Soldiers marching in North Korea. In extractive institutional systems such as North Korea, the state plunders the fruits of hard work by its population through various devices and apportions them among those who support or are made up of the top echelon of the government
Good governance to be complemented by economic policy governance
Restoring good governance in the political sphere was the main promise made by the incumbent President at the presidential election in January 2015. It was considered that good governance would usher a new era to Sri Lanka by paving way for the creation of justice-based rule and a society responsible and accountable for its actions.
Now that the election is over and a new President is in place, all systems are being directed toward introducing political reforms but the promise has been delivered only halfway through. In this political reform exercise, what is missing is the introduction of an effective mechanism for assuring economic policy governance without which good governance exercise becomes incomplete.
Good economists and bad economists
The rationale of economic policy governance could be explained by drawing on the viewpoints expressed by French economist, philosopher and legislator Frédéric Bastiat in two of his publications, one in 1848 and the other in 1850.
In the first publication, ‘Selected Essays in Political Economy’, Bastiat has distinguished between a bad economist and a good economist. A bad economist would see only what is seen at the moment and upholds a policy if it contains, at the very first glance, perceived benefits to society. A good economist would see through the effects of the policy that would come subsequently as well. Since such subsequent effects cannot be seen, they have to be foreseen. A good economist, therefore, confines himself to both seen and to be foreseen.
Economic policies which are being implemented by those economists in the government bureaucracy tend to overlook this ‘to be foreseen’ aspect because such an approach does not serve the objective of their political masters, namely, political expediency. Hence, they uphold only what is seen. If ‘to be foreseen aspects’ bring in unsavoury effects, the policies pass unexpected miseries on people who are supposed to be supported by them. Hence, it is necessary to assess both the ‘seen aspects’ and ‘to be foreseen aspects’ before any policy is introduced. This is the starting point of economic policy governance.
Legal powers of governments are to protect property and not to destroy it
Bastiat in his 1850 publication, ‘The Law’, has remarked that law is simply “the collective organisation of the individual right to lawful defence”. The right referred to here is the right to person, liberty and property. The lawful defence involves the use of force to defend oneself and not to destroy the right of another to his person, liberty and property.
“And this common force”, says Bastiat, “is to do only what the individual forces have a natural and lawful right to do: to protect persons, liberties, and properties; to maintain the right of each, and to cause justice to reign over us all”. In such a society, according to Bastiat, order will prevail among the people in thought as well as in deed. It therefore, carries rights as well as responsibilities: right to protect oneself and responsibility not to destroy another’s. If the government does not intervene, says Bastiat, it would cause to develop a system in which people’s wants and their satisfaction would develop in a logical manner.
Explains Bastiat this logical manner in The Law: “We would not see poor families seeking literary instruction before they have bread. We would not see cities populated at the expense of rural districts, nor rural districts at the expense of cities. We would not see the great displacements of capital, labour, and population that are caused by legislative decisions”
Labouring painful, but plundering easy
Bastiat remarks that man can live and satisfy his wants by using his labour and mental faculties to natural resources ceaselessly, thereby giving birth to ‘property’. But man can also acquire property by plundering those developed by others. Since this is the less painful and easier way to acquire property than expending one’s labour, there is a natural tendency, according to Bastiat, for plundering rather than labouring. Because of this natural tendency, Bastiat says that neither religion nor morality can stop people from resorting to plundering of property owned by others.
Though the force of law is to be used to stop plundering of property, alleges Bastiat, those who wish to plunder would acquire power to make laws that enable them to engage in lawful plundering. The result is a chain of events that converts law, instead of an instrument of protection, to an instrument of lawful plundering.
Governments exact private resources
Modern governments, for practical reasons, cannot be relegated to laissez faire governments with least intervention in the economy, though that has been the most ideal form. Hence, powers have been given to governments to frame economic policies to lead nations to prosperity, a common goal of all nations. These powers enable governments to exact resources from society through taxation, coercive expropriation or generating price inflation in the economy and expend the same back on society.
The criterion to be used by governments in this seemingly public good delivering exercise is simple: What is delivered to society should be more than what is exacted from it. But these powers, contrary to the good intentions they underlie, could be abused by bad economists in authority. They could just highlight only what is seen and put into effect systems that permit lawful plundering of property developed by one class by a class they favour. Such bad economic policies bring in a loss to society on a net basis highlighting the need for establishing proper economic policy governance systems.
Institutions are values and beliefs in society
In modern times, plundering of economic resources has been explained as the cause for some nations to fail while others to succeed by two economists, Daron Acemoglu of the Massachusetts Institute of Technology and James A Robinson of Harvard University. In their 2012 book, ‘Why Nations Fail: The Origins of Power, Prosperity and Poverty’, the two economists have argued that it is all to do with the nature of institutions a country has. Institutions for economists are not the institutions which are commonly meant in society.
In economics, they mean ‘the rules influencing how the economy works and the incentive structure that motivates people to do what they do’. In other words, institutions are simply the values, beliefs and behavioural patterns that guide a nation as a whole. This is equally applicable to individual units functioning in an economy such as a family or a company and to their aggregation at national levels which are called nations. They have called the type of institutions that cause nations to fail as ‘extractive economic institutions’; in the opposite, those who contribute for nations to succeed are called ‘inclusive economic institutions’.
A classic example, according to Acemoglu and Robinson, to illustrate this has been provided by North Korea and South Korea which are made of the same ethnic stock, the same geographical attributes and the same natural endowments.
North Korea drives youth to despondency
Teenagers in North Korea are beset by a common institutional structure: growing up in poverty without entrepreneurial initiative, creativity or adequate education that equips them for skilled work. The accepted value system is that even if one works hard, one is not able to enjoy its fruits since it is immediately appropriated by the state. It forces some of them to get into illegal economic activities which are high cost and high risky. For others, it is a life of despondency.
But in the South, the youth have prospect of growing up into success through good education and excellence in chosen vocations. They are aware from early in life that if they are successful as entrepreneurs or workers, they can enjoy the fruits of their hard labour. They have the prospect of improving their standard of living. The institutional structure in North Korea is extractive while that in South Korea is inclusive.
In extractive institutional systems, the state plunders the fruits of hard work by its population through various devices and apportions them among those who support or are made up of the top echelon of the government. Say Acemoglu and Robinson: They are “extractive because such institutions are designed to extract incomes and wealth from one subset of society to benefit a different subset”.
In contrast, “inclusive economic institutions create inclusive markets which not only give people freedom to pursue the vocations in life that best suit their talents but also provide a level playing field that gives them the opportunity to do so”.
Facilitating politicians prosper extracting economic institutions
Acemoglu and Robinson say that extractive economic institutions are prospered by the type of the political setup prevailing in a country. If the political parties or those who lead political parties wield exclusive political power, that is, only they could engage in illegal acts with impunity and not others, the whole economic system is converted to an institutional system that preys on others to sustain itself.
Extracting resources from others is considered a normal and moral activity by politicians and those who are around them. The values that are implanted into the psyche of all those in society have only one element. That is, robbing from society, either through government or through the market by means of franchises bought from politicians, is a normal legitimate activity. In such a system, misusing state property for private gains is considered an innocent activity which should not be an offence to be handled by law enforcement authorities or an immoral act to be discussed publicly by civil society. Thus, all institutions in government or in civil society are converted to instruments supportive of extraction.
An example was the recent downplaying, by the former President as a very trivial act, of using some 20 odd vehicles belonging to the State for private commercial gain by a top politician in Sri Lanka. Such intolerance of the acts of extraction supported by its justification in public leads to the establishment of a value and belief system endorsing what extractive economic institutions do in society.
Wholly inclusive economic institutions are the best
Economic policies can create either extractive institutions or inclusive institutions or a mixture of both. Extractive institutions will plunder resources from beginning to the end. Inclusive institutions will prosper resources and allow citizens to enjoy the fruits of their labour.
The mixture of both extractive and inclusive will provide a better deal to society depending on the relative importance of the extractive side or inclusive side in the whole institutional structure. If the extractive side is preponderant, then, it is as bad as extractive institutional setup created by the first type; in a setup where inclusive type is preponderant, it is still acceptable though it is not the ideal setup which a society should aspire to have. That is because it does not allow a society to have the best for its future.
Dismiss extractive institutions
So, what is to be dismissed by a society is a structure in which institutions are wholly extractive or preponderantly extractive. What is to be aspired is a wholly inclusive institutional structure; a structure where inclusive aspects are preponderant maybe accepted as a temporary arrangement until a society moves to a wholly inclusive institutional structure.
Economic policies should not prosper extractive institutions
So, what is the responsibility cast on economic policy makers? They should avoid policies that lead to wholly extractive or preponderantly extractive institutional structures. If any policy leads to a structure where inclusive side is preponderant, they should have that policy under continuous surveillance so that they could adopt measures to change into wholly inclusive institutional structures as the final goal of policy.
Contributors to extractive institutions
How could an extractive or preponderantly extractive institutional structure be established in society? There are two contributors. One is the general policy being implemented by the state favouring or promoting economic extraction. The other is the individual policies that permit one setup of society to extract economic resources from another setup.
Governments’ failure will generate extractive institutions
In the first case, governments’ failure to uphold three good governance requirements will change the entire value and belief system in society. They are the non-observance of the rule of law, violation of property rights and toleration of bribery and corruption in society. When these bad elements are supported by the prevailing exclusive political setup, the nation descends to a perilous state.
The program to introduce constitutional reforms in Sri Lanka after the presidential election in January 2015 sought to address this issue. The implementation of the program only halfway through so far has denied society the benefit which it sought to bring in. Hence, the system of governance in Sri Lanka today is not different from that prevailed prior to presidential election in January, 2015. As such, the country has the same risk with respect to economic policy governance.
Economic policies should be made by technically qualified experts and not politicians
The individual policies are in the hands of the economists working under political authorities. If they fail to assess the outcome of a policy as it pertains to today as well as in the future, the overall impact of the policy, whether it is wholly extractive, wholly inclusive or a mixture of both, is not taken into account. This is the working of the bad economist referred to by Bastiat. The result is a net loss to society.
To prevent such a net loss, economic policy making should be handed to a group of technically qualified individuals instead of leaving in the hand of a single official or a single politician or a group of politicians. Such group assessment will prevent the implementation of policies that do not bring in overall economic benefits to society. Hence, economic policy makers should be made accountable even after they leave office if the policies which they have implemented have brought a net loss to society by allowing one group of people to extract resources from another group of people.
Empower civil society to ensure economic policy governance
These are important requirements which have to be put in place in order to satisfy economic policy governance. Since it is unlikely that politicians would implement them on their own, it is important to empower civil society so that an effective voice could be made whenever there are deviations from the accepted policy.
(W.A. Wijewardena, a former Deputy Governor of the Central Bank of Sri Lanka, could be reached at firstname.lastname@example.org.)