'Good enough' is sometimes as good as it gets

Published on Wednesday 4 April 2007 01:51

ONE of the most pervasive and apparently self-evident assumptions of development economics is that sustainable investment and growth require the rule of law. Without impersonal, general norms and their enforcement by independent judicial authorities, according to this view, little development, if any, is possible, because the risks facing both labour and capital - including corruption, arbitrariness and rigid traditions - will be too high. But is this conventional wisdom always right?

Consider an admittedly limited counter-example: South Africa's booming mini-bus taxi industry. The mini-bus taxis developed in response to severe shortcomings in the country's public transport system, but they operate entirely outside of formal laws and regulations. What makes the industry work is a commonly agreed informal business "culture" that is flexible, innovative and keeps operating costs down.

The results are undeniable: at peak times, mini-bus taxis hold 65 per cent of the entire commuter market. The mini-bus taxi industry thus illustrates the importance of informal conventions. Local culture and traditions not only matter, but they are decisive in shaping the behaviour of people - all the more so in developing countries.

In these societies, the social order is predominantly shaped by informal agreements rather than formal laws and regulations. As the South African example shows, such agreements can even promote a country's development. In many developing countries, village associations that are solely based on trust and peer pressure provide access to credit and insurance, guarantee help in times of distress and facilitate the construction of public roads and sewage systems. The community-based health insurance schemes that are prospering all over Africa are a good example of this.

Even so, while informal institutions can improve people's lives, they can also be detrimental to development. The very resources that form the basis of informal security systems - solidarity, social capital and collective action - can have perverse effects. For example, forced solidarity will oblige any hard-working farmer in Benin who has accumulated some wealth over the years to share the fruit of his labour with his enlarged family, including distant relatives.

In economic terms, the "informal institution of sharing" may become a disincentive to invest and thus result in opportunistic behaviour, because there is no obligation to reciprocate. For all of their success, South Africa's mini-taxis could not escape high accident rates, violent incidents over uncommissioned routes and fare levels, and tax evasion, which imposed high costs on society, prompting the government to regulate the service.

Moreover, some informal institutions based on long-standing cultural traditions lead to discrimination and violation of human rights. In these cases, women are often the victims. They might be excluded from participation in informal networks, or have limited influence in appropriating the benefits of collective action. The reported abuse of micro-credits to pay dowries is one alarming example. Likewise, the tradition of female circumcision is still a common practice in African countries such as Guinea, Sudan, Mali, Somalia and Eritrea, where more than 85 per cent of young women suffer from it.

ABOLISHING such customs is a moral obligation, but in other instances, the international community often needs to decide which institutions to change and how. Indeed, one of the most difficult tasks for policymakers is to identify correctly those institutions that are conducive to development and those that may be harmful. Even then, successfully changing institutions is easier said than done, as they are rooted in deeply enshrined norms and values.

Neither the "romantic preservationist" nor the "bulldozing moderniser" approach promises an adequate solution. In some cases, good intentions may even aggravate the status quo.

Reforms need to acknowledge the mindsets of people and the incentive structures that govern their behaviour. Thus, those who benefit from reforms may champion the process, but losers must be adequately compensated in order to prevent them from resisting the transformation. Without building public support and providing proper enforcement mechanisms, changing laws alone is bound to be ineffective.

Institutional change requires a long, tedious and modest implementation of multiple small steps, in which the correct sequencing of reform is crucial. To obtain sustainable results, policymakers need to accept that, sometimes, "good enough is enough".

• Johannes Jtting is a senior economist at the OECD; Denis Drechsler is policy analyst at the OECD.