Good Governance and Economic Performance

BERLIN – The debate about emerging countries’ growth prospects is now in full swing.
Pessimists stress the feared reversal of private capital flows, owing to the US
Federal Reserve’s tapering of its purchases of long-term assets, as well as the
difficulties of so-called second- and third-generation structural reforms and the
limits to “catch up” growth outside of manufacturing. Optimists argue that the
potential for rapid growth remains immense, owing to better macroeconomic
fundamentals and the promise of best-practice technology spreading throughout the
emerging world.

So who is right?

Recent events point once again to the importance of good governance and responsive
political systems, a familiar topic in studies of long-term economic growth.
Countries that appeared successful for a long time, such as Turkey or Thailand,
suddenly seem to face obstacles related to governance and the ability to forge
domestic political compromises. The resulting divisiveness and dysfunction are
surely bigger threats than the Fed’s tapering.

It is the nature of governance that determines whether people deploy their talents
and energy in pursuit of innovation, production, and job creation, or in rent
seeking and lobbying for political protection. And here the contrast between Egypt
and Tunisia may turn out to be an object lesson in what makes the difference between
success and failure.

In Egypt, the old regime under Hosni Mubarak, having failed to democratize,
collapsed in the face of massive protest. A low-turnout election gave a plurality of
the popular vote to the Muslim Brotherhood, which came to power alone and proceeded
to ignore good governance and alienate all except its most fervent followers.

The Brotherhood’s approach to governance also explains the mess it made of the
economy. Instead of trying to build non-partisan and competent regulatory
institutions, all positions were stacked with political followers. Unfortunately,
the military intervention last July gave rise to yet another regime that seems
unable to build durable institutions that could foster political reconciliation and
deliver inclusive growth.

Tunisia may give us an example of the opposite scenario: a real constitutional
compromise supported by an overwhelming majority (reflected in a 200-16 vote in the
National Constituent Assembly). If that compromise holds, stability will take hold,
markets will function, Tunisia will attract investment, and tourism will thrive

At the heart of the difference between the two cases is a vision of governance that
makes such compromise possible. Such a vision presupposes an assurance that a
winner-take-all system will not be established, as well as broad agreement that
regulatory institutions should be reasonably non-partisan and staffed with competent

China’s long-lasting success is sometimes given as a counterexample to the
importance of good governance for economic performance. The Chinese example
certainly calls into question a strong correlation between multi-party democracy and
economic growth.

Democracy is of course something valuable in itself and can be desired independently
of its effect on economic growth. But, in the context of economic performance, it is
important to emphasize that there is a huge difference between dictatorial regimes,
where a single individual monopolizes all power – à la Mubarak or Syrian President
Bashar al-Assad – and China, where there has been competition and contestability
within a large communist party. And it is the party, operating as a fairly inclusive
and meritocratic institution, not an autocratic leader, that has governed in the
post-Mao period.

Lack of reasonably independent regulation and competent public administration – or,
worse, one-person dictatorships – lead inexorably to economic waste and
inefficiency, and eventually to political turmoil. This is true even in cases like
Venezuela, where large oil revenues masked the underlying weakness for a while. In
the complex global economy of the twenty-first century, sustained good economic
performance requires a panoply of well-functioning institutions that do not fall
within a single leader’s purview.

For example, successful economies require a reasonably independent central bank, and
competent bank supervision that does not get dragged into short term politics. They
also need regulatory agencies in sectors such as telecommunications and energy that
can pursue policies in accordance with broad goals established by the political
process, but with appointees selected according to nonpartisan criteria who then
exercise their authority in a way that fosters competition open to all.

When credit decisions, public procurement, construction contracts, and price
determination reflect only short-term and purely political goals, good economic
performance becomes impossible – even in countries with large natural-resource
endowments. In countries with little or no such endowments – where innovation,
competitive efficiency, and a focus on production rather than rents is all the more
important – the lack of good governance will lead to failure more rapidly.

All of this implies that analyzing the determinants of economic success is a subject
not just for economists. Why do some societies achieve the compromises needed to
sustain an independent judiciary and a modern regulatory framework – both necessary
for an efficient modern economy – while others perpetuate a partisan,
winner-take-all approach to governance that weakens public policy and erodes
private-sector confidence?

The contrast is starkest in emerging countries, but differences also exist among the
advanced economies. Perhaps Germany’s ability to reach sociopolitical compromise –
again demonstrated by the formation of a right-left coalition after the 2013
elections – has been more fundamental to its recent economic success than the
details of the fiscal and structural policies it has pursued to achieve it.

Kemal Derviş, former Minister of Economic Affairs of Turkey and former
Administrator for the United Nations Development Program (UNDP), is Vice
President of the Brookings Institution.