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political economy

Can political stability hurt economic growth?

Zahid Hussain's picture

Mumbai traffic, India. Simone D. McCourtie / World Bank
The standard definition of political instability is the propensity of a government collapse either because of conflicts or rampant competition between various political parties. Also, the occurrence of a government change increases the likelihood of subsequent changes. Political instability tends to be persistent.
 
Economic growth and political stability are deeply interconnected. On the one hand, the uncertainty associated with an unstable political environment may reduce investment and the pace of economic development. On the other hand, poor economic performance may lead to government collapse and political unrest. However, political stability can be achieved through oppression or through having a political party in place that does not have to compete to be re-elected. In these cases, political stability is a double edged sword. While the peaceful environment that political stability may offer is a desideratum, it could easily become a breeding ground for cronyism with impunity. Such is the dilemma that many countries with a fragile political order have to face.  
 
Political stability is by no means the norm in human history. Democratic regimes, like all political regimes, are fragile. Irrespective of political regimes, if a country does not need to worry about conflicts and radical changes of regimes, the people can concentrate on working, saving, and investing. The recent empirical literature on corruption has identified a long list of variables that correlate significantly with corruption. Among the factors found to reduce corruption are decades-long tradition of democracy and political stability. In today’s world, however, there are many countries that combine one of these two robust determinants of corruption with the opposite of the other: politically stable autocracies or newly formed and unstable democracies.

Some see political stability as a condition that not only precludes any form of change, but also demoralizes the public.  Innovation and ingenuity take a backseat. Many seek change in all sectors of life--politics, business, culture--in order to have a brighter future through better opportunities. Of course change is always risky. Yet it is necessary. Political stability can take the form of complacency and stagnation that does not allow competition.  The principles of competition do not only apply to business. Competition can be applied in everything – political systems, education, business, innovation, even arts. Political stability in this case refers to the lack of real competition for the governing elite. The ‘politically stable’ system enforces stringent barriers to personal freedoms. Similarly, other freedoms such as freedom of press, freedom of religion, access to the internet, and political dissent are also truncated. This breeds abuse of power and corruption.

Vietnam, for example, is controlled entirely by the ruling party. The economy is one of the most volatile in Asia.  What once was thought of being a promising economy has recently been in distress. Vietnam’s macro economy was relatively stable in the 1997-2006 period, with low inflation, a 7 to 9 percent total output expansion annually and a moderate level of trade deficit. But Vietnam could not weather the adverse impact from the 1997-98 Asian financial turmoil, which partly curbed the FDI flow into its economy. Starting in late 2006, both public and private sector firms began to experience structural problems, rising inefficiency, and waste of resources. The daunting problem of inflation recurred, peaking at an annualized 23 percent level for that year.

The politics of rural electrification in Sri Lanka

Thilani L. Navaratne's picture

The 10th South Asian Economics Students Meet (SAESM) was held in Lahore, Pakistan, bringing together 82 top economics undergraduate students from the region. The theme was the Political Economy of South Asia, with a winning paper selected for each of the six sub-themes. In this post, Thilani Navaratne presents her winning paper on the political economy of energy and natural resource use. Posts from the other winning authors have also been featured on this blog, and can be found at the end of this post.

In the past, Sri Lankan policy makers and politicians paid considerable attention to creating surplus energy capacity at the national level in order to support rapid development while at the same time, embarked on rural development as a prime political initiative where the rural electrification infrastructure formed a crucial component of the policy framework.

I conducted an analysis of the dynamics and the characteristics of the political economy of access to energy in rural electrification in Sri Lanka. The study focuses on how national policies shaped rural energy access and what influence rural politics and demand at the grassroots level have had on the energy infrastructure.

In addition to that the study explores the budgetary policies that had a direct bearing on national energy policies, and more specifically in creating rural energy infrastructure itself.  While the provision of energy is the main component of rural energy access, the affordability of energy at rural level remains a key factor in the ultimate, tangible outcomes of energy usage. Clearly, rural economic development and enhancement of living standards are intrinsically linked with the degree of access to energy at affordable prices.

My paper finds that rural access to energy has come about both as a direct outcome of specific policies as well as a result of broader policies of rural development. Specific policies include the National Energy Policy which addresses the basic energy needs of the nation and sets out strategies to be followed to fulfil such needs. Much broader, macro level policies relating to Rural Development and energy accessibility are captured in the  “Mahinda Chinthana”- The long term plan for the future of the nation, presented by the governing regime and in the Ministerial Policies.

Can Businesses Help Create Political Stability?

Zahid Hussain's picture

 © Simone D. McCourtie/World BankBusinesses generally stand little chance of doing well when politics is not stable. Political stability is a necessary condition for an enabling business environment. What can the business community do to help achieve sustained political stability? Experience shows more often than not they fail to do so. What keeps the private sector divided even when both their collective and personal interests are directly at stake? Such an apparent puzzle can be explained by the soft budget constraint syndrome interacting with cronyism.
 
The term “soft budget constraint” (SBC) was originally conceived by the economist, Janos Kornai. The concept has since been regularly invoked in the literature on economic transition from socialism to capitalism. Now the concept is increasingly acknowledged to be pertinent well beyond the realm of socialist and transition economies. A host of capitalist phenomena, ranging from the collapse of the banking sector of East Asian economies in the 1990s and the business rescue packages seen in the midst of the recent global financial crises can be usefully analyzed in SBC terms.
 
The syndrome is at work only when organizations can expect to be rescued from trouble, and those expectations in turn affect their behavior. The more frequently financial problems elicit support in any part of the economy, the more organizations will count on getting support themselves. The government may from time to time announce they will break with past practice and refrain henceforth from bailouts. But such announcements have little effect unless combined with some institutional change that lends credibility to their claims.
 
SBC syndrome alone cannot explain why business groups do not react collectively to political adversities. The divisive force in this process comes from cronyism.
 
Cronyism normally means some of those close to political authorities receive large economic favors. The most visible ones usually entail ownership of a business or its operation, such as the privatization of state-owned enterprises (SOEs). More frequently, however, economic entitlements are provided through privileged access to governmental favors. The most valuable are the provision of monopoly or quasi-monopoly positions and the extension of domestic credit at highly subsidized terms. Favoritism in awarding government contracts is also important and may be as significant as the others. 

Economic growth and elections in Bangladesh

Zahid Hussain's picture

Bangladesh has turned the political business cycle phenomenon upside down.
 
Political business cycles are cycles in macroeconomic variables – output, unemployment, inflation – induced by the electoral cycle. This type of business cycle results primarily from the manipulation of policy tools by incumbent politicians hoping to stimulate the economy just prior to an election and thereby improve their reelection chances. 
 
Expansionary monetary and fiscal policies have politically palatable consequences in the short run. When pursued to excess, these very policies can also have very unpleasant consequences in the longer term in the form of accelerating inflation, decreasing savings, worsening foreign trade balance, and long-term expansion of government's share of the GDP at the expense of private consumption and investment. So immediately after the election, politicians tend to “bite the bullet” and reverse course by raising taxes, cutting spending, slowing the growth of the money supply, and allowing interest rates to rise. As a result, the regular holding of elections tends to produce a boom-and-bust pattern in the economy because of the on-again-off-again pattern of government stimulus and restraint to induce an artificial boom at every election time.
 
Bangladesh’s experience also shows the existence of a political business cycle in GDP growth, albeit with exactly the opposite pattern of boom and bust. GDP growth has consistently declined in each of the last five election years. It happened in 1991, 1996, 2002, 2007 (an election year without election) and 2009 (Figure 1). From the perspective of Western political business cycle theory these growth tendencies appear suicidal for the incumbent. Instead of expanding the economy faster to gain votes, the incumbents appear to be shooting themselves in the foot by allowing the pace of expansion to slow in the election year!
 
Is this another case of the Bangladesh paradox?