Stocks vs. flows, or why governance reform is still on the agenda

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I seem to have Dani Rodrik on my mind lately. In a new post yesterday he argues that the governance reform agenda is dead. Here is his logic:

There was a time when economists believed that institutional reform--improving governance--was a key ingredient in improving living standards in the developing world.  "Good governance" is surely a good thing in its own right.  But a lot of recent academic and policy research has focused of late on its instrumental value for growth. 

The argument is simple and appealing. Rich countries are those characterized by democracy, rule of law, political competition, and low levels of corruption.  So poor countries have to emulate them in all these respects if they want to get rich too.

Oddly, some of the most vociferous advocates of this view have apparently given up on it in the aftermath of the financial crisis. Not consciously, perhaps.  But a repudiation is implicit in the arguments that they now make about the central role of governance failures in the current crisis in the U.S.

Exhibit no. 1 is Simon Johnson, who as part of the famous AJR (Acemoglu-Johnson-Robinson) triumvirate, has done as much as anyone to cement the view that better institutions cause higher incomes.  In this view, the reason that the U.S. is richer than, say, Russia, is that the former is run by a democratic, accountable political authority that is not in the pockets of narrow interests.  The AJR story presumes that institutional quality is a very slow-moving attribute, with events lodged deep in history still exerting strong effects today.  Yet in his recent Atlantic piece, Johnson argues that U.S. economic policies have been captured by a (financial) oligarchy, in much the same way that business elites corrupt policy-making in much poorer countries such as Russia.  The U.S., it turns out, is not that different...  

...Now I am a fan of Simon's and Dani's work, and I count them both among my friends. They may well be right about their diagnosis of the origins of the crisis.  But an implication of their recent arguments is that we need to significantly downplay the role of improved governance as a causal mechanism for economic growth. 

After all, no-one can deny that the United States, for all its financial follies, is a rich country.  It turns out that it is possible to be corrupt in a fundamental way and still be rich.

Rodrik seems to confuse a stock and a flow in this argument. Good governance doesn't immediately make a country rich (a stock of wealth) - it contributes to a higher rate of growth over time (a flow), which eventually leads to increased wealth. Likewise, if you transition from good governance to bad governance, following Simon Johnson's argument about a financial oligarchy in the U.S., then you'll see a hit to the growth rate (the flow). And, lo and behold, the U.S. economy is in a serious recession. So for my money, the crisis in the U.S. only makes governance reform that much more central to development.

There is one point in the governance agenda that's worthy of reconsideration, though: "The AJR story presumes that institutional quality is a very slow-moving attribute." Perhaps it is much easier to undermine good governance than was previously supposed.


Ryan Hahn

Operations Officer

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