risk because the
alternatives are not good.
22
A reminder of your learning outcomes

Having completed this chapter, as well as the essential reading and
activities, you should be able to:
• explain what institutions are, and give examples
• explain what organisations are, and give examples
• identify the main ways in which institutional and organisational change
comes about
• discuss how institutional change can drive the development process.
Sample examination questions

1. Define ‘institution’. Define ‘organisation’. Why does each matter for
development?
2. Why are some institutions better than others?
3. Provide an example of an institution that you consider dysfunctional.
Explain its dysfunctionality in terms of the incentives it creates, and the
outcomes these lead to.
23
Notes
24
Part 2: Governance
Part 2: Governance
25
Notes
26
Chapter 2: Political accountability and public action
Chapter 2: Political accountability and

public action
Introduction and aims of the chapter

The first chapter in this module on governance is about political
accountability, and the extent to which it exists or not in a democracy. In
modern times we have grown used to thinking reflexively that democracy
implies ‘government of the people, by the people, and for the people’.
But at the same time, we have grown used to thinking that politicians
are corrupt, governments inefficient, and public services inflexible and
unresponsive. The difference between these plainly contradictory beliefs
is in part the difference of theory versus practice – the difference between
what democracy should be, and its real-world realisation in far too many
countries.
But part of the problem is an uncritical, undifferentiated view of what
democracy is, and how it works, that is generally held by the majority
of citizens in many, if not most democracies. We accept that democracy
is ‘good’, but do not question why it is good, what are the necessary
preconditions for it to function in a way leading to good outcomes, nor the
distortions, inefficiencies, and even oppressions that can result when these
preconditions are not met.
This chapter examines democracy from first principles, asking under
what conditions and to what extent it can make government accountable
to the governed. We begin with the single most important characteristic
of democracy, voting, examine what it can and cannot do, and then
move on to a broader view of democracy that sets voting, campaigning,
and political competition in a broader social and economic context.
We motivate the latter part of this exploration with specific empirical
examples from Latin America.
Learning outcomes
By the end of this chapter and having completed the essential reading and
• define ‘accountability’
• explain the roles of information and accountability in making
governments responsive to citizens
• explain the role of voting in revealing and transmitting information to
politicians
• summarise how voting interacts with other aspects of democratic
government, such as lobbying, campaigning, and the activities of civic
organisations
• analyse the strengths and limitations of democracy for providing
government that is accountable to its citizens.
Essential reading
Brett, E.A. Reconstructing Development Theory. (Basingstoke: Palgrave-
Macmillan, 2009) Chapter 5.
Faguet, J-P. ‘Governance From Below: A Theory of Local Government With
27
Two Empirical Tests’ STICERD Political Economy & Public Policy Discussion
Paper No. 12, (2005). http://eprints.lse.ac.uk/475/1/WPt2-05.pdf
Further reading
Kohli, A and V. Shue, ‘State power and social forces: on political contention
and accommodation in the third world’, in J. Migdal, et al. (eds) State
Power and Social Forces: Domination and Transformation in the Third World.
(Cambridge, 1994) [ISBN 9780521467346] Chapter 11.
Moe, T. ‘The Politics of Structural Choice: Toward a Theory of Public
Bureaucracy’ in O.E. Williamson Organization Theory. (Oxford: Oxford
University Press, 1995 ed.) [ISBN 0195098307] pp.116–53.
Olson, M. ‘Dictatorship, democracy and development’ in Olson, M. and S
Kahkonen A Not-so-Dismal Science: a Broader View of Economies and
Societies. (Oxford: Oxford University Press, 2000) [ISBN 9780198294900]
pp.119–38.
Works cited
Besley, T. and S. Coate ‘An Economic Model of Representative Democracy’
(1995), CARESS Working Paper #95-02 available at www.econ.upenn.edu/
Centers/CARESS/CARESSpdf/95-02.pdf
Downs, A. (1957) An Economic Theory of Democracy. (New York: Harper and
Row, 1957) [ISBN 0060417501].
Faguet, Jean-Paul ‘Designing Effective Social Funds For a Decentralized
Context’, World Bank Social Protection Discussion Paper (Washington DC:
The World Bank, 2002).
Mueller, Dennis C. Public choice III (Cambridge: Cambridge University Press,
2003) third edition [ISBN 0521815460].
Democracy and voting

Does voting make governments act in the interests of the governed? It
is self-evident that two conditions must be met for government to be
responsive to society:
1. Information. A mechanism exists by which citizens’ policy
preferences are revealed to government officials. This typically occurs
either through the selection of politicians with majority-preferred
platforms, or the communication of the majority’s preferences to
elected officials.
2. Accountability. A mechanism exists by which elected officials are
held responsible to voters for acting upon this information. By placing
power over officials in the hands of voters, the former are given
incentives to act in the interests of the latter.
Activity 2.1
What is accountability? Why would we say that person A is accountable to person B? In
what sense does he give her account? Of what? Write down your answers.
What is this ‘accountability’? The Oxford English Dictionary defines the

term as:
Being bound to give account, to explain.
My old Random House College Dictionary defines the term as:
Subject to the obligation to report, explain, or justify some thing;
responsible; answerable.
If we think in pure abstract terms, accountability must involve a minimum
of two people (although it can involve many more). Person A will be
28
accountable to person B if he must answer to B for his actions. This gives B

significant influence over the actions of A. Where accountability is complete, B
can make A do what she wants. In a similar sense, we say that government is
accountable to voters when it does what they want it to do.
Let us begin with the first of the two conditions. Do elections reveal
information about voters’ preferences? Do they transmit such information to
elected politicians? If so, how do these processes work?
Two of the earliest technical approaches to these questions were Hotelling
(1929) and Black (1948). Their contributions showed that majority voting can
bring about an equilibrium in single-dimensional space given single-peaked
preferences.
Activity 2.2
What does the term ‘dimension’ mean in geometry? What might it mean in a political
economy context?
What is the political economy meaning of the term ‘dimension’?
Dimension: A domain within which quantities are comparable (e.g. voters’ preferences for
education spending, or for health spending; not for education+health spending).
A good illustration of their insight is known as the ‘Hotelling beach game’.

The motivating story is as follows: imagine a beach that is naturally bounded
at either end, beyond which sunbathers cannot go. Imagine also that the
beach has no width, making it a one-dimensional beach. Assume sunbathers
are equally distributed along the length of the beach. A refreshments vendor
encounters such a beach – the question is, where on the beach will she choose
to locate?
The Hotelling beach game can be depicted graphically as in the figures below,
where the black circles are the natural endpoints, the horizontal line is the
beach, and the small vertical lines are players. Hotelling points out that the
vendor’s problem is: which position on the beach will maximise her market
share, in the sense of attracting the most customers? It is easy to see that for a
single vendor, the solution is in the middle of the beach (Figure 2.1). For this
first case, the vendor competes not with other vendors, but with the implied
transaction costs borne by customers of traversing the beach some distance
to the vendor’s position. The further away the vendor is from a particular
customer, the lower are the chances that he will get up off the beach and walk
to the vendor to purchase a drink. Hence when there is only one vendor on
the beach, she will locate at the midpoint, because this minimises the distance
that the average customer will have to walk to her stall. This is a stable
equilibrium in the sense that the vendor has no incentive to defect, meaning
no incentive to change her position.
Figure 2.1: The Hotelling beach game with one player

Now analyse the game for two vendors. Assume, further, that the vendors
and their wares are identical in every way, such that customers will not prefer
one to the other for any reason other than how far they have to walk to their
stalls. Where will the two vendors locate on the beach? Many students are
tempted to say about one-third and two-thirds of the length of the beach, as in
Figure 2.2(i) below. But this is wrong. To understand why, consider the initial
29
payoffs and accompanying incentives faced by each vendor, if the two begin
the game at those locations. At the outset, the leftmost player will capture all
the sunbathers to his left, and half the sunbathers between him and the other
vendor. The rightmost vendor will capture all the sunbathers to her right, and,
likewise, half the sunbathers between her and the other vendor. The halfway
point is marked with a dotted line in the figure below. But the leftmost player
can increase his market share by moving to the right. This is because he will
not lose any sunbathers to the left of him, and can steal away some of the
other vendor’s market by moving closer to her. But the rightmost vendor faces
equal and symmetric incentives, hence the two vendors will converge at the
midpoint (see Figure 2.2(ii) below). Neither has any incentive to deviate from
the midpoint, because neither can increase her market share by moving to
any other location. The fact that neither player has any incentive to deviate is
what makes this a stable equilibrium. It is possible, however, that one of the
vendors is more intelligent than the other, and locates at the midpoint from
the start, while the other locates elsewhere on the line. In this case, a process
of trial and error will reveal to the less intelligent vendor his mistake, and he,
and if necessary the other vendor also, will adjust their positions over time
until both once again converge at the centre.
Figure 2.2: The Hotelling beach game with two players
Now consider the Hotelling beach game with three players. Does this game
have a solution? For any initial distribution of vendors along the beach, the
players will tend to converge on the midpoint, as in Figure 2.3 below, for the
same sorts of reasons analyzed above. But once all three players have reached
the middle of the beach, they will not be able to find a stable equilibrium.
This is because the player that ends up in the middle loses his entire market
share to the two outer players. Hence he will relocate to a position just to
the left or the right of one of the two players surrounding him. But this will
leave another player stuck in the middle, who will then behave likewise. In an
abstract game such as this, with no relocation costs, this sort of competitive
churning will go on forever, until the end of time, and no stable solution will
ever be found. Any stable solution for the three player game would entail one
of the players accepting zero market share, which none of the three will do.
Figure 2.3: The hotelling beach game with three players
30
Lest you think there are no solutions for more than two players, consider
the six-player game depicted below. This game has a solution that is
unambiguous and stable at the positions depicted in Figure 2.4 below.
At these positions, the outermost players will capture the entire market
between them and the endpoints, and the four interior players will split
the remaining market between them, where each interior player catches
the line segment between himself and the nearest dotted line (which are,
again, the midpoints of the two interior line segments). This solution is
somewhat counterintuitive, but is stable.
Activity 2.3
Convince yourself that Figure 2.4 is indeed the solution to the six-player hotelling game,
and then work out solutions for four and five players. Do solutions exist for these cases?
Are your proposed solutions stable equilibria?
Figure 2.4: The Hotelling beach game with six players

The Hotelling beach model has been applied frequently to the analysis
of party positions in political ‘space’, where the beach becomes an
ideological continuum varying between left-wing and right-wing positions.
In particular, the two and three player games have been used to explain
why third parties, and third-party candidates, fare so badly in countries
like the US and UK, with entrenched two-party systems. There is no
ideological space for a third party to occupy such a system, the Hotelling
model implies. When a third party forms in such a system, the existing two
parties will manoeuvre to take away its market share, in this case potential
voters, by relocating so as to surround it on both sides. Such dynamics
also explain why two-party systems always battle for the political centre.
Neither the left nor the right-leaning political party will actually locate
on the left or right of the ideological spectrum. Both will locate firmly
in the middle, because the middle ground is where elections are won.
Only in political systems with more than three parties do you find parties
with reliably left wing ideologies and left-wing platforms, or right-wing
ideologies and platforms.
It is impressive that such a simple, parsimonious model can shed light on
such complex real-world phenomena as the number of parties that survive
in different political systems, and the ideological positions they take up.
But does Hotelling’s model shed light on our two conditions for responsive
government above? Unfortunately, both uni-dimensionality and ‘single
peaked-ness’, key assumptions of the Hotelling model, are implausible
if votes are to transmit useful information to politicians. With respect to
voting, uni-dimensionality implies that voters can only care about a single
domain of their lives, such as education, transport, or defence. But they
may not care about any of the three domains, let alone more. Given that
voters do care about more than a single domain, and then elections must
transmit information across a number of domains if they are to make
politicians accountable to voters, uni-dimensionality is simply unrealistic.
And given multi-dimensional tastes, single peaked preferences are
implausible, for reasons that we will not go into detail about here.
31
More recent scholars, including notably Downs (1957), and Besley and
Coate (1995), have devised a variety of models of voting. But voting
equilibria are problematic for deep reasons first recognised over two
centuries ago by the Marquis de Condorcet – the possibility that voting
in multi-dimensional space will lead to cycling. To understand the logic
behind this, consider the following experiment. After a long night of
revelry, three Development Management students crave ice cream. They
find themselves in the last ice-cream selling venue still open in London,
and with only enough money between them for one tub of ice cream.
The vendor offers them Chocolate (C), Strawberry (S) or Vanilla (V).
The students are named 1, 2, and 3. They vote for which flavour to buy.
Figure 2.5 depicts the order of their individual preferences over the three
flavours:
1 2 3
C C V
S S C
V V S
Figure 2.5: Three students’ ice-cream preferences
Activity 2.4
Is there a stable equilibrium in this situation? Carry out the voting experiment for this
situation. What would the vote count be for each flavour?
There is a stable equilibrium in this situation, and a simple vote reveals

that chocolate is preferred to vanilla by a majority of two votes to one.
Now assume the students’ preferences are instead as in Figure 2.6:
1 2 3
C S V
S V C
V C S
Figure 2.6: Condorcet cycling
Is there a stable equilibrium with preferences that look like this?
Activity 2.5
Repeat the vote counting exerise for Figure 2.6 above. Which flavour do the students
choose?
There is no stable equilibrium for this situation. None of the three flavours
is preferred by a majority, and no stable equilibrium will form around any
particular flavour. To understand why, imagine a hypothetical election.
The shopkeeper calls out ‘chocolate’, and student 1 raises her hand. Then
the shopkeeper calls out ‘strawberry’, and student 2 raises his hand. When
the shopkeeper calls out ‘vanilla’, student 3 raises her hand. The prospect
of getting chocolate, which is student 2’s least favourite flavour, leads him
to propose a vanilla alliance with student 3, which student 3 accepts. But
student 1 likes vanilla least, so she approaches student 2 and suggests a
strawberry alliance. At this point, student 2 breaks the vanilla alliance,
and joins the strawberry alliance, which flavour he prefers. But strawberry
is the flavour student 3 likes least… and so on. In the absence of frictions
and transaction costs, meaning in practical terms that the students have
nothing else to do, and do not die of hunger, these broken-coalition
elections can go on and on and on until the end of time without ever a
stable equilibrium being reached.
32
There are two distinct problems in this situation. One is the impossibility of
the existence of a stable equilibrium in multidimensional space. The other
is about instrumentality, (i.e. of the voting mechanisms we commonly
use as a means for bringing about such an equilibrium.) A number of
scholars have tried to solve one or the other of these problems, by proposing
increasingly restrictive assumptions about the sorts of preferences voters
are allowed to have, or by positing probabilistic voting mechanisms, which
remove the mechanical link between voters’ beliefs and/or preferences,
and their voting behaviour. Although some progress has been made, none
of these contributions has managed to solve either problem in a way that
is approximately realistic, and allows our two conditions – information
and accountability – to be met. We do not have the space to consider such
issues further here. Students who want to pursue this further, and who
are prepared for a discussion that becomes very technical very quickly, are
strongly encouraged to consult Dennis Mueller’s Public Choice Three.
The overarching lessons of these theoretical models would appear to be
uniformly negative. Democracy can produce stable equilibria – that is to say,
clear results of some sort – only in the simplest models, and under highly
unrealistic assumptions, that make the transfer of information from voters to
politicians impossible. Relax the assumptions of these models even a little,
to allow for – say – three dimensions, and even the equilibria disappear, and
the models have no solution. In other words, our conditions of information
and accountability cannot even be asked in a Condorcet-type model, where
as few as three people voting over three dimensions are incapable of even
producing an outcome.
Do these results imply that democracy is a sham? Do they imply that
democracy is an elaborate show, a Roman circus meant to distract the
people while fundamentally different means are used to govern them?
Such conclusions, sometimes put forward by democracy’s critics, are too
harsh on two counts. First of all, real world elections are generally one-
dimensional. We cast a vote for one party or another, or for one candidate or
another, rather than expressing detailed preferences across a menu of policy
options. The latter exercise would much better inform our leaders as to
what we want them to do. But real-world voting mechanisms by and large
do not work that way. Hence it is not necessarily our models of voting that
are limited, but rather our real voting systems, which the models in some
fundamental respects try faithfully to represent.
A second objection to the gloomy view is that voting is not everything.
What about interest groups, pressure groups, and civil society? What
about campaigns, polling, and individual encounters between voters and
politicians? When we model democracy by focusing on voting, we miss
more than half the action. So our task consists of building a more realistic
model of governance that includes civic groups, along with producer and
consumer lobbies, and other actors or interests in society who lobby, express
preferences, and otherwise participate in policy-making.
An empirical study: local government at the extremes

Rather than continue with abstract theoretical models, we turn instead to a
close, deep, detailed empirical analysis of government in two very different
kinds of cases: one very good quality, the other very bad. In doing so, we
hope not only to understand what caused the quality of governance to
vary so much between these two localities – though we will do that – but
rather to derive a general model of governance that identifies its structure
and necessary preconditions, and maps shortfalls or distortions of these
33
into specific types of policy failure. This model of governance will go

beyond elections, to contemplate broader interactions in the economy and
society, and how these combine with political movements and dynamics to
produce the level of governance that a specific society achieves.
But first let us consider Viacha and Charagua. Both are municipalities,
in Bolivia as it happens, during the period immediately following
decentralisation (see Chapter 3), when previously ignored and often
non-existent local governments received a sudden shock of immense new
resources, and significant new power and political authority over public
services. What we see in Bolivia, as one might expect, is a significant
variation in the way that different municipalities responded to this
shock. Amongst the large majority with little or no experience of local
self-government, some municipalities were able to manage their affairs
with probity and transparency, while others were marred by corruption
and poor government effectiveness, and a third group remained ‘caught
in the headlights’, seemingly incapable of doing anything at all. Of our
two case studies, Viacha was at the lower extreme of terrible government
performance, while Charagua resided at the upper extreme of high quality
governance. We consider each in turn, before attempting to theorise. Our
evidence is based on six months of fieldwork, and scores of interviews.
Viacha
Viacha is located on the Altiplano, about an hour’s drive south of the
capital, La Paz, on the highway to Oruro. It is an industrial town, boasting
the Bolivian National Brewery’s1 bottling plant, and a large cement 1
CBN, in Spanish, a privately
held company, unlike what the
factory. The municipality is headed by the town of Viacha, and includes a name suggests.
large rural catchment area that reaches up to the Peruvian border. Local
government in Viacha was unresponsive, violent and corrupt. There was
abundant evidence that the mayor short-circuited public accountability by
sabotaging the institutions of government. This left him with little effective
oversight,
freeing him to engage in corrupt deeds. These he pursued with vigour and
relish according to many knowledgeable sources, including even his direct
political superior within the party he represented.
Evidence for the bad quality of government in Viacha includes:
• Local government expanded its payroll by more than 100 per cent,
without significantly increasing administrative ability or technical skills.
• The sewerage refurbishment project, awarded to a political supporter
of the mayor, replaced underground pipes with new pipes that were too
small and structurally weak, leading them to explode and project
sewage up through large holes onto the city streets.
• The most prominent public project, the Municipal Coliseum, was
unfinished and over-budget long past its completion date.
• The ‘Park of the Americas’ had become a rubbish tip, and one of its
main attractions, a 15-foot high children’s slide, was missing several
of its main steel panels, making it dangerous or even deadly for any
children who might attempt to slide down.
• Public officials, municipal councillors, and even the mayor’s political
boss testified to the mayor’s corruption, and
• A national audit of municipal accounts charged the mayor with
malfeasance.
Misconduct- gross misconduct seems more accurate
34
Box 1: Project identification in Viacha

In Santa Ana de Machaqa
The mayor comes along brightly to ask us what projects we want, but then does
nothing about it…. The municipality isn‘t like the Plan Internacional [an NGO
active in the area], which does come through for us. […] We spend money making
trips to Viacha to make formal requests for projects, but nothing comes of it.
The municipality did build a schoolhouse and public urinals in Santa Ana, but local
residents were not consulted about project design, and were not told the value of
their counterparts. The community’s request to change the urinals to an additional
classroom was rejected. Then they were overcharged for their lime supplies, and
discovered that the wood the municipality had provided was rotten.
from Faguet (2002)
Box 1 provides a flavour of the sort of testimony given again and again in
Viacha.
The proximate causes of poor government in Viacha included a corrupt
and corrupting mayor, an ineffective municipal council who demanded
to know in interviews precisely what their duties and powers were, and a
neutered, corrupted oversight committee which was meant to represent
civil society before the local administration, but in practice operated as a
servant and plaything of the mayor.
These proximate causes are correct as far as they go, and are undoubtedly
connected to the phenomenon of bad government. But they are not
very useful, indeed, they are akin to explaining that in order to become
wealthy, one needs to acquire a lot of money. To understand the causes
of corrupt, ineffective government in Viacha, we need to go much deeper
– to structural factors. Consider structural factors in three categories: the
economy, the political party system, and civil society.
The Viachan economy was dominated by the bottling plant of the CBN
brewery, whose influence on the local political system was even greater
than its economic weight, since the other big firm – a cement factory – had
effectively withdrawn from politics a few years earlier. The national owner
of the CBN also headed the UCS (Unión Cívica de Solidaridad) political
party, which he had founded as a personal vehicle, and which had become
one of the main political parties in the country. Hence the director of the
bottling plant, Juan Carlos Blanco, was also the head of the local branch of
the UCS.
To first build up, and then maintain, the UCS’s dominant position in
Viachan elections, Blanco placed the assets of the bottling plant at
the service of the party, and acted with fiercely partisan aggression to
dominate the political party system. His twin strategy was to capture votes
and to promote the UCS/CBN brand. Hence he funded campaign rallies
with dual-branded banners and signs, staffed by workers from the bottling
plant, where beer was given away free initially, but subsequently sold. His
delivery trucks, often the only regular contact from the city experienced
by small, rural communities, also distributed political pamphlets and other
propaganda. He provided the local branch of the UCS with all the support
and resources it could possibly need.
And he became the monopolistic provider of political finance not just
to his party, but to all political parties. Rival parties confided that he
contributed to their campaign funds on condition of being allowed to veto,
or occasionally choose, candidates for their electoral lists. In effect, Blanco
paid opposition parties to not compete. With this system in place, the
35
UCS won a succession of local elections. But voter turnout fell sharply, as
citizens sensed little real political competition, and hence no substantive
political choice.
The third pillar, civil society, might have been a counterweight to this
confluence of politics and economics. But unhappily, in Viacha civil society
was doubly divided against itself: once between the ‘white’ city dwellers,
self-described descendents of Europeans, modern and rational, versus
the pre-modern indigenous countryside; and a second time between the
Machaqas region, guardians of pre-Columbian cultural traditions and
self-governing institutional forms, versus the rest of the countryside,
permeated by the peasant unions that the 1952–53 Revolution established.
Hence there was widespread distrust between town and countryside,
and additional distrust between different parts of the countryside, with
episodic outbreaks of violence, and low social cohesion.
Charagua
The contrast with Charagua was immense. Charagua’s government was
participative and responsive, led by strong organisations of government
that produced high-quality policy outputs. Evidence for this includes:
• The mayor of Charagua topped a departmental ranking of municipal
mayors.
• Operating costs were kept to four per cent of the total, in a period
when the municipal budget grew 6,500 per cent.
• National government audits concurred that local government was well-
organised and transparently administered.
• Local testimony overwhelmingly concurred.
Indeed, this last point is perhaps the most impressive. In scores of
interviews across all areas, political tendencies, and social levels of
Charaguan society, not a single respondent criticised the honesty or good
intentions of the municipal administration. Many took issue with specific
budget items, or disagreed with general priorities. But no one disputed
that the municipality was led by a high-quality administration.
The proximate causes of Charagua’s honest, effective government were an
honest, hard-working mayor; a representative, responsive, well-informed
municipal council; and a vigilant, independent oversight committee. Once
again, these proximate explanations are fine as far as they go, but they do
not go far enough.
Box 2: Project identification in Charagua

Communities throughout the large municipality of Charagua were well informed about
the costs, schedules, and counterpart contributions of projects being implemented
locally. In Kapiwasuti, the entire community discussed and agreed plans for an
irrigation project for local farmers, and then approved the design drawn up by a local
NGO. And villagers mobilised themselves to provide collective services. Thus Acae
boasted three production teams which planned, organised and worked communal
lands for the benefit of all. And this was not limited to more prosperous areas. Even
the poorest communities such as El Espino and Taputamí, where respondents were
shirtless and scarcity was evident, had village presidents, community officers and
production teams. These organisations permitted villages to coordinate relatively large
and complex projects. Thus Taputamí was able to design and build a 100 meter bridge
over a local stream entirely on its own.
from Faguet (2002)
36
The structural causes of high-quality local government in Charagua are far

more telling. First, Charagua benefited from a competitive local economy
led by relatively pluralistic cattle ranchers. Charagua’s agricultural
economy was traditionally dominated by cattlemen, and the remainder
consisted of a large number of subsistence farms owned by impoverished
members of Bolivia’s third-largest ethnic group, the Guaraní. But a group
of cattlemen, even in a small community like Charagua, and despite
high levels of intermarriage, is nevertheless a collection of independent
businessman. It is not a single, monolithic firm marshalling its resources
under a unified command, as was the case in Viacha. Hence at campaign
time, Charagua’s cattle ranchers supported parties across the political
spectrum, even if they and their families voted mostly for centre and right-
wing parties. This generally took the form of ranchers donating a cow,
which a party would barbecue for its supporters at a political rally. In this
way, individual ranchers did not alienate the opposition, should they win.
This more competitive, less monolithic economy contributed to an open,
competitive political system. Politics in Charagua was open to new
entrants, a point proven when the left-wing MIR party, which had never
exceeded five per cent of the vote in Charagua, made an offer to Guarani
civic leaders that transformed local politics and won them control of
the municipality. The MIR invited the dominant Guaraní organisation to
choose the person who would lead the MIR’s electoral list in Charagua,
and to negotiate a political platform jointly. The MIR’s only condition was
that the Guaraníes work to get out their rural vote. The parties agreed,
and their strategy proved an unprecedented success, as the MIR took over
local government under the leadership of a Guaraní-selected leader. This
is a clear example of how an open, competitive political system foments
political entrepreneurialism, and hence the broad representation of
different social groups and political interests in government policy-making.
The third structural cause of good government in Charagua was a highly
organised, coherent civil society. Bolivia’s Guaraní-speakers were enjoying
a cultural renaissance during this period, after nearly dying out at the
turn of the twentieth century, after which they lived for decades in the
shadows of national public life. Their ‘peak association’, the Guaraní
People’s Assembly (APG in Spanish), existed to give its members voice,
help them organise collective action, and represent their interests and
culture more broadly. Its roots lay deep in Guaraní village traditions,
which had survived a century of neglect unscathed, and which provided
the APG immense legitimacy and convocatory power amongst Guaraní
villagers. Hence civil society in Charagua benefited from characteristics
that were the polar opposite of civil society in Viacha: high degrees of
organisation, trust, legitimacy, and a proven ability to solve the collective
action problem. Hence when decentralisation opened up a new sphere of
public life in Charagua – the local sphere – the APG simply took it over
and made it its own through the straightforward expedient of winning an
election in which it represented three quarters of voters. Local government
in Charagua changed decisively for the better.
A simple model of government

The experiences of government success and failure in Charagua and
Viacha suggest the following model of government, which has sufficiently
general properties as to apply to both local and national contexts.
Politicians need to win power if they are to control the institutions of
government, so consider first elections. Politicians and political parties
make policy promises to individual voters in exchange for votes. This is
37
‘quasi-market 1’, in which political ideas and influence are traded at the
retail level. But political parties do not run on ideas or intentions alone.
Parties require resources, if only to run campaigns. Hence they must
engage in a separate market, ‘quasi-market 2’, in which they trade blocs of
policies, and longer-term influence over policy, in exchange for money at
the wholesale level. Such trades occur with organisations that have money,
and are interested in influencing policy. These, for the most part, are firms
and economic interests, although we need not limit this group in any
particular way.
The combination of these two quasi-markets, and also the way in which
they interact with each other, is the electoral exercise, in which one
political team wins and the other loses, and the winners take control of
the institutions of government. Once the new government is formed,
it enters into a very different sort of organisational dynamic with the
intermediating organisations that comprise ‘civil society’. Here, civic
groups provide government with information on social preferences,
feedback on the efficacy and desirability of previous interventions, and
community counterparts and participation, in exchange for public goods
and services. Note that the same citizens appear in two separate boxes
in this model. In the upper left-hand box, citizens are conceptualised as
individual voters exercising the secret ballot. In the bottom-middle box,
citizens are construed as members of intermediating organisations that
aggregate their interests and preferences, and organise their collective
action, according to a rich set of cross-cutting cleavages and identities into
which society spontaneously organises itself.
Figure 2.7: A simple model of government

A comparison of the two quasi-markets is revealing. Quasi-market 1 is
both powerful and compelling because it is the only means by which
inadequate governments can be removed from office. This would seem
to place an inordinate amount of power in the hands of ordinary citizens.
But quasi-market 1 is infrequent and discontinuous in the temporal aspect,
and thus plays a supporting role through most of the electoral cycle to
quasi-market 2, where the influencing of politicians is continuous, and a
much smaller number of individuals take much bigger decisions. These
advantages of timing and aggregation are more or less counteracted by the
38
organisational dynamic into which politicians and civic organisations enter

once the former assume power. Here, contacts between politicians and civil
society are much more continuous, and at a higher level of aggregation,
than in the electoral sphere. These characteristics magnify the incentives
that civic organisations provide to politicians, to the point where they can
broadly rival those wielded by firms and economic interests.
This, then, is an account of the structure of government, and the
main dynamics that define its operation. Government will tend to be
effective when the two quasi-markets and the organisational dynamic
are in rough balance. Where one dominates the others, systematic and
predictable distortions of policymaking will occur. For example, where
quasi-market 2 is dominant, policymaking will reflect the preferences
of one or a small number of economic interests. Politicians will not be
accountable to ordinary voters, nor will they respond to the demands of
civil society from below. This, in essence, is the story of Viacha. Where
the market for policies/votes is weak or missing, government will tend
to be undemocratic. Where the market for political influence is weak,
under-funded parties may be unable to canvass voter opinion effectively,
and government may be insensitive to economic conditions. And where
society’s civic organisations are weak, government will be lacking in
information, oversight and accountability.
By contrast, a competitive local economy will tend to lead to competition in
politics, as we saw in Charagua. Where local politics benefits from an open
and transparent electoral system, as well as a competitive party regime,
the natural dynamics of political competition will tend strongly towards
a substantive focus on local issues and local people. The latter arises
endogenously, via the sorts of political entrepreneurship described above.
But in order to work well, the system requires civil society to be well-
structured and vigorous. Civil society is crucial to government effectiveness
through its informational and coordinating roles. A well-ordered civil
society will have the following characteristics:
1. the ability to communicate
2. minimum levels of human capital amongst civic leaders
3. minimum resources and
4. norms of trust and responsibility, both within communities and amongst
them, as well as across time.
Where such conditions obtain in the economy, politics, and civil society,
and there is a stable tension between the three, the markets and dynamics
of power and influence that swirl within government will tend to
counterbalance each other, leading to governance that is open, inclusive,
and responsive to the various constituencies and interest groups. The
fundamental conditions of information and accountability that we defined
at the outset, implicit in different ways in both quasi-markets and the
organisational dynamic, will be met. In such circumstances, government
will be accountable to the governed, and democracy will be achieved.

• define ‘accountability’
• explain the roles of information and accountability in making
governments responsive to citizens
39
• explain the role of voting in revealing and transmitting information to

politicians
• summarise how voting interacts with other aspects of democratic
government, such as lobbying, campaigning, and the activities of civic
organisations
• analyse the strengths and limitations of democracy for providing
government that is accountable to its citizens.

1. Democratic elections provide a façade of accountability where really
there is none. Discuss.
2. What stable equilibria exist for 1, 2, 3, 5 and 6 player combinations on
a Hotelling beach? What does the concept of ‘stable equilibrium’ mean
in such a context? Why might this model be inappropriate for analysing
real-world issues?
3. After a hard night of post-examination revelry, three Development
Management students crave ice cream. They find themselves in the last
ice-cream selling venue still open in London, and with only enough
money between them for one tub of ice cream. The vendor offers them
Chocolate, Strawberry or Vanilla. The students are named 1, 2, and 3.
They vote for which flavour to buy. Figure A depicts their individual
preferences:
1 2 3
C C V
S S C
V V S
Figure A
Is there a stable equilibrium? If so, what is the majority-preferred

preference ordering of the three flavours? If there is no stable
equilibrium, describe how temporary equilibria break down.
Now assume their preferences are as in figure B:
1 2 3
C S V
S V C
V C S
Figure B
Is there a stable equilibrium? If so, what is the majority-preferred

preference ordering of the three flavours? If there is no stable
equilibrium, describe how temporary equilibria break down.
In one or two sentences, what does this model imply about real-world
elections?
40
Chapter 3: Democracy and decentralisation
Chapter 3: Democracy and

decentralisation
Aims of the chapter

The second chapter in this course is concerned with one of the most
widespread, and potentially powerful, reforms in the world today,
designed to improve the quality of governance that a country achieves,
thereby both accelerating and deepening its development. This is the
question of decentralisation. Over the past two decades, decentralisation
has become one of the broadest movements, and one of the most
debated policy issues in the world of development. It is at the centre of
reform throughout Latin America, Asia, and Africa. Indeed, under the
guises of subsidiarity, devolution, and federalism, is at the centre of the
policy debate in the EU, UK, and US as well. The World Bank estimates
that between 80 per cent and 100 per cent of the world’s countries are
experimenting with one or another version of decentralisation.
It is therefore curious, if not bizarre, that the empirical literature is so
ambivalent about the effects of decentralisation on a number of important
policy variables. Does decentralisation improve service delivery for the
poor? Does it increase or decrease the unit cost of health, education,
irrigation and roads? Does it increase or decrease economic growth? Does
it increase or decrease corruption? We simply do not have clear answers
to these or many other important questions. Even in cases where theory
unambiguously predicts a certain direction of effect, attempts to establish
such effects empirically have produced contradictory results.
Why is this the case? There are several good reasons, which we
explore further below. The most important ones are the lack of a
good, clear definition of decentralisation in the empirical literature,
which in turn leads researchers to compare cases that are not strictly
comparable, because the specific actions they have taken in the name of
‘decentralisation’ are fundamentally different from one another.
How, then, can we learn more about decentralisation’s effects on poverty,
growth, efficiency, and development? This chapter provides a way in to
these questions by first defining decentralisation clearly. We then discuss
the predictions of theory about what decentralisation of this type might
achieve’. Lastly, we empirically examine the experiences of two countries
where decentralisation of this type was vigorously implemented, to try to
establish what its systematic effects across hundreds of municipalities are.
Learning outcomes
• define ‘decentralisation’
• explain the major benefits and costs associated with decentralisation
• explain why the empirical literature on decentralisation is characterised
by contradictory conclusions and recommendations
• give a detailed account of the underlying trade-offs involved in moving
from a highly centralised to a decentralised form of government.
• explain the major effects of decentralisation in Bolivia and Colombia.
41
Essential reading
Faguet, J-P. and F. Sánchez ‘Decentralisation’s Effects on Educational Outcomes
in Bolivia and Colombia’, World Development 36 (2008) pp.1294–316.
Available here: http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_
id=260795
Putnam, R.D. Making Democracy Work: Civic Traditions in Modern Italy.
(Princeton: Princeton University Press, 1993) Chapters 2, 5 and 6.
Further reading
Bardhan, P. and D. Mookherjee ‘Decentralisation in West Bengal: Origins,
Functioning and Impact’ in Bardhan, P. and D. Mookherjee
(eds) Decentralisation and Local Governance in Developing Countries:
A Comparative Perspective. (Cambridge, MA: MIT Press. 2006)
[ISBN 9780262524544] pp.203–22.
Litvack J., J. Ahmad and R. Bird ‘Rethinking decentralisation in developing
countries’, The World Bank Sector Studies Series, 21491 (1998).
Ostrom, E. et al., ‘Decentralized institutional arrangements’ in Institutional
Incentives And Sustainable Development. (Boulder, Westview, 1993)
[ISBN 9780813316192] Chapter 8.
Tarrow, S. ‘Making Social Science Work Across Space and Time: A Critical
Reflection on Robert Putnam’s Making Democracy Work’, American Political
Science Review, 90(2) 1996, pp.389–97.
Works cited
Campbell, Tim The quiet revolution: decentralization and the rise of political
participation in Latin American cities. (Pittsburgh: University of Pittsburgh
Press; London: Eurospan, 2003) [ISBN 9780822957966].
Introduction
Two small anecdotes hinted at the growing enthusiasm with which
decentralisation is viewed in policy circles. In 1997, Professor James
Manor gave a lecture in Rome in which he called decentralisation ‘a
quiet fashion of our time’. Four years later, Tim Campbell published a
book about decentralisation in Latin America called The Quiet Revolution
(2003). In this book, Campbell shows that it is not just the number of
countries decentralising that impresses, but the scope of authority and
resources that have been devolved to sub-national governments: ‘From
Guatemala to Argentina, local governments began spending 10 per cent to
50 per cent of central government revenues’.
Decentralisation is thus an important reform affecting most, if not all, of
the world’s countries; and the scale of the changes it can bring about in
how countries are governed is potentially significant. It is odd, then, to
look at the empirical literature and find so few clear answers concerning
decentralisation’s effects in the countries where it has been tried. This is all
the more so because the decentralisation literature is itself vast. Empirical
studies have tended to come in waves. The first was in the mid-1960s to
early 1970s, the second in the early 1980s, and a third beginning in the
mid-to-late 1990s. Taken as a whole, this literature is often frustrating,
and broadly indeterminate. This is not to say that it is uniformly of poor
1
World Development
quality. It contains many excellent studies, and individual pieces of
is one of the two most
evidence that are compelling. But any particular conclusion about any
important journals in the
aspect of decentralisation is contradicted by at least one opposite finding
field of decentralisation;
of apparently equal weight. This has led scholars in the past to despair
the other is the Journal of
about our ability to conclude anything about the impact of decentralisation
Public Economics.
42
on the things that we care about, such as poverty, economic growth, the
responsiveness of government, and development more broadly.
I myself recently conducted a review of decentralisation studies published
in World Development for a paper just published in that same journal.1
More than 50 studies have been published in recent decades. Of the 24
articles published since 1997, 11 reported broadly positive results from
decentralisation, and 13 were broadly negative. The following lists some
of the most interesting of these results:
Positive
• Fiszbein (1997): decentralisation can spur capacity building in local
government in Colombia.
• Shankar & Shah (2003): decentralisation decreased regional inequality
through political competition in a sample of 26 countries.
• de Oliveira (2002): decentralisation boosted the creation and
administration of protected areas (Bahia, Brazil).
• Parry (1997): decentralisation improved educational outcomes (Chile).
• Rowland (2001) and Blair (2000): decentralisation improved the
quality of democratic governance in large cities and small towns.
• Andersson (2004), Larson (2002), McCarthy (2004) and Nygren
(2005) are more cautious; decentralisation is a complex, problematic
phenomenon that may ultimately be good for local welfare.
Negative
• Ellis, Kutengule & Nyasulu (2003), Ellis & Mdoe (2003), and Ellis &
Bahiigwa (2003): Decentralisation probably depresses growth and
rural livelihoods by facilitating the creation of new business licenses
and taxes that stifle private enterprise (Malawi), and propagates rent-
seeking behaviour down to the district and lower levels, so becoming
‘part of the problem of rural poverty, not part of the solution’ (Tanzania
and Uganda).
• Bahiigwa, Rigby & Woodhouse (2005) and Francis & James (2003):
decentralisation in Uganda did not lead to independent, accountable
local governments, but rather local governments captured by local
elites, and hence little poverty reduction.
• Porter (2002) agrees with the previous point for Sub-Saharan Africa
more generally.
• Woodhouse (2003): decentralisation will fail to improve access of the
poor to natural resources, or reduce ecological damage.
• Casson and Obidzinski (2002): decentralisation in Indonesia has
spurred depredatory logging by creating bureaucratic actors with a
stake in its proliferation.
• Martinez-Vazquez & McNab (2003): cross-country evidence doesn’t
show whether decentralisation affects growth directly or indirectly;
there are no clear theoretical grounds for predicting a relationship
either way.
• De Mello’s (2000) study of 30 countries: failures of intergovernmental
fiscal coordination will lead to chronic deficits and, eventually,
macroeconomic instability.
• Sundar (2001), Thun (2004) and Wiggins, Marfo & Anchirinah (2004)
provide cautious arguments that are on the whole sceptical about the
possibility of beneficial change through decentralisation.
43
These results are reviewed in more detail in Faguet and Sánchez (2008).
The lack of clear conclusions reflected in these results is echoed in the
broadest international surveys of the literature. Rondinelli, Cheema
and Nellis (1983) find that decentralisation has seldom if ever, lived
up to expectations. Most developing countries experimenting with
decentralisation experienced a series of administrative problems,
with limited success in some countries, and little or none in others.
Fifteen years later, surveys by Piriou-Sall (1998), Manor (1999) and
Smoke (2001) are slightly more positive about decentralisation, but
with many caveats about the strength of the evidence in its favour.
Manor notes that decentralisation is no panacea, and evidence about it is
incomplete, but it has many virtues and is worth pursuing. Smoke, on the
other hand, finds the evidence mixed and anecdotal, and asks whether
there is empirical justification for pursuing decentralisation at all. More
recently, a survey by Shah, Thompson and Zou (2004) reviews 56 studies
published since the late 1990s. They find that decentralisation in some
cases improved, and in others worsened, service delivery, corruption,
macroeconomic stability, and growth across a large range of countries.
Hence we find ourselves in an absurd situation. After 50 years of policy
experimentation, and hundreds of studies, and at a time when most or all
of the world’s countries are decentralising, we still know very little about
decentralisation’s empirical effects, and whether it is likely to accelerate or
hold back development. On what is so much enthusiasm based? How can
we know so little?
Activity 3.1
What does ‘decentralisation’ mean? Write down the best definition you can think of.
A large part of the problem is about concepts and definitions. Many of the
studies surveyed by Rondinelli and others compare decentralisation in a
handful of countries, such as (for example) Mexico, India and Thailand,
or China and Russia. Despite high initial expectations, the results they
find range between indifferent and inconclusive. This, in turn, is at
least in part due to the very different nature of reforms pursued in each
country. This, in turn, is largely due to the way decentralisation has been
defined in the literature. One influential taxonomy of the various types of
decentralisation is the following:
1. Deconcentration moves some administrative authority to lower
levels within central government agencies. It gives limited discretion to
field agents (to plan and implement programs and projects, or to adjust
central directives to local conditions within the guidelines set by the
higher level of government).
2. Delegation transfers managerial responsibility for specifically defined
functions to organisations outside the regular bureaucratic structure,
and only indirectly controlled by the central government. But the
sovereign authority retains ultimate responsibility for public service
provision.
3. Devolution creates or strengthens sub-national units of government,
the activities of which are substantially outside the control of central
government. Local governments are independent, autonomous, and
usually have exclusive authority over explicitly reserved functions.
4. Privatisation is the auto-divestiture by governments of functions that
are either transferred to voluntary organisations or left to the private
sector. (Rondinelli, et al., 1984)
44
Although each of these measures is an interesting and important

phenomenon in its own right, the four of them do not belong under a
single rubric called ‘decentralisation’. In fact, no two of them belong under
the same rubric, as if they were similar phenomena, or minor variations
on a theme. Each of these four reforms belongs to a different category,
because each sets up distinct incentives that will promote particular
behaviours distinct from the rest. Hence the incentives faced by a public
service providers under deconcentration are fundamentally different from
those faced by public service providers under devolution. In the former,
lines of authority and accountability go upwards to ministerial authorities
and the capital; in the latter, lines of authority and accountability go
downwards to local voters. When we treat these reforms as closely
connected, and compare countries implementing different ones, we are,
in effect, comparing beans with bananas. It is not surprising that the
comparison yields little fruit.
Hence the first step in analysing decentralisation rigorously is to choose a
clear, unambiguous definition. I suggest the following:
Decentralisation is the devolution by central (i.e. national)

government of specific functions, with all of the administrative,
political and economic attributes that these entail, to democratic
local (i.e. municipal) governments that are independent of the
centre within a legally delimited geographic and functional
domain. (Faguet 2004)
Activity 3.2
Which of the definitions of decentralisation (i–iv) listed above do you consider best?
Why?
Arguments for and against decentralisation

With that definition in mind, we can now consider the underlying
theoretical arguments for and against decentralisation. The first of these
is that reform can bring government ‘closer to the people’. This is the
popular expression of a deeper set of arguments that we must unpack
in order to analyze them. The first component of ‘bringing government
closer to the people’ is that decentralisation can provide government with
more and/or better information on local conditions and local needs. This
will allow government to take better decisions about what sorts of public
services to offer in each locality, and thus improve the efficiency and
responsiveness of the state. Secondly, the argument refers to increased
voice and participation in public affairs. By locating public authority and
resources closer to citizens, the latter will more easily make their voices
heard, and more fully and more frequently participate in public decisions.
A third interpretation of ‘bringing government closer to the people’ is
that decentralisation can improve the accountability of public officials
to citizens by putting the fate of the former in the hands of the latter via
regular elections, lobbying, and all of the usual accoutrements of (local)
democracy.
A second argument in favour is that decentralisation will deepen
democracy by providing a fuller and more intimate version of it for citizens
far from the main cities, where national politics tend to be focused.
This argument is in essence a reformulation of the first argument, but
focusing more on politics and the value of participation per se, and less on
technocratic notions like information, voice, and responsiveness.
45
A third argument in favour of decentralisation is that it can ‘cut through’

bureaucracy and improve the efficiency of the state. In this view, the
problem of a bureaucratic, inefficient state is that it consists of too
many layers, arranged in a centralised administration that is distant and
wasteful. Decentralisation can solve these problems by relocating power
and resources related to local services in small government units that will
tend to be less bureaucratic and less wasteful than central government.
A fourth argument in favour is that decentralisation can reduce
public spending. This is a claim frequently made by those promoting
decentralisation in a specific country. The argument is frankly a red
herring, and is frequently used by national elites who seek to reduce
fiscal deficits by devolving responsibility for service provision to local
governments without providing adequate resources. In these cases,
decentralisation can be a rallying cry designed to obscure a series of
unfunded mandates, and a relocation of political responsibility to local
politicians whose efforts are systematically underfunded.
In theory, by contrast, there is no strong reason for thinking that
decentralised government will be cheaper or more expensive than
centralised government. In other words, theoretical arguments go both
ways, and so are indeterminate. There are solid reasons for thinking that
local governments will enjoy lower unit costs in the production of public
services, as the markets in which they operate typically feature lower
prices than those of large cities. This is in large part a function of lower
property prices in towns and villages, which feed through to lower product
prices and lower wages. But on the other hand, a decentralised system of
government will be expected to have higher overhead costs, as economies
of scale in administration are lost by locating elected governments and
their administrative apparati in localities throughout the country, instead
of centralizing them in the capital. The question of which affect will
dominate – higher overheads or lower unit costs – cannot be resolved
theoretically, and is the proper subject of empirical research.
Activity 3.3
Will decentralisation tend to make governments more corrupt or less? Why?
The principal argument against decentralisation is that it will abet elite

capture. This is because local elites (landowners, businessmen, or other
notables) are small compared to national government, but can be very
large compared to local government. In the latter case, local elites can
capture the local policy-making process, and systematically distort policy
to favour it themselves and their interests, and not those of the majority.
A second argument against decentralisation is that it will tend to
generalise graft and corruption. An advantage of centralisation is that it
limits the number of people with discretion over public authority and the
public purse. Decentralisation, by contrast, allows far more people to ‘put
their hands in the pot’, and will thus exert a corrupting influence on the
state and the nation. Local government is ‘naturally’ corrupt, claim some,
and hence the last thing reformers should do is to put more power and
resources at its disposal. A curious footnote to this argument is that the
president of Bolivia, when announcing his decentralisation programme,
turned this argument on its head. If the only thing achieved is that more
people steal public funds, he claimed, at least that will be preferable to the
current situation, where a few steal everything, and much of the money
leaves the country.
46
A final argument against decentralisation is that it will undermine

macroeconomic stability. This is because local politics is less transparent
than national politics, which allows local governments to run large deficits
and become highly indebted. Although central governments may proclaim
their determination to not bail out local governments, in practice this will
be extremely difficult politically, especially around election time, when
local fiscal crises can lead to economic and social displacements. In this
way, decentralisation can destabilise the central government’s accounts,
and lead to macroeconomic instability.
How do we resolve this set of claims and counterclaims, some of which
are theoretical, others empirical, and which span a variety of disciplines
and demand different methodologies if they are to be answered? Rather
than approaching them head-on at a high level of generality, we opt
instead for a deeper, more contextual analysis, examining what were
decentralisation’s effects in two particular countries, where a number of
political, economic, social and cultural factors can be explicitly accounted
for. The characteristics of our two country case studies are particularly
well-suited to an exploration of this nature, and the data available for
each is a surprisingly good quality. The countries in question are Bolivia
and Colombia, two Latin American countries of almost identical size that
decentralised in the mid-1990s.
Decentralisation in Bolivia and Colombia

We begin with the pre-decentralisation political and economic context in
both countries, then describe the main elements of the decentralisation
reforms that each country undertook, before turning to an analysis of the
effects of decentralisation in each.
Bolivia’s modern political history divides neatly into the long period before
the 1952–53 nationalist revolution, and afterwards. Pre-1952 Bolivia was
a poor, backward country with extreme levels of inequality, presided over
by a ‘typical racist state in which the non-Spanish speaking indigenous
peasantry was controlled by a small, Spanish speaking white elite, [their
power] based ultimately on violence more than consensus or any social
pact’ (Klein 1993, 237). The nationalist revolution embarked upon a
state-led modernization strategy of breaking down provincial fiefdoms
and transforming social relations (Dunkerley 1984). Their main tool was
a highly centralised state. The revolutionaries organised state power into
a cascading chain of authority that originated with the President. The
President named his ministers and prefects, who in turn named regional
and local authorities beneath them directly, a dedo. For the most part, the
legal and political instruments of local government did not exist in Bolivia.
Hence beyond some 30-odd cities, local government existed in Bolivia only
in name, as a ceremonial institution devoid of administrative capability or
funds.
Colombia was similarly a highly-centralised country, where governors
and mayors were named directly by the executive branch, albeit without
Bolivia’s extreme levels of inequality and discrimination in modern times.
Indeed, Colombia had seen the ascendancy of a Liberal party dedicated to
progressive social policies, the extension of suffrage, and the separation of
church and state from the nineteenth century onwards. These progressive
instincts implied little desire to devolve power away from the centre, but
they did imply a country where the poor and working classes had many
more opportunities than their Bolivian brothers.
47
The Bolivian decentralisation programme

Decentralisation was announced in Bolivia in January of 1994, and
implemented on July 1, 1994, as a radical ‘shock therapy’ treatment. The
program had four main components:
1. Resource allocation. Transfers to municipalities doubled to 20 per
cent of all national revenues. The allocation of these funds amongst
municipalities switched from an unsystematic, highly political criteria
to a strict per capita basis. The difference this made to municipal
finances in the majority of Bolivia’s districts was immense: before
decentralisation, 86 per cent of all devolved funds went to the three 28.7% of total allocated per city
biggest cities; after decentralisation, these three cities garnered only
27 per cent of devolved funds, in accordance with their population.
2. Responsibility for public services. Ownership of local
infrastructure in education, health, irrigation, roads, sports and culture
was given to municipalities, along with the responsibility to maintain,
equip and administer facilities, and invest in new ones.
3. Oversight committees (Comités de Vigilancia) were established
to provide an alternative channel for representing popular demand
in the policy-making process. Composed of representatives from
local, grass-roots groups, these bodies propose projects and oversee
municipal expenditure. Their ability to have disbursements of ‘popular
participation funds’ suspended if they find funds are being misused or
stolen can paralyse local government, and gives them real power.
4. Municipalisation. Municipalities were expanded to include suburbs
and rural catchment areas. One hundred and ninety-eight new
municipalities (out of 311 in all) were created in law and in fact.
The Colombian decentralisation programme

Decentralisation in Colombia was a much more gradual, measured,
consensual affair, carried out over several decades.
Phase 1 began in the late 1970s, and consisted mostly of fiscal measures
aimed at strengthening municipal finances. The most important of these
were Law 14 of 1983 and Law 12 of 1986, which increased municipal tax
collection powers and regulated their investment.
Phase 2 runs from the mid-1980s to 1991. This phase was primarily
concerned with deepening democracy. It established the popular election
of mayors and governors, and sought to promote popular participation
in local public decision-making via local administrative committees, and
other similar bodies. The 1991 constitutional reform established citizens’
initiatives, municipal planning councils, open cabildos, mayoral revocation,
referenda, and popular consultations.
Phase 3 consisted of laws to regulate the new constitution, and
other fiscal and administrative reforms. It promoted greater municipal
responsibility for the provision of public services and social investment.
It also provided additional resources by increasing central government
transfers to local governments. Automatic transfers to regional
governments rose from about 20 per cent to over 40 per cent of total
government spending. In this way, Colombia moved to first in the region
amongst unitary states, and third overall behind the two big federal
countries, Brazil and Argentina, in terms of total sub-national spending
(Alesina et al., 2000).
48
What were the results? Four stylised facts about Bolivia and
Colombia
What were the results of decentralisation in Bolivia and Colombia? We
compare investment flows before and after decentralisation in each
country, in order to get a sense of what, if any, where decentralisation’s
effects. Consider first how central versus local governments in Bolivia
invested resources across sectors, (i.e. across the various uses to which
resources can be put.) Figure 3.1 shows central government investment
during the final three years before decentralisation, compared with local
government investments during the first three years after decentralisation.
We see that central government invested most in transport, followed
by energy, and ‘multisectoral’ (a collection of odds and ends difficult
to characterise). Local government, by contrast, invests in education,
followed by urban development, and then water and sanitation. Hence
central government preferred infrastructure and economic production,
whereas local government preferred primary services and human capital
formation.2 2
Much ‘urban development’
investment constituted of
Industry new municipalities building
Central
Communications Local or refurbishing office space
Multisectoral in localities that had never
Water Management had a local government,
Agriculture
and where necessary
Sector
Energy
physical infrastructure did
not exist .
Health
Transport
Water and Sanitation
Urban Development
Education
0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

Percent of Total
Figure 3.1: Central vs. local government investment (Bolivia)

Source: National Secretariat of Public Investment and External Finance; original calculations.
A second way in which we can compare centralised versus decentralised

government is to see how each regime invested its resources across space.
In Figure 3.2, each black point represents investment in one municipality.
3
Each graph shows investment in bolivianos3 per capita, again summed The average boliviano
over the last three years before, and the first three years after, the exchange rate for this
decentralisation reform. The most unequal allocation of resources across period was Bs. 5 per US
space that one can imagine would show a single municipality receiving dollar.
all national investment, and all the other municipalities aligned in a row
at zero investment. The first graph in Figure 3.2 is not quite this unequal,
but it looks fairly close. The extremely high top few observations, reaching
over 50,000 bolivianos per head, distort the vertical axis, so we drop the
highest 12 observations in order to expand this axis and look for more
variation. The second graph shows that there is indeed more variation,
but if we count all the black dots on the horizontal axis, we see that half
of all Bolivian municipalities received exactly nothing during the final
three years of centralised rule. The third graph in Figure 3.2, which shows
local government investment per capita between 1994–96, demonstrates a
much less unequal distribution of investment across space, with two-thirds
of all municipalities located in a band between Bs. 100 and 300 per capita.
49
Investment per capita, 1991-93
60,000
Bs per capita 50,000
40,000
30,000
20,000
10,000
0
0 50 100 150 200 250 300
Number of Municipalities
Investment per capita, 1991-93

(highest 12 obs. dropped)
2,000
1,500
Bs per capita
1,000
500
0
0 50 100 150 200 250 300
Local Investment per capita, 1994-96
700
600
Bs per capita
500
400
300
200
100
0
0 50 100 150 200 250 300
Figure 3.2: Public investment allocations across space
Lastly, Figure 3.3 shows scatter plots of central government investment

(left-hand side graphs) vs. local government investment (right-hand
side graphs) in education. Again, the graphs plot central government
investment during the last three years before decentralisation vs. local
government investment during the first three years after decentralisation,
against objective indicators of real local need in each municipality. Each
graph includes a regression line summarising the overall relationship.
The first comparison shows that central education investment fell as the
50
Central Government, 1991-93

80
Education Investment (Bs/cap)

70
60
50
40
30
20
10
0
0 10 20 30 40 50 60 70
Illiteracy Rate (%)
Local Government, 1994-97

250
(Bs/cap)
200
Education Investment
150
100
50
0
0 10 20 30 40 50 60 70
Illiteracy Rate (%)
Figure 3.3: Central vs. local investments in education
illiteracy rate rose, meaning central government chose to concentrate

education resources where literacy was higher. This is the opposite of
what we would expect if central government were investing in areas
of greatest need. After decentralisation, by contrast, local governments
invested progressively more where illiteracy was higher. Both regression
lines are statistically significant – at the 5 per cent and 0.1 per cent
levels respectively. Note how many municipalities received no education
investment at all under centralised rule. These graphs imply that
decentralisation increased government responsiveness to real local needs.
A graph of central versus local government investment in Colombia
(Figure 3.4) shows a similar pattern to that described above for Bolivia,
albeit not quite as dramatic. Colombia’s central government invested
most in infrastructure, followed by health and education. Under
decentralisation, local governments invested more in health, followed
by education, with infrastructure a distant third. But Figure 3.5 reveals a
more interesting pattern still. Here, school enrolment is normalised to one
in the year 1994, and the graph shows its evolution over the following
decade, with total enrolment divided into its public and private shares.
The graph shows that total enrolment rises in Colombia after 1997, and
finishes the period some 20 per cent higher than at the outset. But public
school enrolment rises more strongly still, to some 130 per cent of its
1994 level. Whereas private school enrolment, which does initially rise,
falls back after 1999 to below its initial level. Education was perhaps the
51
Culture
Central
Local
Industry and Commerce
Sector
Infrastructure
Water and Sanitation
Health
Education
0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%
Percent of Total
Figure 3.4: Central vs. local government investment (Colombia)
1.5
Public Private Total
1.4
Enrollment Index
1.3
1.2
1.1
0.9
0.8
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Year
Figure 3.5: Index of public and private school enrolment
most important sector over which central government devolved control and
resources to municipal governments. Figure 3.5 implies that decentralisation
coincided with an increase in total school enrolment, and that this increase
was disproportionate in those schools that local governments controlled. In
fact, there appears to be a substitution effect, where parents who initially
withdrew their children from public schools in 1997–99, put them back
into public schools after 1999, presumably because public education under
local government was a more attractive option. The reader should note that
Colombia’s recession in this period came in 1997, and by 1999 the economy
had returned to strong growth. Hence public school enrolments are not
simply varying with economic cycle.
Sophisticated regression analysis establishes two more stylised facts for
Bolivia and Colombia. In Bolivia, centralised investment was economically
regressive, concentrating public investment in richer municipalities and
ignoring poorer ones. Decentralisation, by contrast, shifted resources towards
poorer districts; after 1994, public investment rose in municipalities where
indicators of wealth and income are lower. And in Colombia, in municipalities
where decentralisation had progressed further, implying more local control
over investment resources and less central intervention in local policymaking,
student enrolments went up strongly. By contrast, where education
investment was more firmly tied by central government, implying central
priorities and criteria intervening in local decision-making, student enrolment
52
actually declined. The findings are robust to a number of different estimation

techniques and strategies, and significant at the 1 per cent level of confidence.
We can summarise our findings from these two country cases of
decentralisation as follows:
Bolivian stylised facts

Decentralisation:
1. shifted public investment into social services and human capital formation,
at the expense of economic production and infrastructure
2. distributed investment more equally across space
3. made investment more responsive to local needs
4. shifted investment towards poorer districts.
Colombian stylised facts

Decentralisation:
1. shifted public investment into social services and human capital formation,
at the expense of infrastructure.
2. improved enrolment rates in public schools. In districts where educational
finance and policy making were most free of central influence, enrolment
increased. In districts where educational finance was still based on
centrally-controlled criteria, enrolment fell.
In both countries, these changes were driven by the smallest, poorest
municipalities investing devolved funds in their highest-priority projects.
This contradicts common claims in the literature that local government is too
corrupt, institutionally weak, or prone to interest-group capture to improve
upon central government. At least for Bolivia and Colombia it is not the case
that local governments administered public resources with less ability or
sensitivity than the centre had done before them. Rather, in both countries
local governments performed better, and in Colombia local governments
obtained demonstrably superior results.

Having completed this chapter, as well as the essential reading and activities,
you should be able to:
• define ‘decentralisation’
• explain the major benefits and costs associated with decentralisation
• explain why the empirical literature on decentralisation is characterised by
contradictory conclusions and recommendations
• give a detailed account of the underlying trade-offs involved in moving
from a highly centralised to a decentralised form of government.
• explain the major effects of decentralisation in Bolivia and Colombia.

1. Provide three distinct definitions of ‘decentralisation’. Which one do you
think is best? Why?
2. Decentralisation takes power away from insensitive national bureaucrats
and places it in the hands of local politicians who are, on the whole,
dumber, less educated and more vicious. Hence it is to be avoided. Discuss.
3. It is consistent to have a strong normative bias in favour of democracy and
oppose decentralisation. Discuss.
53
Notes
54
Chapter 4: International aid and international governance
Chapter 4: International aid and

international governance
Aims of the chapter

This chapter is about international aid and the international aid regime,
and their connection – or lack thereof – to international development.
What is aid? What are the different kinds of aid? What are the most
important types of institutions that deliver aid to developing countries?
How does aid work, or fail to? These are the questions with which this
chapter is concerned.
• We begin with definitions of aid and development, as they are defined
within the ‘aid community’, and then contrast aid to colonialism
– arguably the closest historical analogue to aid.
• We explore the origins of the ‘aid industry’ in post-war reconstruction,
and examine how the aid institutions that emerged operate today.
• We then critically examine the seven broad paradigms in development
aid over the past six decades, before turning to evidence on whether
this aid has worked.
• Lastly, we analyse the current aid regime in terms of the underlying
incentives it generates, for both donor and recipient countries, and
suggest a starting point for reform of the entire system.
Learning outcomes
• define ‘international development aid’
• define ‘development’ and contrast it to ‘colonialism’
• explain what the ‘development project’ is and how it works
• explain the historical origins of international development, and their
importance for the current array of institutions and organisations that
characterise the sector
• give a detailed account of the perverse incentives that institutions and
organisations create and sustain
• discuss the links between these incentives and the perverse outcomes
that result.
Essential reading
Bauer, P.T. Equality, the Third World, and Economic Delusion. (London:
Weidenfeld and Nicolson, 1981). Read two chapters: ‘Western Guilt’ and
‘Third World Poverty’, available at: www.valt.helsinki.fi/atk/gpe/texts/
bauer.htm and ‘Foreign Aid and Its Hydra-Headed Rationalisation’.
Sen, A. ‘Just Deserts’, review of Bauer’s Equality, the Third World, and Economic
Delusion, New York Review of Books, 4 March 1982.
55
Further reading
Boone, P. and J-P. Faguet. ‘Multilateral Aid, Politics and Poverty: Past Failures
and Future Challenges’, in R. Grant, and J. Nijman (eds) The Global Crisis in
Foreign Aid. (Syracuse, New York: Syracuse University Press, 1998) [ISBN
9780815627715].
Easterly, William The elusive quest for growth: economists’ adventures and
misadventures in the tropics. (Cambridge, MA: MIT Press, 2001)
[ISBN 026205065X] Chapters 2 and 6.N
Rodrik, D. ‘Why Is There Multilateral Lending?’, ABCDE paper (1995) available
at: www.nber.org/papers/w5160.pdf
Works cited
Stern, Nicholas. 2001. ‘Globalization: Facts, Fears, and an Agenda for Action,’
Lecture, London School of Economics, London, UK.
The development economics reader. Edited by Girgio Secondi. (London, New
York: Routledge, 2005) [ISBN 0415771500] Chapter 1 ‘New directions in
development thinking’.
Introduction
As was mentioned at the outset, most students approach development
management with the expectation that it is largely about administering
international aid projects of one sort or another. While this course argues
for a different, and much broader, understanding of the subject, it is
nonetheless true that the aid industry plays a large and important role
in the lives of most developing countries. It is an important (although
decreasing, as we shall see below) financier of development projects, and
an incubator and disseminator of ideas about policy reform and service
delivery across the developing world. More prosaically, most students of
development management will go on to work with or in the aid industry at
some point in their careers. Hence it is important to understand what aid
is, how it operates, and why it so often fails.
What is aid? What is development? Or more to the point, how does
the international aid community define development? It is better if we
start with this last question. The World Bank defines development as
the creation of ‘sustainable improvements in the quality of life for all
people. While raising per capita incomes and consumption is part of that
goal, other objectives – reducing poverty, expanding access to health
services, and increasing educational levels – are also important.’1 Other 1
World Bank. 2008. ‘New
organisations, especially a number of well-known NGOs, give analogous directions in development
definitions that focus less on income and services, and more on human thinking.’ Chapter 1 in The
rights and freedoms. By and large these definitions are consistent with Development Economics Reader,
the one we offered in Chapter 1, adapted from Amartya Sen, based on p.9.
increasing human freedom. But they are more specific, and thus more
easily operationalised in terms of activities, programs, and goals.
Aid, then, consists of financial flows and technical assistance (including
policy advice) that are meant to improve the living standards and human
potential of people in poor countries. The financial and technical resources
come from people in rich countries, either individually, or collectively via
firms, governments and other organisations. Thus aid consists of people in
rich countries trying to improve the lives of people in poor countries. Aid
can be divided into two categories:
• humanitarian assistance, which seeks to alleviate suffering and help
people survive natural disasters, wars, famines, and the like; and
56
• development aid, which seeks to provide the physical, intellectual, and

human/social inputs needed to push people and countries into virtuous
circles of physical and social capital accumulation that increase
living standards, and provide resources for further investment and
accumulation.
It is useful to contrast international development with colonialism, its
nearest historical analogue, vestiges of which continue to exist today.
Colonialism can be defined as the domination of one country or people by
another country, usually effected through military violence or the threat
of military violence. As Landes points out (1998; 423), the word ‘colony’
initially had a more innocent meaning: ‘in the ancient world it meant a
place of distant settlement – the Phoenician colony of Carthage or the
Greek colonies in Italy. But settlement, we now know, implies some kind of
displacement’, and hence victims, and so the innocence was long ago lost.
As a movement, and international mobilisation of resources, men, and
military might, colonialism reached its zenith in the late 19th century and
early 20th – what Hobsbawm (1987) calls The Age of Empire – although
its lineage goes back more than two millennia. Most authors agree that
colonialism had two overriding motives:
1. the search for commercial gain, and
2. a westernising, ‘civilising’ mission.
The extent to which the latter was sincere, or a mere propaganda tool,
or to salve the conscience of the Western intelligentsia, is a contentious
point much debated in the literature. So to is its underlying premise, that
one people or culture can be superior to another, and that the former are
thus justified in helping or forcing the latter to be more like them. We
will not engage in these debates here, beyond pointing out that even if
this ‘civilising’ mission was of far inferior importance to colonialism as a
historical phase than the prospect of commercial gain, Europeans believed
in this mission with sufficient sincerity that they were willing to bear
enormous costs, and the loss of many lives, in their attempts to ‘civilise’
the inhabitants of far-off lands, and convert them to Christianity.
International development, by contrast, does not seek to conquer foreign
peoples or nations by military force. But although its means are different,
its principal motives are strikingly similar: (1) to increase the standard
of living of the people in poor countries, the vast majority of whose
forebears were the subjects of colonialism; and (2) securing commercial
gains for donor-country firms through procurement contracts and access
to resources and markets. It seeks to do so not through conquest, but by
providing resources, especially targeted finance, on concessionary terms,
along with technical assistance and other forms of intellectual engagement
and persuasion. These similarities, added to the fact that the protagonists
of the modern international aid regime are largely the colonizing powers
of old, has led many commentators to decry international development as
the modern, softer, disguised face of neo-colonialism.
The origins of international development

To understand how international aid works, we must first understand what
the main aid institutions are, and where they come from. The international
aid regime has its roots in the immediate post-war reconstruction of the 2
Both organisations are formally
late 1940s. This is when the Bretton Woods organisations – the World part of the UN system, athough
Bank and International Monetary Fund (IMF)2 – were established, along in practice each operates as an
with the United Nations and its system of agencies, and when the system independent agency.
of rules and conventions that govern the sector were put into place.
57
Hence we can say that international development/development studies is

only about 60 years old. Compare this with political science, which as a
discipline is at least 2,000 years old; or economics, which as a discipline
recognisable to us today is some 300 years old. It is perhaps not surprising
that the field of development has not advanced further.
It is important to realise that the Bretton Woods organisations were not
designed to do international development. Rather, they were designed
to aid in the reconstruction of Europe. They were meant to work hand-
in-hand with the Marshall Plan, Lend/Lease, and other such initiatives
to direct resources towards the rebuilding of Europe’s manufacturing
capacity, shipping and rail stock, and infrastructure. In this, the Bretton
Woods organisations, Marshal Plan, etc. succeeded magnificently. Starting
from a state of war-torn ruin and famine in 1945, West Germany by 1960
was once again a dynamic, wealthy industrial society; and by the 1970s
it had become an exporting powerhouse, and beacon of democracy and
development to the world. Similar stories were true of Holland, Belgium,
Italy, and the rest of western Europe.
Having succeeded so dramatically, the World Bank in particular would
have been justified in winding down its operations and preparing for
obsolescence. But bureaucracies seldom behave in this way, and the
World Bank and its sisters did not. Instead, they found a new mission,
and justification for their existence, in the poverty and development
needs of the world’s developing countries. Conveniently, this coincided
with the decolonisation period, in which scores of new, independent
developing countries were being born that sorely lacked infrastructure,
manufacturing, and domestic savings. These mid-century developments
suited the World Bank, IMF, and similar organisations very well. And the
international aid regime was born.
It was born with noble intentions and immense optimism. These were
the organisations and methods, after all, that had helped western Europe
re-develop faster and more comprehensively than anyone in 1945 could
have predicted. Indeed, the chronicles of statesmen, planners, and other
knowledgeable observers immediately following the end of the Second
World War despair at the scale of Europe’s physical and economic
devastation. Poverty and hunger stalked the continent, in many countries
politics was chaotic and unstable, and Soviet communism loomed on
the horizon. None would have believed that in only 15 years – half a
generation – western Europe would be transformed into a wealthy,
democratic, peaceful region brimming with confidence and potential. If
so much could be achieved in a region consumed by war, surely the same
institutions could guide the new nations of Africa and Asia, and the older
nations of Latin America, to industrialisation and rapid development?
As we shall see, such bright hopes were bitterly disappointed. At the
most general level, this is because of what we can call the fallacy of
liberation, which holds that external intervention can be used to lift the
constraints that oppress the economy and society, allowing both to spring
forth, and democracy to flourish. Intervention can take the form of either
development assistance or military force. It is informed by the remarkable
experiences of German and Japanese (and other European) reconstruction
in the post-war period. Although the facts involved are of course
correct, the broad lesson drawn from them – that rapid development is
fundamentally a question of sufficient financial and technical resources,
and that foreign intervention can lift these constraints – is not. That we
continually fail to understand this is testament to the persistence of the
damaging grip that the German example has on our collective imagination.
58
In order to reconstruct the international development regime in a way that

systematically incentivises investments, innovation, and development, we
must first break free of this fallacy. But before entering into this deeper
analysis, let us first examine what the institutions and organisations of
international aid are, how they work, and what are the main sorts of aid
they have delivered over the past six decades.
Development institutions – how do they work?

The international aid regime is populated by three types of organisation:
1. multilateral agencies, such as the World Bank, IMF, and the various
regional development banks
2. bilateral agencies, such as USAID, DFID (UK), KfW and GTZ
(Germany), and others
3. and non-governmental organisations (NGOs), such as Oxfam, Save the
Children, and the Red Cross/Red Crescent.
Of these, the largest, most influential, and hence most important are the
multilaterals. Amongst the multilaterals there is a sharp functional divide
between stabilization policy and long-term development efforts:
• Stabilisation: the IMF focuses on stabilisation policy, and hence
inflation, budget deficits or surpluses, the balance of payments,
exchange rates, and international capital flows more generally. Its
concerns are more short-term, and its structure and methods are
geared towards helping developing countries during periods of
crisis. Although its work has been overwhelmingly directed towards
developing countries during recent decades, its earliest clients were
European countries; it is instructive to remember that its last loan to
the United Kingdom was as late as 1976.
• Long-term development: the World Bank and the regional
development banks are primarily concerned with long-term
investments in infrastructure, physical capital, and the provision of
primary services such as education and health that build human capital
in the population. Their focus is on subsidizing flows of resources
and knowledge to developing countries, in a context where such
investments have good rates of return, but otherwise would probably
not be made. Why are such investments foregone if they are profitable?
The answer, according to the multilaterals, is poor information, low
government capacity, an underdeveloped domestic financial sector,
and other market failures, which the multilateral agencies should be
designed to overcome.
In broad structural terms, multilateral agencies are quite similar. They
are owned by their member nations, which include developing as well as
developed countries. To join, a country must pay a capital subscription,
which varies according to the size of its economy and degree of
development. Hence the major shareholders of the World Bank and IMF
are the United States, Japan, and the countries of the European Union.
The largest shareholder, the US, owns less than 20 per cent of each
organisation’s shares. These capital subscriptions serve as a guarantee for
the funds the multilaterals raise on international capital markets to lend
on to developing countries. That is to say, the capital shares of developed
(and developing) countries are never lent on to developing countries.
Rather, they guarantee the funds that these organisations themselves
borrow for this purpose. Because of this guarantee, multilaterals can
borrow at the lowest rates available on any given day in international
59
markets. This is usually the same as the rate at which the US Treasury –
historically the world’s most creditworthy entity – borrows. They then lend
to developing countries at the same rate, plus a modest administrative
charge, typically about 0.75 per cent. In this way, developing countries
have access through the multilaterals to both short-term and long-term
finance at rates of interest which would otherwise be unavailable to them.
The next most important group of agencies are the bilaterals. Many of
these agencies grew out of previous colonial administrations, and some
retain the same regional focus and even organisational structure. Bilateral
agencies exist so that rich countries can pursue development policies that
are more clearly in their own national interest, unencumbered by the
demands and oversight of other multilateral shareholders, or the economic
analysis and strategic goals of the multilateral agencies. For example, the
‘war on drugs’ is a major component of American foreign policy, especially
towards its southern neighbours. Hence the US channels most of its
‘alternative development’ aid, meant to wean farmers off coca production
in countries like Bolivia, Peru, and Colombia, through USAID, and not
through the World Bank or Inter-American Development Bank. Similarly,
France’s efforts to maintain political and economic stability in its former
African colonies, which it regards as its ‘area of influence’, are mostly
channelled through its own bilateral development agency.
The third group, NGOs, is the most difficult to characterise. The term ‘non-
governmental organisation’ tells us why. Any group or category defined
in terms of a negative – not what it is, but what it is not – is in essence
a group that has not yet been well defined. So the NGO world is a vast,
diverse array of organisations engaged in a broad range of activities all
over the developing and developed world. What they have in common
is that they are not part of the government apparatus (hence the name),
although many received donations from governments and public agencies;
and they are not profit-seeking firms. But what they are is difficult to tell,
because they are so many things, and do so many things, that they are
ultimately, collectively nothing in particular.
Hence NGOs vary from professional, transparent, highly structured
organisations with sophisticated operations and highly trained personnel
that span dozens of countries, to small, virtually unknown ‘organisations’
consisting of one or two people, that spring to life when a donation
or contract arrives, only to go back into hibernation when the money
runs out, and staff return to their normal jobs. At their best, NGOs can
operate with the level of dynamism and effectiveness similar to the best
governments or private firms, but in sectors or activities where both
governments and firms typically fail. At their worst, NGOs can be little
more than convenient fronts that neither pay taxes nor report financial
data, for swindlers who seek to fool gullible foreigners into giving them
money in exchange for promises and hope.
In terms of magnitude, aid flows vary significantly by country. The amount
that developed countries give to developing countries varies between 0.1
per cent of GDP in the case of the United States, to 0.7 per cent of GDP in
the case of Denmark. For reference, the benchmark adopted by the United
Nations and its member countries is that aid budgets should total 0.7 per
cent of the GDP of developed nations. Most developed nations fail to meet
this target.
How important is this aid to the countries that receive it? Consider figures
from the year 2000, when the turn of the millennium prompted a large
outpouring of reflection on international aid and development. Overall
60
investment in developing countries totaled some US $1.5 trillion. The sum

of foreign direct investment (FDI) flows reaching developing countries was
about $160 billion, or about one ninth of total investment. Compare this to
total development assistance, which summed about $99 billion that year.
Compare, too, to World Bank lending, which is around $16 billion per
year, or about 10 per cent of FDI and only one per cent of private capital
flows.
Total investment in developing countries: $1.5 trillion

Total foreign direct investment (FDI): $160 billion
Total development assistance: $99 billion
World Bank yearly lending: $16 billion
Figure 4.1: Aid and investment flows compared

Source: Nicholas Stern, 2001.
Thus aid is important not because of the quantity of resources it provides

to the developing world, but because of the countries and sectors in which
it is concentrated. Most aid, especially from multilateral organisations,
goes to the poorest countries, and is often concentrated in areas – such
as education and health care – that private investment and FDI do
not serve. This is reflected in the internal structure of the World Bank,
which is divided between the International Bank for Reconstruction and
Development (IBRD), which delivers low interest loans to middle-income
developing countries, and the International Development Association
(IDA), which channels funds to the poorest countries at extremely low
rates of interest, making these ‘loans’ more like grants.
Aid is also important because at least some of the agencies that deliver
it do significant basic and operational research into such issues as the
determinants of development, the effects of particular policy reforms on
output and welfare, and the most effective ways to deliver public goods
and services in developing countries. Such research activities give these
organisations intellectual leadership. Others – including public, private,
and civic organisations – follow their lead in areas that appear to be
successful or promising. Their research also allows them to set the terms
of debate for a number of issues important to development policy, and
international trade and finance more broadly. Because multilaterals lead,
and even define, what international development is and how it should be
done, the remainder of this chapter focuses primarily on them and their
activities.
The development of development: physical capital and

the financing gap
In order to understand more deeply how development aid works, or fails
to, let us explore the principal strategies and activities that donors have
pursued since the Second World War. This period has seen seven broad
paradigms of development thinking and development policy, which have
attempted to reach fundamentally different goals based on different
diagnoses of the main problems that developing countries face. We
consider them roughly in the order in which they occurred. Note that none
ever entirely died out, and thus the paradigms overlap more and more as
we get closer to the present.
The first paradigm is based on the importance of physical capital
formation, and the financing gap. Central to this approach was the
61
Harrod-Domar growth model (1939/46), which stressed the importance of

investment to drive economic growth. Aid programs based on these ideas
diagnosed a lack of investment capital as the principal failing holding
back developing countries. This was often complicated by a shortage of
hard currency, which – in a world of currency controls and closed capital
accounts – often needed to be rationed in order to buy machinery for
plants, technology, and other investment goods.
The Harrod-Domar model was based on a simple equation that links a
country’s income to its capital stock
Y=mK + b (1)
where Y is income (GDP), K is the country’s capital stock, b is a constant,
and m is the Incremental Capital Output Ratio (ICOR) – a measure of the
efficiency with which additions to the capital stock K lead to increases in
income Y. Hence we can write
Y = m(K) (2)
where K is a change in the capital stock, and Y is the resulting change in
income. If we define the growth rate g as
g = Y/Y (3)
then we see by substitution that
g = Y/Y = m(K)/Y = mi
where i is the investment rate.
Activity 4.1
Assume you are principal development manager of a small country where national in-
come is equal to $100, the capital stock is worth $45, and minimum GDP is $10 (i.e. the
lowest level GDP would fall to if the entire capital stock were wiped out). In other words,
Y = $100
K = $45
b = $10.
What is the value of the Incremental Capital Output Ratio?
Assuming no depreciation, how much would you have to invest in new productive capital
to raise national income to $150?
This intellectual framework for development was operationalised through

the instrument of the development project. That is to say, donor countries
did not write developing countries blank checks, but rather channelled
money to them for specific investments or activities designed to raise
their capital stock in the most productive way. Taken individually, these
investments and activities, and the funds that go with them, fall under the
rubric of the project. The project can be defined as:
A coherent, self-contained set of actions, married to a discrete
budget and time frame, that are intended to produce identifiable
outputs.
Key characteristics of development projects, then, are their limited
budgets, and the fact that they have a natural beginning and end. In
intellectual, financial, and administrative terms, they are separable
from the ongoing business of government. They are meant to generate
distinct additions to a country’s productive capacity, and hence result in
measurable increments to its output or well-being.
The project is above all an intellectual construct, and a convenient tool
for packaging and administering aid resources. As a tool, it proved so
62
convenient and powerful that it significantly outlived the Harrod-Domar

financing gap approach, and is still the cornerstone of international
development activity today. Its discreteness and ‘self-containedness’ have
had a profound impact on how the challenges facing developing countries
are conceptualised, and how possible solutions to them are designed
and implemented. For this reason, the idea of the project is significantly
implicated in the successes and failures of 60 years of development efforts.
Before moving on, let us develop the parable of the road, as a narrative
that illustrates and motivates our story. This is not a true story, but
a stylised example based on many true stories, that seeks to capture
the essential characteristics and problems of each of the development
strategies reviewed below. Thus, early development professionals working
in, say, the mid-1950s in Bolivia might have diagnosed a lack of roads
as a fundamental constraint to development. Blessed with significant
mineral and agricultural wealth, Bolivia’s difficult geography and
lamentable infrastructure raised the cost of getting products to market,
reducing national income and hence available resources for investment.
The country’s capital stock was thus smaller than it should have been,
leaving the country in a vicious circle of low productivity, low output,
low investment, leading again to low productivity. The solution was
to build a road, with investment costs subsidised by international aid,
which would also bring technical and managerial know-how to the
project. Once endowed with a good road, Bolivia could export more,
increasing income, and producing more investment capital with which
to spur industrialisation, which would also benefit from more efficient
transportation. If planned well, the road could tip Bolivia into a virtuous
circle of increasing productivity, increasing income, increasing investment,
and further increasing productivity.
Continuing our example, assume the World Bank financed the road, which
was built by sophisticated contractors from abroad. Problem solved?
Unfortunately, it almost never worked out that way. The road was indeed
built, and was modern, and perhaps even beautiful. But national income
went up much less than expected, because the businesses and industries
that might have taken advantage of the road faced other, unforeseen
constraints that were not solved by the road. Thus the increasing
government revenues that might have financed road maintenance and
expansion did not materialise. And so the road began to decay. Small
potholes appeared which, untended, grew into large potholes capable of
swallowing small vehicles. This greatly reduced the productivity of the
road, and hence national output. In much less than the road’s expected
lifespan, it was little better – or perhaps worse – than the dirt road it had
replaced.
Integrated rural development

Successive development professionals who sought to understand the
failure of the road focused on the expected economic benefits that were
not realised. The problem they diagnosed was that Bolivia suffered from
other development bottlenecks – low crop yields, poor irrigation, low
health and education standards in the workforce etc. – that prevented
increases in production from happening. Thus for the road to reach its
full potential in terms of economic productivity, these other problems also
had to be solved. And so was born Integrated Rural Development
(IRD). As the name suggests, Integrated Rural Development was an
approach to international development that placed the agricultural/rural
63
sector in the centre of focus. Developing countries are (were) primarily

agricultural in terms of both output and employment, its proponents
argued, and hence attempts to develop their economies should begin here,
where they can do the most good. And as the example above illustrates,
aid interventions must be comprehensive and integrated if they are to be
successful on a scale which allows their benefits to become self-sustaining.
Another way of saying this is that the problems faced by the rural sector in
developing countries are multiple and interrelated, and cannot be solved
through a piecemeal approach that attacks one problem at a time. Rather,
an integrated approach is necessary for both sustainability and rapid
development.
And so Bolivia’s IRD specialists not only refurbished the road, but invested
in new, higher yielding seeds, provided technical assistance to farmers in
their use, and built irrigation systems to increase their harvests. Problem
solved? Unfortunately, this was almost never the case. Because although
the new seeds did arrive, they had been developed in Asia, and were not
entirely suited to local growing conditions. And the technical assistance
in how to use the seeds was late, sapping farmers’ enthusiasm and the
credibility of the project. The road was nicely refurbished, but heavy rains
caused delays, and hence significant cost overruns. And construction of
irrigation systems was held up by the road delays, and so was completed
too late for the growing season.
The failure of IRD projects was in large part a failure of integration.
Regardless of how carefully regions were studied in advance, and how
carefully IRD projects were designed, the management of large, complex,
multidimensional interventions in places where problems of that nature
had – in effect – never been solved, proved extremely difficult. It was
rarely possible to do everything that was required successfully, at the
right times and in the right sequence, in places where the challenges
in question were deeply set and intermingled. And that assumes that
‘everything’ could be known – that the physical and intellectual boundaries
of a coherent project that solved the underlying development problems
could be correctly identified. For an ‘intervention technology’ predicated
upon the importance of integration for its success, failures of integration
necessarily implied failure of the projects.
The disillusion caused by the failure of integrated rural development
was deep and even bitter. If targeted, specific interventions did not
work, and broad, integrated interventions did not work, then what did
work? How could development be spurred in the portion of the world
containing the majority of its population? Were these countries somehow
doomed to poverty and underdevelopment? The dramatic success of a
handful of small countries in Southeast Asia saved development experts
from complete despair. Attempts to study the success of countries like
Taiwan, Singapore, and South Korea coincided with the revolution in
economic theory often associated with the University of Chicago, which
stressed the the importance of competition, and the superior efficiency of
markets over public and other forms of provision. This school of thought
drew market-type lessons from the experience of the Southeast Asian
‘tigers’: their success was based on a thriving private sector that allocated
resources according to price signals emerging from competitive markets,
a high degree of integration into the international economy, and limited
government intervention in the economy.
64
Structural adjustment
Structural adjustment arose from this current of thought. According
to its proponents, the fundamental problem with integrated approaches
were not failures of coordination, or of the technical parameters of
specific components. The fundamental problem, rather, was the fact that
underlying economic incentives were distorted by an overbearing state
that interfered with markets and appropriated too many resources, leaving
too little for investment, and causing people and firms to produce the
wrong products at the wrong prices. The road did not fail because it fell
apart, but rather because full advantage could not be taken of it because
state interference in markets kept farmers and businesses from producing
the products in which they had comparative advantage. Restricted,
instead, to products in which they were less competitive, road use was
kept artificially low, generating too little revenue for its maintenance, let
alone expansion. The same was true of integrated rural development, only
more so. The rural economy did not flourish as a result of simultaneous
improvements in seed stock, irrigation, technology, and infrastructure not
because these interventions were not needed, but because the production
they were meant to encourage would have been sold in markets so
distorted that they were unprofitable to enter. Extensive intervention
in factor and product markets left the state with too few resources to
dedicate to those things it should have been focusing on. And so public
education, health care, transport infrastructure, etc. languished.
The problem with developing countries, according to this train of thought,
was that the state did too many of the wrong things (production of
private goods, intervention in markets), and not enough of the right
things (provision of public goods and services). The solution, therefore,
was to reform the state – to adjust its structure – so as to redirect it away
from areas of the economy better suited to market activity, and focus its
efforts and resources on those areas where market provision typically
fails. By ending subsidies, price floors or ceilings, and other regulations
that distorted market signals, markets would become freer and hence
more efficient, and productivity would increase. These more efficient
markets would be taken advantage of by better educated, healthier
citizens benefiting from improved public infrastructure. In this way,
reformers hoped, developing countries could be tipped into a virtuous
cycle of growing productivity, increasing investment, and accelerating
development.
Despite being a significant departure from previous aid strategies, the
intervention ‘technology’ used to deliver structural adjustment was – once
again – the project. It is curious that a set of interventions that were
policy-based, with almost no material components, fit fairly easily into
the project framework. Hence the World Bank, which led the charge into
structural adjustment – this time with few followers other than the IMF –
packaged structural adjustment programs into projects specifying menus of
policy reforms tied to specific timelines, in exchange for which it granted
governments ‘fast-disbursing’ loans or credits. These loans were meant to
finance the inevitable transaction costs accompanying the disengagement
of the state from one sector or type of activity, in exchange for others. Such
projects were meant to make the economy more efficient, and a more
efficient economy should produce increased tax revenues. Hence with a
limited number of assumptions, structural adjustment could be analyzed
as a productive investment producing a financial return. Interest on the
loan would be paid out of this return, and hence the project was viable.
65
Returning to our example, a new round of development lending no

longer focused on the road, or irrigation, or seed varieties. Rather, the
government of Bolivia agreed to a $50 million credit over three years,
in exchange for promises to end fertiliser subsidies, price controls on
wheat, rice, and soya, and reduce other regulations that interfered with
the efficient operation of agricultural markets – not only in the region
where the road was located, of course, but throughout the country. Other
promises tied to the credit might include privatising the fertiliser factory,
lowering export taxes, and lowering tariffs on farm tools and related
machinery. This last measure might effectively end Bolivian attempts to
promote a national industry in these manufactures.
Problem solved? The success of structural adjustment was initially difficult
to judge, as the intended improvements in economic efficiency were
diffused across the entire economy, and might be swamped by movements
in international prices, weather patterns that affected agricultural output,
or other unforeseen external shocks. But by the late 1980s, when many
countries across the developing world were agreeing their seventh,
eighth, or tenth structural adjustment program, it was clear that structural
adjustment was not working. After all, if a country needs a ninth structural
adjustment loan, it must be the case that the previous eight adjustments
failed to adjust the economy properly.
What caused the failure? Specific reasons varied across countries,
according to their characteristics and the particular conditions attached
to each loan. But two underlying weaknesses of the paradigm affected all
structural adjustment projects. But first is important to understand the
historical context in which structural adjustment arose. The structural
adjustment paradigm was born at a time of international market
turbulence, following the huge oil price rises of the 1970s. Rises in the oil
price hit developing countries hard, as most of them imported oil and oil-
based products. The result was large fiscal deficits, and large trade deficits,
as the price of imports rose and governments struggled with rising costs
and falling tax revenues.
Hence the first weakness of the structural adjustment paradigm. Because
of rising fiscal and trade deficits, structural adjustment programs generally
called upon governments to reduce their expenditures. Most governments
accomplished this by disproportionate reductions in health, education,
and other social expenditure. This is because such expenditure cuts were
politically easier to accomplish, as the constituencies affected are large
and diffuse, and disproportionately populated by lower strata of the
population. By contrast, reducing expenditures in other sectors harmed
the interests of narrower constituencies that were often well-connected to
social and political elites, and therefore had more voice. Hence in practice
structural adjustments too often implied a deterioration in primary public
services, even at the cost of maintaining distortionary activity in other
sectors – a direct contradiction of what they were supposed to achieve.
The second weakness is a product of ‘conditionality’ – the menu of reforms
that developing country governments agreed to in exchange for loans (or
credits). These conditions specified the reductions in expenditures and
investments that governments agreed to, as well as the public sector’s
reorientation out of certain activities and into others. Such reforms
caused significant displacements in the economy, especially to labour
markets, as many public employees had to be fired or pensioned early.
This generated significant opposition to structural adjustment amongst
voters in developing countries, and made governments unpopular. In a
sort of spontaneous technocratic conspiracy, both developing country
66
governments and multilateral organisations encouraged voters to blame

the latter for the conditions they did not like, as a tool for deflecting blame
from reformist governments that the international community sought to
support.
The effect of this was to make conditionality seem like a foreign
imposition, alien to a developing countries’ characteristics, and to the
wishes of its voters. This, in turn, encouraged governments to deny
responsibility for, and ownership of, the substance of the structural
adjustments over which they presided. The entire paradigm soon
degenerated into an elaborate game in which developing country
governments signed up to long menus of detailed reforms in exchange
for large loans, only to immediately begin backtracking, hoping to do the
minimum necessary to keep the money flowing. This had the significant
additional advantage of protecting governments’ popularity. But it fatally
undermined confidence in the Bretton Woods institutions, especially
amongst the populations of the countries they sought to serve. By the late
1990s, any agreement of any nature with the World Bank or, especially,
the IMF seemed toxic to the voters of many developing countries, and a
concrete sign of ‘surrender’. It is a sad irony that this grandest attempt of
the multilaterals to help developing countries ended up undermining belief
in the motivations and technical ability of the organisations themselves.
Human capital formation and good governance

The failure of structural adjustment to produce improvements in public
services provoked direct efforts to do the same. This coincided with a
growing consensus amongst development economists in the late 1980s
and 1990s that human capital was the key to long-term economic growth.
Because the market systematically under-provides public services, and
skews those it does provide towards wealthier segments of the population,
it was up to governments to invest broadly in these services. So began
the human capital formation paradigm, which – as the name
suggests – focused on boosting investment in education and health care,
often including rebalancing state expenditure from tertiary to primary
services in both sectors. Aid flowing under this banner continued to be
packaged into projects, which typically built or refurbished schools and
health clinics, trained teachers and health staff, and invested in improved
curricula, treatment protocols, materials and equipment.
Continuing with our example, aid agencies now returned to the area
where our road was initially built. But instead of bulldozing the
countryside and pouring asphalt, they invested in improving the education
and health of the people who lived there. So empowered, poor people
would face lower costs (e.g. from illness) and would be able to take
advantages of better economic opportunities, so earning more income and
making the economy more productive. Tax revenues would accordingly
increase, allowing government to invest more in infrastructure – such as
roads – and the country would enter a virtuous developmental circle.
Problem solved? Unfortunately, things did not turn out that way. Although
gleaming new schools and healthcare centres were built, provision of
supplies was variable and tended to decrease over time, staff reported
for work only erratically, and many of the new facilities remained closed.
Although important additions were made to the stock of education and
health facilities, the flow of education and health services increased
much more modestly. Thus the actual benefits that flowed through to the
population – where human capital was meant to be formed – were much
67
lower than expected. And so the hoped-for growth and development

benefits never came about.
Analyses of the failure of human capital formation projects focused on
the bureaucratic failures which saw new infrastructure and equipment
under-used, inadequately maintained, and ultimately degraded. The
similarities with analyses of the failure of physical capital formation
projects were striking: the fundamental problem seemed not with the
projects themselves, nor with the ‘hardware’ or ‘software’ investments they
financed, but rather with the governance systems into which they were
inserted. Poor governance prevented facilities from being used correctly,
and kept potential beneficiaries from taking full advantage of investments
that had already been made. It meant that education and health services
were run for the benefit of teachers and doctors, or central ministry staff,
or construction firms and other business interests, or local elites, or any of
a variety of other interest groups, but not of ordinary citizens.
Analysts began to note the similar poor governance roots of other
phenomena that afflicted developing countries, such as elite capture of the
institutions of government, oligopolistic business practices, the inequality
of citizens before the law, and other economic and political distortions that
decreased fairness, efficiency, growth and development in the countries
concerned. The fundamental problem that had to be tackled first in
developing countries was not a lack of physical or human capital, nor the
low productivity of agriculture, nor the structure of government finances,
analysts concluded, but rather the structure of public decision-making.
The rules that society used to govern itself, and the resources spent and
invested on its own behalf, were biased towards certain groups and against
the majority. The entire enterprise was shrouded in secrecy and mired in a
bureaucratic labyrinth that ordinary citizens found impossible to negotiate,
but which benefited peddlers of influence and corruption. So was born
the good governance paradigm, which focused on improving
the voice of citizens and accountability of government in developing
countries, improving regulatory frameworks, strengthening the judiciary,
making decision-making and resource allocation in the public sector more
transparent, and reducing crime and improving security.
Continuing with our example, the fifth generation of aid specialists who
approached Bolivia invested in programmes that trained judges and
lawyers, and reformed the judiciary to improve the professional incentives
they faced. They reformed electoral laws and invested in modern voting
machinery that might help reduce fraud. They funded management studies
of parliamentary and congressional procedures in the hopes of making the
legislature more efficient and transparent. They bought computers and
software for many branches of government, and trained people in their
use. And they reformed or attempted to establish civil services across the
developing world. But the delivery ‘technology’ did not change; aid of this
type continued to be delivered in project form.
As with structural adjustment, but more so, the effectiveness of good
governance-type aid is difficult to assess due to the immaterial character
and diffuse spread of intended benefits throughout society. And the
concept of aid for good governance is still too new for a comprehensive
assessment of its results to be made. But it is safe to say that the countries
receiving such aid do not seem to have grown faster as a result, nor
have their governments show appreciable improvements in probity,
transparency, or public service efficiency.
68
Learning activity 4.1

Consider the case of Zaire (now the Democratic Republic of the Congo), which received
large aid flows during its first four decades of independence (1960–2000). During this
same period, public infrastructure decayed notably, and the population grew significantly
poorer in both absolute terms and relative terms. What role do you think large aid flows
played in these developments?
By now we have reached the early 1990s, and the international aid
‘industry’ was nearing its fiftieth birthday. The approaching milestone
prompted many analyses of the failures of aid, much of which blamed
the development project per se. Bundling budgets, actions and timelines
together into discrete packages may be convenient for donors and aid
workers, but it made no sense intellectually, the critics charged. There
is no sense in which the development process, or the actions required to
promote it, can be separated into distinct pieces that that can be designed,
financed, and managed independently from the rest. And resources are
interchangeable, so tying money to particular actions or investments is a
nonsense.
In other words, the project is the problem. Aid delivered via project
‘technology’ inevitably fractures the systems for delivering public
infrastructure and services that it is precisely trying to strengthen. It may
facilitate labelling/crediting exercises that are convenient for donors (e.g.
‘This bridge was financed by USAID and the people of the United States
of America’), but in doing so it breaks up and disperses responsibility for
public sector outcomes, which should accrue unbroken to elected officials,
not numerous foreign agencies. It multiplies and complicates public
administration in developing countries, which must learn to cope with
donors’ different – even conflicting – systems of budgeting, contracting,
procurement, reporting, and assessment, often operating alongside each
other in the same sector.
Most importantly, the project is inherently, unavoidably unsustainable
by definition. And so, therefore, are the actions it promotes, regardless
of their character. So long as development projects feature a discrete
budget tied to a specific timeline – which all of course do – the actions or
investments they sponsor will end when the project does. Donors have
long tried to circumvent this problem by requiring developing countries to
promise to assume the recurrent costs that project sustainability implies.
And developing countries have by and large made such quixotic promises,
in order to get the aid projects. But inevitably, over 60 years, the projects
end, developing country governments fail to allocate the promised
resources, and the facilities or infrastructure financed by the projects cease
to function and fall into disrepair. With the relevant projects officially
closed, donors have little leverage over governments, and little incentive
to pursue the matter. They could, of course, adjust future aid flows as a
function of past sustainability. But this has very rarely happened.
Progamme lending, SWAPs and GBS

Programme lending and Sector-wide approaches (SWAPs)
emerged as responses to this analysis. If the project was the problem,
then it should be eliminated. Programme lending did this by tying a
specific set of investments – for example, building a number of health
clinics – to a policy dialogue that committed the government to reorienting
expenditures in that sector, and prioritising activities that the donor
argued were important. This amounted to giving donors a seat at the
69
policy table, and solved the problem that individual investment projects
were typically too small to give donors significant policy leverage. Sector-
wide approaches took this logic further, by linking program lending to
structural adjustment loans. One of the aims of SWAPs was to work in
partnership with sectoral ministries. This was partly in response to the
perceived failure of structural adjustment conditionality, which was seen
as being excessively adversarial in nature. By providing common vehicles
that different donors pledged funds to, both program lending and SWAPs
pushed donors to coordinate much more, which reduced transaction costs
for developing countries.
Thus the sixth generation of aid professionals to land in Bolivia arrived
with pots of money, but no specified budgets or timelines. Rather than
design and finance a road, they engaged in a policy dialogue with the
Ministry of Transportation about how the road network could be extended
and made more efficient. They agreed a program with the authorities that
used capital-intensive techniques for asphalt-topped trunk roads, labour-
intensive stone and brick methods for intermediate roads, and improved
dirt roads for tertiary routes with more frequent maintenance. And they
committed resources to it alongside government and other donors.
The last paradigm, and the most recent to emerge, is general
budgetary support (GBS). This takes the movement towards program
lending and SWAPs one step further, by untying aid from specific actions
or sectors. Under GBS, donors engage in a broader policy discussion with
governments about their problems and goals, but do not dictate specific
actions. Agreement on development goals is turned into specific indicators,
such as infant mortality or illiteracy rates. Donors then channel aid into
the overall budget, and not to certain ministries or sectors. Governments
inform donors using their own accounting systems, and do not submit
to intrusive donor evaluations. GBS is conceived as a partnership, with
mutual obligations and accountability on both sides. Entering into it
implies a commitment by donors to continue aid flows into the medium
term. This is meant to provide a measure of predictability for government
budgets, and sustainability of development efforts. GBS represents the
final deconstruction of the development project. It is far too soon to judge
what effectiveness it may have.
Has aid worked?

Developed countries have spent an estimated $2 trillion since 1945 trying
to improve the lives of the world’s poor, and bring development to their
nations. What has this vast expenditure achieved? After reading the
previous section, it will come as no surprise that the evidence is not good.
In the very best case, the evidence is mixed, leaving no clear empirical
grounds for stating that aid promotes development. Although a 2000 study
by economists at the World Bank3 found that aid has a positive impact on
3
Craig Burnside and David
growth in a subset of developing countries with good fiscal, monetary, Dollar ‘Aid, Policies, and Growth’
and trade policies, these results were overturned by another study that American Economic Review,
extended the dataset to include more years. These studies spawned an 90(4), 2000, pp.847–68.
outpouring of research on the effectiveness of aid, along with a heated
debate about appropriate methodologies for estimating it. Although many
papers have since been written on the issue, little has changed in the
underlying paradox. The evidence implies that $2 trillion of expenditures
over 60 years have left us with little to show for our efforts.
To probe the matter further, and to understand why this is the case,
consider the following figures, taken from a 1998 study of politics and aid
70
effectiveness.4 Figures 4.2 to 4.7 plot the relationship between aid received 4
Boone, P. and J.P. Faguet.
by developing countries as a proportion of their GNPs, and a number 1998. “Multilateral Aid, Politics
of outcome variables of interest that might be positively influenced by and Poverty: Past Failures and
aid. The data cover 96 developing countries between 1971–1990, and Future Challenges”, Chapter 2
come from the World Bank. Figure 4.2 plots aid as a proportion of GDP in R. Grant and J. Nijman (eds).
against per capita growth rates, using ten-year moving averages. If aid The Global Crisis in Foreign
were effective in increasing economic well-being in developing countries, Aid. (Syracuse University Press:
we would expect to see a positively sloped line, implying that aid flows Syracuse, New York.)
increase per capita growth rates in the receiving countries. The line that
we do see is positively sloped, but the slope is so small as to make the line
nearly flat. Indeed, the regression co-efficient on aid/GNP is statistically
insignificant, implying that our best estimate of the slope is zero (i.e. the
line is in effect flat, and aid has no effect on economic growth.)
0.0
Per Capita Growth Rate
-0.1
0 0.05 0.1 0.15

Aid/GNP
Figure 4.2: The impact of aid on growth

Source: Boone and Faguet (1998).
But aid does not only target economic growth. Much aid is focused on
specific social outcomes, which can be directly measured. It is possible
that such goals are being reached even if there is no aggregate effect on
economic growth. The following three figures investigate whether or not
this is true. If aid were effective in improving the health of developing
countries’ citizens, we would expect infant mortality to decrease as aid
flows increase, and life expectancy to increase as aid flows increase. Figure
4.3 shows that infant mortality decreases very slightly as aid/GNP rises,
but the slope is tiny and the coefficient is again statistically insignificant,
implying no relationship. Figure 4.4 shows that life expectancy seems to
decrease as aid flows increase. But the slope is tiny and the co-efficient is
statistically insignificant, implying once again no relationship. If aid were
effective at improving education in developing countries, we would expect
to see a positive correlation between aid flows and indicators of schooling.
Figure 4.5 plots aid/GNP against changes in primary school enrolment
ratios. The line is negative, implying that aid flows worsen educational
outcomes.
71
0.5
Change in Log Infant Mortality

0.25
-0.25
-0.5
-0.1
0 0.05 0.1 0.15

Aid/GNP
Figure 4.3: The impact of aid on infant mortality

0.5
Change in Log Life Expectancy
-0.05
-0.1
0 0.05 0.1 0.15

Aid/GNP
Figure 4.4: The impact of aid on life expectancy

0.4
Change in Log Primary School Ratio
0.2
-0.2
-0.4
0 0.05 0.1 0.15

Aid/GNP
Figure 4.5: The impact of aid on primary school enrolment

72
How could it be that such large aid flows ostensibly targeted at some of
the key constraints facing developing countries appear to have had no
beneficial effect on any of them? Figures 4.6 and 4.7 tell us why. In Figure
4.6, we see that aid had no effect on total investment in the 96 countries
for which we have data, over 20 years. This implies that even if the
resources that flowed from donors were invested in these countries, they
did not add to investment, but rather substituted for domestic resources
that would otherwise have been invested, leaving no net effect. Figure
4.7 bears this out. There is a strong, positive relationship between aid
flows and consumption in our 96 countries. That is to say, the significant
aid flows these countries received between 1971 and 1990 were not
invested – they were ‘eaten’. In practice, they were probably consumed by
elites with preferential access to politicians, decision-makers, and public
accounts. It is possible that much of this consumption was carried out by
poor people, but it is highly unlikely. In any case, we can say for certain
that aid resources were not invested in the education and health services
that developing countries require for rapid development, which poor
people typically lack but rich people do not.
0.2
0.1
Total Investment/GNP
-0.1
-0.2
0 0.05 0.1 0.15
Aid/GNP
Figure 4.6: The impact of aid on total investment

0.2
0.1
Total Consumption/GNP
-0.1
-0.2
0 0.05 0.1 0.15
Aid/GNP
Figure 4.7: The impact of aid on consumption

73
Institutions, incentives and aid

The situation we are left with is dire and depressing. Vast sums of money
have been channelled to developing countries over the past six decades
under a broad range of strategies and approaches, with very little apparent
effect. Only a small handful of the world’s 130+ developing countries have
made rapid progress, and many of the remainder have either stood still or
moved backwards. Why have so much money, enthusiasm, and some of
the brightest minds in the social sciences failed?
To answer this question, let us ask, first, a simpler one: If capital exhibits
decreasing returns to scale, why don’t poor countries develop more
rapidly? This question is based on an idea that is highly ingrained in
economics: decreasing returns to scale. In essence, it implies that the
benefit of adding more and more capital to a given system of production
decreases as the stock of capital rises. For example, imagine a factory
consisting of a team of workers that have no tools or machinery. As a
factory owner invests in tools and machinery – productive capital – the
output of the team will increase very rapidly. But after a time, once each
member of the team has all the basic tools she requires, the addition
of further capital produces smaller positive gains in output. Production
continues to rise as tools or machines are added, but less quickly than
before given a constant number of workers.
The obvious economic difference between developing and developed
countries is that the former have relatively low levels of productive capital,
whereas the latter have relatively high levels. The principle of decreasing
returns to scale thus implies that capital should be more productive – and
hence more profitable – in developing countries. This, in turn, implies that
capitalists will choose to invest resources in poor countries, where the
return is higher, and also that developing countries will as a result grow
more quickly than developed countries, eventually catching up with them.
That this plainly does not happen must be the result of some external
constraint or distortion that prevents the economic logic described from
operating in the way that it should. If this blockage can be identified and
targeted effectively, then international aid makes sense and aid should
work. If aid does not work, as it appears not to, then it must be the case
that either the blockage has been misidentified, or the tools used to
remedy it are ineffective. To understand which of these is correct, let us
analyse the current aid regime in terms of its underlying assumptions
about the main obstacles that developing countries face, and the main
solutions that aid offers for these problems.
The main assumption that motivates aid flows is that developing
countries face a shortage of capital. This is why poor countries with a
low capital stock, which therefore have many opportunities for highly
profitable investments, actually invest very little. It therefore justifies the
aid community’s offer of loans and grants to such countries. But is the
assumption correct? Underdeveloped financial markets – especially in
developing countries themselves – along with extensive capital controls
in developed countries, implied that the assumption was probably correct
in the immediate post-war period. But rapid financial liberalisation
and integration throughout the world, combined with the rapid pace
of financial innovation, mean that developing countries today have
greater access to private capital markets today than they ever had in
the past. Well-managed developing countries can access international
capital via both bond markets and bank loans, without the need for
donor intermediation. And developing countries that are badly managed
74
should not be lent money by donors because they are unlikely to pay it
back. Hence the assumption that developing countries require special
organisations to provide them with capital no longer holds.
The second assumption is that developing countries suffer from high levels
of ignorance and worse information than developed countries, limiting
their ability to make favourable policy decisions, and thus keeping them
from catching up with the developed world. If true, then donors – and
especially multilateral institutions – have a role to play, leveraging their
expertise and cross-country experience to the benefit of poor countries.
It is arguably true, once again, that this assumption was correct in the
immediate post-war period, when the very little that was known about
development was concentrated in the already-developed countries. But
the vast growth of academic production, and its wide dissemination
through modern information and communications technologies – above
all the internet – imply that the frontier of knowledge about development
is available to any country whose governments are willing to look for it.
Hence the assumption of poor information is also no longer true.
A third assumption is that developing countries are plagued by bad
institutions, which produce distorted incentives that lead to bad policy,
and hence continuing poverty. Which aspects of the international aid
regime does this assumption justify? Unfortunately, there appeared to be
none. Indeed, if distorted institutions comprise a significant blockage to
development, then international aid may well be counterproductive, as
multilateral and bilateral donors work overwhelmingly with developing
country governments, thus empowering those whose decisions are shaped
by perverse incentives. Is this assumption correct? As we shall see in the
chapters that follow, distorted institutions and perverse incentives are
large and growing problems that explain a large part of the variation
between countries that are poor and the rich, developing and developed.
Thus it appears that the two principal blockages to development that
aid is designed to attack are no longer relevant. And aid does little to
address the institutional blockage that is a large and growing problem in
developing countries. Indeed, aid may unintentionally exacerbate its ill
effects. Consider how the international aid regime, viewed through this
lens, operates: Donors lend money to developing country governments
to pursue positive net present value (NPV+) projects. NPV+ projects can
be defined as investment projects (e.g. a road, a factory, a school) that
will produce a positive return (to an individual, firm, government, or
society more broadly) net of all investment costs. Finance theory makes
the intuitive point that all NPV+ projects should be financed, as all are
profitable to the investor.
But this logic implies that developing country governments should
pursue NPV+ projects anyway. They should begin with the projects that
promise the highest returns, and then work their way down until they
have executed all projects available to them whose NPVs are greater than
zero. As we have discussed above, finance for such projects is available to
reasonably well-run developing countries on open international capital
markets. Hence if developing country governments are not investing
in NPV+ projects, one of two things must be true: either they are not
sufficiently well-managed that they are likely to repay their debts, and
international markets will not lend to them; or they face strong and
persistent incentives to spend resources in ways other than NPV+ projects.
In the former case, it makes little sense for donors to finance long-term
development projects, as – ignoring the question of repayment – the
chances that projects will be well executed are small. It is worth noting
75
here that capital markets’ standards for countries that are ‘reasonably well-
managed’ are low, referring overwhelmingly to their public finances, and
not to their openness, transparency, or the degree of political or human
rights that are guaranteed.
If the case is the latter, then we must ask ourselves: Will giving such
governments a loan or grant somehow overturn the systematic incentives
they face to avoid NPV+ projects? If government officials face systematic
incentives not to invest in projects that will help the economy grow and
improve the welfare of citizens, what exactly will be accomplished by
providing them with cheap money? Worse, what will be accomplished by
providing them with cheap money in a world where aid agencies wield
few sanctions beyond the threat of reducing future aid – a threat which
they very rarely carry out?
The answer, as we have seen above, is little in the way of development.
That this is so can be explained at least in part by the perverse incentives
that the current aid regime generates. Because poorer countries and
countries with lower savings receive more aid, aid provides a material
incentive for developing countries to maintain low rates of investment.
This, in turn, holds back developing country growth. Thus aid begets
poverty. Because countries with bad policy tend to be poorer, and therefore
receive more aid, aid begets bad policy. Because the job of bad government
officials, who fail to make their country develop, is facilitated by aid, aid
begets bad government officials. And because all of these pathologies keep
countries poor, and thus continuing subjects of aid, aid begets aid.
The key to understanding the performance of international aid over the
past 60 years is to understand the mistaken assumptions upon which the
aid regime is built, and the perverse incentives that aid flows therefore
create. A detailed recommendation for how to reform the system of
international aid is beyond the scope of this chapter. But in order to attack
the problem, one would have to begin with the question of incentives. If
foreigners have a role to play in fomenting development in developing
countries – a claim that we should approach with scepticism – it must be
by creating or strengthening incentives for developing country leaders to
do things that tend to lead development, and refrain from doing things
that block economic growth and decrease levels of human freedom. The
remaining chapters examine the role of institutions and incentives in
expanding both prosperity and freedom. We returned to the question
of what development managers can do to actively pursue both goals in
Chapter 11.

• define ‘international development aid’
• define ‘development’ and contrast it to ‘colonialism’
• explain what the ‘development project’ is and how it works
• explain the historical origins of international development, and their
importance for the current array of institutions and organisations that
characterise the sector
• give a detailed account of the perverse incentives that institutions and
organisations create and sustain
• discuss the links between these incentives and the perverse outcomes
that result.
76

1. What is the ‘development project’ and why has it been central to the
delivery of international development aid?
2. ‘Structural adjustment’ is simply ‘colonialism’ by another name. Discuss.
3. It is a curious paradox that an international aid regime which
increasingly stresses the importance of institutions is itself
institutionally dysfunctional. Discuss, connecting major institutional
features of the post-World War II regime with empirical results from 50
years of development efforts.
77
Notes
78
Part 3: Private provision
Part 3: Private provision
79
Notes
80
Chapter 5: Hierarchy, cooperation and incentives in private firms
Chapter 5: Hierarchy, cooperation and

incentives in private firms
Aims of the chapter

This chapter is concerned with the private sector firm as organisational
form. This means the internal structure of firms, the incentives these
structures create, and the behaviours such incentives promote, both at
the level of individuals working within firms, and the behaviours and
performance of firms per se. It is a topic important for countries at all
levels of development, and in all regions of the world. Indeed, it is a topic
too often understudied by theorists and practitioners of international
development.
Learning outcomes
• explain why firms exist in a market economy
• describe the most important characteristics of the firm as organisational
form
• give a detailed account of the internal incentives that the firm’s
structure creates, and the relationship of these with firm performance
• contrast the private sector firm with the government bureau (per
Chapter 2) in terms of structure, incentives and performance.
Essential reading
Alchian, A. and H. Demsetz ‘Production, information costs and economic
organization’, American Economic Review 62(5) 1972, pp.777–95.
Coase, R.H. ‘The Nature of the Firm’, Economica (4) 1937, pp.386–405.
Semler, R. ‘Managing without managers’, Harvard Business Review 67(5)
Sep/Oct 1989, pp.76–84.
Further reading
Bonin, J. et al. ‘Theoretical and empirical studies of producer co-operatives’,
Journal of Economic Literature, 31(3) 1993, pp.1290–1320.
Williamson, O. The economic institutions of capitalism. (New York, Free Press,
1986) [ISBN 9780029348215] Chapter 10.
Introduction
To understand why the theory of the firm is important, consider the
following questions: should firms be hierarchical or flat? large or small?
participative (unruly) or vertically disciplined? Consider further the
overarching trends of the past 50 years. Throughout the western world,
the 1960s and 1970s saw the growth of large commercial and industrial
conglomerates. Such firms spanned a broad range of products, often with
few similarities amongst their underlying businesses. Examples include
General Electric and Unilever, which brought together under the same
roof businesses as diverse as jet engine and light bulb manufacturing with
financial services.
81
Two decades later, the late 1980s and 1990s saw a huge wave of private
sector slimming down and deconstruction, as firms focused on their ‘core
competencies’, subsidiaries were spun off, and management structures
deemed excessively complicated and bloated were ‘de-layered’ and
simplified. Do these changes amount to little more than corporate fashion,
akin to skirt lengths increasing and decreasing over time, or changing fads
in hairstyles? Or is there something systematic and theoretically grounded
that we can say about how firms should be structured, what their optimal
size is, and hence which of these historical periods came closer to getting
it right?
Consider also the following remark (paraphrased) by the great economist
Ronald Coase: All of neoclassical economics is as consistent with a world
economy consisting of a single firm subdivided into an infinite number of
divisions and subdivisions, as it is with a world economy composed of an
infinite number of small, independent firms. But when we look across the
real economy, we see neither extreme. What we see is systematic variation
across sectors, and across economic activity by type.
Hence the global market for long-range passenger aircraft is dominated by
two firms: Airbus and Boeing. And the global market for regional aircraft
is dominated by a further two firms: Embraer (of Brazil) and Bombardier
(of Canada). The international automotive industry is dominated by
between 15 and 20 large international firms (producing a larger number
of automobile brands), who exist alongside a much larger number of
small, local producers based mostly in Asia. And lastly, the food retailing
business is characterised by a few gigantic international corporations with
long, complicated supply chains that sell food across many countries (e.g.
Wal-Mart, Carrefour), an enormous number of small, often family-run
food markets (the familiar ‘corner shop’), and essentially every form of
organisation in between.
Why do different sectors have different types and sizes of firms? Are
the differences noted above coincidental, or do they respond to deeper,
underlying characteristics of the firm as organisational form? As Coase
noted, neoclassical economics had very little to say about such questions
in his time. But theory has advanced since then. Institutional theory, and
in particular the New Institutional Economics, has made significant strides
in recent decades in understanding the deep logic of the private firm, how
it is structured, how it operates, and hence how its size and shape should
optimally vary across sectors and functions.
These are the issues that this chapter will seek to elucidate. But it is
important to note that their significance does not end with a static analysis
of the world economy, nor even with an analysis of corporate trends
over time. The theory of the firm has implications for a range of political
economy issues of surprising range and importance. The political and
economic competition between capitalism and communism (in particular
the Soviet bloc) was in large part a question of how best to structure
productive units within the economy (i.e. firms). Under communism, there
was a much smaller number and variety of ‘firms’, and a much greater
degree of central control and coordination. The desire to achieve large
economies of scale was central to Soviet economic policy, and hence small
productive units were seen as backwards and wasteful. Under capitalism,
by contrast, the number and variety of firms (by structure, internal
organisation) is much greater, and the degree of active coordination
amongst them much, much lower.
How firms are structured is also centrally connected to questions of
efficiency and employment in the economy. Indeed, the striking economic
82
success of Japan in the 1980s was commonly attributed to Japanese

corporate practices, in particular the greater involvement of ordinary
workers in decision-making, and a less bureaucratic, more participative
firm culture more generally. This led Western firms to mimic a number of
Japanese practices in terms of worker relations and internal organisation,
thus underlining the importance of the topic to questions of equality,
democracy and workers rights in the workplace as well.
The traditional capitalist firm (late nineteenth century)

To understand the theory of the firm, it is useful to begin with Marx’s
attempts to understand the structure and function of the firm in the
economy, and consider the most important characteristics of real firms
that existed at that time. Consider a private firm as it would have looked
in the late nineteenth century (in Britain, Germany or the United States
for example). Such a firm was dominated at the top by one or a small
number of capitalists. These are the people who owned the firm, who
hired the day-to-day managers of the firm, who took important decisions
about production, products, and the future direction of the firm, and who
appropriated any profits that the firm produced. The main organisational
tools they employed to run their firms were a hierarchical management
structure, and hierarchical (vertical) organisation of the firm more
generally. Management, monitoring, and relations of authority more
broadly were based on command and control.
These structures and practices were predicated on the existence of an
uneducated, largely unskilled workforce, who laboured in large numbers
for a small number of managers and a smaller number of capitalists. The
tasks that these workers engaged in were simple, repetitive physical tasks
employing mechanical technologies to make things. The markets into
which such firms sold their products were broadly stable, in the sense that
products and production technologies changed slowly over long periods of
time.
At the bottom of the hierarchical pyramid, the system was anchored in
what Marx called the ‘reserve army of the unemployed’. This consisted
of a previously rural population displaced to the cities in search of
employment, who lacked welfare programs and social safety nets, and
were thus desperate to work at whatever wages they could find. The
existence of this reserve army strengthened the power and control that
capitalists wielded over workers. This is because any one of the latter
could be replaced at very short notice with another uneducated, unskilled
worker equally useful for the simple, repetitive tasks the firm required of
her.
The scientific advances of the day reinforced these labour relations.
Consider the time-and-motion studies of Frederick Winslow Taylor. These
were careful, detailed, highly formalised studies of production processes
which sought to increase efficiency within firms by simplifying and
regularising tasks. They were part of a movement known as ‘scientific
management’. One of Taylor’s most famous discoveries, for example, was
that the optimal shovel held a payload of 21 pounds. This is because a
typical worker of typical strength at that time (1910s) lost productivity by
wasting scooping motions with respect to total payload if equipped with
a smaller shovel; but the same worker grew tired too quickly if the shovel
exceeded 21 pounds.
Monitoring and domination in labour relations thus came to define the
internal organisation of the firm. This was consistent with the function of
83
the firm in the broader economy, which according to Marx was to organise
production in a fashion which extracted ‘surplus value’ from the workers
who produced things, in order to put it into the hands of the capitalists
who owned things. The work of the latter was facilitated by the capitalist–
government nexus, a corollary of the simple fact that capitalists and
politicians belong to the same class, studied at the same schools, join the
same gentleman’s clubs, intermarried, and ultimately looked out for each
other. Hence capitalists could rely on government to make policy amenable
to them, to protect them from episodic uprisings or violence directed at
them or their interests, in exchange for financial and political support at
election time.
In this way, the capitalist class grew continually richer, while the working
and unemployed classes grew poorer and more desperate as the ranks
of the reserve army of the unemployed swelled. This led naturally to the
concentration of capital in the hands of a few, and increasing polarisation
within society, which mimicked increasing levels of control and
polarization within the firm, Marx wrote. Both were signs that the firm
was doing its job.
It is evident that the reserve army of the unemployed plays a crucial role
in the story. One might reasonably ask where this reserve army comes
from? A somewhat stylised explanation is as follows. Consider the rough
equilibrium of the pre-industrial economy: more or less full employment
was a product of a large, labour-intensive agricultural sector, and small-
scale, low-technology cottage production of manufactured goods by
artisans working in workshops throughout the country. Consider, then,
the considerable disequilibrium of the Industrial Revolution. Rapidly
advancing technologies transformed the production of manufactured
goods such that a small number of workers using (then) advanced
machines could produce enormous quantities of goods, far more than a
much larger workforce had done before. In this way, weavers, shoemakers,
carpenters, and artisans across the entire economy were put out of work.
As the Industrial Revolution intensified, their ranks strengthened. The
application of industrial technologies to agriculture put farm labourers
out of work, thus worsening the problem further. These casualties of the
Industrial Revolution became Marx’s reserve army of the unemployed.
Marx confidently predicted that the continual impoverishment and
oppression of the working class would eventually lead them to see their
common interests, in opposition to those of the capitalist-government
nexus. The former would then rise up and overthrow not just the
government but capitalism, and a new era of socialism would be born. He
expected the revolution to come first in Germany, the most industrially
advanced nation of his time, and then spread throughout the industrialised
world. He was proved wrong, and the reasons include both broad political
and social changes in western countries, and significant changes in the
way western firms are organised and run.
The modern firm (ca. 2008)

The modern firm of our own times is a very different animal from that
which Marx observed. Its employees are largely educated, sophisticated
professionals concerned with their careers. The tasks they carry out are
complex and often highly intellectual. These tasks rely on electronic
and biological tools, ranging from personal computers to machines and
technologies that the nineteenth century could not have imagined. The
sorts of causation that define production in the twenty-first century firm
84
are organic, with multiple cause-and-effect. The markets that firms engage
in are far more fluid (unstable), in terms of both products and supplies.
And the degree of overlap between workers and managers is far greater.
These simple facts have a number of profound implications for the
characteristics and internal dynamics of the modern firm. Firstly, workers’
rights are protected, and their training – both within and outside the
firm – is given high priority, and often subsidised by the firm. This is
in the interests of both firm and workers, as it supports the production
and careers of both. Secondly, teamwork and participation are far more
important to the profitability of the firm. This is because production is no
longer linear, mechanical, and repetitive. Modern production is, instead,
sufficiently complex that teams of highly specialised professionals are
required to make it work. Such professionals have deep insight into the
characteristics of the production process per se, and hence their opinions
come to be highly valued within the firm.
Workers are far more autonomous than anything the nineteenth century
witnessed. More creativity and decision-making is devolved to worker
level by the firm, because the production process demands it, and hence it
is profitable to do so. In such an environment managers do not command,
but rather persuade. The characteristics of production, and the degree of
specialised knowledge that it demands, require managers to enlist workers’
goodwill, not just their physical strength, if production and profits are to
be maximised.
Fifthly, authority within the firm comes from knowledge, experience,
and the goodwill of colleagues, not simple position or rank. Command-
and-control is ill-suited to complex, specialised production teams, where
enthusiasm is key to successful teamwork. Hence managers have to
develop authority in different ways. As a result of this, there is a far more
intertwined destiny between capital and labour than in the factories of old.
It is far, far more costly in terms of lost knowledge, experience, goodwill,
and reputation to fire workers today, and hence the machines in which
firms invest are often tailored to the characteristics of their workforce, and
not vice versa.
Lastly, firm operations are characterised far more by structural flexibility
(effective reaction) than in Marx’s day, and far less by planning
(controlling the future). The strategic planning that firms engaged in
once has given way to tactical planning in an uncertain and unpredictable
environment today.
Underlining these changes are a number of broad phenomena that
characterise the modern world. The first of these is the simple observation
that the economic and social environment in which firms operate is far
more dynamic and unpredictable than in centuries past. Things change
faster than before, and in a greater variety of ways, and this affects not
just firms’ products, but their structures and procedures as well. An equally
powerful factor are the long-term social changes that have characterised
western societies in the post-war period. These include the rise of the
welfare state, deepening democracy and expanding human, civic, and
political rights, and the rise of a prosperous and politically powerful
middle class.
A final factor might be called the pervasive instability of punctuated
equilibrium. Here, the confluence of technological progress with economic
growth leads to episodic and unpredictable economic and technological
earthquakes, such as the rise of the personal computer, the internet, and
mobile telephony, which create and eliminate entire markets in very short
85
periods of time. From the point of view of firms and their managers, they
are heaven-or-hell scenarios which can quickly multiply firm size, or kill a
firm overnight. Shareholders and managers thus expend significant energy
attempting either to generate such disequilibria, or insulate their firms
from them, or both.
Thus we see that the capitalist firm has changed out of all recognition in
the past century and a half. A good theory of the firm needs to understand
both paradigms, and the transition between them. This chapter considers
three broad classes of theories of the firm: Marxist, neoclassical economics,
and new institutional economics. The first of these has been adequately
outlined above. Hence the following focuses on the latter two.
The neoclassical view of the firm

The neoclassical view of the firm begins with two assumptions:
1. firms seek to maximise profits; and
2. the competitive markets that a firm inhabits comprise a dynamic,
Darwinian system for the survival of the fittest.
Firms producing products that are either better or cheaper than their
rivals’ increase their profits. Competitors see their profits decline, and
either fight back by improving their products and/or business practices, or
eventually go out of business. Business practices can be improved in terms
of the technologies a firm deploys, or the way it organises itself internally.
The crucial point about the neoclassical view of the firm is that, in effect,
there isn’t one. Economists don’t need to know what the firm looks
like, because they know what the firm does: it maximises profits. In an
evolutionary system operating over time, those firms that survive must by
definition have adopted the most advantageous organisational forms, and
the best technologies, because these are necessary in order to produce the
best products at the most competitive prices. And that must be what the
firms that survived did in order to survive.
Neo-classical economists view the firm as a black box which engages in
profit maximizing behaviour, the structure of which it is unnecessary to
understand. At any point in time, existing firms must possess efficient
technologies and efficient internal structures, or they would have ceased
to exist. Furthermore, in a competitive context where markets and
technologies can move rapidly, the characteristics of currently successful
firms tell us a little about what successful firms in the future might look
like. Hence studying firm structure is of limited interest, and neoclassical
economists by and large do not do it.
π =R–C
= pQ – (wL + FC)
Figure 5.1: The neoclassical view of the firm
86
The new institutional economics view of the firm

Unlocking the black box of the firm was one of the first priorities of a new
school of theorists that came to be called New Institutional Economics
(NIE). One of the earliest, and most illustrious, of these was Nobel
laureate Ronald Coase, who focused on transaction costs, and their
implications for standard models of economic behaviour. Indeed, the
new institutional economics was initially known as the ‘transaction costs
school’.
Coase (1937)
Coase’s approach to the question of the firm begins with the observation
that western economies are typically characterised as market economies,
not firm economies. Why do we have firms? Why not have all production
in the economy organised via market transactions? And if we are to have
firms, how big should they be? Will a firm operating in a market grow
and grow until it contains the entire market within it? If not, how do we
analytically delineate the frontiers between the firm and the market?
Coase approached these questions by noting that establishing a firm
signifies replacing market mechanisms (in particular, spot market
mechanisms) with internal fiat. What would happen to a firm that
disbanded itself, and sought to reorganise along pure market lines? To
answer this question, imagine that you own a company that makes tennis
rackets. In particular, you own the building that houses the tennis racket
factory, and you own the machines located inside. You have decided
that internal fiat is not for you, and you are going to use spot market
mechanisms to organise your production. Every morning you go down
to ‘the market’ – imagine a large area not unlike an open-air food market
– and look for workers to hire. You go around the market making offers to
potential employees to work in your factory that day. Different individuals
consider your offers; some accept, others decline.
Activity 5.1
Define ‘spot market’. Can you think of some examples?
Which of the following goods would typically be bought in a spot market?
• gold
• oil
• a house
• life insurance.
Once you have found enough workers with the right mix of skills and
experience to operate the machines in your factory, you go to the factory,
and the day’s production begins. At the end of the day, you pay all of your
workers the agreed rate, they all go home, and the following day you
begin again from scratch.
Although this model sounds ridiculous in a world accustomed to firm
production, it might just about be feasible. But it would impose a number
of important costs on you, the firm owner, which it is important to
consider. First and most obviously, the transaction costs of wading into the
market place to look for your employees every morning are likely to be
very large. This is a pure transaction cost that does not add value per se,
and time that would be better spent, for example, designing new products,
or studying company accounts in order to reduce costs.
87
Secondly, the pure market model would insert a significant degree of

instability into your workforce. You, the owner, would never know from
one day to the next whether an employee who is particularly hard-
working, honest, or otherwise useful to have around the factory might be
available to work for you. Any incipient team-building that might occur
in your factory, as people learned to work with each other and so became
more productive, would be destroyed each time the team disbanded, at
the end of each day. And at certain points in the economic cycle, when the
labour market tightens, you might not be able to find anyone to occupy
certain positions, leaving your factory operating at reduced capacity, or
even closing it down altogether.
Thinking through this example answers Coase’s question: why is all
production not organised according to spot market principles? Firms
appear because they lower the cost of market contracting. It is simply
more efficient to have firms. Firms replace continuous spot market
transactions with long-term contracts, for example with personnel. These
reduce transaction costs of the type described above, and also inject far
more stability and predictability into the productive process. Coase’s
answer further tells us how big firms should be. The logic laid out above
implies that a firm should expand until the cost of marginal transaction
within the firm is equal to the cost of carrying out that transaction in the
market, or with another firm. In other words, a firm should keep growing
in the sense of internalising market activity within its structure, up until
the point that doing so does not save the firm any money. Once the owner
of the firm is indifferent between hiring a particular worker (i.e. via long-
term contract), or contracting his services in the spot market, then the
owner stops expanding his personnel, and firm growth comes to a halt.
As an example of this, consider an accounting firm that occupies large
offices and has a number of plumbers on its payroll. How many plumbers
should it employ? The advantages of keeping plumbers on the payroll are
that:
1. they are available when you need them, and cannot refuse a job on
your premises; and
2. the average rate paid them is much lower than the spot market rate
that plumbers charge.
The main disadvantage is that much of the time plumbers have little or
nothing to do. Hence, non-plumbing firms hire plumbers as a form of
insurance, for when something goes wrong.
How many plumbers should our accounting firm hire? The Coasian logic
laid out above implies that a firm will hire plumbers up to the point where
keeping one on the payroll costs as much as hiring in a plumber when
you need him. Hence a rational firm will employ enough plumbers to deal
with the normal day-to-day flow of problems, but too few to deal with bad
plumbing days, when it will go out into the market and pay much higher
spot rates for external plumbers’ services.
Alchian and Demsetz (1972)

Coase’s transaction costs approach stood as the motivating force behind
firm organisation for 35 years, until Alchian and Demsetz introduced the
problem of monitoring. Their insight is based on the observation that
much production in the modern economy is carried out by teamwork.
The main problem, for both firm managers and economists studying firm
behaviour, is how to monitor the marginal product of workers working in
teams. This is because economic theory holds that rewards should equal
88
the marginal product of workers. That is to say, workers’ salaries should

equal the value of their contribution to a firm’s output.
Activity 5.2
Define ‘marginal cost’. What is the economic concept of ‘the margin’? What is the
difference between the marginal product and average product of workers working in a
team?
If the worker in question is a cobbler working alone, then it is easy to

measure the value of his output, as that is equal to the number of pairs of
shoes he makes (per month, year, etc.) multiplied by their average price.
But if the worker in question is part of the team who labour together
to produce the output, it is generally very difficult to determine how
much each team member has contributed, as distinct from all the other
team members, to the collective output. In technical language, this is
the problem of separable versus non-separable production functions. A
row of cobblers sitting in a factory, each making a different type of shoe,
would be analogous to a separable production function. It is easy in these
circumstances to tell how much each worker produced, and thus what was
her contribution to the total product.
By contrast, a team of lawyers working on a single case, or a team of
engineers designing a common project, would be characterised as a
non-separable production function. In either case, the team’s output is a
continuous, and continuously varying, function of the efforts of everyone
on the team. It is very difficult to identify what each individual’s marginal
product was, not least because absent his teammates, production might
have collapsed, and there may not have been any product at all.
If you are not yet convinced of this, consider the extremely simple
productive activity of loading boxes. Imagine two men who lift boxes
off the floor of a warehouse together, and deposit them in the back of a
delivery truck. To the extent that the two men lift boxes together, and
neither man lifts boxes alone, this is team production via a non-separable
production function. Now consider the problem of a manager determining
how much to pay each worker. How can the manager tell which worker
is working harder? The manager might observe the angle of the boxes as
they approach the back of the truck, and notice that one worker seems
to be lifting his consistently higher. This might mean that that worker is
putting in more effort. But it might also mean that the boxes are loaded
asymmetrically, and the other worker is bearing a heavier load. In that
case, it might be the second worker who is putting in more effort, even
though the first worker’s side of each box rises higher. The manager would
not be able to tell without opening each box, weighing the contents, and
measuring the angle at which each box enters the truck. Once again, it
could just about be done. But the transaction costs of doing so would
be immense relative to the value of the productive activity in question
(loading boxes into a truck).
This is Alchian and Demsetz’s first insight: because it is very expensive,
and sometimes impossible, to monitor the marginal outputs of team
workers, firms choose instead to monitor workers’ inputs. This is
altogether easier and cheaper. In the example above, the manager would
simply observe how many hours the two box lifters work, taking into
account coffee, lunch, and other breaks. The monitoring problem is crucial
to firms not just because of abstract notions of efficiency, or the correct
calibration of workers’ pay, but because workers in team situations have
such large incentives to shirk. Shirking refers to using paid work time to
89
do something else instead. Examples include gossiping on the telephone,

surfing the internet for entertainment, taking extended coffee breaks, or
writing personal e-mails during working hours.
Activity 5.3
Have you ever shirked? Why did you shirk? What were the benefits and who enjoyed
them? What were the costs and who suffered them? What were the sanctions, if any?
Would you do it again?
Shirking is a major problem for firms because the marginal benefits

of shirking accrue entirely to the worker who is shirking, whereas the
marginal costs of his shirking accrue to the entire firm in terms of lost
production. From the private perspective of the worker in question, the
marginal benefits of shirking vastly outweigh the costs that he is likely
to bear, and hence his incentives will always be strongly aligned towards
shirking. Hence the manager’s task is to identify shirking, and impose
penalties on shirking workers that raise their private costs from shirking to
levels that outweigh their private benefits, leading them to work instead.
Firms do this by deploying full-time monitors at the centre of all
contracts the firm has with its workers. The role of the monitor is to
measure workers inputs into the productive process, and adjust their pay
accordingly, and also to sanction and penalise shirking. But this simply
raises the question: won’t the monitor also shirk? Isn’t she subject to
the same incentives set out above, but with potentially more disastrous
consequences for the firm that employs her?
This is indeed so, which is why, say Alchian and Demsetz, firms must
invest monitors with residual rights over the product of the firm. That
is to say, the monitor must own the firm, and thus hold a claim on all
profits that the firm produces. Profits are defined here as the economic
‘residual’, or the amount left over after the firm has paid all its input
labour and overhead costs. All such profits accrue to the monitor, thus
providing the monitor with a strong incentive to carry out her monitoring,
in the interests of maximising firm efficiency, and hence profits, which she
gets to keep. When these residual rights can be bought and sold to other
entrepreneurs/monitors, we have before us all of the essential elements of
the capitalist system that we know so well.
Williamson (1986)
To this now-sophisticated intellectual construct, Williamson adds firm-
specific human capital. His idea is founded on the notion that continuity
in employment is valued when firm-specific human capital is developed
by employees. Firm-specific human capital can be defined as a worker’s
knowledge and expertise that are more valuable to his employer than to
the market. That is to say, the knowledge and skills that the employee has
accumulated are particular to his firm (because of technology, internal
organisation, specific work practices, etc.), and hence of greater value to
that firm than they would be to any other firm. As a result, his human
capital is systematically undervalued in the marketplace, in the sense that
no other firm will value his abilities as highly as his own from does. Hence,
his salary is likely to fall if he leaves to work elsewhere.
Firm specific human capital is typically developed in two ways:
a. learning by doing, and
b. training.
But for the reasons laid out above, it is much less in the interests of
90
workers to develop this sort of human capital than it is in the interests

of their employers. Hence firms must establish a protective governance
structure that encourages workers to develop such skills, despite the
fact that doing so does not raise their employment value in the broader
marketplace. A protective governance structure will encourage employees
to invest in human capital that makes their employer more productive, and
hence more profitable for its owners.
Williamson divides economic activity into four broad types, according to
the ‘separable-ness’ or ‘non-separable-ness’ of the underlying production
function, and the degree of firm-specificity of human capital involved.
These are as follows:
Figure 5.2: Williamson’s characterisation of economic activity

Note that the top row summarises the types of production that Coase and
Alchian and Demsetz described, whereas the bottom row summarises
Williamson’s own contribution.

• explain why firms exist in a market economy
• describe the most important characteristics of the firm as organisational
form
• give a detailed account of the internal incentives that the firm’s
structure creates, and the relationship of these with firm performance
• contrast the private sector firm with the government bureau (per
Chapter 2) in terms of structure, incentives and performance.

1. ‘The theory of the firm implies that private firms will be accountable
to their customers. By extension, it also implies that NGOs will be
accountable to their beneficiaries.’ Discuss.
2. Which organisational form is more accountable to citizens: a firm or an
elected government? Why?
3. Is hierarchy a better organisational principle for service provision than
more participatory models?
91
Notes
92
Chapter 6: Real firms, small firms: microentrepreneurs and the informal sector
Chapter 6: Real firms, small firms:

microentrepreneurs and the informal
sector
Aim of the chapter

The previous chapter analysed the private firm as organisational form at
a fairly abstract level. In order to discuss how firms operate in developing
country contexts, we must consider the informal sector, as this is the part
of the economy where a large portion of firms, and a larger portion of
workers, reside.
This chapter seeks to answer the following questions:
• What is the informal sector?
• How does it operate in comparison with formal sector firms?
• What are the consequences for investment, wages and economic
growth?
• What are the best policy responses, if any, of developing country
governments to the phenomenon of informality?
Learning outcomes
• define ‘informal sector’
• describe the major characteristics of informal sector firms, and informal
economic activity
• explain how informality comes about in a developing economy
• discuss policy options for repressing or formalising the informal sector.
Essential reading
World Bank Informality: Exit and Exclusion. (Washington, DC: The World Bank,
2007) Overview, available at: http://siteresources.worldbank.org/INTLAC/
Resources/CH0.pdf
Further reading
De Soto, H. The Other Path. (Perseus Books Group, 2002)
[ISBN 9780465016105]. Foreword, Preface, and Conclusion.
MacGaffey, J. The Real Economy of Zaire. (Oxford: James Currey, 1991)
[ISBN 9780852552131] Chapters 1 and 2.
Portes, A. and R. Schauffler ‘Competing Perspectives on the Latin American
Informal Sector’, Population and Development Review (19) 1993, pp.33–60.
Additional resources
Additional Evidence: The Cost of Doing Business Around the World from
www.doingbusiness.org/
Ease of Business Interactive Map: http://rru.worldbank.org/businessplanet/
Business ease DB (2007 database)
93
Works cited
Fields, Gary S. ‘Labour Market Modeling and the Urban Informal Sector: Theory
and Evidence’ in David Turnham, Bernard Salomé, and Antoine Schwarz
(eds) The Informal Sector Revisited. (Paris: Development Centre of the
Organisation for Economic Co-Operation and Development, 1990).
World Development 6(9/10), 1978, special issue on the informal sector.
Meagher, K. ‘Crisis, Informalisation and the Urban Informal Sector in
Sub-Saharan Africa’, Development and Change (26), pp.259–84.
Wiles, P. ‘Peter Wiles, “Second Economy, Its Definitional Problems’ in Sergio
Alessandrini and Bruno Dallago (eds) The Unofficial economy : consequences
and perspectives in different economic systems. (Aldershot: Gower, 1987)
[ISBN 0566051311].
World Bank Doing business 2007: how to reform: comparing regulation in 175
economies. (Washington, DC: World Bank, 2006) [ISBN 9780821364888].
Introduction
The previous chapter dealt with the firm as organisational form at
a fairly abstract level of analysis. That was the world of firms in terms of
Max Weber’s ‘ideal-typical model’, operating as they were designed to do.
But hidden behind this analysis is a large number of assumptions about
institutions that support the ability of such ideal firms to operate, and
underlying social characteristics that help to determine their structure
and dynamics. At this point we must note that the theory of the firm was
developed primarily by theorists operating in the developed world, and by-
and-large assumes conditions typical of rich, developed economies.
Once we suspend these assumptions, we begin to see how important
institutional context is to how firms operate, and how important these
underlying, unspecified preconditions are for the success of the models
described above. Amongst the most important of these are secure property
rights, the rule of law, an impartial judiciary, representative government,
an educated workforce, and open, competitive markets. Put simply, firms
in developing countries do not look like firms in developed countries, and
do not display the same characteristics or dynamics, in large part because
the institutional background does not conform to the characteristics just
listed.
Hence in order to discuss how firms operate in developing country
contexts, we must consider the informal sector, as this is the part of the
economy where a large portion of firms, and a larger portion of workers,
reside. What is the informal sector? Students of this subject have almost
certainly come across it, regardless of where they live. This includes
Europeans and North Americans, as the informal sector exists everywhere,
although it does vary in size by country and region. Examples include:
• street vendors
• traders in contraband or stolen goods
• no-receipt commerce
• unregistered builders
• tax-free plumbers, electricians, and carpenters.
As I write these words, I can remember coming across examples of each
of these right here in London, as well as in other countries I have visited.
To understand the informal sector better, consider its principal objective
characteristics:
1. Small-scale: informal enterprises are disproportionately small, with
lower levels of capital and less sophisticated technology than their
94
formal sector competitors, and often located in peri-urban or slum

areas of cities and towns.
2. Unregistered: informal sector firms are typically unregistered with
tax authorities and hence do not pay taxes, which lowers their costs
and provides them with an important competitive advantage in the
marketplace. But the other side of this coin is that they typically do
not join business associations, and are unable to lobby government or
otherwise represent their interests.
3. Limited access to the legal system and other state benefits: the fact that
they are ‘flying under the radar’ vis-à-vis tax and regulation authorities
implies that informal firms have no recourse to the (formal) legal
system. This is because officially such firms do not exist, and thus
cannot be party to a lawsuit. Informal firms thus depend on informal
types of dispute resolution and contract enforcement, which are often
more expensive, and may be less fair and less transparent than the
formal system.
4. Ease of entry: because such firms officially do not exist, and because
they operate with limited capital and low levels of technology, it is easy
for competitors to enter their markets.
5. Operate in unregulated, competitive markets: the combination of the
previous four characteristics implies that the markets in which informal
firms operate are unregulated, open to all entrants, and hence fiercely
competitive.
6. Often family based: it is an empirical regularity that informal sector
firms are often dominated, or even entirely owned and operated by,
families. In such lean, low value added, highly competitive markets,
informal businesses often extract free or partially compensated labour
from family members, who are encouraged to view their contributions
as a familial obligation and not a market transaction. The family thus
becomes one of the competitive advantages on which informal firms
trade.
Our notion of the informal sector first took form in the early 1970s, and
was seen as a temporary phenomenon en route to full modernisation in
developing countries. As such, it was considered a typical characteristic
and corollary of under-development. Informal firms were viewed as
pre-modern, irrational, and inefficient. They belong to a dirty, poor
past which it was the job and purpose of development to leave behind.
This corresponds to a teleological view of development, in which man
leaves his agrarian past and marches in a more or less linear fashion
towards a modern, urban, industrialised future. Developing countries
were somewhere in the middle of this road, and were being held back
by an informal sector which was backward, un-modern, illegal, dirty,
inefficient, and unsafe. Understood in this way, the informal sector was
officially ignored by national and international policy-makers, and by
development specialists, and often actively repressed by developing
country governments.
But since the 1980s we have seen changes in the way the informal sector
is understood, and the way it is treated by policy-makers. These changes
are a product of both intellectual currents, and real events. Amongst the
latter, the case of Italy was perhaps the most important. There is general
agreement that Italy has traditionally had the largest informal sector of
all western economies. As explained above, this ‘second economy’ was
traditionally ignored by Italian statisticians, and hence excluded from
national accounts and estimates of GDP. But a growing realisation of the
95
size and importance of this parallel economy led Italian policy-makers in

the mid-1980s to attempt to measure it.
After fine-tuning their estimates, Italians were surprised to find that the
informal sector added as much as one-third to total GDP. That is to say,
Italians were collectively some 33 per cent richer than they thought they
were before they tried to measure the informal sector. More recent studies
estimate that the informal sector is still worth 27–30 per cent of Italian
GDP. Russia provides another notable case. The collapse of the Soviet
economy and the rapid transition to a market economy experienced by
Russia resulted in an informal sector estimated at 50 per cent of GDP
in the late 1990s, a huge rise over what it is likely to have been at the
beginning of the decade.
If the informal sector is important in developed countries, it is far more
important in developing countries, as the following table makes clear.
These data are taken from an International Labour Organisation study
from 2002, which estimated informal employment across a large number
of developing countries, a few of which are excerpted below.
(excerpt from a larger table)
Informal Women’s informal Men’s informal
employment as % employment as employment
non-agricultural % women’s as % men’s
employment non-agricultural non-agricultural
employment employment
N Africa 48 43 49
Algeria 43 41 43
Morocco 45 47 44
Tunisia 50 39 53
Egypt 55 46 57
Southern Africa 73 84 63
Benin 93 97 87
Chad 74 95 60
Guinea 72 87 66
Kenya 72 83 59
S Africa 51 58 44
Lat America 51 58 48
Bolivia 63 74 55
Brazil 60 67 55
Chile 36 44 31
Colombia 38 44 34
Mexico 55 55 54
Venezuela 47 47 47
Asia 65 65 65
Indonesia 78 77 78
Philippines 72 73 71
Thailand 51 54 49
Syria 42 35 43
Figure 6.1: Informal employment in non-agricultural employment, by

gender 1994/2000
96
Although only a handful of countries are listed under each region, the
regional averages cover all countries in each region. Looking across
this table, several key facts stand out. First of all, in no region does the
informal sector account for less than 48 per cent of total employment,
and in sub-Saharan Africa and Asia it is considerably more. Secondly,
there is great variation not only amongst regions but within them as well.
Hence South Africa shows only 51 per cent of employment in the informal
sector, whereas in Benin informal employment is 93 per cent of the total.
Likewise, Asian informality varies from 42 per cent in Syria to 78 per cent
in Indonesia. And thirdly, women’s employment is disproportionately
informal in many countries, especially in sub-Saharan Africa and Latin
America.
Definition and evolution of the idea

Although informality is a relatively new topic in the social sciences, the
underlying concept, and how best to deal with it in policy terms, have
changed significantly over time. What we now think of as the informal
sector was first laid out in an International Labour Organization study
referred to as ‘The Kenya Report’, in 1972. It defined the informal sector,
characterised it, and was very influential. It is worth quoting it here.
Our analysis lays great stress on the pervasive importance of

the link between formal and informal activities. We should
therefore emphasise that informal activities are not confined to
employment on the periphery of the main towns, to particular
occupations or even to economic activities. Rather, informal
activities are the way of doing things, characterised by:
Ease of entry
• Reliance on indigenous resources
• Family ownership of enterprises
• Small scale of operations
• Labour-intensive and adapted technology
• Skills acquired outside formal schooling
• Unregulated and competitive markets

The report pointed out that the informal sector was often ignored by
developing country policy-makers, but repressed by the police, and
questioned whether this was helpful. Although the report was influential
in initiating and helping to shape the policy debate on the informal sector,
it came to be criticised over time for its black-and-white definition of
informality as unrealistic and fundamentally flawed.
The ILO report was shortly followed by a second influential study, Hart’s
(1973) work on informal urban employment in Ghana. Hart focused
on the individual operating in the formal or informal sector, where he
characterised wage earners as formal sector, and the self-employed as
informal sector. This led to a tripartite classification of the economy, as
follows.
97
Formal, informal and illegitimate income opportunities

Formal income opportunities include:
• Public sector wages.
• Private sector wages.
• Transfer payments – pensions, unemployment, etc.
Informal income opportunities include:
• Primary and secondary activities – farming, building, artisans, other
simple self-employed manufacturing (e.g. tailors, cobblers).
• Tertiary, capital-intensive production – housing, transport, utilities, etc.
• Small-scale distribution – petty traders, street hawkers, carriers, etc.
• Other services – musicians, launderers, waste removers, magic and
medicine, etc.
• Private transfers – gifts, remittances, borrowing, begging.
Illegitimate income opportunities include:
• Services – hustlers, spivs, usury, drug trafficking, sex workers.
• Transfers – theft, embezzlement, gambling (many countries).
Hart underlined that trying to eradicate the informal sector is
counterproductive. Attempting to repress or eradicate the informal sector is
likely to be costly and ineffective. It is much better, he argued, to work with
the informal sector in order to reach broader policy goals.
A few years later, a World Development special issue on the informal sector
(1978) approached the problem from a very different perspective. In this
issue, and most notably in a survey article by Moser, the duality of formality
and informality was rejected. A Marxist-inspired analysis argued that there
is in fact a continuum between the two, governed by how capitalism tries to
extract the most wealth (surplus value) from workers.
Formal capitalist firms benefit from informal sector petty commodity
production. Formal sector firms can reduce their risk, and even shift it
entirely onto others, by subcontracting low value work into the informal
sector, and then varying the quantity they demand over the business cycle.
This preserves stability and profitability with informal sector firms, and
outsources risk, variability, and the transaction costs that these entail, onto
informal sector firms and workers, who are in a poor position to defend
their interests. This ‘structural’ exploitation perpetuates poverty.
The informal sector is thus capitalism’s residual. Its long-term persistence
is in the interests of powerful groups who are allied, or part of, the political
class. This explains why, despite apparent attempts at repression, the
informal sector never disappears.
Wiles (1987) took a more normative, and even gloomier, view. He argued
that this ‘second economy’ is ultimately immoral, and confirmation of the
sad state of human nature. In his view, informality is not just about poverty
and low skills. It is also illegal, immoral, and evil. Many of the participants
and informality, he points out, are not in fact poor, but rather prosperous
gangsters and racketeers.
Meagher (1995) echoed some of the themes of the World Development
special issue with an analysis of informality as a globally connected process.
Informalisation is part of an economic strategy to defend the formal sector
and its profits – part of a conscious strategy of impoverishing some workers
98
Urban
Rural Sector Formal Sector
o o o o o x o o x o o o
o o o o o o o o o o o
o o o o o x x x x x x
o o o o o x o o o o o o
o o o o o o o o o o o o o
o o o o o o x x x x x x x x x
o o o o o x o x o o
o o o o o o o o o o
o o o o o
o o o o o x o x o x o
o o o o o o o o o o o o Informal
o o o o o o x x x x x x x Sector
o o o o o x o x o
o o o o o o o o o
o o o o o o o o o o o o
o o o o o o o o o o o
Urban Unemployment
Figure 6.2: Fields’ (1990) Model of the Informal Sector
and eliminating some firms so that others can flourish. And developing-
country governments, she argued, are complicit in this.
Allen (1999) took a different tack from all of these studies, emphasising
that the ‘real informal economy’ is characterised by creativity and rugged
self-reliance. It is not a moral black hole in his view. The key incentives
that define informality relate to livelihoods, and to the struggle of the
poor to survive and reproduce. State policy often criminalises the informal
sector, which is costly, of questionable effectiveness, and can be tragic, as
the poor often have few alternatives to informality. Much of the dynamics
of the informal sector arise from the imperatives of economic survival
in marginal populations. Antisocial behaviour results as people compete
harshly at times to survive.
Finally, we review one example of more formal attempts to model the
informal sector, and its interactions with the formal sector. The following
model is due to Fields (1990). In this model, the ‘0’s’ represent workers,
and the ‘X’s’ represent entrepreneurs or business owners. The model is
divided into the rural sector on the left-hand side and the urban sector
on the right-hand side, the latter divided again into formal and informal
sectors, and the unemployed. Because so much agriculture in developing
countries consists of family farming, it is not useful to attempt a division
of the rural economy between formal and informal. Essentially all of the
rural sector is informal, as the state makes little effort to regulate, tax,
or otherwise control it, and so much of the employment located there is
partially or un-remunerated.
Figure 6.2 shows how the various parts of the economy link to each other.
Individual workers can move from the rural sector to the urban sector, and
join the ranks of the urban unemployed. From there, they can find work
in an informal sector firm, which they might eventually come to own.
Some informal sector employees may be able to obtain work in similar
firms in the formal sector. Alternatively, they might transfer from informal
99
sector employment to becoming independent entrepreneurs (0  X) in the

informal sector. Or, informal sector workers might join the formal sector
when an entire firm is formalised. Other movements are also possible,
of course, including downward movements, as employees and even
entrepreneurs can fall from formal to informal sector, or into the ranks of
the unemployed.
Activity 6.1
What other sorts of movements are possible amongst workers and entrepreneurs in
Figure 6.2? Under what sorts of circumstances would such movements occur?
Activity 6.2
Does the model in Figure 6.2 help us to think about the informal sector rigorously? Does
it add anything to common sense? If so, what?
Analysis of key differences

The previous discussion highlighted a number of differences between
the formal and informal sectors, which vary according to point of view.
It is time to summarise these arguments, and in particular to highlight
the most important characteristics and differences between the two.
Because this subject is founded in institutional theory and institutional
economics, the analysis that follows relies on efficiency criteria from the
rationality school. It is important to note that the statements that follow
are comparative in nature, and should not be taken to mean the adherence
of either sector to some ideal.
As compared to the informal sector, the formal sector is notable for its
reliance on impersonal market forces, such as prices, to the exclusion of
effective and solidaristic ties. In the informal sector, by contrast, who you
are – the identity of workers and entrepreneurs – determines to a much
greater extent how you function in the economy, as well as your level
of success. Ascriptive and family ties are much more important. This is
because relationships are used to secure access to productive resources
and locational rents in the informal sector. Examples of locations that
provide rents include urban markets and pavement stalls. Once rent-
providing locations are secured, relationships and social conventions can
be used to maintain access and exclude others.
Informal firms often rely on informal contracts, for reasons discussed
above. Because such contracts cannot be enforced through the formal
legal system, they are often maintained via social conventions, that in
turn rely on identity and family ties for their support. Taken together,
these can amount to informal systems of justice and enforcement that
operate in parallel to the formal legal system, but with little overlap.
In such a system, firms incur costs in order to prevent their turf from
being encroached upon. This can inflate overhead costs, and decrease
profitability. On the other hand, informal contracts are often preferred to
formal contracts, because they are cheaper, more agile, more familiar, and
may be more reliable. We return to this point below.
This analysis underlines that the theory of the informal sector is
indeterminate, and that it sustains two possible views. The first of these is
that formality ‘locks in’ efficiency, because impersonal market forces rule,
and the only way to prosper in such an environment is by increasing a
firm’s efficiency. The second view is that the informal sector is embedded
in reciprocal relations which transcend market exchange, and which serve
to maximise returns in the long term, and therefore are not irrational. That
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is to say, the non-economic characteristics of the informal sector help it to

increase its efficiency.
Which view is correct? The theories laid out up to this point do not allow
us to resolve this question. Thus we must turn to a broader theory of
informality that locates its causes and the deeper institutional structure of
government and society. We must turn to De Soto.
De Soto’s The Other Path (1987)

De Soto’s 1987 book The Other Path was highly influential because it went
beyond the existing dichotomies and partial analyses, and set the question
of formality vs. informality in a broader model of the economy and society.
His fundamental insight is that when legality is a privilege available only
to those with political and economic power, those who are excluded have
no alternative but illegality, and hence informality.
To understand this point, consider the experiments that De Soto and
his researchers undertook in Peru. A team of researchers from De Soto’s
organisation, the Institute for Liberty and Democracy, attempted to register
a fictitious clothing factory in their native Peru. It took them 289 working
days to succeed, equivalent to about 14 calendar months, and the full-
time work of a well-qualified team of individuals. The transaction costs
amounted to $1,231 (in 1987 US dollars), equivalent then to about 32
months of minimum wages. A separate experiment sought permission
to build houses on a vacant lot. Gaining the requisite permits required
six years and 11 months, and cost $2,156 – equivalent to 56 months of
minimum wages. Gaining a license to operate a street kiosk required 43
days of work, and $591.
To be clear, the nature of the experiments was to determine the costs
associated with operating in the formal sector. The same team of
researchers could have established an informal sector clothing factory
in Lima in a matter of days – the time required to locate a site, buy the
necessary machinery, and hire workers. What the experiment shows are
the enormous inefficiencies of operating in the formal sector. Why these
inefficiencies? De Soto’s answer is a bureaucratic, intrusive, controlling
state. When economic activity is over-regulated in this matter, many
otherwise legitimate entrepreneurs and workers, and much otherwise
legitimate production, is expelled from the formal sector and forced to
occupy the shadowy, strictly illegal world of informality, because the
businesses in question simply cannot afford the time and costs of operating
legally.
Why do such regulations and controls exist? Why does the state expel
entrepreneurs when it could embrace them and charge them taxes?
In De Soto’s view, this is because the status quo benefits a business
elite with good political connections. This business elite comprises an
entrenched informal sector uninterested in competition, and uninterested
in expanding the economy. They have become used to oligopolistic-type
rents. They comprise a rentier class, and in turn support and are protected
(from competition) by a rentier state. This rentier class owns the firms that
populate the formal sector, and it is in their interests to limit competition
by expelling entrepreneurs and workers into the informal sector, where
they cannot benefit from access to the financial system, the legal system,
or the tariffs and licenses that the state provides.
What are the instruments by which such a system is maintained? In Peru,
De Soto points out, most of the laws on the books at that time emanated
from an unaccountable executive branch. In fact, fully 99 per cent of
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Peruvian laws were approved via executive decrees. Only one per cent of
Peruvian laws emanated from the legislature, the product of due process,
a certain degree of transparency, and scrutiny by official and opposition
political parties, the press, interest groups, think tanks, etc. The remaining
99 per cent were drafted behind closed doors, discussed only within a
limited circle of presidential advisers, and often not revealed even to
Congress before their promulgation as fully binding laws. Such a system is
unlikely to produce a legal structure that supports the efficient operation
of markets, nor a competitive, innovative economy. And in Peru it did not.
De Soto’s analysis yields a definition of the informal sector distinct from
those discussed above. In his view, the informal sector is the refuge
of people who find that the costs of abiding by the law in pursuit of
legitimate economic objectives outweigh the benefits. Such a definition, he
claims, transcends Marxist notions of class. The poor don’t want to abolish
the bourgeoisie, they want to join it. But the state won’t let them. It also
transcends traditional right-wing notions of modernity, based on culture,
race, education, etc., and the underlying unequal rights that such notions
support.
Not only was De Soto’s work path-breaking, it spurred the creation of a
mini-industry dedicated to measuring the cost of doing business across
countries, and promoting reforms. Such efforts have revealed phenomena
similar to what De Soto described in Peru in all of the world’s regions, and
often in more extreme versions. It is useful to quote from the World Bank’s
Doing Business 2007 report:
In Bolivia 400,000 workers have formal jobs in the private

sector—out of a population of 8.8 million. In India 30 million
workers have such jobs—in a country of 1.1 billion people.
In Malawi, 50,000 out of a population of 12 million. In
Mozambique, 350,000 in a country of 20 million.
The possibility of reform

Identifying the problem of informality in this way opened up new
avenues of reform and policy interventions aimed at increasing the rate
of investment and economic growth, improving working conditions and
workers’ rights, and decreasing the costs of doing business across the
developing world. Indeed, previous approaches to such problems have
been fundamentally misconstrued, argued De Soto. Structural adjustments
and institutional capacity building miss the point. The main problem
resides neither in the budget nor the management systems, but rather
the laws, regulations and bureaucratic discretion that politicians and
government officials have.
Hence the solution to informality is to reduce government’s remit, and
make it accountable to the people. The current dense web of business
laws and regulations across many developing countries should be replaced
wholesale with laws that are consistent with normal, healthy human
incentives. This would have a number of effects:
• It would allow businesses to grow faster, as the costs and difficulties of
doing business were reduced, thus leaving more resources and time for
productive investments.
• Such laws and regulations would be far easier and cheaper to enforce.
Instead of the government acting as gatekeeper, purporting to police
100 per cent of the actors in the economy, it would act as overseer,
policing the much smaller number of evasions likely to occur in a
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system where laws are incentive-compatible, and most enforcement is

thus self-enforcement. Such a system of enforcement is referred to as ex
post facto, as opposed to ex ante enforcement.
• Such a system would be much better at managing the complexity
of modern societies, and in particular their rapid development, if
and when such occurred. This is because the system of laws and
regulations described above is essentially reactive, and not predictive
and controlling, as was the case in Peru (and many countries) in the
mid-1980s.
De Soto stressed that reform should draw on what works. This implies
incorporating as much of the informal, quasi-legal, quasi-judicial
provisions in use in the informal sector as possible (especially with
reference to contracting and enforcement). This, in turn, is because
such provisions are typically accepted by large numbers of people, and
because they work. Hence the thrust of De Soto’s recommendations is to
formalise the informal sector, but also to ‘informalise’ the formal sector,
simultaneously. A coherent plan of reform might look like this:
1. Simplification – rid the legal system of duplication, overlapping and
contradiction. ‘Debureaucratise’ the legal system.
2. Decentralisation – devolve power, authority, resources and
administrative responsibility to lower levels of government.
3. Deregulation – increase the responsibilities and opportunities of
private individuals and reduce those of the state. Depoliticise the
economy.
4. Rationalise law-making – more transparency. Allow the legislature
to take precedence over the executive. Institute deliberative law-
making, as opposed to executive decrees. Conduct a cost-benefit
analysis of every legal or regulatory proposal.
Pursuing this path would leave resources, time, and energy to the state for
the things it should be doing, but typically – argues De Soto – doesn’t do,
or doesn’t do well, such as providing public goods, alleviating poverty, and
enforcing law and order.
Could such a program work in practice? Again, consider the Doing Business
2007 report:
Reform can change this, by making it easier for formal

businesses to create more jobs. Women and young workers
benefit the most. Both groups account for a large share of the
unemployed (figure 1.1). Reform also expands the reach of
regulation by bringing businesses and workers into the formal
sector. There, workers can have health insurance and pension
benefits. Businesses pay some taxes. Products are subject to
quality standards. And businesses can more easily obtain bank
credit or use courts to resolve disputes.
Or consider a report on the same topic from The Economist magazine
(15 September 2005):
This January, Serbian entrepreneurs needed 15 days and a

deposit of €500 ($650) to start a business, compared with 51
days and €5,000 a year earlier. Taxes are now easier to pay,
debts easier to collect and temporary workers easier to hire. As
a result, start-ups have boomed: the number of registered firms
leapt by 42 per cent in 2004.
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• define ‘informal sector’
• describe the major characteristics of informal sector firms, and informal
economic activity
• explain how informality comes about in a developing economy
• discuss policy options for repressing or formalising the informal sector

1. Do informal sector firms have better or worse access to capital than
formal sector firms? Why?
2. Markets in the informal sector are more competitive, and hence more
efficient, than markets in the formal sector. Hence far from repressing
informal firms, governments should encourage other firms in the
economy to be more like them. Discuss.
3. The persistence of informality supports Marx’s notion that the poor are
kept poor so the rich can stay rich. Discuss.
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Chapter 7: Managing common resources: private solutions for collective action
Chapter 7: Managing common resources:

private solutions for collective action
Aims of the chapter

The third topic in this module on private provision is about managing
common resources. The common resource problem lies at the heart of
environmental management – and the looming environmental debacle
that many researchers think we face today – as it deals with the potential
conflict between the individual use of any asset and the long-term
management of that asset.
This chapter begins by defining common resources and analysing their
economic characteristics, focusing especially on the role of economic
externalities. We then discuss:
• the implications of these economic characteristics for the sustainable
management of common resources
• institutional alternatives intended to solve the collective action
problems that bedevil this class of goods, which theory predicts will all
fail for a variety of reasons
• real-life cases of successful common resource management, from
which we take lessons that serve to refine the theoretical paradigms
previously discussed.
Learning outcomes
• define ‘common resources’, and explain how they differ from private
and public goods
• explain what is the ‘tragedy of the commons’, and why it results from
individually rational behaviour
• give a detailed account of the analytical links between tragedies of the
commons and environmental degradation
• discuss the extent to which private solutions are viable alternatives to
public sector intervention.
Essential reading
Hardin, G. ‘The Tragedy of the Commons’, Science 162, 1968, pp.1243–248,
download at: www.lrainc.com/swtaboo/stalkers/gh_tragc.html), also
Hardin’s follow-up at:
www-physics.mps.ohio-state.edu/~wilkins/sciandsoc/commons_extension.
html
Olson, M. The Logic of Collective Action. (Cambridge, MA: Harvard University
Press, 1965).
Stern, N. The Economics of Climate Change: The Stern Review. (Cambridge:
Cambridge University Press, 2006) Executive summary (long version).
Available at: www.hm-treasury.gov.uk/independent_reviews/stern_review_
economics_climate_change/stern_review_report.cfm
105
Further reading
Cleaver, F. ‘Moral Ecological Rationality, Institutions and the Management of
Common Property Resources’, Development and Change, 31(2) 2000,
pp.361–83.
Ostrom, E. Governing the Commons. (Cambridge: Cambridge University Press,
1990) [ISBN 9780521405997] Chapters 1, 6 and notes.
Wade, R. Village republics: economic conditions for collective action in South India.
(Cambridge: Cambridge University Press, 1988) [ISBN 9781558153875]
Chapter 10 pp.179–98.
Introduction
Consider the plight of the Colorado River in the United States, as reported
recently in the Independent newspaper (UK). This great river once swept into
the Gulf of California, a wonder filled wetland boasting some 400 species
of plants and animals, including jaguars, beavers, and the world’s smallest
dolphin. In recent decades this wetland has become a forbidding desert of salt
flats and giant heaps of dead clamshells.
Not a drop of the mighty river which once carved the Grand Canyon
now flows through the delta to the sea. It has all been used upstream
– to slake the thirst of cities such as Tucson, Arizona, feed fountains
in Las Vegas, green golf courses and irrigate farmland. (Geoffrey
Lean, ‘Rivers: a drying shame’, 12 March 2006)
Much the same is true of the Rio Grande. Officially one of the 20 longest
rivers in the world, in reality its waters stop some 800 miles inland at El Paso,
Texas, which takes all the remaining water. The next 200 miles or so feature
occasional pools of waste in the former river bed. Or consider the biblical
River Jordan, nominally some 104 miles in length. This river effectively ends
below the sea of Galilee, and the site where Jesus was baptised is now a pool
of sewage. Damage to the river appears terminal.
These and other common resource problems are concerned fundamentally
with the question of externalities. These are defined as benefits or costs
that accrue to others due to an individual’s activity. If an activity that benefits
me also produces some benefits for those around me, then I am producing
a positive externality. If, by contrast, my activity produces some harm for
those around me, then I am producing a negative externality. Vaccines exhibit
positive externalities, because by protecting me from illness they keep me
from spreading illnesses to others too. Pollution is a negative externality.
Externalities arise when those who use an asset, whether as a source or a sink,
do not carry the full cost of maintaining it, but impose a cost on others (on
society). This happens when costs are transferred to common resources, such
as air, seas, lakes and rivers, forests, and roads.
The salient, underlying, but inescapable point is that capitalism has produced
an exponential growth in population and resource use, which threatens the
viability of all open access resources. Consider as evidence a simple graph
produced by the Canadian International Development Agency (CIDA). The
graph (Figure 7.1) illustrates changes in tropical forests cover worldwide,
between 1800 and today. What we see is not only a significant decrease over
200 years, but an increasing rate of forest destruction.
For a micro-level picture of what deforestation looks like, consider the NASA
satellite images below. The first photo (Figure 7.2) shows the eastern lowlands
region of Bolivia, an area of relatively recent settlement, and rapid in-
migration. The photo focuses on a biologically rich area of Bolivia where the
Andes mountains and foothills subside into the great eastern plain, the soils
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of which are rich and very productive. The darker patches in the upper left
of the photo are original forest cover. The lighter patches on the lower left
are arid
3100
2900
2700
2500
2300
2100
1900
?
1700
1600
1800 1850 1900 1950 2000
Figure 7.1: Area of tropical forests (millions of hectares)

Source: CIDA (1999).
mountain ranges (snow capped mountain tops lie on the border between
these two zones). The pale, patchy, roughly diamond-shaped zone in the
centre of the photo is what human migration and deforestation look like
from space.
Figure 7.2 Deforestation in Bolivia: The View From Space

Source: SeaWiFS Project, NASA/Goddard Space Flight Center, and ORBIMAGE.
The photographs that follow (Figure 7.3) are from a NASA landsat
satellite, and show the same agricultural settlements, with increasing
optical zoom from top to bottom. Each pie-type radial pattern in the top
photo is a small community settlement. The lower left photo zooms in
further on one. Here we can make out some of the typical features of
such communities, which include a church, a school, a bar/restaurant,
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Figure 7.3: Deforestation in Bolivia: Closer Up

Source: http://earthobservatory.nasa.gov/Newsroom/NewImages/images.php3?img_id=4544
and a football pitch. The lower right-hand photo shows large soybean fields
cultivated for export by agribusiness concerns. The dark strips running
through these fields are windbreaks. Notice that areas of large-scale
cultivation are not obviously in the majority. One of the underlying messages
that emerges from these photos is that environmental degradation is often
brought about by ordinary (poor) people in search of their livelihoods.
Resource degradation is generally not a simple question of good and evil, and
we do not often make progress by construing it as such.
What can be done about such large, complex problems as environmental

degradation? You will not be surprised to hear that the answers are not easy.
Indeed, even thinking about this usefully requires specific theoretical tools.
This is what we turn to in the next section.
Theoretical models of collective action

Theorists have devised a number of models of the problems social groups face
in attempting to organise collective action to deal with externalities and the
problem of common provision. The most important of these models are the
‘tragedy of the commons’, the ‘prisoner’s dilemma’, and the ‘logic of collective
action’. Below, we review each of these models to understand its workings
and assumptions, and to explore what each can explain, and what it cannot.
But first we review quickly the neoclassical model of the firm in a market
from two chapters ago. This is useful because it is commonly understood
that the private market model of provision fails where common resources are
concerned. But it is not enough to assert this. We must understand in detail
why this is so, as these causes give us insight into viable alternative solutions
for common resource (such as environmental) problems.
The neoclassical model of a firm in a market

The neoclassical model of a firm in a market is built upon a number of key
assumptions. These include:
• a large number of producers and consumers
• homogeneous products
• full information about prices and the availability of specific products
• the goods being bought and sold are private goods (i.e. excludable
and rival).
π =R–C
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In neoclassical theory, the shape and internal organisation of the firm are
irrelevant. Rather, it is what the firm does that is important, which is to
maximise profits. Hence the firm is construed as a black box that seeks to
maximise the difference between revenues and costs. In this theoretical
construct, the firm operates in an environment of plenty: plenty of buyers,
plenty of sellers, and abundant information. When these conditions obtain,
economic theory can demonstrate that competition will lead the prices of
products to equal their marginal costs of production and marginal benefits
to consumers. This has powerful welfare implications, in the sense of
producing an optimum distribution of resources within society, given initial
endowments. We will not demonstrate or explain these points here now,
but only signal them to students as points of information.
As an interesting aside, economic theory is by and large unconcerned with
which firm survives this competitive environment. Economists worry,
instead, about the characteristics of the equilibria that occur through
market competition, in particular efficiency and welfare, as stated above.
The question of which firms survive and prosper in the market is the main
concern of management theorists and business schools.
For our purposes here, the main conclusion to draw from this model is
that when its underlying assumptions are violated, the model does not
work. When we have only a few producers, for example, the competitive
market fails, and monopoly or oligopoly ensues. When products are not
homogeneous, such as in the housing market – where each property is
non-trivially different from every other property – efficient outcomes are
not guaranteed. And when there are externalities, such that the marginal
benefit to society of a good or service exceeds the private benefit that
individuals derive, the market will systematically under-provide the goods
and services in question.
With respect to common resources, the fundamental point is that the
model of market provision does not work. Common resources are defined
as collective goods where exclusion is difficult but consumption is rival.
Exclusion refers to the extent to which one can keep others from benefiting
from a particular good. Exclusion is high for private goods, but low for
common goods. For example, I can lock my house and my car to keep
others from using them, and I can take physical action to prevent others
from eating my sandwich. Hence these are private goods. But it is difficult
to keep others from benefiting from street lighting, or using the atmosphere
in various ways. These goods have low levels of excludability, and hence
are not private goods. But in order to be a common resource, a good must
additionally be rival in quality. In economic terms, rivalry refers to the
extent to which consumption by one individual subtracts from the quantity
of the good available for others. A sandwich has a high degree of rivalry,
because each bite I take leaves one bite less for anyone else to consume.
Public lighting, by contrast, exhibits low rivalry, in that many can benefit
equally and simultaneously.
Hence common resources refer to goods that are limited, but where
exclusion is difficult. Additional key characteristics include the following:
• a finite number of users
• incomplete information
• important transaction costs, for example of monitoring and enforcement
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• relations amongst users are often governed by reciprocity

• symmetry of interests amongst users.
Because the market model of provision is inefficient for such goods, we
have to look for other alternatives. In considering these alternatives, we
must pay special attention to their institutional features, because the ways
in which these do or do not respond to the particular characteristics of
common resources will determine whether the latter are sustained or not.
But first, consider in detail the characteristics of the problem.
The tragedy of the commons

The tragedy of the commons, (the phrase comes from Hardin (1968)),
is a simple theoretical construct analysing the key elements at work
in common resource problems. Consider a common pasture used
by 10 farmers, each of whom owns 10 cows. Assume the maximum
‘carry capacity’ of the pasture is a hundred cows, meaning this is the
upper bound of cows it can feed before the biological load becomes
unsustainable and the pasture begins to degrade. The situation described
is a stable equilibrium, in the sense that each farmer can continue to graze
10 cows indefinitely without harm to the underlying biological resource.
The problem in this situation is that an individual farmer has a strong
incentive to increase the number of cows he puts to pasture, because the
benefits of grazing more cows accrue solely to him, whereas the costs are
borne by all the farmers, in the sense of less grass for all the cattle, and the
long-term decline of the pasture. But this incentive to increase the number
of cows will be symmetric for all farmers. All farmers make the same cost-
benefit calculation, and hence the overall number of cows on the pasture
rises rapidly. In fact, once farmers detect that some of their neighbours are
behaving in this way, they will seek to increase cows even more rapidly,
before the pasture collapses.
Hardin describes the situation in the following way:
Each man is locked into a system that compels him to increase his
herd without limit – in a world that is limited. Ruin is the desti-
nation toward which all men rush, each pursuing his own best
interest in a society that believes in the freedom of the commons.
Freedom in a commons brings ruin to all. (Hardin, 1968, p.4)
According to Hardin, morality depends on the characteristics of the system
of which it is a part. What is acceptable in a situation of plenty and/or very
low population density is no longer acceptable in a situation of scarcity or
high population density. Intriguingly and provocatively, Hardin argues that
conscience is not an answer. In his view, a kind of social Darwinism will
breed conscience out of the population over time, as conscientious people
compete with less scrupulous people. In this view, conscience is pathogenic
– a kind of mental disease – which natural selection will tend to eliminate.
Hence we need appropriate institutions, defined by Hardin as ‘mutual
coercion mutually agreed upon’.
The prisoner’s dilemma

A different kind of cooperation failure relevant for common resource
problems is analysed by the prisoner’s dilemma. This is probably the
single most important and most influential piece of game theory ever
devised, in terms of its broad influence within the social sciences, and
on policy analysis and policy prescriptions. The motivating story behind
the prisoner’s dilemma is that the police catch two criminals whom they
suspect of committing a serious crime. The police realise they do not have
110
conclusive evidence to that effect, but do have evidence against them of a

separate, less serious crime, for which they are confident they can convict.
The police place the criminals in separate, soundproof rooms, and make
them the following identical offers. ‘We know you are a criminal, and can
convict you of a less serious crime. Admit to the more serious crime, and
you will receive a reduced sentence for co-operation. But if you deny the
serious crime and your partner confesses and implicates you, you will
receive the maximum sentence.’ The prisoners’ options can be modelled as
the following decision matrix:
Figure 7.4: The prisoner’s dilemma
In this figure, ‘cooperate’ refers to each prisoner cooperating with the

other, (i.e. failing to confess or implicate the other, whereas ‘defect’ means
confessing to the crime and implicating the other). If the two prisoners
cooperate with each other, they will be convicted of the lesser crime, and
each will serve one year in jail. If one confesses but the other maintains
his innocence, the one who confesses will serve six months in jail, and his
partner will serve 10 years in jail. And if both confess to the crime and
implicate each other, each will serve eight years in jail.
The characteristics of the game are that play is simultaneous, the game
lasts one period and is not repeated, and each prisoner has incomplete
information (about what decision the other will take). The way to analyze
the game is to consider what each prisoner’s payoff will be, given the
decision of the other prisoner. As neither prisoner can know what decision
the other is taking, he must consider both possibilities. Hence, prisoner
1 sees that if his partner cooperates, his payoffs are (-1) if he cooperates,
and (-1/2) if he defects. If the partner defects, prisoner 1’s payoffs are
(-10) if he cooperates and (-8) if he defects. It is evident that in each
situation, regardless of his partner’s decision, prisoner 1 is better off
defecting. Hence prisoner 1 will choose to defect.
The game is symmetric for both players, hence prisoner 2 will also
choose to defect. The outcome produced by both prisoners choosing to
defect is the lower right-hand quadrant, shaded gray above, where each
prisoner obtains a payoff of eight years in jail. Notice that this is the worst
possible outcome for this two- prisoner mini-society, in the sense that
the aggregate payoff to the two of them is the largest possible negative
number. Unfortunately for them, this solution is a stable equilibrium in the
sense that each prisoner has unambiguous incentives to select ‘defect’, and
– once selected – neither prisoner has any incentive to change his strategy.
This solution is referred to as the ‘Nash equilibrium’, in honour of the great
John Nash.
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The welfare maximising equilibrium in this game is the upper left-hand

quadrant, where both prisoners choose to cooperate and are convicted
of the lesser crime. This outcome would provide the prisoners with an
aggregate two years in jail, the lowest joint outcome achievable in this
game. But despite the fact that this is clearly the highest welfare solution,
the prisoners will never choose it. In fact, no rational pair of prisoners
playing this game under the conditions outlined above will ever choose
any outcome other than defect–defect, which will get them the worst
outcome they can obtain.
The logic of collective action

The logic of collective action is the title of a famous book by Mancur Olson
that first provided an economic analysis of why collective action often
fails, even when it is in the interest of each individual member for it to
succeed. To understand the deep logic at work, consider a group of private
citizens living in a neighbourhood without street lighting. They attempt to
cooperate in order to provide street lighting themselves, from which all of
them will benefit. Assume there are 10 households, and the benefits that
would accrue from street lighting are about $10 per household. Assume
further that the cost of lighting the neighbourhood symmetrically is $59.
It is clearly in the interest of each household to contribute $6 to the
provision of street lighting, as each will then receive a net benefit of $4, a
very large return on a $6 investment.
The problem is that the good in question – street lighting – is non-
excludable, and hence each household calculates that a failure to co-
operate will gain it the full benefits of street lighting at zero cost. Such
behaviour is referred to in the literature as ‘free riding’. Because each
household realises that a subgroup of nine, eight, seven, or even six
households will still find it rational to provide street lighting (for all),
each household will rationally attempt to be part of the non-cooperating
minority. Now scale this problem up to large numbers of people. In a large
group, absent coercion, the threat of non-provision fails to motivate co-
operation because:
• The group of providers loses many times more from non-provision than
the target of their pressure.
• The group of providers also loses much more than they could get from
a free rider in contributions.
Olson points out that if transaction costs are zero in such a situation,
manoeuvring will go on forever as participants attempt to stay out of
the coalition of providers. This gives rise to what economists call ‘games
without cores’ – games where solutions are not feasible. No coalition to
provide street lighting will prove stable, as all participants will manoeuvre
to free ride. And the game will go on and on and on until the end of time
without ever being solved.
These three models of social behaviour, and the insights that they
represent, have been very influential in the social sciences and in public
policymaking. They have been interpreted in ways which are, on the
whole, quite gloomy. The most common reading is that cooperation to
solve common problems, or provided collective goods, is so unlikely as
to be impossible in practice. They seen as a strong sign, or even ‘proof’,
of our flawed human nature. And they are seen as a compelling case
for strong, interventionist governments that can impose solutions on
society. If people cannot be relied upon to bargain amongst themselves
and reach beneficial arrangements even when the benefits are clear, then
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technocratic solutions must be imposed from above. Heilbroner (1974) even

referred to the need for ‘iron governments’ to solve ecological problems.
The government solution

But the government solution to problems of collective action and common
resources has problems of its own. These include:
• The technical problem of accuracy in determining the carry capacity of
the Commons, or more broadly finding a sustainable level of exploitation
of a particular resource. Hardin’s analogy above implies that doing so
is straightforward. But very often it is not, not least because conditions
change in such a way as to vary carry capacity over time. Also, such
calculations are intrinsically tricky, and involve a number of variables
that can be difficult to estimate.
• The ability to monitor use accurately. Monitoring resource use, as
a source or a sink, is intrinsically costly, although the level of costs
involved can vary widely, and may be technically difficult as well. This is
not to say that the correct level cannot be determined, but rather that it
may be difficult to determine for a third-party monitor, which is what the
government solution entails.
• Fairness in assigning applications. Any solution, whether government
or otherwise, presupposes an idea of an ‘appropriate’ allocation among
users. Such allocations must be regarded as fair to be legitimate.
Because government is a third party with respect to any group of
users, government allocations of use quotas can lead to favouritism, as
different individuals or subgroups compete for priority.
• Transparency in running the system. Advantage-seeking users will be
tempted to corrupt government monitors and officials for the sake of
their own gain.
• Transaction costs. Setting up any third-party system of management and
enforcement involves unavoidable costs, as each necessary step in the
process – estimating carry capacity, assigning allocations, monitoring,
etc. – is costly.
For years, the intrinsic problems of the government solution were largely
ignored or underemphasised in the literature. But these problems are real,
and have been encountered again and again in cases where the government
solution has been attempted.
An additional risk of the government solution is that it can compound the
problems it was meant to address. Where monitoring and punishment are
too low, inaccurate, or inefficient, farmers will have an incentive to cheat
anyway. This can easily result in a situation worse than the pre-government
equilibrium, where people still cheat, not all the guilty are punished and
not all the punished are guilty, but all bear the costs of administering the
system.
Solutions from real life

All of the analysis of common resource problems provided so far would
seem to lead to conclusions of doom and gloom. Government intervention
is too costly or ineffective, and social cooperation rarely succeeds. Should
we expect our forests to be slashed, our oceans and rivers poisoned, and our
fisheries fished to exhaustion? The paradigms set out here imply the answer
is yes. But happily, a number of real-world examples suggest otherwise.
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We analyse two cases below, but the literature includes numerous other
examples, many with interesting characteristics. Our first case is the
Alanya fisheries in Turkey (Ostrom 1990).
The Alanya fisheries

The early 1970s were the ‘dark ages’ for the Alanya fisheries. Unrestrained
use had led to a depletion of stock. Hostility and violent conflict broke out
amongst fishermen regularly, as they competed for fish in the bay. Their
production costs were rising due to competition for the best spots, as well
as the costs of entangled nets and damage to their boats. And each boat
faced increased uncertainty regarding its production in any given year.
As the spiral worsened, the economic viability of the fishing industry in
Alanya was put into doubt.
Fishing did not collapse in Alanya because a new institutional solution
emerged over 10 years of trial and error. The solution was developed
through local initiative, and did not involve the intervention of national
government, NGOs, or any multilateral agencies. The solution has the
following characteristics:
• The fishing season runs from September to May.
• All usable fishing sites are identified and named; they are spaced to
avoid interference amongst fishermen.
• All licensed fishermen are listed in September.
• Fishing sites are allocated by drawing lots.
• Each day during the fishing season, fishermen rotate east to the next
named site. Hence all fishermen have equal opportunities to fish all
areas regardless of fish migration.
In addition to being arrived at via long-term consensus amongst the local
fishermen, this solution had a number of desirable properties:
• The productive potential of each site was maximised by design.
• Transaction costs were lowered, as there was no longer any need to
fight for individual fishing sites.
• There was greater equality amongst fishermen and the conditions they
faced.
• Collective enforcement, collective punishment, and the weight of
collective opinion proved efficient methods of enforcement.
• Incentive-compatible self-monitoring underpinned the regime.
The last point is worth stressing. Any solution involving third-party
monitoring implies transaction costs associated with paying and supplying
monitors. Alanya’s solution does not, because monitoring is incentive-
compatible. This is because it is in the natural interests of each fishermen
to police his fishing site, and prevent or report others from encroaching
on it. Each fisherman will tend to do this anyway, and no additional cost
(to third parties) need be paid. This is a significant benefit of community
solutions to common resource problems.
The Kottapalle villages

Our second example is the Kottapalle villages, as described by Wade
(1988). Kottapalle is a region in India containing a number of villages,
some of which have strong common resource institutions, and others of
which do not. The common resource institutions that do exist have certain
regular characteristics:
114
• They are three-tiered: work groups of field guards and irrigators, a

local council, and a general assembly.
• The lowest level can take quick decisions. Higher tiers are required for
more important decisions with greater cost implications.
• Decisions are taken by consensus, not majority vote.
• Council meetings are in a public place, so that all can participate.
• This division ensures both agility and the continued support/
acceptance of the regime by villagers.
• Coercive sanctions include fines in varying amounts and lost
reputation. Reputation loss is a serious thing in a village, where there is
no anonymity.
Although the institutions in question predate Wade’s research, and hence it
is difficult to know how they came about, a number of interesting qualities
can be pointed out. The first of these is that these common resource
institutions mostly defend what people already have, rather than changing
the distribution or ownership rights. This makes collective action easier.
The institutions are directed at protecting the status quo, not changing it.
Secondly, Wade notes the ‘moral basis’ of collective action. Villagers are
not steered by sense of devotion or obligation to an impersonal ‘cause’.
The village public realm is about getting things done rather
than about ceremony and symbolism… ‘efficiency’ rather than
‘dignity’. The farmers’ involvement remains calculative rather
than moral. (p.196)
Thirdly, in Wade’s view, the Kottapalle villages with common resource
institutions represent a higher level of political development than other
villages. The growth of a differentiated political domain marked by
established norms and rules sets these villages apart. Elsewhere there is
simply suffering and revenge.
These examples demonstrate that the doom and gloom scenarios described
above are overstated, and that community solutions to collective action
problems, and to the management of the commons, are possible. These
solutions are present in the world, and have successfully avoided disaster
for the cases described. It is possible for people to manage common
resources successfully such that the underlying resource base is sustained.
Indeed, what these examples suggest is that the fundamental problem may
lie not with the reality, but rather with the theory that attempts to analyse
it. If our theories predict doom, but doom does not always obtain, then
it is our theories that are at fault. The success of such examples suggests
that we should study them, and others like them, in order to devise better
theories of common resource institutions as we battle with this enormous,
and still potentially catastrophic, challenge.
115

• define ‘common resources’, and explain how they differ from private
and public goods
• explain what is the ‘tragedy of the commons’, and why it results from
individually rational behaviour
• give a detailed account of the analytical links between tragedies of the
commons and environmental degradation
• discuss the extent to which private solutions are viable alternatives to
public sector intervention.

1. What are the economic characteristics of common pool resources? How
do they differ from public goods and private goods?
2. ‘The problem of managing a common pasture is analytically identical to
that of managing the atmosphere. Hence the same tools should be used
to solve it.’ Discuss.
3. The problems of abuse of common resources are in principle
intractable, which is why ‘tragedies of the commons’ are so common.
Where communities find stable solutions to these problems, it is mainly
through luck or extraordinary leadership. Hence common resources
should fall under the authority of powerful governments that can
regulate their use. Discuss.
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Part 4: Empirical studies of transformation and decomposition
Part 4: Empirical studies of

transformation and decomposition
117
Notes
118
Chapter 8: Geography, values, factor endowments, institutions
Chapter 8: Geography, values, factor

endowments, institutions
Aim of the chapter

With this chapter we begin the final module of the subject, consisting
of detailed empirical studies of development success and failure. In this
chapter, and especially the two that follow, we leave behind the rarefied
realm of theory and stylised empirical facts, in favour of detailed, data-
intensive studies of countries’ success and failure in achieving rapid
development. In doing so, we hope to bring together the different pieces
of knowledge built up during the previous chapters into a coherent whole,
which views development not as a series of distinct sectors or questions,
but rather as a set of processes that happen – or fail to – in ways that are
roughly simultaneous and interdependent.
This also allows us to use the unit of analysis most relevant for questions
of development: the country. Country-level analysis is important not only
because this is how most people conceive of and experience development,
but because some of the most powerful drivers of development and non-
development are country level phenomena, as we shall see below. This
chapter addresses questions of national transformation or decomposition
at a still-broad level of cross-country empirical evidence, and deep theory.
The two chapters that follow take the analysis to a much more detailed
level, exploring the dynamics of reform and positive or negative change in
individual countries over time.
Learning outcomes
• give a good account of ‘cultural’ explanations of comparative
development
• give a good account of ‘geographic’ explanations of comparative
development
• give a good account of ‘institutional’ explanations of comparative
development
• analyse the relative strengths and weaknesses of each class of
explanations of why some countries are more developed than others.
Essential reading
Acemoglu, D., J.A. Robinson and S. Johnson ‘The Colonial Origins of
Comparative Development: An Empirical Investigation’, American Economic
Review 91(5) 2001, pp.1369–401.
Gallup, J.L., J. Sachs, and A. Mellinger ‘Geography and Economic
Development’, International Regional Science Review 22 1999,
pp.179–232.
Glaeser, E., R. La Porta, F. Lopez de Silanes and A. Shleifer ‘Do Institutions
Cause Growth?’, Journal of Economic Growth 9(3) 2004, pp.271–303.
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Further reading
Bardhan, P. ‘Institutions Matter, but Which Ones?’, Economics of Transition (13)
2005, pp.499–532.
Diamond, J. Guns, Germs and Steel. (London: Jonathan Cape, 1997) Chapters 4,
5 and 6. [ISBN 9780224038096].
McArthur, J. and J. Sachs. ‘Institutions and Geography: Comment on AJR
(2000)’ NBER Working Paper 8114.
Sokoloff, K.L. and S.L. Engerman ‘History Lessons: Institutions, Factor
Endowments, and Paths of Development in the New World’, Journal of
Economic Perspectives 14 2000, pp.217–32.
Works cited
De Long, J. Bradford ‘Overstrong Against Thyself: War, the State, and Growth
in Europe on the Eve of the Industrial Revolution’ in Olson, M. ‘Dictatorship,
democracy and development’ in M. Olson, and S. Kahkonen A Not-so-
Dismal Science: a Broader View of Economies and Societies. (Oxford: Oxford
University Press, 2000) [ISBN 9780198294900].
Engerman, Stanley L., Stephen Haber and Kenneth L. Sokoloff ‘Inequality,
Institutions, and Differential Paths of Growth Among New World Economies’
in Claude Menard (ed.) Institutions, Contracts,and Organizations.
(Cheltenham:Edward Elgar, 2000) [ISBN 139781840642254].
La Porta, R., F. Lopez-De-Silanes, A. Shleifer, and R.W. Vishny ‘The Quality of
Government’, Journal of Law, Economics, and Organization, 15 (1) 1999
pp.222–79
Putnam, Robert D. with Robert Leonardi and Raffaella Y. Nanetti Making
democracy work: civic traditions in modern Italy. (Princeton, N.J.: Princeton
University Press, 1993) [ISBN: 0691037388].
Weber, Max The Protestant Ethic and the Spirit of Capitalism. Originally
published in German (1904–05) as Die protestantische Ethik und der “Geist”
des Kapitalismus. Various English translations.
Internet resources
The Angus Maddison dataset: www.ggdc.net/maddison/
Introduction
Why are some countries more developed and others less so? This is one of
the biggest questions that we can ask in the social sciences. It is pressingly
urgent in terms of the welfare and life chances of the more than one billion
people around the globe living on less than one dollar a day, and the 2.7
billion people who live on less than two dollars a day. In order to answer
this question, we must ask ourselves: Why are some countries rich and
others poor? Why are some populations free and others oppressed?
The answers to these questions are important not only to the world’s
developing country populations, but to those of the rich, stable, developed
countries as well. In economic terms, increasing prosperity in the South
will contribute to economic growth in the North. But the more powerful
implications of development have to do with human migration, political
stability and security, and the environment. Poverty and deprivation can
lead to political instability and environmental degradation, which in
turn lead to large migratory outflows. Rapid development, by contrast,
supports political stability by providing the means to meet people’s
needs. International experience shows that as countries become richer,
their inhabitants tends strongly to care more about the environment, and
have the means to preserve it more effectively. Thus rapid development
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can transform developing countries from turbulent exporters of poor

people, pollution, violence and extremism, to stable zones where conflicts
are solved peacefully, and citizens invest in their country and their
environment.
Activity 8.1
Why is Germany a more prosperous, technologically and socially sophisticated country,
where citizens’ civic and political rights enjoy more protections, than Ghana? Why is Italy
similarly more developed than India? Why is Norway richer than Nepal? Do your answers
to these questions differ according to country pairings, or are they similar across countries
and regions?
How do we ask questions about transformation and decomposition? This

chapter begins with empirical studies of how and why some countries are
able to make the transformation from traditional, inefficient, patriarchical
institutions and systems of government, to societies that promote wealth
creation, freedom, and self and group realisation. We begin with the
‘reduced form’ question – Why are some countries rich and others poor?
But before turning to this question, consider first some stylised facts
about economic growth through time, in order to properly calibrate our
expectations about what ‘rapid development’ means.
Some simple growth empirics

We rely upon Angus Maddison’s wonderful dataset of cross-country
economic performance, going back to the year 1 AD. Figure 8.1 plots
GDP per capita in constant 1990 international dollars, for a selection of
European countries over the very long term. The first striking fact to note
is how much wealthier Italy was than her peers – very much wealthier
than the second-placed country, France, and more than twice as wealthy
as Britain. The second striking fact is Italy’s economic decline between
the year one and the year 1000 A.D. – empirical proof, if any is needed,
that being invaded by Goths is bad for development. From the year 1000,
when all of these countries are at quite similar levels of development, Italy
rebounds strongly to resume its pre-eminence by the year 1500. This is
followed by more than 300 years of stagnation in terms of GDP per capita.
The story of the period between 1500 and 1800 is the stunning economic
rise of the Netherlands, which becomes the wealthiest country in the world
around 1600, and remains so until about 1850. The UK follows a growth
3,000
2,500
1990 Intern'l Dollars
Belgium
2,000 Denmark
Finland
France
1,500
. Germany
Italy
1,000
Netherlands
Norway
500 Switzerland
United Kingdom
0
1 1000 1500 1600 1700 1820 1830 1840 1850 1860
Year
Figure 8.1: Long-term historical GDP/cap: 1–1860

Source: Angus Maddison’s dataset; author’s graphs.
121
path that is nearly as impressive during this period, and more consistent,
leading it to finally pass the Netherlands into first place around 1850. It
is notable that countries like Germany and Switzerland, at or near the
pinnacle of world wealth tables for many decades now, lag significantly
behind the frontier countries throughout these 1800 years.
Figure 8.2 plots the rise of the United States and Australia against a
smaller number of European countries. It is interesting to note that
economic development in the United States takes off very rapidly around
1700, but then slows significantly after 1820. By contrast, Australian
economic growth begins accelerating notably in 1820, and then
accelerates further throughout the rest of the century, leading Australia to
overtake first France, then the United States, Belgium, the Netherlands,
and finally Britain in GDP/capita terms, by 1860.
3,500
3,000
Belgium
2,500 Finland
2,000 France
Netherlands
1,500
United Kingdom
1,000
United States
500 Australia
0
1 1000 1500 1600 1700 1820 1830 1840 1850 1860
Year
Figure 8.2 Long-term historical GDP/cap: 1–1860

16,000
14,000
12,000 Germany
Netherlands
10,000 United Kingdom
United States
8,000 Argentina
Brazil
6,000 Colombia
Mexico
4,000
India
Japan
2,000
South Korea
0
00
04
08
12
16
20
24
28
32
36
40
44
48
52
56
60
64
68
72
76
80
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88
92
96
00
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
Year
Figure 8.3: LT GDP/cap: Old vs. New Worlds

Figure 8.3 focuses on a much shorter period, the twentieth century,

plotting countries that divide into two broad groups at the start of the
period: the richer European and neo-European countries, the latter
characterised by (by now) small indigenous, and large European, migrant
populations; and the poorer non-European countries, characterised by
large indigenous populations. The chart shows two kinds of cross-group
movements. The first is the huge GDP decline of several countries,
122
especially Germany and the Netherlands, caused by the Second World War.
The second is the upward rise of Japan, which breaks ranks definitively with
its group towards the end of the 1950s, and never looks back thereafter.
This is followed a generation later by South Korea, which follows almost as
steep a growth curve and soon joins the club of rich, developed nations.
The reason that Korea and Japan were able to grow so stunningly during
the second half of the twentieth century, compared with the centuries-long
development paths of countries like the Netherlands, UK, and United States,
is that they did not have to make the many mistakes of the commercial and
industrialising trailblazers. They did not have to develop high-productivity
technologies themselves, but could simply adopt those that had been
invented elsewhere. They did not waste time or effort taking the many
wrong turns and dead ends that the entrepreneurs, inventors, and policy-
makers of the first countries to grow rich stumbled into and out of. When
conditions are right and a number of factors come together appropriately,
it is possible for societies to generate development ‘miracles’, such as the
Japanese and Koreans did. Across the developing world, many countries
are growing at leisurely rates that will bring them up to current levels of
development in countries like, for example, Portugal, in roughly a century.
This is not what we are trying to achieve. Development management is
about trying to replicate development miracles across a greater number of
the world’s countries, to lift their struggling populations up to rich country
standards of freedom and wealth within roughly a generation.
Activity 8.2
Download Angus Maddison’s database at: www.ggdc.net/maddison/Historical_Statistics/
horizontal-file_03-2007.xls
Make your own time series comparison of economic growth in the US, UK, Brazil, Russia,
India, China and a developing country of your choice. Study the patterns that emerge care-
fully and explain the divergent trends that you see.
Geography
The first set of explanations we examine posit the crucial role of geography
for determining development and underdevelopment. Geographic
explanations can appear deceptively simple, as they are some of the most
commonplace explanations for why some countries are rich and others poor.
In this formulation, Africa or the South simply ‘are’ poor – in the sense that
poverty is somehow a characteristic of the African continent or the southern
hemisphere. Academic explanations of comparative development rely on
geography in a far more sophisticated way, to which we now turn our
attention.
One of the foremost exponents of the role of geography in recent years
is Jeffrey Sachs, who has written widely on geography, poverty, and
development. One good example of such work is the paper ‘Geography and
Economic Development’, by Gallup, Sachs and Mellinger (1999). Here the
authors lay out a number of provocative stylised facts. The first of these is
that African GDP per capita in 1992 was $1,284, about the same as that of
western Europe in 1820, when it was $1,292. On this measure, Africa lags
western Europe by about 170 years. What is holding Africa back?
The second stylised fact is that across the world, tropical countries are
nearly all poor. High income economies, by contrast, are nearly all in middle
and high latitudes. In other words, the countries that lie between the tropics
of Cancer and Capricorn are mostly poor, while rich countries lie mostly
north or south of this tropical zone. Gallup, Sachs and Messenger categorise
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countries into 10 bands according to GDP perception. The only country in

the world in the richest two bands that has a significant landmass within
the tropical zone is Australia. But most of Australia’s population, industry,
and economy are located along the southern coast, well outside of the
tropics.
A third stylised fact is that coastal economies generally have higher
incomes than landlocked economies. Of the 28 non-European landlocked
countries that exist in the world, not one is high-income. European
countries are excluded from this comparison because strong transport and
trade links with coastal countries in Europe make their ‘landlockedness’
less important. A fourth stylised fact is that of the top 30 economies in
the world in terms of purchasing power parity GNP per capita, only three
are tropical: Hong Kong, Singapore, and Mauritius. All three are small
economies with small populations, and at least two of these – Hong Kong
and Singapore – have very particular histories that played a decisive role
in their development.
How can we explain these stylised facts? Is there something about tropical
geography, weather, etc. that somehow causes countries to remain poorer?
Do colder climates lead people to work harder, or save more, and so make
their countries wealthier? Gallup, Sachs, and Mellinger point out four
key reasons which, in their view, provide the link between geography
and development. The first of these is that the tropics have a significantly
higher disease burden, and lower agricultural productivity, than the
world’s temperate zones. The illnesses that disproportionately affect
tropical areas include some of the most feared communicable diseases:
malaria, dengue, yellow fever, schistosomiasis, and others. The countries
with the highest incidences are nearly all located within the tropical zone,
whereas countries outside the tropics suffer low malaria incidence, or
none at all. The reason for this is that the insects that carry malaria thrive
year-round in hot, humid tropical conditions, allowing malaria to remain
endemic and widespread. In colder climates, by contrast, mosquitoes and
other insects did not survive the winter, halting the spread of the disease,
and thus greatly facilitating its eradication.
A second reason is that controlling for inputs, tropical agriculture is
between 30 and 50 per cent less productive than agriculture in the
temperate zones. This is a characteristic of the temperature, rainfall, and
the types of plants that grow in tropical areas, which in turn determine the
fertility of the soil. Better agricultural productivity is an advantage that
temperate countries have, which tropical countries simply do not.
A third reason is that trade is beneficial to development. This is because
it gives a given set of producers access to much greater and more diverse
demand, spurring them to compete more intensely for the greater gains to
be had. Producers engaged in trade can capture much greater economies
of scale than their home markets alone permit, allowing for a greater
and more sophisticated division of labour, and hence greater productive
efficiency. Trade also provides the clients of these producers with many
more options for their supply, preventing them from being ‘captured’ by
producers who do not wish to compete. For this reason, trade provides
strong incentives for both efficiency and innovation amongst producers,
more choice and lower costs for consumers, and hence increased wealth
and productivity in an economy. Because of this, coastal regions and
regions linked to coasts by ocean-navigable waterways have a strong
development advantage compared to hinterlands.
Synthesising these points, the authors argue that high population density
in coastal regions, or regions with good riverine access to trade, is good for
124
development. This is because the combination of high population density

plus trade yields a refined division of labour, which is the key to high levels
of efficiency and productivity, and thus wealth. High population density
in the hinterland, by contrast, is bad for development. This is because the
high transport costs that are associated with overland transport reduce the
amount of trade that is feasible, resulting in a low division of labour. Less
efficient industries that trade less imply a larger agricultural workforce,
which in turn implies decreasing returns to scale for labour where supplies
of land are limited. Thus the economic interaction of population density
and geography can produce fundamentally different outcomes, depending
on the geography in question. High density plus coastal regions or ocean
navigable rivers yields a virtuous circle of high trade, high productivity,
and wealth. High density plus landlocked regions yields a vicious circle
of high transport costs, low trade, low productivity, and poverty. The
key difference between whether a country is locked into a vicious or
virtuous circle is thus an external given, not easily subject to policy or aid
interventions – its geography.
As if this is not bad enough, Gallup, Sachs and Mellinger go one step
further, arguing that good geography and good policy may go together.
For a given discount rate, a revenue-maximising sovereign is more
likely to impose lower taxes if his country is inherently productive and
responsive to good policies. This will allow the economy to grow faster,
trading off lower taxes today for higher revenues year in and year out,
into the indefinite future. If the country in question has an unproductive,
unresponsive economy, however, the sovereign’s incentive will be to tax
at a higher rate, further depressing economic growth. This is because the
benefits of higher taxes – higher tax revenues today – are not offset by the
prospect of even greater tax revenues tomorrow in a (landlocked, tropical)
economy with a low potential for growth. In this way, natural differences
in countries’ growth rates tend to be amplified endogenously by the
actions of politicians.
In the overall sweep of human history, the arguments laid out above exist
in the relatively short to medium term, in the sense that they only affect
the period since ocean-going trade became technologically feasible some
500 years ago. But there is a much longer view that links geography
to development, put forward by Jared Diamond (1997). According
to Diamond, technological diffusion in agriculture, communications,
transport, etc. is a fundamental driver of human progress over the
past 13,000 years. Research into the fossil remains of ancient human
settlements reveals the spread of particular advances in any of these fields
from the areas in which they originated to adjacent, and then increasingly
distant, populations. Technological diffusion works most effectively within
ecological zones, and hence in an east-west direction, where soils, climate,
and other environmental conditions are similar. It is here that the sorts of
innovations that have dominated the past 13,000 years – in seed varieties,
domesticated animals, and agricultural tools – are most appropriate.
By contrast, technological diffusion in a north–south direction, across
latitudes and hence ecological zones, is significantly less effective. This
is because different ecological zones have different climates, growing
conditions, soils, and other environmental variables, making them suitable
different kinds of crops and animal stock. Thus innovations that boost
yields, and thus food supply, in one zone are not particularly appropriate
to another.
In this long view of human history, Eurasia enjoyed the benefits of its vast
east–west axis, heavily situated in temperate zones. Africa, by contrast,
125
was disadvantaged by a north–south axis that crosses the Mediterranean,

Sahara, tropics, and the southernmost sub-tropics. And the Americas and
Australasia were cut off by oceans from the vast majority of humans, and
hence the vast majority of technological progress happening in the world.
These factors, plus important initial advantages in the animal and plant
species native to the continent, especially the fertile crescent in the Middle
East, gave Eurasia a fundamental long-term development advantage over
the rest of the world.
But even if geography is fixed across time, geographic advantages are not.
Rather, they change in conjunction with technological change. Hence for
early civilisations, where transportation was mainly land-based and hence
expensive, and communications technologies were primitive, extensive
trade was simply not feasible. In this context, geographic advantage
came overwhelmingly from agricultural productivity. Hence the earliest
civilisations emerged in the fertile river valleys of the Nile, Indus, Tigris,
Euphrates, yellow, and Yangtze rivers. The high-density populations that
emerged in these areas proved disadvantageous for growth much later due
to their remoteness from international trade.
By contrast, northern Europe could not be densely settled before the
discoveries of appropriate technologies to fell forests and plough the land.
Before such developments, northern Europe lacked inhabitants and was
therefore absent from world history. After their invention, Europe’s fertile
land and temperate climate could be exploited, and a rich society develop.
As time went on and the overland and coastal-based trade with Asia that
gave Europe an early advantage lost out to oceanic commerce in the
sixteenth century, economic advantage shifted from the Middle East and
eastern Mediterranean to Europe and the north Atlantic.
Culture (values)
A second set of explanations for comparative levels of development is
concerned with culture – the set of values that characterise different
peoples and different societies. Such explanations may seem at first
familiar, as they constitute the other commonplace explanation for
differences in levels of national wealth and development. But once again,
the academic appeal to values and culture is more subtle.
La Porta et al. (1999) characterise this class of explanations well:
Certain beliefs and values arise in different places over time, and
these give certain populations economic advantages that, in turn,
explain differences in the wealth of nations. Some of these be-
liefs and ideas are non-verifiable (punishments or rewards follow
death), others verifiable and false (racism, anti-Semitism), and
others are self-fulfilling (the belief that your neighbours don’t
cooperate in any collective action leads you not to either). When
these beliefs are highly pervasive and persistent, they’re called
‘culture’.
(adapted from La Porta et al., 1999)
Without doubt the most important cultural explanation of development is
Max Weber’s The Protestant Ethic and the Spirit of Capitalism (1904–05).
Weber’s work is an imposing piece of economic sociology and economic
history, and continues to be a key reference in both fields. He claims that
the development of capitalism in northern Europe is not accidental, but
rather directly linked to the Protestant faiths dominant there. According
to Weber, Calvinist sects developed the concept of predestination, which
126
held that only some humans are pre-chosen by God to be saved from
damnation. But human intelligence is incapable of fully comprehending
the designs of God, and hence it is impossible for men to know which
among them are destined for heaven, and which for hell. Weber
characterises the effects of such beliefs as follows:
‘In its extreme inhumanity, this doctrine must above all have had
one consequence for the life of a generation which surrendered
to its magnificent consistency … .a feeling of unprecedented in-
ner loneliness.’ (p.104)
Two pastoral developments followed: it became obligatory to regard
oneself as chosen, since lack of certainty indicated insufficient faith; and
performance in worldly activity became accepted as the medium whereby
such surety could be demonstrated. Hence worldly success came to be
regarded as a sign – never the means – of being one of the elect.
Thus the Protestants of northern Europe became hard working,
abstemious, trustworthy entrepreneurs who consumed little, saved a
large part of their income, and dedicated their lives to becoming rich so
that they might be regarded – including by themselves – as one of the
elect. The confluence of Protestant values with certain legal and financial
innovations then taking place in northern Europe created a fertile soil in
which capitalism could be born.
Weber’s analysis is not only elegant, but based upon a great quantity
of detailed micro-level research, including quotations from scripture,
sermons, and the personal correspondence of important reformers and
preachers. It is impressive, and has had a deservedly long-lasting impact
on the social sciences. But it suffers from a fatal flaw at the core of its
argument. Weber’s project is to link the birth of capitalism to Protestant
religious beliefs. The crux of his argument concerns predestination, and
the sorts of behaviours that belief in this doctrine encouraged. The flaw
is that a belief in predestination is at least as likely to make its subjects
slothful and dissolute as it is to make them upstanding, hard-working
citizens. If I truly believe that only God can decide whether or not I will be
saved, that He has already made the decision, and that nothing I do or say
can ever change that, then I may as well eat, drink, and merrily enjoy the
present, while waiting to discover what He has planned for my hereafter.
By contrast, if no amount of worldly success, and no quantity of good
deeds, can prevent my passage to hell if that is what has been decided,
then why forego pleasures now?
Weber’s thesis that capitalism is based on a Protestant ethic is a deep
and thoughtful piece of work. But it is based upon the Protestants
whose beliefs he dissects deceiving themselves and each other about the
substance of their beliefs. In other words, it is still possible that capitalism
flowed from Protestantism. But if so, the core Protestant beliefs that made
them behave in the ways they did must be something other than what
they said and wrote down. This is no solid foundation for a theory of
development.
A more recent contribution to cultural theories of development is Robert
Putnam’s (1993) Making Democracy Work. The puzzle he seeks to explain
is why northern Italy is so much more prosperous and organised than
the south, and why its regional governments are so much more effective.
He finds the answer deep in the country’s past, in the social patterns of
interaction that prevailed in the north versus south, and the different
levels of what he calls social capital that accumulated in each region as a
result. Beginning some 800 or more years ago, certain Italian communities
127
in the north developed horizontal social bonds amongst urban, free men,
while in the deep south vertical relations of dependency between patron
and peasant prevailed. These horizontal bonds of northern Italy facilitated
trust, cooperation, and eventually the establishment of institutionalised
social structures for solving collective action problems. Such structures, in
turn, facilitated economic growth. By contrast, vertical bonds in the south
substituted dependency for trust and cooperation. Institutional forms to
solve the collective action problem never emerged, and the region stayed
poor. Why these different beliefs emerged is shrouded in the mists of time.
In the end, all we can be sure of is that people in different parts of Italy
believed different things and behaved in different ways.
A third, and even more recent example, is Landes’s Wealth and Poverty
of Nations (1998). Landes’s premise is that some people hold beliefs that
are rational, meaning logical and non-superstitious, and open-minded,
meaning they are open to novelty and not given to bigotry or xenophobia.
Countries whose people hold such beliefs will tend to develop more
rapidly than others because their citizens will be more open to external
ideas and innovations, and their habits more attuned to hard work, thrift,
and timeliness. Thus Catholic Spain at the height of her power turned in
on herself, expelling Moors and Jews, and became intolerant and obsessed
with religious purity at the expense of industry and science. So too the
Muslim world after about 1300 became inward-looking, intolerant, and
xenophobic as a means of political and religious control, leading to a
centuries-long decline that continues to this day. By contrast, Protestant,
tolerant England and Holland allowed individuals much greater leeway to
believe what they wanted. These societies, never closed to foreigners and
their innovations, supported vibrant commercial and industrial economies,
and extensive scientific experimentation. They were quick to adopt
technical and institutional innovations. And they very rapidly became rich.
Factor endowments
A third set of explanations for comparative levels of development focuses
on factor endowments, well represented by a classic study by Sokoloff
and Engerman (2000). An economic factor is an input into the process
of production; Sokoloff and Engerman focus on land and labour. Their
analysis examines the New World, and they begin with two provocative
stylised facts. First, they point out that economic performance rankings
do not persist over time. ‘Haiti was likely the richest society in the world
on a per capita basis in 1790, on the eve of its Revolution’ (p.218). Today
it is the poorest country in the Western Hemisphere. Secondly, during the
colonial period, Caribbean economies had the highest per capita incomes
in the world, and it made little difference whether they were Spanish,
British, or French. In particular, the Caribbean economies were much
richer than those of North America, which was comparatively a poor,
backward region dominated by modest family farms.
How can we explain this early ascendancy, and the remarkable reversal
of fortune that subsequently left most Caribbean countries poor and
underdeveloped? Sokoloff and Engerman point to the role of sugar in
the eighteenth century world economy. Sugar was cheap to produce,
and could be sold at good prices to a buoyant European market that
had recently acquired a taste for adding sugar to its food. It was also
particularly well-suited to large-scale plantation agriculture in the climate
and soils of the Caribbean, which offered significant economies of scale.
This combination made sugar by some measure the most profitable
industrial product in the eighteenth century world.
128
Lack of Wealth Literacy Proportion of

Secrecy In Requirement Requirement the Population
Balloting Voting
1840–1880
Chile 1869 Y Y Y 1.6%
Costa Rica 1890 Y Y Y —
Ecuador 1856 Y Y Y 0.1
Mexico 1840 Y Y Y —
Peru 1875 Y Y Y —
Uruguay 1880 Y Y Y —
Venezuela 1880 Y Y Y —
Canada 1867 Y Y N 7.7
1878 N Y N 12.9
United States 1850a N N N 12.9
1880 N N N 18.3
1881-1920
Argentina 1896 Y Y Y 1.8b
1916 N N N 9.0
Brazil 1914 Y Y N 2.4
Chile 1920 Y N Y 4.4
Columbia 1918c N N N 6.9
Costa Rica 1912 Y Y Y —
1919 Y N N 10.6
Ecuador 1894 N N Y 3.3
Mexico 1920 N N N 8.6
Peru 1920 Y Y Y —
Uruguay 1900 Y Y Y —
1920 N N N 13.8
Venezuela 1920 Y Y Y —
Canada 1917 N N N 20.5
United States 1900 N N Yd 18.4
1920 N N Y 25.1
1921-1940
Argentina 1937 N N N 15.0
Bolivia 1951 — Y Y 4.1
Brazil 1930 Y Y Y 5.7
Colombia 1930 N N N 11.1
Chile 1931 Y N Y 6.5
Costa Rica 1940 N N N 17.6
Ecuador 1940 N N Y 3.3
Mexico 1940 N N N 11.8
Peru 1940 N N Y —
Uruguay 1940 N N N 19.7
Venezuela 1940 N Y Y —
Canada 1940 N N N 41.1
United States 1940 N N Y 37.8
Figure 8.4: Laws Governing the Franchise and the Extent of Voting in Selected
American Countries, 1840–1940
Source: Sokoloff and Engerman (2000).
Economies of scale were best exploited using a labour-intensive model

of production that relied on slaves. Those areas of the Americas where
conditions appropriate to sugar plantations existed specialised in this crop.
In these places, an economic order emerged based on a small number
of landowners and a large number of slaves. Huge wealth accumulated
very rapidly in these places, alongside huge inequality. Other areas of the
Americas had rich mineral deposits, and often a substantial number of
129
Year Ages Rate %

Argentina 1869 +6 23.8
1895 +6 45.6
1900 +10 52.0
1925 +10 73.0
Barbados 1946 +10 92.7
Bolivia 1900 +10 17.0
Brazil 1872 +7 15.8
1890 +7 14.8
1900 +7 25.6
1920 +10 30.0
1939 +10 57.0
Chile 1865 +7 18.0
1875 +7 25.7
1885 +7 30.3
1900 +10 43.0
1925 +10 66.0
1945 +10 76.0
Columbia 1918 +15 32.0
1938 +15 56.0
1951 +15 62.0
Costa Rica 1892 +7 23.6
1900 +10 33.0
1925 +10 64.0
Cuba 1861 +7 23.8
1899 +10 40.5
1925 +10 67.0
1946 +10 77.9
Guatemala 1893 +7 11.3
1925 +10 15.0
1945 +10 20.0
Jamaica 1871 +5 16.3
1891 +5 32.0
1911 +5 47.2
1943 +5 67.9
Mexico 1900 +10 22.2
1925 +10 36.0
1946 +10 48.4
Peru 1925 +10 38.0
Uruguay 1900 +10 54.0
1925 +10 70.0
Venezuela 1925 +10 34.0
Canada 1861 All 82.5
English-majority counties 1861 All 93.0
French-majority counties 1861 All 81.2
United States
North Whites 1850 +10 96.9
South Whites 1850 +10 91.5
All 1870 +10 80.0
(88.5, 21.1)
1890 +10 86.7
(92.3, 43.2)a
1910 +10 92.3
(95.0, 69.5)a
Figure 8.5: Literacy Rates in the Americas, 1850–1950

Source: Engerman, Haber and Sokoloff (2000).
130
natives who survived contact with colonisers. These areas also specialised
economically, creating again huge wealth and huge inequality. In all of
these regions, an economic structure was generated in which wealth,
human capital, and political power were held by a small group of people.
These elites were drawn from a relatively small group of European descent
that was racially distinct from the mass.
The final category of new world colonies were located on the North
American mainland (the US, Canada). These were characterised by sparse
populations of natives, and lacked climates and soils advantageous to the
production of plantation crops. The crops that grew well in these regions,
given the technology of the time, were well suited to small, family-run
farms. Hence the development of the North American mainland was based
on labourers of European descent who had relatively high and similar
levels of human capital. In these homogeneous populations, the great
majority of adult men operated as independent proprietors.
In the plantation-economy Caribbean, and in the mining economies of
South America, the initial conditions described generated economic and
political elites who built institutions designed to defend their power
and privilege. The policies they subsequently made, born of inequality,
reproduced inequality. By contrast, in the more homogeneous societies
of North America, efforts by elites over time to institutionalise unequal
distributions of political power were relatively unsuccessful. Crucially,
Sokoloff and Engerman argue that equality or inequality in landholding
policies tended to spread to other areas of law and administration:
for example, the establishment of corporations, regulation of financial
institutions, granting of property rights and intellectual capital, industrial
policy, and access to mineral and other natural resources on government
owned land. Figures 8.8 and 8.9 provide evidence of such institutional
‘spillover’ or ‘contamination’, to such areas as the franchise and public
literacy.
Institutions
A fourth set of explanations of comparative levels of development focuses
on the role of institutions. Although such explanations are not new – Karl
Marx’s is perhaps the best-known – recent research has brought the issue
back to the fore. Amongst latter-day contributions, the best-known is
probably Acemoglu, Johnson and Robinson (AJR) (2001a). AJR begin with
a stylised fact of their own – the worldwide colonial ‘reversal of fortune’.
Systematically, the richest colonies in 1750 are amongst the poorest today,
and the poorest in 1750 are amongst the richest today.
Although detailed income data from the early colonial period are not
readily available, data on population density are. And the authors argue
that population density is a reliable proxy for the level of wealth, as
a significant agricultural surplus is required to maintain high-density
populations in cities. Thus colonies with high population density in 1500
should be richer than colonies with low population density. Accepting
this assumption, Figure 8.6 shows the reversal of fortune over 500 years
in graphic form. The regression line is negative and strongly significant.
Those colonies with the lowest population densities in 1500, and hence
poor economies, such as Canada, Singapore, and New Zealand, are
systematically amongst the richest countries in the world today. Conversely,
those colonies with the highest population densities in 1500, such as
Rwanda, Egypt, and Bangladesh, are amongst the poorest countries in the
world today.
131
10
Log GDP per capita, PPP, 1995
6
-5 0 5
Log Population Density in 1500
Figure 8.6: Reversal of fortune

Source: Acemoglu, Johnson and Robinson (2001a).
How do we explain such a dramatic and consistent reversal of fortune?

AJR claim that the cause is institutional. But institutional explanations are
difficult to demonstrate empirically, because of the obvious endogeneity
involved: richer countries can afford better institutions, and hence a
positive correlation may easily imply the opposite causal process. AJR’s
solution to this problem is to use colonial mortality rates as a statistical
instrument for early institutions. In order to do this, they posit the
following mechanism:
(Potential) Settler mortality  Settlements  Early institutions  Current institutions  Current Performance
The rates at which Europeans died in different colonies determined

which areas Europeans chose to colonise in large numbers. Thus in
some colonies, European settlers moved en masse with their families
and created ‘neo-Europes’; in others, small numbers of European men
went alone, risking death to extract wealth. These patterns of settlement
determined the early institutions established in different colonies. Because
institutions, once established, tend to persist over time, early institutions
determine current institutions. And – the key step – current institutions
determine current development performance.
AJR provide detailed evidence in favour of this causal chain. They show,
for example, that mortality rates were a key determinant of European
settlements. The British and French press regularly informed the public
about mortality in colonies. And these rates were often extremely high.
Initial European hopes to establish settlements in West Africa were dashed
by the very high mortality rates experienced there. In Bulama in 1792–93,
61 per cent of settlers died; in Sierra Leone in 1792–93, 72 per cent died;
and in Mungo Park’s second expedition from Gambia to the Niger, 87 per
cent of Europeans died within six months, and all died before completing
the expedition.
Hence two different kinds of colonies emerged across the non-European
world:
• Settler colonies, where migrants carrying in their heads European
ideas about individual rights and freedoms established representative
institutions to promote what they wanted: freedom and the opportunity
to get rich via trade. In such colonies, private ownership of land and
livestock was established very early. Where such institutions did not
arise naturally, settlers fought for them against the wishes of the home
country. Thus Australia, where the struggle for power between ex-
132
convicts and the ex-gaoler landowning elite became intense. Settlers

demanded institutions: jury trials, freedom from arbitrary arrest, and
electoral representation. The British government resisted at first, but
from the late 1840s onwards bowed to local pressure, and allowed the
institutions to be formed.
• Extractive colonies, such as Latin America in the seventeenth
and eighteenth centuries, and Asia and Africa in the nineteenth and
twentieth centuries. Here, the overriding goal of colonial powers was
to extract wealth for the metropole. European crowns granted rights
over land and labour to white elites, and set up complex mercantilist
systems of monopolies and trade regulations designed to extract
resources. European elites were at the top of this system, and ran it
on behalf of the crown. Representative institutions that guaranteed
individual rights and property were never established as they would
have contravened these colonies’ fundamental purpose. Thus between
1930–40, the British government retained £2,400,000 in taxes from
northern Rhodesia, while granting the territory only £136,000 in
development grants. In 1905–14, France extracted some 50 per cent
of GDP from Dahomey (now Benin). And in the 1920s and 1930s, tax
rates on Africans in the Congo approached 60 per cent of income.
With this evidence in favour, AJR use colonial mortality as an instrument
to test the effect of institutions on current income per capita across a large
sample of countries. Their exclusion restriction is that, conditional on the
controls used, settler mortality rates more than 100 years ago have no
direct effects on GDP per capita today. That is, their only effect should be
transmitted via institutions.
Their results are striking. Figure 8.7 shows the relationship between settler
mortality and current income per capita (at purchasing power parity).
The correlation line is negative and significant. The regression results
show a large effect of institutions on per capita income levels, such that
improving Nigeria’s institutions to the level of Chile’s could produce up
to a seven-fold increase in Nigeria’s income per capita. This relationship
is robust to controlling for: colonial origin, legal origin, latitude, climate,
current disease environment, religion, natural resources, soil quality,
ethno-linguistic fragmentation, and current racial composition. It is also
10
Log GDP per capita, PPP, 1995
4
2 4 6 8
Log of Settler Mortality
Figure 8.7: The effect of settler mortality on income

Source: Acemoglu, Johnson and Robinson (2001a).
133
interesting that variables for Catholic, Muslim, Protestant and ‘Other’

religions have little effect on their estimates, implying that the religion
of the colonising power, on which other studies have laid much stress, is
unimportant.
Activity 8.3
Using Angus Maddison’s database (www.ggdc.net/maddison/Historical_Statistics/
horizontal-file_03-2007.xls), plot a time series comparison of economic growth in the
nine major South American countries. With which broad explanation of development is
the pattern you see most consistent?
Conclusions
What can we conclude from all of this? Why are some countries rich
and others poor? Why are some countries more highly developed than
others? The first lesson is that to answer this question, we should apply a
version of the ‘Lucas critique’ to models of the wealth of nations. That is
to say, explanations of comparative development should be based on deep
structural features that persist over time, and not on transitory correlates
of development that certain societies exhibit at certain points in their
history. Geography and factor endowments are examples of such deep
structure – they are objectively verifiable, cannot be changed suddenly, if
at all, and they have broad effects on the incentives and opportunities that
people face for production, collective action, etc.
Cultural or value-based explanations are not examples of deep structure.
An individual’s core values are often vague, elastic, contradictory, and
capable of rapid change. This makes them difficult to verify objectively.
This vagueness, contradiction and non-stability multiply when we
aggregate up to the level of society, making it extremely difficult to pin
down what defines a society’s beliefs or ‘culture’. Even Weber’s masterful
study of Protestantism is ultimately unable to attribute the behaviours
characteristic of capitalism to an unambiguous set of beliefs that
Protestants held. As a result, culture is too often an intellectual rubbish bin
into which we throw that which we cannot explain.
Another way of saying this is that such explanations are ‘essentialising’.
Why did Germany experience such a rapid industrial transformation
in the late nineteenth century, and then such a rapid recovery after
the devastation of the Second World War? Because rapid development
requires thrift, hard work, honesty, and a high rate of savings, and these
are German traits. Thus Germany’s repeated economic success is due to
its ‘German-ness’. Voila – problem solved. This explanation may seem
compelling at first, until we realise that we have done no more than
restate the initial question as a solution, using a slightly different form of
words. Why, then, do Germans have German-ness? Why do Indians not
have it. Is China’s recent economic success due to creeping German-ness?
More interestingly, consider what German-ness would have entailed in
the year 1600: a balkanised social and political mosaic lacking a common
market or currency, a unifying political authority, or common institutions,
amounting to an economic and political backwater unable to compete
with France, England, or Spain. By 1900, each of these characteristics
had changed radically. Can this be explained by German-ness? Were the
Germans of 1900 more German than those of 1600, or less so?
The answer is that cultural and national attributes change over time, and
are in large part defined by the development-type characteristics that
we are trying to explain. Hence appeals to such arguments fail the Lucas
134
critique, and are ultimately circular. ‘Germans are rich because they are
German, and to be German is to be rich.’
It is also important to note that periodicity is often determinant for the
phenomena we are trying to explain. As De Long reminds us,
In the grandest sweep of world history, northwestern Europe
is a backward region. Two thousand and fifty years ago the
Roman politician Cicero could dismiss the island of Great Britain
as a region not worth conquering because it was inhabited by
barbarians too stupid even to make good slaves. (De Long in A
Not So Dismal Science, 2000)
Eighteen centuries later, their nation’s wealth and power convinced many
British people of their innate superiority.
Geography and factor endowments set the costs and opportunities that
societies face, but no more. They are not determinant for development.
Such costs can be overcome, and new opportunities generated. Singapore
is an example of this. Consider, also, natural experiments where similar
geographies have radically different outcomes – North vs. South Korea,
or East vs. West Germany. The difference in both comparisons concerns
neither geography nor factor endowments, but institutions.
Institutions are the third set of structural features that satisfy the Lucas
critique. They are objectively verifiable, long-lived, and have broad effects
on the incentives and opportunities that people face for production,
collective action, etc. Institutions matter because they allow nations to
make the most of their geography, resources, and opportunities, or not.
And to a much greater extent than geography or factor endowments, they
are susceptible to human agency. Good institutions can help countries to
develop rapidly, and bad institutions will prevent them from doing so. If
we are going to manage development, institutions are the place to start.

• give a good account of ‘cultural’ explanations of comparative
development
• give a good account of ‘geographic’ explanations of comparative
development
• give a good account of ‘institutional’ explanations of comparative
development
• analyse the relative strengths and weaknesses of each class of
explanations of why some countries are more developed than others.

1. Why are some countries more developed than others?
2. Do institutions explain why some countries are rich and others poor?
3. There is a logical inconsistency at the core of Weber’s argument that
capitalism has a protestant core. Discuss.
135
Notes
136
Chapter 9: Analytical narratives of development failure
Chapter 9: Analytical narratives of

development failure
Aim of the chapter

The previous chapter examined broad theoretical approaches to questions
of development and non-development, and tested some of these ideas with
cross-country empirical evidence. But if we are to understand the deeper
reasons behind development success and failure, we must go beyond
broad-brush approaches, and push the analysis much more deeply into
particular countries’ experiences. Hence this chapter turns to analytical
narratives of development failure. In order to be robust, any theory of
development must also be able to account for failure. A good theory of
development should be able to explain:
• How do countries fail?
• Why do they fail?
• What are the precursors and what are the consequences of failure?
In the pages that follow we consider the cases of Venezuela, Zimbabwe
and Pakistan. Each of these represents a different sort of ‘failure’. We seek
to understand each on its own terms, and then draw more general lessons
about development failure.
Learning outcomes
• define ‘analytical narrative’, and contrast it to ‘cross-country study’ as a
way of gaining knowledge about development performance
• explain how the factors that contributed to Venezuela’s rapid
development success in the first half of the twentieth century
subsequently led to its economic and political implosion in the second
half of the twentieth century
• describe the roots of the current Zimbabwean collapse, and explain the
events constituting the major turning-point in 1997–98
• explain why Pakistan has suffered ‘growth without development’ since
independence.
Essential reading
Brett, E.A. ‘State Failure and Success in Uganda and Zimbabwe: The Logic
of Political Decay and Reconstruction in Africa,’ Journal of Development
Studies, 44(3) 2008, pp.339–364.
DiJohn, J. ‘The Political Economy of Industrial Policy in Venezuela,’
Unpublished manuscript, University of London (2007). Available at:
www.cid.harvard.edu/events/papers/0604caf/DiJohn.doc
(You may also be interested in the skypecast interview with DiJohn at:
http://caracaschronicles.blogspot.com/2006/07/skypecast-jonathan-
dijohn-casts-doubt.html).
Rodrik, D. ‘Introduction: What do we learn from country narratives?’ in D.
Rodrik (ed.) In Search of Prosperity: Analytical Narratives on Economic
Growth. (Princeton: Princeton University Press, 2003) Chapter 1, pp.1–19.
137
Further reading
Easterly, W. ‘The Political Economy of Growth without Development: a case
study of Pakistan.’ in D. Rodrik (ed.). In Search of Prosperity: Analytical
Narratives on Economic Growth. (Princeton: Princeton University Press,
2003). Chapter 14.
Hausmann, R., F. Rodríguez, and R. Wagner. (2006) ‘Growth Collapses.’ CID
Working Paper No. 136. (www.cid.harvard.edu/cidwp/136.htm)
Internet resources
The Angus Maddison dataset: www.ggdc.net/maddison/
Introduction
The previous chapter examined broad theoretical approaches to questions
of development and non-development, and tested some of these ideas
with cross-country empirical evidence. Such approaches are attractive
for a number of reasons. Because they focus on ‘big ideas’, they can
apparently provide relatively simple, powerful answers to some of the
biggest problems facing the world today. And because the evidence covers
scores of countries and long periods of time, any significant empirical
results have a high degree of generality, meaning potentially worldwide
implications.
Such advantages are real, and give these approaches justified power. But
if we are to understand the deeper reasons behind development success
and failure, we must go beyond broad-brush approaches, and push the
analysis much more deeply into particular countries’ experiences. This is 1
In other words, studies based on
because ‘large-N’,1 cross-country empirical evidence is ultimately about a
a large number of observations.
series of controlled correlations, which can be very informative, but which
do not comprise explanations of complicated institutional and economic
phenomena. Statistical analyses can tell us that when X increased, Y also
increased, or alternatively Y decreased, and also what was the degree of
the statistical confidence in these relationships. But these analyses tell us
very little about social mechanisms of causation, for the simple reason
that a series of (controlled) correlations is almost always consistent
with a broad variety of competing explanations. This is why responsible
researchers always clothe their conclusions in terms of the evidence being
‘consistent’ with a particular explanation, as opposed to the evidence in
any sense ‘proving’ that explanation to the exclusion of other feasible
explanations.
In order to approach social mechanisms of causality with empirical data,
we must turn away from cross-country evidence, and from the very broad
theoretical approaches they support, to specific country experiences of
development and non-development. We must explore what happened
in each of these cases, in all of its historical and contextual detail, in
order to understand why changing constellations of institutions, power
relations, and economic conditions led some countries and peoples to
succeed, and others to fail. Such an approach is much narrower than the
previous approach, but also much deeper. By placing variables and actors
in their own historical context, it gives us far more insight into the political
economy dynamics of development success and failure then the previous
approach. And it allows us to rule out feasible alternative explanations of
correlation-type evidence when we observe that they simply did not occur
in particular places at particular times.
138
Hence this chapter turns to analytical narratives of development failure.

In order to be robust, any theory of development must also be able to
account for failure. How do countries fail? Why do they fail? What are the
precursors and what are the consequences of failure? In the pages that
follow we consider the cases of Venezuela, Zimbabwe and Pakistan. Each
of these represents a different sort of ‘failure’. Failure occurred in each
case for different reasons, with varying degrees of severity, with varying
consequences, and with very different likely dénouements.
Activity 9.1
Which countries do you consider to be the three worst cases of development failure
in the world today? Write down the three or four main reasons that explain their poor
performance.

Before entering into our analytical narratives, is useful to get a historical
sense of the three countries’ economic performance as compared to other
countries. Hence we call again upon Angus Maddison’s wonderful dataset.
Figure 9.1 plots economic performance during the twentieth century for
our three countries, against a selection of high and low income countries,
including Japan and South Korea, whose development took off mid-century.
It is interesting to note that at the outset of the twentieth century, the
US and UK were at very high levels of development, whereas the other
countries were clustered together at only a fraction of their GDP per capita.
But from the early 1920s, Venezuela begins to break ranks with its peers,
growing significantly faster than Japan or Korea. The country goes through
a very steep growth curve during the mid-to late 1940s, when it surpasses
the UK in income per capita terms. That is to say, Venezuela goes through
two rapid development phases that lead it to leapfrog the UK, previously
the nation on the world’s technological and development frontier, in terms
of the average wealth of its citizens. This is an astonishing achievement.
Venezuela remains clearly wealthier than Britain for a decade and a half,
after which it suffers stagnation, and then an extended and painful decline.
The graph also shows the relentless rise of Japan immediately following
the second world war, and the similarly impressive rise of South Korea two
decades later.
The need to capture American income per capita levels circa 2003 leads to
the compression of the vertical axis. This means that Figure 9.1 captures
little variation for Zimbabwe or Pakistan. Hence Figure 9.2 expands the
X-axis, so that we can get a better idea of these countries’ growth dynamics,
and also focuses on the period since 1950. By concentrating on the income
range below $3,000 per capita, we lose the US, UK, and Venezuela entirely
from the graph; Japan only barely appears in the extreme left-hand side,
while the first part of Korea’s rise is still visible. The graph shows more
variation in Zimbabwean and Pakistani economic performance than was
apparent in the previous graph. From about 1960 onwards, Pakistan shows
a long, steady record of economic growth that is modest year-on-year,
but remarkably steady, without a single sustained downturn. Zimbabwe,
by contrast, shows much more rapid growth in the late 1960s and early
1970s, an important phase that we will return to below. But the economy
shrinks in the mid-1970s and, after another growth spurt in the late 1970s,
shrinks again after 1980. Indeed, after 1980 Zimbabwe is unable to sustain
economic growth, and enters an increasingly serious economic and social
decline, the worst by far of which is not yet in the dataset.
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LT GDP/cap: Development Failure

3 0 ,0 0 0
United K ingdom
United S tates
V enez uela
2 5 ,0 0 0
India
Japan
S outh K orea
2 0 ,0 0 0
Zim babwe
P ak is tan
1 5 ,0 0 0
1 0 ,0 0 0
5 ,0 0 0
0
1900
1904
1908
1912
1916
1920
1924
1928
1932
1936
1940
1944
1948
1952
1956
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
Figure 9.1: Long-term GDP per capita, selected countries
LT GDP/cap: Development Failure

3 ,0 0 0
Japan
2 ,5 0 0
S outh K orea
Zim babwe
P ak is tan
2 ,0 0 0
1 ,5 0 0
1 ,0 0 0
500
0
1950
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
Figure 9.2: Long-term GDP per capita, Zimbabwe and Pakistan (with
Japan and S. Korea)
How did these patterns come about? What caused these dynamics of
sustained growth, followed by stagnation and/or serious economic
decline? Where decline led to collapse, what are the political economy
constellations of power and interests that caused this collapse? We are
in search not just of descriptions of the processes involved, but rather
an account of the deep factors at work that led some countries to be
prosperous, sophisticated, and free, while others became mired (as we
shall see below) in poverty, oppression, and strife.
Our first analytical narrative is of the case of Venezuela. Because Venezuela
flew far higher than either Zimbabwe or Pakistan, and because its reversal
of fortune is further in the past, we devote more attention to it here.
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Analytical narrative 1: Venezuela

The rise
Any review of Venezuelan economic performance in the twentieth century
must begin with its sustained record of success between 1920 and 1980.
GDP growth averaged 6.4 per cent per year during the 60 year period,
making it the fastest of the major Latin American countries. As opposed
to many developing countries, rapid growth in Venezuela coexisted
alongside a relatively equal distribution of income – one of the most equal
distributions in Latin America. Unusually for Latin America, the country
had no history of inflation. Of all the countries in the IMF’s IFS2 database, 2
International Financial
Venezuela had the lowest inflation between 1950 and 1980. Lastly, the Statistics.
country’s debt was AAA rated.
Turning to politics, the country’s political system was characterised by two
main parties that competed fiercely for power. Voter turnout exceeded
90 per cent throughout the period, and party membership numbered in
the millions, out of a total population of only 20 million. The political
system developed formal and informal rules that ensured a balance of
power. These rules ensured that the party out of power retained important
attributions in the Supreme Court, Congress, judicial appointments, the
comptroller general, and the Attorney General. Along the lines of smaller
European countries (notably the Netherlands), Venezuela developed a
corporatist model of governance in which very strong labour and business
institutions negotiated and resolved social conflicts. Political competition
was sustained by a free press and a high degree of transparency in
policymaking. This combination led to a high degree of accountability on
the part of politicians and the state.
Venezuela was seen as the most stable democracy in Latin America right
up to 1980. Hence the growth collapse, which began in the same year,
took not only Venezuelans but most international observers by surprise.
But once things began to go wrong, they went comprehensively wrong
– the scale and scope of Venezuela’s development failure quickly became
general.
The fall
Non-oil output3 per worker fell by almost 50 per cent between 1980 3
The oil sector is usually
and 2000. Hausmann (2003) illustrates this decline, and then poses the excluded for oil-producing
question: ‘How is it that after 50 years of global technological progress, a countries because large
more educated, healthier, and more urban labour force can only produce swings in the value of oil
as much output per worker as in 1950?’ production usually say very
little about the strength of
But it was not only worker productivity that collapsed. The political party
the underlying economy,
system also soon collapsed – not just individual parties, nor even the main
or of productivity, and are,
parties, but rather the system of parties and of alternation in power.
rather, the result of swings in
Democratic participation collapsed alongside, with voter turnouts falling
the international oil price.
below 50 per cent. The pacted regime of power-sharing amongst the
parties was halted. And transparency declined throughout the system.
More broadly, the corporatist system of political negotiation and conflict
resolution between government, business, and labour ended. Social
conflicts multiplied across the country and came to dominate politics.
Inflation, never a problem in modern Venezuela, rocketed. By 1983, the
country was forced to default on its foreign debts.
How can we explain such a startling reversal of fortune? What would
cause a country with strong economic growth, abundant natural
141
resources, firmly established traditions of competitive democracy and

citizen participation, alternation in power, and progressive social policies
to implode in this way? It is a fair characterisation to say that for a long
time no one knew, neither Venezuelans nor foreigners. The Venezuelan
public initially thought the problem was corruption, and repeatedly kicked
out whoever was in power. International financial institutions (such as
the World Bank and IMF) assumed that insufficient structural reform, or
bad institutions, or both were at fault, and advised structural adjustment
programs. Despite the application of both types of remedy, Venezuela’s
economic decline deepened, and its politics became more fractious.
What are other possible explanations? Before considering some of the
most plausible options, note that any explanation of 20 years of decline
must also be consistent with an astonishing 60 year episode of rapid
development.
Oil
The most obvious alternative explanation for Venezuela’s economic (and
political and social) performance is oil. Oil is the resource that drives
Venezuela’s economy, and the source of taxes and royalties to finance its
government, infrastructure, and social programs. The period between
1973 and the present day is remarkably different in oil terms from that
preceding 1973. During the period between the end of the second world
war and 1973, oil prices varied very little, around the long-term average
of some $15 per barrel. But the Arab oil embargo of 1973 led to a tripling
in the oil price, which had only begun to abate before a second OPEC
price hike overlapped with the beginning of the Iran–Iraq war to drive
prices in the early 1980s to historic highs. But a few years later, the price
of oil had fallen back to around $20 a barrel, and then declined further
in the aftermath of the first Gulf War, to below $15 a barrel. But then the
attacks of September 11, 2001, followed by the American war in Iraq, led
oil prices to zoom back up to their previous highs, and even beyond, to the
point where $140 per barrel of oil is now a reality.
For an economy and government so dependent on oil revenues, are these
movements, and the broad turbulence they cause, not sufficient to explain
Venezuela’s rise and fall? A more careful look at this argument reveals
that the answer is ‘no’. First, consider that in the 1960s, the economy kept
growing despite a decline in oil revenues. Second, Venezuela’s growth
collapse occurred around 1978, before the second oil shock. Oil revenues
kept rising consistently after 1978, and only turned down after 1982. So
although the general logic is attractive, the timing of the facts simply does
not support an oil interpretation of the Venezuelan debacle.
Public sector inefficiency

So perhaps the international financial institutions were right, and
Venezuela’s demise was driven by a bloated and ineffective public sector
that wasted its natural wealth and stifled growth? Hausmann (2003)
disputes this, with data that show that the dynamics of investment and
disinvestment in Venezuela were driven by the private sector, not the
public sector. We reproduce his table in Figure 9.5. This chart divides total
Venezuelan investment between public and private sectors, and records its
evolution between 1950 and 2000. It shows that the huge increases and
decreases in worker productivity during this period were not caused by
changes in public sector investment, but rather private sector investment.
Hence the collapse of output and investment, and apparent fall in
productivity, or alternatively the destruction of Venezuela’s capital stock,
142
was principally a private sector phenomenon, and not a consequence of

investment decisions taken in the public sector. Hence, argues Hausmann,
arguments about public sector inefficiency are not central to the story.
Hausmann provides his own proto–explanation, which will serve as an
informative starting-point for us. A massive rise in interest rates on dollar-
denominated debts occurred between 1978–2001, taking spreads to over
800 basis points by 2001. Such changes are usually due to investor’s
perceptions of a country’s risk of default. But the price of oil has been high
since 1999, and Venezuela’s debt-to-export ratio is lower than better-rated
countries. Additionally, Venezuela enjoys a structural current account
surplus, is an international net creditor, possesses high international
reserves, and has a low debt ratio. Hence Venezuela cannot have an
ability-to-pay problem. Rather, it has a willingness-to-pay problem.
This line of reasoning is provocative, but does not itself account for
Venezuela’s growth collapse. To do so, we must begin here and drive the
analysis deeper. DiJohn (2007) urges us to consider the series of economic
strategies pursued by Venezuela after 1958. The concept of Import
Substitution Industrialization (ISI) is key to all of these strategies,
and hence it is important to understand the underlying idea before going
further. The logic of ISI is based on the observation that developing
countries tend to export natural resources, primary materials, and low-
value-added products. Developed countries, by contrast, tend to export
high-value-added manufactured and industrial goods. ISI proposes that
the road to prosperity is through industrialisation, and that developing
countries can promote industrialisation by replacing the industrial goods
they import with similar goods produced at home. Because new, national
industrial firms will find it difficult to compete with established industrial
firms based in developed countries, import substitution must take
place behind a wall of protective tariffs designed to make imports more
expensive. ISI usually also features technical assistance, subsidised credit,
and investment subsidies designed to make national industrial production
more competitive and profitable.
Venezuela’s first self-conscious development strategy was small-scale ISI,
implemented between 1958–1974, and focused on ‘light’ manufactured
goods, such as food processing, clothing and textiles. In 1974, Carlos
Andres Pérez’s first administration broke with this strategy, initiating a
‘big push’ into heavy industrial development, such as oil, aluminium,
steel, chemicals, and automobiles. This move to a large-scale ISI strategy
was accomplished via the creation and protection of big, capital-intensive
national manufacturing champions. Large-scale ISI lasted until 1989, when
Pérez’s second administration announced El Gran Viraje (‘The Big Turn’), a
broad liberalisation program that, by decreasing tariffs and diminishing or
eliminating subsidies and state-directed credit, went against the spirit and
the detail of the previous 30 years of economic policy, and was designed to
get the state out of Venezuelan development.
DiJohn points to two key facts that we must keep in mind if we are to
understand the Venezuelan experience: (i) oil exports per capita (in 1990
prices) declined from a peak of US $1,600 in 1978–82 to about US $600
in 1983–99, thus depriving the state of a great deal of revenue during
the last two decades of the century; and (ii) a massive shift in the factor
distribution of income in favour of profits away from wages. Figure 9.6
shows the distribution of national income in Venezuela by a decade,
between wages and salaries vs. profits, dividends, rents and interest. This
table demonstrates that one of the consequences of Venezuela’s import
substitution strategies was relatively higher income equality, and that this
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outcome was reversed when the country moved to liberalisation. Note the
amount that Venezuela’s wage earners lost: 13 percentage points of GDP is
not a small sum.
Share of wages and salaries in national Share of corporate profits, dividends,

income (annual average, percent) rents and interest payments in national
income (annual average percent)
1950–1960 47% 53%

1960–1970 46% 54%
1970–1980 49% 51%
1980–1988 46% 54%
1989–1998 36% 64%
Figure 9.6: Net factor distribution of national income in Venezuela,

1950–1998
Source: BCV, Statistical Series, various years
The explanation
With these facts and context in mind, we can now attempt a more
sophisticated explanation of Venezuela’s success, and its failure. The
democratic transition of 1958 was based on a political pact of the Punto
Fijo (literally ‘fixed point’), which sought to draw a line in Venezuela’s
political history, and start afresh with institutional mechanisms of
consensus building and cooperation between the dominant political
party, Accíon Democrática (AD) and the leading opposition party, the
Christian Democratic COPEI (Committee for Political Organisation and
Independent Elections). The pact, and the political consensus to which it
responded, regarded political polarisation and alienation as the biggest
threats to democracy because they could easily lead to authoritarianism,
such as that which had tainted Venezuela’s past. Hence the new status
quo built significant measures of negotiation and consensus building,
accommodation, and cooption into the country’s political institutions and
practices. In the words of DiJohn (2007), the pact established
a centralised form of political clientelism where the political
parties were the main channels of patronage. … regardless of
who won the elections, each party was guaranteed some access
to state jobs and contracts, a partitioning of the ministries, and
a complicated spoils systems that would ensure the political and
economic survival of all signatories, which included the main
labour unions federations (CTV) and the main umbrella business
association (FEDECAMERAS).
A key component for the maintenance of the system was clientelism, which
means material benefits provided by a political patron in exchange for
political support. Examples of material benefits include subsidised credit
for industry and housing, high tariffs, import licenses, public-sector jobs,
and price controls. Examples of political support include campaign finance,
active campaigning, and voting for the patron’s party. These definitions
imply that an important degree of clientelism was deeply woven into
Venezuela’s import substitution industrialisation strategy. The practice of
politics was not conceptually or functionally distinct from the substance of
industrial policy. Rather, each was deeply embedded in the other.
During the late 1960s and 1970s, as the threat of authoritarianism
faded, Venezuelan politics became more fractious, and political parties
144
became more factionalised. This led the system to rely more and more on
clientelistic buy-in to maintain participation and stability, and less and less
on voluntary cooperation. These changes occurred at the same time that
deepening ISI increased the economic rewards of controlling the state. But
the logic of deepening ISI also demands much greater capital investment,
as well as greater coordination and selectivity from the state. Light ISI can
be less selective because the economies of scale involved are smaller. In
other words, there is room in a country attempting to industrialise behind
high tariff barriers for a number of competing clothes manufacturers, food
processors, and textile makers; government can be less choosy in deciding
which ones to support. But with deep ISI, investments are much bigger, as
they must be if the significantly larger scale economies of heavy industry
are to be captured. This, in turn, demands selectivity and coordination on
the part of government, as it tries to support the development of heavy
industry. A typical developing country in such a position can only afford
one steel plant, one aluminium plant, and a very small number of car
factories. And the timing and coordination among these investments must
be finely tuned if they are all to reach reasonable levels of efficiency and
profitability, without which heavy industrialisation cannot succeed.
Hence it is much more important for a state attempting heavy ISI to
discipline firms (i.e. cut subsidies) when they don’t meet targets (for
exports, efficiency). The historical record shows that South Korea and
Taiwan managed this difficult task successfully. But Venezuela did not.
Venezuela could not do this because clientelistic pact politics required
the state to buy in large numbers of factions in order to maintain system
stability. This stability criterion led Venezuela’s ISI regime to become very
expensive, and led ISI firms to become a very inefficient. But this was
just when oil revenues began to run out, post-1982. This combination of
factors led to the balance of payments crisis in 1988, and to the collapse
of the then-dominant economic strategy. A newly elected Carlos Andrés
Pérez saw that the state simply could not continue to afford the industrial
strategy that he had set out 15 years earlier, and he implemented the
Gran Viraje liberalisation. This, in turn, led to deeper political and social
conflicts (including especially the Caracazo in February, 1989). A period
of increasing civil strife saw two coup attempts, and then the eventual
collapse of the political party system.
The breakdown of the political party system led to a much greater level
of overall uncertainty in Venezuela, and thus to much higher interest
rates, and collapsing private investment. As private investment collapsed,
Venezuela entered into a period of long-term industrial decline. But the
roots of this lie in the intertwining of industrial policy with the demands of
political stability. Venezuela became a society that cannot resolve conflict.
And a society that cannot resolve conflict cannot develop.
Analytical narrative: Zimbabwe

The rise
Zimbabwe is also a case of very high hopes, and significant initial success.
The precursor to Zimbabwe, Rhodesia, was a settler state that built a
sophisticated capitalist economy through the use of tight state controls
introduced in response to international sanctions after the unilateral
Declaration of Independence in 1965. The period from 1965 to the late
1970s saw a rapid industrialisation and sustained growth rates of 6–7
per cent a year, only brought to an end by the onset of civil war. The
winners of that war were the ZANU-PF party, who rechristened the country
145
‘Zimbabwe’. They inherited a relatively sophisticated state-controlled

economy, but one where large-scale agricultural, commercial, industrial
and financial capital were all monopolised by people of European descent.
During its initial period in power, ZANU-PF left many white officials in
their posts, and white agrarian and urban elites in control of their assets.
The economy grew by over four per cent per year between 1980–1990,
and tax revenue expanded. The government used these revenues to
expand education and health services rapidly, especially for the African
majority living on subsistence communal farms. Some commercial land
was also redistributed. The combined ZANU-PF and ZAPU parties, which
by then had merged, won 83 per cent of the vote in the 1990 elections.
Underlying these positive developments were two important truths: (i)
Zimbabwe was the bread basket of southern Africa, with fertile soils and
a relatively well-educated population; and (ii) the country’s transition
to democracy and majority rule had been surprisingly smooth, and the
government of Robert Mugabe had shown many signs of pragmatism and
open-mindedness. In both 1980 and 1990, hopes for Zimbabwe were high,
and many expected an African success story.
The fall
Despite starting off from a much lower level of development, Zimbabwe’s
collapse proved deeper, more severe, and more violent than Venezuela’s.
Zimbabwe’s nascent industries collapsed, with output falling more than 50
per cent between 2001 and 2006. Over the same period, the Zimbabwean
dollar fell from nine to the US dollar to more than 600,000 per US dollar.
The agrarian economy collapsed. The country can no longer feed itself,
and basic foods must be imported in order to keep large swathes of the
population alive. Zimbabwe’s middle-class entered terminal decline, and
average life expectancy fell from 60 to 36. Food rationing became a fact of
life for large parts of the population. Many Zimbabweans were reduced to
one meal a day.
Worse yet, these rations became a political tool, as the government
initiated the strategic starvation of opposition supporting areas. Hence
the government’s political strategy became to dampen opposition to their
policies by directly limiting the caloric intake of opposition-supporting
Zimbabweans. When this proved insufficient, the government sent
bulldozers to flatten large parts of opposition-supporting townships,
costing an estimated 700,000 people their homes, livelihoods, or both.
More recent news includes a cessation by Zimbabwe’s biggest state
hospital of surgical operations, because of the breakdown of equipment
and acute shortages of drugs. This is but a sign of broader collapse in
Zimbabwe’s public health care system. Also, inflation has recently broken
through the 100,000 per cent per year barrier, and unemployment is
estimated that 80 per cent of the adult population. Such figures are
sufficiently surreal that they obscure the extent of Zimbabwe’s tragedy.
Hence an illustration is useful: according to the BBC, a candle cost twice
the daily official government wage for a farm worker, while the price tag
for single banana is 15 times the price of a four bedroom house seven
years ago.
The explanation
To understand Zimbabwe’s crisis, we must first understand the political
and economic context in which it began. By the late 1980s, Zimbabwe’s
ISI industrial policy had suppressed exports and caused a shortage of
foreign exchange. Growing state spending led to fiscal deficits and credit
146
rationing. This led to controls over foreign and domestic investment,

which in turn caused rising unemployment. It was clear that the economic
policies being pursued could not continue, and some sort of change was
needed. The change the Zimbabwean government chose was structural
adjustment, which it introduced in 1991. This programme was designed
by the ministry of finance, and negotiated with Zimbabwe’s major business
associations. It was, of course, also supported by the international financial
institutions, although not designed by them.
Structural adjustment produced mixed results in Zimbabwe, with growing
fiscal deficits, falling social spending, and lower growth. Tariff reductions
and increased interest rates lead to closures in high-cost industries, and
higher unemployment. As labour conditions worsened, civil service jobs
became threatened. But then the effects of reform began to become
apparent. Output grew rapidly in 1995 and 1996, by over seven per
cent each year. There was strong improvement in Zimbabwe’s balance
of payments position, and the foreign exchange constraint was soon
eliminated. Liberalisation also reduced official opportunities for patronage.
The period saw a rapid growth in civic associations opposed to change,
and an increase in trade union resistance to official economic policy.
These last developments had a number of crucial implications for
Zimbabwe. The political basis for ZANU-PF’s monopoly on power
– realised through regular, relatively open elections – was critically
undermined. Thus, Mugabe won the 1996 election, but with a
substantially reduced majority.
What happened next is best related by a close observer of Zimbabwe:
In 1997, civil war veterans, a constituency that the leadership
could not ignore, staged a threatening demonstration in Harare,
and were given a large payout that destabilised the budget and
threatened ongoing negotiations with the Ibis for an extension of
ESAP [the Extended Structural Adjustment Programme]. A deci-
sion to transfer white owned farms to Africans was announced
in 1998, and the army was sent to the Democratic Republic of
the Congo to support its new government, worsening the deficit
and further alienating the Ibis (Campbell, 2003). Business
confidence, share prices and the value of the currency collapsed.
The regime reintroduced economic controls, but now used them
in clientelistic fashion to reward key elite supporters increas-
ingly involved in crude forms of primary accumulation. This had
disastrous results – an overvalued currency suppressed exports,
budget deficits increased inflation, and parastatal mis-manage-
ment reduced the quality of services. The post-ESAP political
crisis had therefore produced a classic vicious circle by producing
populist policies that led to an economic crisis that increased the
threats to the regime and the temptation to resort to even more
unsustainable expedients. (Brett, 2009)
Hence the government consciously switched away from a liberalisation
program that was beginning to bear fruit, to overt populism, in order
to buy back support it was afraid of losing. It is important to note that
the political opposition the government said it feared was not imagined,
but real. The year 1999 saw the consolidation of forces opposed to the
government in to the Movement for Democratic Change (MDC), which
won a constitutional referendum, and so threatened the regime directly
for the first time. The government’s response was increased anticolonial
nationalism, and state expropriation of white-owned farms. These policies
147
had some of the expected political benefits, but also led to a disastrous fall
in food production and exports, thus kick-starting the vicious circle that
led to the tragedy that we know Zimbabwe to be today.
Analytical narrative: Pakistan

‘Growth without development’ (Easterly 2003)
Pakistan presents a very different pattern to the Venezuelan and
Zimbabwean cases of early success followed by tragic decline. In Pakistan,
early success has never – in a sense – been reversed. But the country’s
potential has never come close to being realised, because of pernicious
social trends that keep large swathes of its people from developing.
First, consider Pakistan’s advantages. Between 1950 and 1999, per capita
income tripled. This growth was much higher than in comparable low-
income countries. Such growth was remarkably steady in Pakistan, without
a single notable recession, nor the boom-and-bust pattern typical of so
many developing countries. Moreover, Pakistan inherited the world’s
largest irrigation system from the British at independence. In between
1960 and 1998 the country received US $58 billion in foreign aid. With
such favourable initial conditions, and such buoyant growth, one would
not expect to class Pakistan as a development failure.
And yet we must, because the signs of Pakistan’s failure are far more
compelling than the size of her success. Consider social development
indicators, which are considerably worse than other countries in its income
class. Compared to countries in its peer group, Pakistan has:
• 36 per cent fewer births attended by trained personnel.
• 11 per cent more babies born with low birth weight.
• 42 per cent lower health spending per capita.
• 27 per thousand more infant deaths.
• 19 per thousand more child deaths.
• 23 per cent lower share of the population with access to sanitation.
• 40 per cent fewer girls attending primary school.
• 24 per cent more of the population illiterate.
• The difference between girl and boy death rates at ages 1–4 is
66 per cent higher than in other similar countries.
If these statistics are not enough, considering the following, telling facts.
The gap between male and female illiteracy actually increased with
rising per capita income in Pakistan, even as it declined sharply in other
countries. And a Social Action Program (SAP) designed to improve
education, health, family planning, and rural water and sanitation
indicators, failed miserably when:
• primary and total school enrolments declined
• the rural-urban enrolment gap grew
• other health and family planning goals were missed
• performance was below that of similar-income countries, and
• total social spending actually declined under the SAP, compared with
the previous period.
How can we explain this paradox of growth without development?
Easterly (2003) points to the distribution of power and wealth within
Pakistani society. In the 1960s, according to Husain (1999), a mere 22
148
families controlled 66 per cent of industrial wealth, and 87 per cent of

banking and insurance. Rural areas even today are dominated by feudal
landowners, who have been prominent in almost all Pakistani governing
coalitions since independence. Because of this, these feudal lords are able
to block taxation and agricultural income. They are allied with military
leaders, who have always wielded much power in Pakistan, even when not
formally in government.
Consider rural/urban and gender gaps, which are highest in Sind, where
‘feudal’ landlords are most prominent, and much lower in Punjab, which
is less ‘feudalistic’. The severe social backwardness of rural areas all over
the country, which explains much of Pakistan’s lag in social indicators,
is consistent with the theory that landowners opposed human capital
accumulation. Hence Pakistan’s good growth record has not yielded
development because powerful landowning elites prefer to keep the rural
population and women in a low-human capital, low-income equilibrium.
In non-technical language, this means that landowning elites keep rural
people over whom they wield power ignorant, sick, and poor. And the
reason elites do so is that they benefit from so doing. Hence Pakistan’s
feudal landowning elite is a blockage to development. How can such a
problem be solved?
Some preliminary lessons of failure

What insights can we gain from these three analytical narratives? It is too
early to draw general conclusions about development success and failure,
until we have had a chance to similarly consider analytical narratives
of development success. Nonetheless, our comparison of Venezuela,
Zimbabwe and Pakistan yields up a few preliminary conclusions worth
mentioning.
The first of these concerns the limits of ISI. There is an ‘easy’ phase
of ISI that sooner or later exhausts its own potential. This threshold will
differ for different countries, of course. But even in oil-rich, sophisticated
Venezuela, hard limits were eventually reached.
Secondly where industrial strategy is concerned, size matters.
Deepening ISI is simply not an option for a small economy. Small countries
must open up to world trade if they are to reap economies of scale in
production. But negotiating this switch to export oriented growth is
very tricky, and more so if protectionism has become intertwined with
politics. Are authoritarian governments required to manage this switch?
Are the social pressures created by a move from import substitution to
export led growth simply too great for democracy to contain? Or, do
we need authoritarian government in order to avoid abusing ISI tools
for clientelistic ends? The state of knowledge on these questions is such
that they cannot be answered conclusively. But in our view, the answer
is probably ‘no’. Authoritarian governments are not, strictly speaking,
required. But governments that isolate economic policy from the practice
of politics are.
Consider also the political basis of development. Society must
be able to negotiate solutions to conflicts. This is in large part the role
of politics and the State. A society that cannot resolve conflict cannot
develop. In Venezuela, the political basis of the system was undermined.
Politics was institutionalised (i.e. the system was bigger than the players),
but this system became comprehensively undermined in the ways we
have described. In Zimbabwe, it was political support for ZANU-PF that
was undermined. But in Zimbabwe, ZANU-PF was the system. Mugabe
149
could have institutionalised politics and the state, but chose not to.
Hence Zimbabwe’s weak institutions gave out at a much earlier stage of
development.
But some countries are cursed with institutions that are anti-
developmental. There is little hope for development in such countries,
because there is essentially no hope of support for development from the
institutions required to bring it about. Such institutions, instead, actively
undermine development. They are convinced they gain from such a
strategy, and in some straightforward material sense they do. What do we
do as development managers in such places?

• define ‘analytical narrative’, and contrast it to ‘cross-country study’ as a
way of gaining knowledge about development performance
• explain how the factors that contributed to Venezuela’s rapid
development success in the first half of the twentieth century
subsequently led to its economic and political implosion in the second
half of the twentieth century
• describe the roots of the current Zimbabwean collapse, and explain the
events constituting the major turning-point in 1997–98
• explain why Pakistan has suffered ‘growth without development’ since
independence.

1. ‘Countries that cannot resolve conflict cannot develop.’ Discuss.
2. Characterise Venezuela’s development success between 1920 and 1980.
Why did growth collapse? Why did the country’s politics collapse?
3. Imagine you become benevolent dictator of Pakistan. What single
reform to the economy or society would you implement to improve
Pakistan’s development performance? Why would this help?
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Chapter 10: Analytical narratives of development success
Chapter 10: Analytical narratives of

development success
Aims of the chapter

In the last chapter we explained the importance of going beyond broad
theoretical approaches and large-N empirical studies of the question of
development success and failure, to focus instead on deep analytical
narratives that explain these phenomena in a rich, highly contextualised
way. That chapter went on to examine three cases of development failure.
Here we examine two notable cases of development success: Botswana
and China. Each cases represents a different sort of ‘success’. We seek to
understand each on its own terms, and then draw more general lessons
about development success.
Learning outcomes
• describe the rapid growth episodes of China and Botswana in historical
context, as compared with the earlier cases of South Korea and Japan
• explain the policy decisions and institutional developments that
overcame poor initial conditions to make Botswana ‘an African success
story’
• describe the transition institutions that China used to accelerate
growth, and analyse their effects on economic incentives
• explain the institutional bases of these rapid development episodes.
Essential reading
Acemoglu, D., S. Johnson and J.A. Robinson. 2003. ‘An African Success Story:
Botswana,’ in Rodrik, D. (ed.) In Search of Prosperity: Analytical Narratives
on Economic Growth. (Princeton: Princeton University Press, 2003) [ISBN
0691092680] Chapter 4.
Ian, Y. ‘How Reform Worked in China.’ in Rodrik, D. (ed.) In Search of
Prosperity: Analytical Narratives on Economic Growth. (Princeton: Princeton
University Press, 2003) Chapter 11.
Wade, R. Governing the Market: Economic Theory and the Role of Government
in East Asian Industrialization. (Princeton, NJ: Princeton University Press.,
1990) Chapter 11: ‘Conclusions (2): Lessons From East Asia’.
Further reading
Bates, R.H. Prosperity and Violence: The Political Economy of Development.
(London: W.W. Norton, 2001) Chapter 4.
Hausmann, R., L. Pritchett and D. Rodrik, ‘Growth Accelerations,’ Journal of
Economic Growth, 10, 2005, pp.303–329.
Introduction
China is, of course, the great economic growth miracle of our times,
which has much of the business and public policy worlds transfixed by
its progress. China is also the greatest ‘poverty event’ in the history of
151
mankind, with an estimated 400 million people lifted out of poverty since
1979. By itself, China’s performance overturned the negative development
story of the 1980s and 90s, based on poor performance by dozens of
African and Latin American countries, into a tale of success, which the
World Bank and other organisations disseminated broadly around the
turn of the millennium. China’s economic development during this period,
and also many aspects of its human development, are nothing short of
astonishing.
Botswana is a much smaller and less populated country that receives far
less public attention than China, and so it may at first seem an odd choice
to present alongside the giant of the east. But as we shall see, its economic
and social performance since 1965 has been exemplary, and is worthy
of study. More interestingly, Botswana is located in what in development
terms can only be called a ‘bad neighbourhood’. But despite sharing many
geographic, historical, and social features with its neighbours, Botswana’s
development performance over four decades has been remarkably
different from almost all of them. It is a combination of these two factors
that brings the country to our attention.
Activity 10.1
Which three countries (besides China) do you consider to be the three best cases of
development success in the world today? Write down the three or four main reasons that
explain their performance.

We call once again upon the Madison database, to get a sense of how
our cases of development success do when plotted against the countries
discussed in Chapter 9, plus, for purposes of comparison, Japan and
South Korea. Although GDP estimates for China go back many centuries,
reliable data for Botswana begins only in 1950. Hence our graph begins
there. Starting from the left-hand side, Figure 10.1 shows the takeoffs of
first Japan, and then South Korea, rising steeply past the US $10,000 per
capita level. As late as 1975, Zimbabwe is still richer in per capita terms
than Pakistan, China or Botswana. Botswana moves from being the poorest
country in the chart in 1950, past first China, then Pakistan, and then
Zimbabwe, as its growth accelerates throughout the 1970s and 1980s.
Growth flattens in the early 1990s, but then accelerates again in the
second half of the decade, and into the 2000s.
China enters the 1950s with about the same GDP per capita that it had
2,000 years earlier, and about a quarter less than it had in 1500. Per capita
income inches upwards through the late 1950s, only to fall back in the
early 1960s. In income per capita terms, little of note happens until the
late 1970s, when growth begins to accelerate. China then goes through
three increasingly faster growth phases in the 1980s, early 1990s, and
again from 1999 to the present day. This performance leaves Zimbabwe
and Pakistan trailing far behind, and China poised to overtake Botswana
around 2005. It is worth noting that China is still ‘only’ a middle-income
country, in the same class as Botswana, Brazil, Mexico and Colombia. It
is not the high level of wealth China has obtained, but rather the sheer
momentum of a billion Chinese attaining middle-income status that is
exciting so many businessmen and commentators, and shaking markets
around the globe.
152
Japan
10,000 S outh K orea
Zim babwe
9,000
P ak is tan
8,000 China
B ots wana
7,000

6,000
5,000
4,000
3,000
2,000
1,000
0
1950
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
Figure 10.1: Long-term GDP per capita, selected countries
Source: Angus Maddison’s dataset; author’s own graphs.
Analytical narrative: Botswana

An inauspicious start
Few independent observers would have singled out Botswana at
independence as a candidate for development success. In fact, as far as we
know, none did. The country is both tropical and landlocked, which, as we
saw in Chapter 8, presents a number of obstacles to rapid development.
Although it has a landmass of some 570,000 km², about the size of France
or Texas, 85 per cent of this is the dry, arid Kalahari desert. Only 4 per cent
of Botswana’s land is easily cultivated.
At independence, there was only one industry in the country – an abattoir
in Lobatse. The country benefited from only 12 km of paved roads, and
the population contained only 22 university graduates and 100 secondary
school graduates. Only two secondary schools in Botswana offered the
full five-year course. More broadly, the quality of education was poor,
with large classes and high failure rates. The country was forced to import
large quantities of food, as it could not feed itself. Most analysts wrote off
Botswana as a poor labour reserve for South Africa. After independence,
diamonds were discovered. But as we saw two chapters ago, it is not
clear analytically whether abundant natural resources tend to bring rapid
development, or corruption and political strife to a country so endowed.
Put bluntly, will diamonds turn Botswana into a Canada or Australia, or an
Angola or Nigeria?
Development success
Framed against such initial conditions, Botswana’s success is all the more
impressive. Economic growth averaged 7.7 per cent over the period
1965–1998, making Botswana the best performer in the world during
these years. By 1998, GDP per capita was four times the African average.
Throughout this period, inflation rarely exceeded 10 per cent, and the
country invested between 20–30 per cent of GDP. The balance of payments
position was consistently in surplus, and the country never had to apply
for a structural adjustment programme. Lastly, Botswana made significant
investments in human capital. This was reflected in the primary school
enrolment rate, which reached 80 per cent, against 50 per cent for Africa,
and the secondary school enrolment rate that reached 89 per cent, against
41 per cent for Africa. Hence Botswana’s development success was real,
broad-based, and worth investigating.
153
How can we explain Botswana success? Let us begin with two attractive
possibilities.
Botswana is more equal
Perhaps Botswana simply began its modern history with a more equal
distribution of income and wealth? If so, we might expect civil and
political conflict to be lower there than in some of its neighbours, thus
facilitating rapid development. This might also help to explain Botswana’s
large investments in human capital. But in fact the thesis is false.
Inequality of assets, in particular cattle, and income are extremely high in
Botswana, as they have been traditionally. In fact, inequality in Botswana
is as high as South Africa and Brazil, which suffer some of the highest
indices of inequality on earth. So idiosyncratically high levels of equality in
Botswana cannot be part of the answer.
Limited government intervention in the market economy
Is Botswana a case of free markets being left alone to do their business of
making people richer? Perhaps Botswana is a kind of African Hong Kong,
where businesses serving the needs of the much larger South African
economy flourish in a febrile, unfettered business environment? Again, the
answer is no. Botswana has, instead, a tradition of massive intervention in
the economy, with detailed planning. The country was newly independent
when diamond exploitation began, and the young government carefully
planned the development of that industry in ways that promoted
broader national growth, and shared the proceeds with large parts of the
population. Circa 2000, central government expenditures were around 40
per cent of GDP – well above the African average. So limited government
and freewheeling capitalism also cannot be part of the story.
An institutional approach (Acemoglu et al., 2003)

Hence we must look beyond these easy explanations, at the political
history of Botswana, and in particular at its institutions. One of the first
points to note about Botswana is its essentially open, inclusive social
character. For centuries, outsiders have been amalgamated into the Tswana
social fabric. Indeed, explicit tribal structures exist for this end. It is
notable that no more than 50 per cent of Botswana’s population is actually
Tswana, but 85 per cent speak Setswana. Botswana is a strong case in
support of the position that social and ethnic identities are constructed,
in this case often by the state or political actors. Hence Tswana tribal
traditions constructed a homogeneous ethnic and cultural identity out of
diverse ethnic groups. So much is this the case that today the different
ethnic groups that exist in Botswana have no separate historiography
or experience of ‘state-ness’, but have instead been integrated into the
broader society.
A second feature of note are the Kgotla, assemblies of adult males called
to discuss issues of public interest. These operate at both low levels
(ward), and high levels (society). According to Acemoglu et al. (2003),
these venues where kings traditionally heard court cases, and the law was
dispensed, served as effective means for commoners to criticise the king.
They informed the king of broader social conditions, and served as a real
constraint on his actions. The authors contend that such features are not
characteristic of other African countries.
Thirdly, the presence of a common enemy not only helped to establish a
national identity, but in the case of Botswana forced diverse tribes to co-
operate extensively in order to achieve military victory. The Batswana had
to fight to defend their territories against Zulus, and – in particular at the
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Battle of Dimawe in 1852 – against Boers, in what is now Botswana.

A fourth factor identified by Acemoglu et al. is the ‘light’ version of
colonialism experienced by Botswana. The British brought Botswana into
the empire not because its territory was valuable or attractive, but for
strategic reasons – to contain Boer and German expansion, and provide a
route into the African interior. They weren’t interested in the territory per
se, and did little to administer or develop it. Hence Tswana institutions
were not transformed, deformed, or repressed. Indeed, in some ways
colonialism fomented further cooperation, as chiefs from the three main
areas travelled to Britain to lobby Queen Victoria for Britain, and not Cecil
Rhodes, to control the protectorate. They succeeded.
Fifthly, the ruling Botswana Democratic Party (BDP) boasts a number of
characteristics that contributed to a democratic inclusion and legitimacy,
and hence political stability in Botswana, thus facilitating the country’s
long-term development. The BDP is a majority political party that, from
its foundation, consciously integrated emerging educated elites (such
as teachers and civil servants) with traditional chiefs. Hence it coopted
the major centres of power and authority in Botswanan society – chiefs
– along with the traditional rural structures of loyalty between chiefs
and commoners, within it. An example of this are the ‘small’ clientelistic
practice of mafisa – lending of cattle by chiefs in exchange for the political
support of commoners. The class alliance that the BDP forged, and its co-
option of pre-existing forms of social legitimacy, were strikingly successful.
The BDP has ruled continuously since independence, always with the
support of a clear majority of the electorate.
Nonetheless, it is important to note that electoral competition is real in
Botswana, and the BDP has clearly responded to the threat of losing
power at different moments, when its electoral fortunes waned. One
example of this is the Accelerated Rural Development Programme, which
Acemoglu et al. characterise as a basically efficient rural investment
programme. At a time when the opposition seemed to be growing stronger,
and the BDP vote was trending downwards towards the 50 per cent mark,
the government implemented a comprehensive programme which invested
in the rural economy, and improved the welfare and prospects of the
country’s rural inhabitants. The BDP vote duly recovered.
Equally important was the use to which such a strong base of support
was put. The post independence leader, Seretse Khama, was himself a
traditional chief from the largest tribe in the country. One might have
expected him, once in office, to use the power of the state to dominate
other chiefs and expand his traditional prerogatives. Instead, Khama did
exactly the opposite, constructing a state that was stronger than the chiefs,
himself included. Over time, the state came to dominate the chiefs through
a steady accretion of legal instruments and traditions. Hence the state, and
not chiefs, now allocates land in Botswana. And the president can remove
chiefs.
The government’s other, major early success constitutes a sixth important
factor: an incentive-compatible early development strategy.
At independence, Botswana’s comparative advantage lay clearly with
cattle ranching. Cattle benefited the elites, the ‘rising rural capitalist
class’ in the words of Acemoglu et al., who owned most of the cattle. An
economic growth strategy based on cattle ranching could be made to
benefit non-elites, both directly and through mafisa. It also reinforced
the elite’s interests in property rights and political stability, and it made
it unattractive for powerful actors to fight for control of resource rents
155
or political power. It is notable that this form of government by farmer-

politicians, so characteristic of the young United States of America, is
unusual in Africa. Curiously, the other important case is Rhodesia.
The seventh and final factor in Botswana’s success are the good decisions
government took from the start. From independence, the BDP invested
consistently high amounts in infrastructure, health, and education. The
diamond rents that began to accrue from the mid-1970s onwards were
largely earmarked for public investment. The government kept in place
its workforce of expatriate civil servants and other workers, and freely
used international advisers, while the pool of local, qualified professionals
grew. Calls to ‘indigenise’ the bureaucracy were resisted. And lastly, the
BDP explicitly chose to nurture probity, autonomy and competence in
government. As a result the ability of politicians in office to abuse the
power and resources of the state to their own advantage was much
reduced. Botswana’s leaders might have chosen to do otherwise, and those
of other African nations mostly did. In most of Africa, good economics
is bad politics, in the sense that good policies do not generate enough
rents to allow politicians to sustain themselves in power. Thus, good
economic policies increase the chances of overthrow of the politicians
who pursue them, and are consequently seldom followed. In Botswana, by
contrast, politics is inclusive, and benefits from public resources are widely
dispersed. In Botswana, an incentive compatible development strategy
makes good economics good politics too.
Analytical narrative: China

Poor initial conditions
If Botswana was an unlikely candidate for development success, then
China was much more so. The China of the mid to late-1970s was a
very poor country, with per capita income about equal to India’s, and
one quarter lower than it had enjoyed in the year 1500. It was seriously
overpopulated for its level of agricultural and industrial output, and its
large population suffered low levels of human capital. It had few natural
resources to consume or sell to the outside world. And it was saddled
with a ruthless dictatorship whose anti-market, anti-reform ideology
stifled creativity and economic growth. Evidence for this last point is
overwhelming. The Communist Party’s collectivisation of agriculture led to
a great famine in the early 1960s, which left 20 million Chinese dead. This
was followed by the Cultural Revolution, which displaced, maimed and
killed millions more, especially the educated elite.
Development success
Despite this dreadful inheritance, reforms enacted by Deng Xiaoping after
Mao’s death tipped China into a virtuous circle of growth, accumulation,
investment, and more growth that has made China home to the greatest
‘poverty event’ in the history of mankind. The past generation has seen
more than 400 million people lifted out of poverty in China. The Chinese
population in absolute poverty fell from more than 250 million in 1978 to
fewer than 50 million today. Between 1978–2000, GDP grew by about nine
per cent per year, increasing the size of the economy by four times during
this period. Life expectancy increased from 64 in the 1970s to more than
70 in the late 1990s. Per capita income is now more than twice India’s,
and GDP in purchasing power parity terms is likely to be the largest in the
world by 2015.1
1
Total GDP, not per capita GDP.
156
Joseph Stiglitz’s simple comparison of China with the other post-

communist giant, Russia, is instructive. At the time that the Berlin wall
came down, the GDP of Russia (then part of the USSR) was more than
twice as large as China’s. Figure 10.2 shows the Chinese GDP grew
impressively, and without pause, through 1997, while Russia’s staggered
and fell, to a point where the tables were turned, and Chinese GDP
was nearly twice Russia’s. How could a country, beginning from such
poor initial conditions, and with a long, varied history of governments
that varied between the inept and the murderous, so suddenly and
comprehensively break with its own past and embark upon development
success on this scale?
800
700
China
600
500
US$billions
400
300 Russian
Federation
200
100
1989 1990 1991 1992 1993 1994 1995 1996 1997
*Measured in constant 1987 US$

Source: Statistical Information and Management Analysis (SIMA) database.
Figure 10.2: Russian and Chinese Gross Domestic Product

Source: Stiglitz (1999).
Explaining development success: transition institutions

(Qian 2003)
A full answer to this question involves understanding the period
immediately following the death of Mao, which resulted in the ascendancy
of Deng Xiaoping. One would also need to understand why reformers
committed themselves to market-type reforms, liberalisation, and
integration with the world economy. A full explanation of late-twentieth
century Chinese economic reforms is beyond the scope of this chapter, and
probably awaits future historians working with the benefit of hindsight.
Instead, we focus here on how China made the transition to a market-led,
rapid industrialisation process. Crucial to understanding this is what Qian
(2003) calls ‘transition institutions’. These institutions are the tools that
the Chinese government used to smooth the transition from a centralised
command economy operated by fiat, to a far more open, diverse economy
based on decentralised production, price signals, and market exchange.
Understanding these tools is a large part of understanding China’s success.
The first transition institution is the dual-track price system. Under
this system, fixed quantities of goods are produced and allocated at
fixed prices under the old planning system. At the same time, a new
market track is introduced in which prices and quantities are determined
157
by the free market mechanism for all quantities above the plan. In this
way, prices are liberalised at the margin, while infra-marginal prices and
quantities are maintained for some time before being phased out. The main
benefit of this system is that it cushions losers. Those who did not benefit
from liberalisation could not afford to consume from the new supply of
production that reform generated. The dual-track price system allowed
such people to maintain their rents – to continue consuming at distortedly
low prices – while also permitting new, Pareto-improving production and
consumption to occur outside the plan. In other words, and simplifying
somewhat, basic needs were met by production in the planned economy. In
the new system, some portion of the demand for goods and services above
this level – previously repressed – could now be met by production outside
the plan. Reforming the price system in this way made best use of existing
institutions (the plan), and allowed the economy to make significant Pareto
improvements without the need to create extensive new ones.
A second transition institution is the township and village enterprises
(TVEs) that reform created. These proved a creative, powerful tool for
an environment marked by the absence of property rights, and hence
no guarantee of control over assets or cash flow. TVE property rights
proved relatively secure, because the central government relies on local
governments to provide public goods (policing, road building, and water
and irrigation, family planning, etc.), and central government relies on
public goods for political stability. Local governments had strong incentives
to invest in public goods because doing so promoted growth, and their
control of TVEs gave them access to expanded future revenue streams
from a growing economy. Anticipating this, the central government did not
confiscate local budgetary surpluses, but rather left them in the hands of
local governments for investment. The aggregate effect of this was
that TVEs enjoyed a form of quasi-property rights, which emerged
endogenously from structural characteristics of the Chinese system. Hence
TVEs effectively operated as decentralised ‘private’ firms, despite the
absence of a legal and judicial infrastructure to guarantee individual rights
over private property. Introducing the innovation of TVEs led China to a
sustained boom in investment and innovation.
A third transition institution is fiscal federalism. Before the onset of
reform, the Chinese central government had extracted some 80 per cent
of increases in provincial revenues. When provincial authorities succeeded
in increasing tax revenues, they were allowed to keep only 20 per cent of
the fruits of their efforts. After central-provincial relations were reformed,
provinces kept the lion’s share of any increases they realised. By allowing
them to benefit directly from increased revenue flows, this reform provided
provincial governments with strong incentives to support TVEs, avoid
confiscations or distortions in the market economy, and to stimulate
economic development more broadly. In a similar way, it provided the
state with incentives to reform state owned enterprises (SOEs), despite
the dislocations this inevitably produced, in the interest of increasing
government revenues.
A fourth transition institution is anonymous banking. This refers to
secret (i.e. nameless) bank account and transactions, which deprived the
state of the information it would have needed to expropriate the rich and
productive. By so doing, it provided a strong constraint on a powerful
state with few other checks on its authority. Anonymous banking forced
the state to impose lower, flatter taxes on financial transactions than it
could otherwise have done, leading to fewer distortions in the financial
system, and hence more efficient capital markets. It also preserved private
158
incentives to save, invest, and produce in a legal context where – again

– private property was not guaranteed, and the state was well-equipped to
confiscate.
Lessons of success
Now let us step back from the specifics of the two cases, and consider what
lessons they teach us about development ‘success’.
Why Botswana?
Why did Botswana, a small country in a region of the world that boasts
few success stories, do so well? Consider, first, the country’s unusual
institutional endowment. Pre-colonial institutions were participative,
giving commoners input into public decisions, and restricting the political
power of chiefs and elites. Giving commoners input into decision-making
is advantageous to development on two counts: (i) in a democracy,
participation is a substantive goal in and of itself; and (ii) it injects more
information into the policy-making process, which should improve the
quality and efficiency of the policies that result. And restricting the
political power of chiefs and elites is advantageous because it limits the
ability of the powerful to distort policy to their own ends, or confiscate the
property of citizens. This, in turn, helps to guarantee individual political
and civil rights, and property rights. Notably, the limited nature of colonial
rule in Botswana means that these pre-existing institutions were not
perverted or undermined, but indeed flourish to this day.
Perhaps the most important component of Botswana success is the early
decisions made after independence to exploit the country’s natural
comparative advantage. The development strategy based on cattle
ranching not only made clear economic sense, but also served to support
property rights for all citizens. And it directly increased the incomes of
the elite, blunting the incentives that alternative centres of power in
Botswanan society might have had to oppose the development strategy,
or destabilise the government. To the contrary, a strategy based on cattle
reinforced the elite’s interest in stability, and in resolving conflict within
existing institutional rules.
Crucially, when diamond income came on-stream some years later, the
Botswanan institutional context was already established. Precedents
existed to lend the system legitimacy. Thus the decision to manage
diamond income along similar lines as cattle-based development was
relatively uncontroversial. This is in no small part because the DDP
and the state of Botswana inherited the deep historical roots of tribal
institutions. Although the independent state of Botswana was new, the
patterns of participation and authority on which it was built were the
subject of deep attachment and legitimacy on the part of her citizens.
Finally, but importantly, the political leadership of the DDP – especially
Khama – was wise and long-sighted in the important decisions it took.
Why China?
How did China, a vast country with a huge population and a long
and terrible history of development failure, manage so suddenly and
comprehensively to break with its past and embark upon a rapid
development process? The first element is the replacement of the
dictator with a rotating and increasingly collective leadership. Post-
Mao, no Chinese leader was sufficiently powerful to dominate the
rest. Consequently, the parties settled on a system of rotation in which
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retirement was enforced upon the country’s highest leaders, but made
secure and highly attractive. This radically reduced the incentives for
individual leaders to cling to power, lest they suffer the wrath of their
successors; it also increased leaders’ incentives to rule honestly and take
long-sighted decisions, as they continued to be highly public ‘senior
statesmen’ throughout their retirement phase.
A second element is the overriding preoccupation of the Chinese leadership
with political stability. China has a long history of peasant rebellion,
political violence, and revolution, which powerfully reminds leaders of the
costs of instability. Such costs are multiplied by the sheer size and scale
of the country. Add to this environment a historical juncture by the late
1970s in which the outer edges of both the planned economy and violent
repression had already been probed, without developmental success,
and it is easy to understand a leadership extremely keen to find ways of
generating the employment and economic output required to quell political
unrest.
A third element required to understand China’s success is the trial and error
nature of its reform process. By the late 1970s, China had lived through
decades of comprehensive, heroic social and political experiments. In a
developmental sense, these must be judged abject failures, as the Chinese
remained overwhelmingly poor, ignorant, and unfree. Part of the genius
of Deng’s reforms, which marked a significant break with the recent past,
was their trial and error nature. Rather than design a huge, centrally-
orchestrated reform program, the approach of Deng and his followers was
to promote many small reforms as policy experiments, let them run their
course, pick the best and move forward. Many of these reforms proved dead
ends. These could be easily abandoned at modest cost. Highly profitable
reforms, by contrast, could be fine-tuned and rolled out very efficiently,
once the experimental phase was over. And building political support for
successful reforms was made easier by the presence of positive empirical
results.
All of the transition institutions outlined above are examples of successful
policy experimentation. These institutions worked because they achieved
two objectives at the same time: they improved economic efficiency, and
they made reform compatible for those in power. The latter point is worth
stressing: good development ideas are worthless if they are not feasible,
(i.e. if the realities of power are such that they will not be implemented).
The success of this trial and error approach is that it identified transition
institutions that both increased efficiency, and hence well-being, and were
compatible with the interests and incentives faced by those in power.
Transition institutions made life better not just for the peasants, but for the
leaders too. The latter point – ultimately – is why they were implemented,
and hence why they revolutionised China’s economy.
Deeper lessons
For deeper lessons about development success, consider the institutional
basis of development. Institutions are not abstract rules. They are not
primarily about electoral conventions, parliamentary systems, or the
structure of the law. They are, instead, the principal means of resolving
conflicts (i.e. conflicting claims) in society and obtaining legitimacy. For
an institutional system to work, and to endure, the means for resolving
conflict must be given, and must be stable and predictable, even if the
specific outcomes of these conflicts are not. Hence a test of the strength of
institutions is whether social and economic conflicts are resolved within the
160
institutional boundaries of the competition for power, or instead overflow

these boundaries and undermine or overthrow the system? This is all the
more important for countries that are developing rapidly, where the strains
and displacements of capital and labour can become very large. Lucky is the
country where strong institutions precede fast development.
Equally importantly, do not confuse the institutional goal (endpoint) with the
process (how to get there). Although such goals are important, and worthy
of debate and careful consideration, they are of little help in informing
the actions of the development manager over the short and medium term.
Development is fundamentally a process, and the role of the development
manager is to ‘manage’ that process. Hence her focus should remain not on
the peak of highly developed institutions, but rather what feasible paths exist
towards that peak, and what are the costs and risks associated with each.
It is worth underlining the complexity of institutional reform. TVEs have
their roots in the collectivisation of agriculture which led to the great famine.
They were moderately successful in the 1970s wave of rural industrialisation.
But in the 1980s they became phenomenally successful as engines of growth
and the driving force for market reform. The reasons for this are not clearly
understood, but have to be viewed in conjunction with complementary
changes in the economy and government that were not in place in the
1970s, but by the 1980s had been enacted. Such complementary changes
are often required for particular organisational forms to become beneficial.
But predicting in advance what these complementary changes will be, given
a complex, multidimensional system that is changing rapidly, is in practice
impossible. This is why trial and error are key to successful reform. The
complexity of institutional reform implies that there is no foolproof way
to design a particular institution, or the reform of a particular institution.
Hence, standardised ‘cookie-cutter’ solutions, and solutions presented as
‘magic bullets’, are always to be distrusted.
Lastly, even successful transition institutions are likely to be time-delimited.
Reforms that are successful in one period are unlikely to be suitable for
another. This is not least because successful reforms change the external
environment, and so make themselves redundant. Consider the case of TVEs.
Although efficient in the context of a planned economy, TVEs are inefficient
and politicised in the context of a fully marketwise economy. As property
rights grew in China in 1990s (e.g. constitutional reform, legal reforms),
foreign investment poured into the country, and the private sector grew
much larger and more dynamic. With increasingly obsolete technology,
primitive organisations, and often high degrees of politicization, TVEs proved
inefficient and uncompetitive in the new market environment. When local
governments were offered the opportunity to keep the proceeds from their
sale, TVEs were privatised en masse. The demise of TVEs shows that
transitional institutions can be superseded by conventional best-
practice institutions when more development and reform take
place. Transitional institutions do not necessarily lead to a partial
reform trap, and incremental reforms to not always create obstacles
to further reforms. (Qian 2003, p.326)

• describe the rapid growth episodes of China and Botswana in historical
context, as compared with the earlier cases of South Korea and Japan
161
• explain the policy decisions and institutional developments that

overcame poor initial conditions to make Botswana ‘an African success
story’
• describe the transition institutions that China used to accelerate
growth, and analyse their effects on economic incentives
• explain the institutional bases of these rapid development episodes.

1. ‘The combination of Botswana’s diamond wealth with its sophisticated
colonial inheritance from Britain destined it for development success.’
Discuss.
2. ‘Fast development in China can be explained by the highly efficient
economic institutions that reformers designed from the 1970s
onwards.’ Discuss.
3. Explain what the notion of ‘incentive-compatibility in development
strategy’ refers to.
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Chapter 11: Towards a theory of development management
Chapter 11: Towards a theory of

development management
Aims of the chapter

In the course of this guide we have considered the question of what
constitutes development and discussed the impact of institutions, political
governance and economic strategies in achieving it. We have studied
examples of countries that have seen successful development management
and those which have so far seen development failure. In this concluding
chapter we draw together the lessons from the guide, outline the
prerequisites for development in a given country and set out a series of
maxims that together form a ‘toolkit’ for managing development successfully.
Learning outcomes
• explain what is meant by the ‘myth of charity’, and why it is a myth
• distinguish between self-reinforcing markets, and institutionally-
contrived markets
• explain why institutions that support high-value added activity also tend
to protect the safety, rights and property of ‘common’ individuals
• explain why some societies do not develop institutions that support high-
value added economic activity
• distinguish between the functions and forms of institutions that are
strongly associated with rapid development
• change the world.
Essential reading
Banerjee, A.V. and M. Ghatak. ‘Symposium on Institutions and economic
performance’, Economics of Transition (13) 2005, pp.421–25.
Ranis, Gustav, Francois Bourguignon and Boris Pleskovic, (eds), ‘The Evolution of
Development Thinking: Theory and Policy’ in Annual World Bank Conference
on Development Economics: Lessons of Experience 2005, (Washington DC:
World Bank, 2005) [ISBN 0821360213] pp.119–40, also Growth Center
Discussion Paper, No. 886, Yale University, 2004.
Ray, D. ‘Annual World Bank Conference on Development Economics: Lessons of
Experience 2005,’ The American Economist (44), 2000, pp.3–16.
Further reading
Amsden, A.H. Rise of ‘The Rest’. (New York, NY: Oxford University Press, 2003).
[ISBN 0195170598] Chapters 1, 6.
Rigobon, R. and D. Rodrik ‘Rule of law, democracy, openness, and income.
Estimating the interrelationships’, Economics of Transition (13) 2005,
pp.533–64.
Work cited
Olson, M. ‘Dictatorship, democracy and development’ in M. Olson, and S.
Kahkonen A Not-so-Dismal Science: a Broader View of Economies and Societies.
(Oxford: Oxford University Press, 2000) [ISBN 9780198294900] pp.119–38.
163
Introduction
We are nearly at the end of the subject on Development management,
and you are nearly development managers. Assume for a moment that after
finishing the subject, you go on to become the senior development advisor to
a powerful president or prime minister of a developing country. What will you
advise him to do?
Activity 11.1
Assume you are the senior development advisor to the leader of the developing country. Se-
lect the country of your choice to illustrate the example. What are the most important pieces
of advice you will give her to support the country’s rapid development? What are the most
important policy decisions, reforms or investments that the government should undertake?
Make a prioritised list of your advice in two columns, where one column consists of your
advice ranked by priority, and the second column contains the underlying problem of
challenge that each piece of advice is meant to respond to.
Most lists of this kind will contain policy advice along the lines of the
following:
1. improve the quality of education, and extend access to it
2. improve transportation infrastructure
3. improve the quality of health services, and extend access to them
4. strengthen the judiciary
5. improve access to finance, especially in rural areas and for the poor
6. improve access to rich-country markets for products that your country is
good at producing
7. …and so on.
Such lists are inevitably both right and wrong. They are right in the sense
that the individual pieces of policy advice are almost certainly good ideas that
most countries – including many developed countries – would benefit from
pursuing. But they are wrong in that they are not necessarily coherent in the
sense of responding forcefully to the principal factors blocking development
in a particular country. Different countries face different challenges, and
different blockages, to development. In order to succeed, a development
manager must first correctly diagnose the principal problems facing his
particular country. More importantly, the list of advice may well be wrong
in the sense of not being feasible, given the political realities of power and
influence that determine outcomes. Even a well-thought-through list of
investments and reforms that is optimal in a first-best world may never be
implemented if some of its components challenge the interests of powerful
people. And powerful people, in the end, are the ones who shape public
decisions and actions.
So how, then, do we design a development plan for your country that is both
coherent and feasible? Let us start at the beginning, with the ultimate goal.
What is ‘development’? We defined development in Chapter 1, following
Amartya Sen, as a combination of: (1) material well-being, and (2) human
and political rights. As development managers, how can we work to achieve
increasing well-being in a context of expanding human rights?
The myth of charity

Many people come to development, and especially development management,
with the idea that ‘doing’ development consists fundamentally of designing
and administering aid projects via NGOs and multilateral agencies. According
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to this view, development is mostly about marshalling flows of financial

resources, usually granted on concessional terms, and technical assistance
from rich countries and people to those that are poor. Such views are rooted
in a common misunderstanding that countries develop as a direct result
of external interventions, and hence that by better administering the aid
projects of such organisations societies can become richer and more free.
Such a view is rooted in a myth of charity, which holds that people
become more developed through the efforts and resources of others.
This is incorrect. As we have chronicled in detail above, with both statistics
and narrative accounts, peoples, countries and societies either develop
themselves through their own efforts, or fail to. Rapid development
processes transform countries’ economies and societies, creating huge
displacements of capital and labour. Achieving rapid development requires
the sustained efforts of policy-makers and business leaders, and a degree
of successful coordination between the state, private sector, and civil
society. And it requires the patience, hard work, and sacrifice of – typically
– a generation of workers who endure technical and organisational
displacements, and forego private consumption for extended periods, so
that the country may invest in growing its economy. Taken collectively, such
efforts are heroic, and the heroes in question are home-grown.
What, then, is the role of development managers? The role of the
development manager is to catalyse changes in a developing country’s
society and economy that accelerate development. Doing so requires
normative judgements about where to direct one’s efforts, and what actions
to prioritise. So now, as you approach the end of this subject, what should
you prioritise? On what basis? How do we do development?
Institutions for development

To answer these questions, ask yourself a fundamental question. What sorts
of societies operate at high levels of development? The answer is simply
those that support high value-added activities. This is because high value-
added activities produce the revenues required to support high incomes
amongst the population, high levels of public services, and the large public
and private investments required to maintain a complex, technologically
sophisticated society. High value-added activities, in turn, rely upon
complex transactions involving a number of actors, often occurring over
extended periods of time. Complex transactions require sophisticated
social arrangements to ensure compliance. Such social arrangements are a
large part of what we refer to as ‘institutions’ in the preceding 10 chapters;
examples include secure property rights, a judiciary, the banking system, etc.
To fully understand what is at stake, consider Olson’s (2000) useful two-fold
division of market activity. Markets can be self-enforcing, he says, where the
nature of the exchange is such that enforcement of the terms of individual
trades is carried out by the participants themselves. Enforcement, in other
words, is compatible with the incentives of those who carry out the trades,
and no outside enforcement is needed. Or markets can be institutionally
contrived, because they occur only where specific institutions exist to
enforce the rights of participants. Such markets are institutionally intensive.
Self-enforcing markets tend to occur spontaneously, wherever there are
beneficial trades to be made. Examples include most of the cash transactions
that we are all familiar with as ‘shopping’. As evidence for their ease and
spontaneity, consider what happened five centuries ago when European
explorers first set off across the oceans in search of spices and treasure.
Again and again, history records them reaching far-off lands where no
165
European had previously ventured. Despite no common language or religion,

no institutions to enforce agreements between them, and no history of
exchange, Europeans were able to exchange the goods they carried with them
for food, water, spices, and precious metals and stones from the ‘natives’.
They were able to do so because such trades can be instantly and credibly
policed. If either party to such a trade becomes dissatisfied with what she is
receiving in exchange for what she gives, she can resume bargaining or simply
withdraw. More prosaically, she can bop the other guy on the head.
By contrast, institutionally contrived markets do not occur spontaneously
amongst strangers. Instead, they require the presence of sophisticated
institutions to sustain them. Without such institutions, the transactions in
question would never occur. Such markets typically involve transactions
that occur across time, space, or large numbers of people, and hence are
not immediately enforceable by the participants themselves. Examples of
such markets include buying a house with a mortgage, investing in a factory,
contracting a supplier to provide a continuing flow of services, or buying
shares on a stock exchange. Transactions involving intellectual property, such
as music, consultancy reports, and computer code, are particularly dependent
on institutions for their existence.
In terms of development, the key difference between these is that self-
enforcing markets mostly involve low value-added trades – purchasing a
sandwich, or a pair of shoes, for example, where the value added in question
is about retailing, and is real but small. Institutionally contrived markets, by
contrast, typically involve high value-added trades; purchasing a car, or a
house, or investing in a factory, or inventing a new machine. Any transaction
involving investment, innovation, or cooperation across time or space relies
crucially on a legal system that guarantees contracts and protects participants’
rights, and a financial system that transforms short-term savings (deposits)
into long-term investments.
With only a few exceptions, notably North Korea and Cuba, most countries
are full of markets. But the markets that characterise developing countries are
overwhelmingly self-enforcing markets, while the markets that characterise
developed countries are institutionally-contrived. And so economic
production in developing countries is comparatively simple, with primitive
technology, less-skilled labour, and lower levels of efficiency. Production
in developed countries, by contrast, is far more complex, involving higher
levels of technology, more highly trained workers, sophisticated financial
arrangements, and often dispersion and hence coordination across large
distances. Thus high-value production is concentrated in the North, and low-
value production is concentrated in the South. The reason for this is that the
transactions on which high value-added economic activity depends can only
occur with the support of certain institutions, and these institutions exist in
the North but not the South.
Much of economic theory concerns the costs of inefficient or distorted
markets. But it is worth remembering that such costs are usually small
compared to the costs of missing markets. This is because most of the gains
from a market are realised even at prices that deviate significantly from
efficient levels. Consider Olson’s (2000) example of a water market, as
illustrated in figure 11.1. Remember that in most developed-country cities,
mains water costs the equivalent of a fraction of a US cent per litre, while
bottled water is often US$1.00/litre or more. If a market distortion (e.g.
a price floor set by government) raises the price of water from Pe to Pd,
consumption will fall from Qe to Qd, as lower-value uses of water, such as
washing the car or watering the lawn, are foregone. Hence consumer surplus
will shrink from the larger yellow triangle to the red triangle below. But the
166
highest-value uses of water will still occur: people will go on drinking

and cooking with water even if Pd goes on rising further and further. In
all likelihood, the price of mains water could multiply 100 times or more,
to that of bottled water, and people would go on drinking it, even if they
stopped bathing. In this extreme case, the highest-value trades would still
be realised, even in an enormously distorted market. But if the market
is missing, as in the right-hand side of figure 11.1 below, then no trades
will occur. In such a situation, Qm = 0, and all the benefits of water
transactions are foregone. Even the highest-value uses will not be served
by the market, because the market will not exist.
P
P
S
Pd
Pe
? D
D
Qd Qe Q Qm = 0 Q
Figure 11.1: Market distortion vs. market non-existence

Hence the major risk for developing countries is not inefficient markets
but missing markets. And this is exactly the problem throughout the
developing world: institutionally contrived markets do not exist because
the contriving institutions do not exist. And so a great deal of economic
activity – especially high-value activity – is foregone in the countries that
need it most. This is why development narratives so often collapse into
simple-sounding stories of virtuous and vicious cycles. And it is also why
the distribution of wealth across the world is so strikingly unequal, with
the top two percent of the world’s adults owning more than half of global
household wealth, while the bottom half the world’s population owns only
one percent.1 Where institutions and development are concerned, good 1
Davies, James B., Susanna
things often do go together. But this is more than a coincidence, a cruel Sandstrom, Anthony Shorrocks
correlation between low incomes, crooked policemen, and lamentable and Edward N. Wolff, ‘The
transport. Beneath the vicious and virtuous cycles that are repeated so World Distribution of Household
regularly that they quickly come to seem banal, there is a deep logic at Wealth’, World Institute for De-
work, and that logic is institutional. Better institutions support higher velopment Economics Research,
value economic activity, some of the proceeds of which can be used to fund United Nations, December 5,
yet more sophisticated institutions and organisations, which in turn make 2006.
even more productive activity possible, and so on. But when institutions
degrade, and individuals and organisations begin to lose their freedoms
and rights, high-value economic activity collapses, or flees. Venezuela,
Zimbabwe and the Congo are all, in their own ways, examples of such
downward spirals.
Explaining underdevelopment
Why do such institutions exist in some countries but not others? To
explain this, we must first understand that the institutions in question
protect the individual’s person – her freedom and rights, and her property
from expropriation. They are based on progressive power relations that
167
assume that people have certain minimum rights which are both equally
distributed amongst citizens, and inalienable from them. And they are
underpinned by notions of incentives and accountability, such that those
who obtain positions of public power face strong incentives to guarantee
the minimum rights of each individual, and can be held to account by the
collectivity for their actions.
Institutions of this nature benefit the majority by construction. This is what
institutions founded on notions of the liberty and equality of all, and not
the few, are designed to do. Such institutions should comprise a natural
equilibrium in any undistorted social system of institutional selection and
maintenance. That is to say, a system of social selection of institutions
that is free, fair, and fully informed, and which weighs each individual’s
preferences more or less equally, should naturally choose institutions that
benefit the majority.
And yet in country after country across the world, institutions of this
nature do not exist. This is particularly true of the developing world. Why,
when they are beneficial to the majority, do they fail to come about? Such
institutions do not exist where distorting power relations undermine them
or keep them from emerging. That is to say, the implicit system of social
selection of institutions is not free, fair and fully informed, and thus does
not weigh the wishes of each individual equally. This occurs when some
groups are powerful enough to: (a) consistently expropriate others and/or
restrict their rights, and (b) maintain themselves in power over extended
periods of time. In such a context, the process of institutional selection
will be skewed towards results that perpetuate the ascendancy of the
powerful. Hence the institutions selected, based on individual inequality
and the superior rights of the few, will perpetuate the power, and hence
wealth, of this group, at the expense of society. Thus, initial conditions
defined by inequality lead to institutions that protect the privileges of the
few, leading in turn to a low-level trap of low productivity, high inequality,
and widespread poverty. And so in dozens of countries across the world
we see stable equilibria of regressive institutions, low productivity, limited
freedom, and low development.
The task of the development manager, then, is to provoke such societies
to move to higher-level equilibria in which (new) power relations
support institutions that increase individual rights and freedoms, and
hence economic efficiency. His tools are not just policy, the focus of the
overwhelming majority of the development literature, but also institutions,
as we have argued throughout this book. We distinguish between the two
as follows:
• Policy is temporary, action-oriented features of the political
environment.
• Institutions are structural features of the political, social and
economic environments.
Development functions and institutional tools

Return now to the question that opened this chapter. What can we do
as development managers to spur material well-being and freedom?
To answer this question, we must synthesise all of the information we
have explored so far on the political, economic and social implications
of development. We must break down the development process into its
principal components, and analyse which functions institutions must serve
to support each component, and so facilitate the process. Once we have
done this, we can map institutional forms (plural) out of these functions.
168
Then we must analyse the political conditions or coalitions consistent with

the emergence of such institutional forms. Finally – and only then – can
we ask the crucial question: How are such institutions demanded? Under
what conditions will the society with which we are working, given its
history, culture, and relations of power, demand specific institutions that
are likely to support the rapid development of its people and economy?
Once we know these conditions, we have the beginnings of a development
strategy that is both feasible and incentive compatible.
Figure 11.2 presents a non-exhaustive list of key functions that must
obtain in an economy and society if it is to develop, as well as some
examples of institutional tools that can achieve each function. The
functions, on the left-hand side of the figure, are distilled from the key
characteristics that all rapid development processes share, as discussed
in previous chapters. The right-hand column lists the institutional forms
(tools) associated with each function – both those characteristic of the
‘leading-edge’ societies, and a few examples of alternatives that have been
used by different countries at different points in time.
For example, the development process requires large investments in
productive and human capital, and infrastructure. An institutional context
that promotes rapid development must either carry out such investments,
or facilitate the initiatives of other actors in society and the economy who
do so. The standard institutional tools of the leading-edge societies for
supporting investment are based on secure property rights, which provide
incentives for private actors – whether individuals or firms – to invest in
improving their capital stocks. Other complementary institutions, such
as an efficient police and impartial judiciary, are also important if the full
benefits of secure property rights on investment are to be achieved; we
omit complementary institutions from the right hand side of figure 11.2 in
the interests of simplicity and clarity. But some economies, notably South
Korea, have relied on state intervention – at least during an early phase
– to achieve high levels of investment and sustained, high growth rates.
Rapid development is also dependent on rapid technological adaptation,
both scientific and organisational. Property rights are an important tool for
supporting this too, although they must go hand in hand with education,
to provide a society with sufficient human capital to carry out and absorb
innovations; and also economic stability, lest the price and demand
signals that spur innovation be swamped by economic turbulence, and the
long-term planning that innovation requires becomes impossible. A third
characteristic of rapidly-developing economies is that labour and capital
can be easily re-allocated in response to market opportunities, and other
changing external and internal conditions. Economic frictions are reduced
to a low level in such countries, usually through the use of markets that
feature automatic, decentralised and continuous adjustment with low
planning and control costs. A different tool that some countries have used
from time to time is autarky.2 While autarky does not reduce frictions per 2
Autarky is defined as economic
se, it does insulate an economy from what is usually the largest source self-sufficiency.
of shocks it must face – international goods and financial markets – thus
reducing the total cost of whatever frictions the economy does have.
169
Key Functions Institutional forms
The development process Public sector effectiveness – in the use of

institutional functions. public resources for public goods.
Standard institutional forms (Tools)
Investment – in firms, people (HK), and ‘Leading-edge’ and Alternative.
infrastructure.
Secure property rights; state-directed
Technological adaptation (progress) investment.
– scientific and organisational.
Property rights; education; economic
Low economic frictions – easy reallocation stability.
of capital and labour; easy adjustment to
shocks. Market economy (automatic, decentralised
& continuous adjustment); autarky.
Political stability – conflicts are resolved
within the system. Democracy; closed autocracy.
Limited government – constraints on Democracy; checks and balances.

discretion of a (powerful) state.
Broad democracy; totalitarianism
Non-capture of politics/inclusion – via,
for example, political competition or Transparency; free press; democracy;
autonomy. embedded autonomy.
Figure 11.2: The development process: Key functions and institutional

forms
The remainder of the list refers to different aspects of a limited, inclusive,

effective government and public sector that are stable, and represent the
broad mass of the population, as opposed to a narrow set of interests.
As the right-hand column indicates, most leading-edge countries rely on
different forms of democracy, joined to a free press, to provide limited,
accountable government that takes decisions in the name of the people
and implements them reasonably well. But some rapid developers have
used various forms of non-democratic government to achieve some of the
same goals, a least during certain phases. The recent experiences of South
Korea and China underlines the main point of the table: there is no unique
optimum in institutional forms for all developing countries at all times,
and hence ‘cookie-cutter’ approaches are unlikely to succeed. Alternative
tools can work – and have worked – at different stages of development.
The main consideration of the development manager should be to map his
country’s principal deficiencies in the institutional functions in the left-
hand column, and then focus on reforms that achieve feasible institutional
forms (right hand column) that address those deficiencies.
Last but not least is the question of complementarity amongst those
institutional forms chosen. It is tempting to devote most attention to the
question of optimality of the individual tool, given economic parameters
and political feasibility. But at least as important is whether the various
tools chosen to solve different problems are complementary amongst
each other, or conflict. Consider the leading edge institutional forms listed
in the right-hand column. The degree of overlap and complementarity
amongst them is striking. Property rights, markets and democracy come
up again and again, and in contexts where the ultimate goal is evidently
the security of individual rights and freedoms. Linked together in these
ways, and complemented further by a public education system, legal
checks on government power, and a free press, they can complement and
170
strengthen each other so as to increase their effects on citizens’ freedoms,

and on economic incentives for investment and accumulation. This is
what the leading-edge societies have discovered, and is the key to their
success – not the institutional tools in isolation, but the complementarity
amongst them. The road to acquiring them is not easy, as most developing
nations have in effect proven, again and again. But once achieved, they
form a unified whole which tends to become more integrated and effective
over time, and thus an increasingly powerful driver of development and
freedom.
Endogenous institutional emergence

Once we have decided on a set of institutional tools that perform key
functions that unblock specific bottlenecks in a country’s developmental
process, we must turn to the question of feasibility. How do we implement
these institutional tools? How do we make development incentive-
compatible? As development managers, how can we design reforms in
ways that are consistent with the interests of those with power, whose
opposition is likely to prove terminal to any developmental intervention?
Feasibility implies: choosing institutional forms/strategies that are in the
interests of the powerful (e.g. China, Botswana); or transforming power
relations to make them consistent with developmental strategies and goals
(e.g. USA, Korea, Taiwan). In other words, if the question is: ‘How do we
get power elites to demand development-friendly institutions?’, then the
two obvious answers are:
1. modify the institutions appropriately, or
2. modify the elites appropriately.
The latter sounds like revolution and in substance often can be, although
it need not be in style. ‘Elite modification’ can involve armed peasants,
the spilling of blood, and much foreign romanticising. But it can also be
catalysed by external shocks (e.g. economic shocks, natural disasters,
foreign invasions) which undermine existing elites, creating short, rich
opportunities for putting more open and progressive institutions in place
before new elites coalesce around the machinery of the state and close it
to the masses. Or it can be driven by reformers, who use policy tools to
undermine existing elites – by land reform, for instance. In the latter ways,
elite modification can be dry, technical, and perhaps not entirely obvious.
But its effects can be transformative, and – because of institutional
persistence – long-lasting.
Hence development management is partly about gradual institutional
reform that attempts to improve institutions and their workings, so as to
slowly improve the freedoms and well-being of the common man. This can
provide a slow path to institutional transformation via the steady accretion
of wealth, knowledge and rights amongst non-elites, who may one day
challenge those in power and change the rules of the game. Reconciling
what’s good for the powerful with what’s good for the many little by little,
over long periods, is not an easy task, and promises much frustration. But
it is a necessary task and a noble one, and the evidence shows that it can
be done.
But development management is also about studying the realities of
power – especially its weak points – planning a transition path and
transition institutions that improve upon the status quo in welfare terms,
and waiting for a confluence of events that generates political and
economic crisis. Crisis creates openings that well-trained, well-informed
institutional entrepreneurs can exploit to transform the institutional
171
endowment of a country, and with it the rights, freedoms, and life chances
of the common man. This, in broad terms and in very different ways, is
the story of Jefferson, Hamilton, Madison, Jay and the other Founding
Fathers in the United States, and of Deng Xiaoping and his allies in China.
Conceived in this way, development management is a high-stakes game
posing numerous dangers of failure, and worse, for its practitioners. It
is a long process of thinking, planning and waiting that may outdo the
more gradual approach in terms of the frustrations it generates amongst
practitioners. But at its best, it can be a powerful, transformative force for
good in the world.
The development manager’s toolkit

Lest we lose ourselves in broad statements so general as to seem unreal,
let us attempt to summarise the chapter, and the subject, into a practical
set of maxims, which we shall call the ‘development manager’s toolkit’.
As a development manager, you should begin with a realistic assessment
of your country’s development status, medium-term possibilities, and
underlying power relations. These will differ country-by-country, and must
determine the parameters of any feasible reform. You should remember
that:
• Geography sets the opportunities and the costs a country faces, and
suggests solutions. But geography is not destiny, and costs can be
overcome.
• Culture is endogenous. It is not fixed across time, and so not
determinant.
• Institutions allow nations to make the most of their geography,
resources and opportunities, or not.
Hence institutions and institutional change are where you should focus
your energies in order to foment a country’s rapid development. Having
analyzed the country’s current status and needs, your first question should
be: What alternatives are available? Devising policy and institutional
alternatives that are politically feasible and suited to the country’s social
and economic parameters is your challenge. When doing so, do not
confuse the institutional goal (endpoint) with the process (how to get
there). Study not the peak, but feasible paths towards it. Hence, do not
be afraid of transition institutions, and do not scorn interim second-best
solutions.
Learn the lessons of China. Perhaps the most important of these is
the importance of trial-and-error. Try lots of things in a small way. If
something fails, your losses will be limited. If something works, expand
it. If it keeps working, expand it more. The complex of institutions and
organisations that lead to development are more likely to come about this
way than through deductive institutional design.
Learn also the lessons of Zimbabwe. The political foundations of
development are crucial for its success. Development strategies built
on weak political foundations are likely to collapse. Also, crisis clouds
judgment. In the throes of a crisis, people can make bad decisions. In the
case of Zimbabwe, crisis led to decisions that re-set the regime’s support
base amongst elites, away from nation-builders and pluralists, and towards
appropriators. Hence the country was diverted from liberal nationalism
with conciliation to economic intervention and expropriation, the logic of
which was self-sustaining and ever-increasing, and soon led to disaster.
But crises can have developmental effects too, if you are able to take
172
advantage of them. Zimbabwe-type dynamics can be made to work in the

opposite direction. Crisis can be exploited to disempower the established
elite, and re-align the political settlement behind progressive policies and
progressive institutions. The process may involve active catalysis to modify
power elites, or it may happen more or less spontaneously.
Lastly, learn the lessons of Venezuela, Botswana, Zimbabwe and China.
Development generates numerous displacements, which in turn generate
conflict. Hence conflict resolution is fundamental to development. A
society that cannot resolve conflict cannot develop. But as many theorists
have pointed out, the currency of politics is conflict, which is why politics
is intrinsically difficult, and conflict an ever-present risk. If your activities
as a development manager raise the level of conflict in a society to the
point where it engulfs the system, and institutions break down entirely,
then you have failed. Rather, you must strive for conflict resolution,
and hence stability, to be institutionalised. The outcome of either a
gradualist programme of accretion, or any crisis-related rapid institutional
transition, must be a high degree of institutionalisation in which the
rules of the game are bigger than the individuals or interest groups
operating within them. When these rules are progressive, empowering
the individual, guaranteeing her freedoms and rights, and making her
effectively sovereign over the state, then you have succeeded at managing
development.

• explain what is meant by the ‘myth of charity’, and why it is a myth
• distinguish between self-reinforcing markets, and institutionally-
contrived markets
• explain why institutions that support high-value added activity also
tend to protect the safety, rights and property of ‘common’ individuals
• explain why some societies do not develop institutions that support
high-value added economic activity
• distinguish between the functions and forms of institutions that are
strongly associated with rapid development
• change the world.

1. ‘The problem of underdevelopment is that aid flows are much too
small, and international development professionals are insufficiently
accountable to the poor.’ Discuss.
2. What are ‘institutionally contrived markets’, and how do they differ
from ‘self-reinforcing markets’?
3. What does the presence of ‘institutionally contrived markets’ imply
about the underlying distribution of political power in a society? Why?
173
Notes
174
Appendix1: Sample examination paper
Appendix 1: Sample examination paper
Important note: This Sample examination paper reflects the

examination and assessment arrangements for this course in the academic
year 2010–2011. The format and structure of the examination may have
changed since the publication of this subject guide. You can find the most
recent examination papers on the VLE where all changes to the format of
the examination are posted.
Time allowed: three hours

Candidates should answer THREE of the following TEN questions: ONE
from Section A and TWO from Section B. All questions carry equal marks.
Section A
Answer one question from this section.
1. ‘Getting institutions right is the key to successful development.’ Discuss.
2. Why are some countries more developed than others?
Section B
Answer two questions from this section.
3. ‘The problem of abuse of common resources is in principle intractable,
which is why ‘tragedies of the commons’ are so common. Where
communities find stable solutions to these problems, it is mainly
through luck or extraordinary leadership. Hence common resources
should fall under the authority of powerful governments that can
regulate their use’. Explain and discuss.
4. Decentralisation takes power away from insensitive national
bureaucrats and places it in the hands of local politicians who are, on
the whole, less able, less educated and more vicious. Hence it is to be
avoided. Discuss, using examples from localities or countries you have
studied.
5. Why do firms exist? Why do civic organisations, interest groups, and
political parties exist? Do they serve similar functions in their respective
contexts?
6. A neighbourhood of 10 households is considering cooperating to
finance a common streetlight from which each household will benefit
equally. The total cost of building and operating the light is £599; the
benefit to each household is £100. Will the streetlight be built? Why or
why not?
7. ‘It is a curious paradox that an international aid regime which
institutionally dysfunctional.’ Discuss, connecting major institutional
features of the post-World War II regime with evidence from 60 years of
development efforts.
8. ‘Democratic elections provide a façade of accountability where really
there is none.’ Discuss, with special emphasis on the role of information
in creating accountability.
175
9. Markets in the informal sector are more competitive, and hence more
economy to be more like them. Explain and discuss.
10. State and community comprise two alternative paths to development.
Discuss.
END OF PAPER
176
Appendix 2: Guidance on answering the sample examination paper
Appendix 2: Guidance on answering the

sample examination paper
General remarks
This paper is designed to test your understanding of the role of institutions
and organisations in fomenting rapid development in countries and
societies, or conversely in keeping nations in a state of poverty and
deprivation. To do well in this subject, you must demonstrate a knowledge
of both institutional theory, and the determinants of development and
non-development. Neither understanding alone will permit you to do well,
and may not even allow you to pass.
The nature of this subject is one of very difficult problems about which
there is sometimes little consensus in the academic or professional
worlds. As a relatively new ‘discipline’ with less than seven decades since
inception, there are many questions about which there are no settled
views. Therefore you will have fewer opportunities than in some other
subjects to appeal to conventional wisdom or rules of thumb. Good
answers must therefore involve not just rigorous theoretical arguments,
but also supporting empirical evidence, as one might expect for a
field about which the theory is not yet settled. What constitutes good
evidence spans a broad range, from qualitative evidence, to stylised
facts, to detailed statistical and econometric evidence. No one of these is
particularly called for in any one question. But a good answer will require
some form of evidence for all of the questions.
The paper is structured in a fairly simple and traditional way. The subject
guide provides a Chapter length discussion of key topics in Development
Management (e.g. democratic theory, theory of the firm, international aid
and governance, the determinants of comparative development) and there
are ten questions in two sections.
• Section A contains two very broad questions which encompass most or
all of the subject. It would be possible to answer these two in similar
ways, and this is why you may not answer both, but must choose
between them.
• In Section B you then choose two questions from a choice of eight, with
no further restrictions. Each question is of equal value.
You are reminded that the examination tests familiarity with the
underlying theory as well as with the subject guide itself. Wider reading
and engagement with the original texts is always obvious in the case
of the best performing students and evidence of this wider reading and
understanding of the main original works is looked for by the Examiners.
The subject guide suggests some further readings which provide an
overview and introduction to a wider secondary literature. The better
candidates are likely to have some familiarity with this material. That said,
you are advised to use further reading carefully as the point is to analyse
and assess the arguments and not to merely list the textbooks that have
been consulted. The use of further reading should always be demonstrated
through the development of a critical analysis of the argument and not
merely as a list of alternative interpretations offered by other scholars.
177
Section A
Question 1
‘Getting institutions right’ is the key to successful development.’ Discuss.
This question draws on various combinations of Chapters 1, 8, 9, 10 and
11. The question gives you the opportunity to synthesise a broad range
of theoretical and empirical material that is central to the subject. The
question is central to what this subject guide is about, and so many of the
required readings are relevant in one way or another. The most relevant
readings are North (1990), Brett (2008), Rodrik (2003), Gallup, Sachs and
Mellinger (1999), Acemoglu, Johnson and Robinson (2001), and Glaeser,
La Porta, Lopez de Silanes, and Shleifer (2004).
There is no single approach or pattern of answer that is ‘right’ for this
question. Generally speaking, you should begin your answer with a
simple definition of what successful development entails, although they
may legitimately disagree on the substance of this point. You should then
proceed to a discussion of the conditions under which development tends
to come about, highlighting the importance/role of institutions in this
process. Good answers will be theoretically broad and deep, avoiding
specific policy details, such as trade liberalisation, or particular forms of
banking regulation.
Many candidates will be tempted to reprise the arguments in Chapters
8, 9 and 10. This is one valid approach, although not necessary for an
answer to be good. Candidates who do this with particular critical insight
may receive excellent marks. The best answers will weave theoretical
arguments together with empirical evidence.
Question 2
Why are some countries more developed than others?
This question refers to the whole of the course, and could be answered
very proficiently using different combinations of Chapters and readings.
The question is most directly relevant to Chapters 1 and 8–11. As for
question 1, but more so, the question gives you the opportunity to
synthesise a broad range of theoretical and empirical material that is
central to the subject. The question is central to what this subject guide
is about, and so many of the required readings are relevant in one way
or another. Key references include Brett (2008), North (1990), Rodrik
(2003), Gallup, Sachs, and Mellinger (1999), and Acemoglu, Johnson and
Robinson (2001).
As for question 1, but again more so, many candidates will be tempted
to reprise the arguments in Chapters 8, 9 and 10. Although this is
one valid approach, it will not be enough to provide vague assertions
about why some people consider geography, others culture, others
factor endowments, and still others institutions to be the main driver
of comparative development, in a ‘some say this, others say that’ style.
Candidates who take this route should show a clear command of not only
the substance of the competing arguments, but also how they relate to
each other. On the other hand, candidates who do this with particular
critical insight may receive excellent marks.
The best answers will provide a theoretical account of why some
countries are more developed than others that also includes empirical
evidence. Such answers will explicitly consider the role of institutions
in (anti-)developmental processes, alongside other broad factors, such
178
as geography, history, culture, etc, assessing the relative importance of

institutions in a comparative context.
Section B
Question 3
‘The problems of abuse of common resources are in principle intractable,
which is why ‘tragedies of the commons’ are so common. Where
communities find stable solutions to these problems, it is mainly through
luck or extraordinary leadership. Hence common resources should fall
under the authority of powerful governments that can regulate their
use’. Explain and discuss.
This question draws on Chapters 7 and 2 of the subject guide. Key authors
include Hardin (1968), Ostrom (1990), and Stern (2006). Good answers
should be based on an understanding of the economic characteristics of
common resources, and why such goods are unsuited to market provision.
The best answers will explain in some detail what problems or distortions
are likely to arise where common resources are governed by markets.
The best answers will link the characteristics of different classes of goods
to the structural features of the institutions best suited to supply or sustain
them. That is, they should be able to go beyond rules of thumb, such as
‘markets are not good at sustaining common resources’, to explain why
this is the case, with arguments clearly based in incentives.
Some candidates may be tempted to reprise the subject guide’s account of
three game theoretic treatments of cooperation/collective action problems.
If done well and clearly connected to the points mentioned above, this
could form the basis of a good answer. But it is not required, and simply
summarising the tragedy of the commons, prisoner’s dilemma, and the
street lighting game in lock-step manner is not sufficient for a high mark.
Good answers will analyse the strong and weak points of government
provision of common resources, as well as provision by community
organisations. The best answers will not only mention empirical evidence
from such cases as the Alanya fisheries and Kottapalle villages, but weave
these into a theoretical account of the conditions required for successful
community provision that allows common resources to be sustained.
Question 4
Decentralisation takes power away from insensitive national bureaucrats
and places it in the hands of local politicians who are, on the whole, less
able, less educated and more vicious. Hence it is to be avoided. Discuss,
using examples from localities or countries you have studied.
This question is based mainly on the material in Chapters 3 and 2.
Answers should begin with a definition of decentralisation. The best
answers will discuss alterative definitions and provide arguments in favour
of one or against others. Key references include Ostrom (1993), Putnam
(1993), and Faguet and Sánchez (2008).
You should show an understanding of the theoretical arguments in
favour and against decentralisation, and should be able to link these to
summarised evidence from the international empirical literature. Good
answers will go beyond simply listing arguments for and against, towards
a deeper understanding of the assumptions that underpin each, and thus
how different arguments about the effects of decentralization relate to
each other.
179
The best answers will pick the question apart and re-phrase it as
something to the effect: ‘Decentralisation is not good or bad, but rather
good and bad. Why does the same reform produce good effects in some
localities and bad ones in others?’ The discussion will then move on
to the prerequisites for effective local governments and a healthy local
democracy.
Question 5
Why do firms exist? Why do civic organisations, interest groups, and
political parties exist? Do they serve similar functions in their respective
contexts?
This question is most closely related to Chapters 2 and 5, although
Chapters 6 and 7 are also relevant. Key references include Brett (2008),
Faguet (2005), Coase (1937), and Alchian and Demsetz (1972).
The question is fundamentally about analysing the roles different
organizations play in parallel institutional settings. Even if a firm, a civic
organisation, an interest group and a political party were optimised for
maximum effectiveness, their organisational attributes and structure
would not converge because key differences would continue to be
determined by their respective environments. This should not obscure
the fact that at a deeper level, they share broad similarities as actors
attempting to produce goods or services for clients or members within a
given institutional setting.
As should be clear from the above, this question does not have a single
good answer. Marks should be awarded based on the sophistication
of your analysis of the similarities and differences between these
organisations, and their ability to tie structural and functional features of
each to their respective environments, and then make comparisons across
environments. Marks will be divided equally between answering part
1: ‘Why do firms exist? Why do civic organisations, interest groups, and
political parties exist?’ and Part 2: ‘Do they serve similar functions in their
respective contexts?’
Question 6
A neighbourhood of 10 households is considering cooperating to finance
a common streetlight, from which each household will benefit equally.
The total cost of building and operating the light is £599; the benefit to
each household is £100. Will the streetlight be built? Why or why not?
This is a straightforward technical question about the logic of collective
action. It refers most clearly to Chapter 7, but has relevance for Chapters
2, 3, and 8–11 as well. Key readings are Ostrom (1990) and Hardin
(1968), as well as Olson (1965) of course.
You should understand that coalitions of as few as six players will still
have clear positive incentives to cooperate to provide the street lighting, as
the benefits to the coalition of providers will outweigh the costs they bear.
But absent selective incentives or any other considerations external to
the simple scenario described above, street lighting will not be provided,
because each player will manoeuvre to form part of the non-cooperating
group, and so enjoy all the benefits of street lighting without paying any
of the costs. The best answers may mention that absent transaction costs,
such manoeuvring will go on forever, giving rise to ‘games without cores’.
The point of this question is to test both candidates’ technical knowledge,
and their ability to interpret the results of game theoretical tools more
broadly. Hence general, hand-waving answers that invoke a vague notion
180
of the collective action problem and declare that street lighting will fail
should receive very low marks. Good answers will analyse the incentives
that lead to collective action failures, and the best answers will explain
how specific changes to these incentives can bring about collective action
success.
Question 7
‘It is a curious paradox that an international aid regime which
institutionally dysfunctional.’ Discuss, connecting major institutional
features of the post-World War II regime with empirical results from
60 years of development efforts.
This question relates most closely to Chapter 4, although candidates could
invoke material from Chapters 8–10, and should be rewarded for doing
so creatively. Key references include Easterly (2001), Bauer (1981), and
Rodrik (1995).
You should show a clear understanding of how the international aid
regime operates, and the major changes it has undergone during the
past six decades. They should be able to provide examples of the limited
successes of aid (e.g. emergency humanitarian assistance, some transition
assistance to former Eastern Bloc countries), as well as its many failures.
Most importantly, you should be able to link this performance to the
main institutional features of the aid regime, in particular the perverse
incentives it establishes for responsible governance and reform in
developing countries.
The best answers may take a few steps towards suggesting reforms of
the aid regime that might establish better incentives for competent,
transparent government in developing countries. Any such suggestions
that are sensible (although not necessarily politically feasible) should be
richly rewarded.
Question 8
‘Democratic elections provide a façade of accountability where really
there is none.’ Discuss, with special emphasis on the role of information
in creating accountability.
This question refers above all to Chapter 2, although Chapters 3, 4, and
8–10 are also relevant at a second-order level. Key references include Brett
(2008) and Faguet (2005), as well as Olson (2000).
Good answers should quickly move beyond the commonplace assumption
that democracy produces government accountable to ‘the people’, to
point out the technical difficulties with demonstrating that elections can
produce stable equilibria in multi-dimensional space that transmit useful
information about voters’ preferences over policy options to politicians.
And without such information transmission, accountability is impossible.
The best answers will go into some detail on issues such as the Hotelling
beach, Condorcet cycling, and deterministic vs. probabilistic voting. You
should then point out that government consists of much more than just
voting, and the relevant question is not just about elections, but rather
can the complex of elections, lobbying, organised civic activity, citizen
mobilizations, the activities of the press, independent universities, think
tanks and other analysts, etc come together to tie politicians’ actions to
what citizens want?
The best answers will analyse the different roles of lobby groups, civic
181
organisations, the media, etc in informational and incentive terms, and

show some of the complex complementarity that can in the best cases exist
amongst them.
Question 9
Markets in the informal sector are more competitive, and hence more
economy to be more like them. Explain and discuss.
This question relates to Chapter 6 of the subject guide. Key references
include De Soto (2002) and World Bank (2007).
You should begin by defining the informal sector, and discuss how its
characteristics set it apart from either: (i) in an empirical context, firms
and transactions in the formal sector, and (ii) in a theoretical context,
the standard microeconomic model of firm production and household
consumption. Excellent answers will do both. Some candidates may
discuss the evolution of the ‘informal sector’ as an idea, but this is not
required for a good answer.
You should then go on to discuss why the informal sector exists, and what
brings it about. This will open the door to the observation that a high
degree of competition in the informal sector is the flip side of the coin
of cosy, anti-competitive, often oligopolistic practices amongst formal
sector firms, which often collude with government and regulators to raise
barriers to formalization for exactly this reason.
Hence firms do not choose to operate in the informal sector because
they seek to be ‘backwards’, ‘dirty’, or otherwise ‘bad’. Rather, they do so
because the costs of formalization are too high, and they have no choice.
Reducing these costs will inject greater competition into the formal sector,
reducing rents there and forcing firms to become, in some respects at least,
more like their informal sector peers, even as it encourages informal sector
firms to formalize.
Question 10
State and community comprise two alternative paths to development.
Discuss.
This question relates to Chapters 2, 3 and 7. Key readings include Brett
(2008), Faguet (2005), Ostrom (1993), Putnam (1993), and Ostrom
(1990).
Another way to pose this question might be ‘Who needs the state when
you have community?’. This question asks you to analyse to what extent
successfully solving the collective action problem can spur development
amongst different groups of people. Can communities develop themselves
in the absence of a benign state, or the presence of malevolent one?
Or is an organization that makes and enforces rules – including broad
institutional rules, raises revenue, provides services, and holds a monopoly
on violence necessary for development to come about? To what extent do
state and community substitute for each other, and to what extent do they
complement each other?
Good answers will go beyond the characteristics of each that are useful
to the other, to a more systematic account of how developmental change
happens in a society, and the role of state and community in bringing it
about.
182

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Development management

University of London International Programmes

Published by: University of London

A reminder of your learning outcomes........................................................................ 104

Introduction .............................................................................................................. 151

Development management is a ‘300’ course offered on the Economics,

Aims and objectives of the course

The objectives specifically include:

Real firms, small firms: microentrepreneurs and the informal

How to use this subject guide

Structure of the guide

Chapters 5, 6, and 7 comprise a module on ‘private provision’. The

Moe, T. ‘The Politics of Structural Choice: Toward a Theory of Public

Online study resources

the University of London are available to download, including updated

Making use of the Online Library

List of abbreviations used in this subject guide

Part 1: Theoretical background

Chapter 1: Institutions, organisations

Aim of the chapter

Consider the development transitions of the United Kingdom, the United

development professionals. This subject will not teach students how to

Institutions and organisations

rich, covering sociology, economics, political science, and anthropology,

…a kind of “expanded economics”. Like standard economics, it

We follow Clague (1997a) and Olson and Kahkonen (2000) in construing

According to Williamson (1995a), the NIE insists on realistic, commonly

actors possess cognitive systems that provide true models of

Bounded rationality and imperfect mental models, combined with

The costliness of information is the key to the costs of

Ascertaining the level of these attributes, protecting rights, and policing

What is an institution? North (1990) defines institutions pithily as the

Why they matter: incentives

Organisational and institutional change

Conclusion: the meaning of development management

A reminder of your learning outcomes

Sample examination questions

Chapter 2: Political accountability and

Introduction and aims of the chapter

Democracy and voting

What is this ‘accountability’? The Oxford English Dictionary defines the

accountable to person B if he must answer to B for his actions. This gives B

A good illustration of their insight is known as the ‘Hotelling beach game’.

Figure 2.1: The Hotelling beach game with one player

Figure 2.2: The Hotelling beach game with two players

Figure 2.3: The hotelling beach game with three players

Figure 2.4: The Hotelling beach game with six players

Figure 2.5: Three students’ ice-cream preferences

There is a stable equilibrium in this situation, and a simple vote reveals

Figure 2.6: Condorcet cycling

Is there a stable equilibrium with preferences that look like this?

An empirical study: local government at the extremes

into specific types of policy failure. This model of governance will go

Misconduct- gross misconduct seems more accurate

Box 1: Project identification in Viacha

Box 2: Project identification in Charagua

The structural causes of high-quality local government in Charagua are far

A simple model of government

Figure 2.7: A simple model of government

organisational dynamic into which politicians and civic organisations enter

A reminder of your learning outcomes

• explain the role of voting in revealing and transmitting information to

Sample examination questions

Is there a stable equilibrium? If so, what is the majority-preferred