Time for change: On the need for institutions

Contacts and graft skirt around rules in Pakistan. That needs to be changed.

LAHORE:

In Pakistan, as in other developing countries with weak implementation of laws, one of the twisted paths to power is to flout the law of the land and get away with it. In a country where the application of law is inversely proportional to the number of contacts and net worth, to be able to break the law without being punished imbibes the offender with a halo of invincibility. The law won’t get you, as long as you’re nice and cozy with the powers that be.

It would be hard to fault the people of this country for these kinds of attitudes. After all, people are a product of the environments they live in. People who tolerated slavery, female infanticide and overt racism were not bad people. In fact, they were much like me and you, only with different environments that made the tolerance of these attitudes the norm. Environments matter a lot.



Where does this lead us then? And of what significance could that be in an economic context? The answer to these two questions lies in one word: Institutions. Institutions are the constraints that dictate or guide human interactions or as Douglas North put it ‘the rules of the game’. The word is an umbrella term for a number of entities and behaviors that exist in society and includes entities such as the army, police, judicial systems and abstract concepts such as the respect for life and property, democracy, social norms, customs and the relative importance of contacts.

How and why some countries develop their institutions while others lag behind in a lawless muddle is a question that still needs more research. However, one thing is certain, a set of strong, non-partisan institutions are an essential component for a country to experience sustained periods of economic growth. Let me elaborate.



Institutions, by being the ‘rules of the game’ set the parameters and framework within which everyone must play. Ideally, the rules of the game must be fair, transparent and applicable to all who are in the game. The umpires must apply the rules without bias and objectively across the board. Additionally, the rules must be consistently applied every time someone makes a foul or tries to break the rules, there must not be any bias, the presence of which is liable to tilt the rules in favour of any one player and hence set off current and future players in the quest for getting away with breaking the rules.

For any environment, you want the right kind of framework and rules that provide the right kind of outcomes and incentives to those operating in that environment. If the outcome for bribery is positive, you get your work done by doling out cash to the authorities, the incentives have been tilted in favour of giving bribery. On the other hand, if institutions are such that the outcome for bribery is a negative one, you end up in jail and have to pay a huge fine; the incentives have been tilted against the giving of bribery.

The main determinant for sustained economic growth is an investment in capital, physical capital consisting of machinery, factories etc and human capital. To increase the amount of investment, investors must be sure of not losing their investment to unfair practices and if indeed that be the case, they must be sure of being able to have effective legal recourse, certainly not the sort available in Pakistan. The incentive for trying to swindle someone of their money must be severe enough and implemented often enough for only the very deranged to attempt the same.



The main point is to put into place incentives and mechanisms that reduce uncertainty in the investment environment. Investors, as a breed, are extremely averse to any sort of uncertainty. They will pull out their money at the first sign of trouble and for each unit increase in uncertainty fewer investors will want to jump in on the investment bandwagon. By providing investors with a regulatory environment where they feel safe doing business, the government can foster greater amounts of investment in the country.

Institutions have a pivotal role in determining how much uncertainty a society has to face at any given time. A set of functional, non-partisan institutions will provide a level playing field for all and penalise severely those trying to work outside the regulatory framework.

Presently, contacts and social capital trump every other institution in Pakistan. Know the right people and you will be untouchable. This has produced a system where instead of relying on formal institutions, people have come to rely on their contacts for recourse. Amongst many negatives, this reduces the predictability inherent in the system, increasing the random component and hence increasing uncertainty. This reliance on informal institutions also unfairly punishes the more vulnerable sections of society, since they are the ones who are unable to rely on formal institutions and lack the contacts to make the system work for them.

Institutions and the incentives they set are often self-perpetuating. A sort of monkey see, monkey do attitude prevails. We see corruption works and we start taking it as the norm and eventually it becomes part of the mainstream. However, intervention can often steer institutions towards setting the sort of incentives we wish for them to provide. Think of the Motorway Police, by far the most honest police force in Pakistan which has little qualm about giving tickets to the high and mighty. Even if a drop in an ocean, such institutions are nonetheless a beacon of hope in a society with an increasingly bleak outlook on everything.

The writer is a graduate student of Ohio State University and is currently a Teaching Fellow at Institute for Career And Personal Development

Published in The Express Tribune, October 21^st, 2013.

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