Africa Economic Brief

2018 l VOLUME 9 l ISSUE 8

VICE PRESIDENCY FOR ECONOMIC GOVERNANCE
AND KOWLEDGE MANAGEMENT

Institutions in Transformational Governance:

Lessons for Africa
Mushtaq H. Khan1

I nstitutions and governance capabilities are important

determinants of the path and pace of development.
Institutions are rules that describe how resources are allocated
social transformation is that these countries had a different and
complementary set of transformational or developmental
governance capabilities and institutions. These institutions and
or choices and decisions are made, while governance governance capabilities differed in detail across successful
capabilities describe how power and authority are used to countries because their political settlements were different, but
enforce or ensure adherence to particular rules. Both are they had some common characteristics in terms of the
important for explaining the stability and credibility of property problems that they solved. They assisted the transformation of
rights, the efficiency of markets, how political decisions about property rights from traditional rights to forms that were more
resource allocation are made, and how and to what extent appropriate for the emerging capitalist market economy,
important market failures can be addressed. Much of the overcoming specific market failures—in particular those
institutional and governance advice given to developing constraining the achievement of organizational capabilities in
countries in Africa and elsewhere has focused on the definition emerging firms—and allocating and managing political
and protection of property rights, and the institutions and resources to achieve sufficient political inclusion for political
governance capabilities required to make markets more stability. At the same time they induced the creation of broad-
efficient. We describe this as the good governance reform based productive capabilities across the regions, tribes,
agenda, or market-enhancing governance, because it focuses ethnicities, religions, or other cleavages within the country.
on the enforcement of market institutions. While this is
undoubtedly important, there are structural reasons why the 1 | Introduction
adherence to a rule of law and the enforcement of property
rights across the board are necessarily weak in developing and In the last two decades, many African countries have
emerging countries. The enforcement of property rights and a achieved high rates of growth. However, the sustainability of
rule of law becomes stronger gradually in line with the the improvements in welfare that have begun to be seen
emergence of a broad-based productive economy, but it also depends on whether the growth is associated with processes
contributes to the efficient operation of this economy. This two- of social transformation that result in a change in the organiza-
way relationship between the enforcement of and adherence to tion of production across society. This typically involves a
the institutions of a market economy and economic change in the sectoral distribution of activities across the
development is not in dispute. The important policy question, country, generally with a growing share of activities in
however, is how to accelerate social transformation in the “modern” sectors of manufacturing, higher productivity agri-
direction of a broad-based and inclusive economy in culture and agro-industries, high-productivity services, and
developing country contexts where market institutions are hard so on. If this social transformation can be sustained, the result
to significantly improve in the short to medium term. The is a broad-based and inclusive improvement in capabilities,
experience of developing countries that have achieved rapid and therefore of welfare across society.

1 Professor of Economics, School of Oriental and African Studies, University of London and Chief Executive, Anti-Corruption Evidence Research Consortium,
[email protected].

Disclaimer: The views and opinions expressed in the paper do not necessarily represent those of the Bank, its Board of Directors, or the countries
they represent.

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However, African countries face many challenges in sustaining African countries have received much policy advice from
such a broad-based social transformation. It requires, among development partners, often backed with conditional financial
other things, ensuring that growth is largely based on the support, urging them to implement “good governance”
development of employment-generating productive sectors, reforms. Good governance has come to mean a combination
in particular manufacturing. This in turn requires changes in of institutions and governance capabilities that support the
property rights to enable appropriate changes in the creation and enforcement of property rights, the enforcement
organization of production, assistance for the development of a rule of law, a significant reduction of corruption, and the
of competitive capabilities in firms, and political arrangements improvement of political accountability. These reforms have,
that ensure stability without reducing economic dynamism. in principle, enjoyed broad support across society because
many of these goals are desirable in themselves. Who can be
Appropriate institutions and governance capabilities for for corruption or against a rule of law?
enforcing these institutions are critical if social transformation
is to be triggered and sustained in difficult developing country But the economic case for these institutions and governance
contexts. Institutions describe rules for making decisions and capabilities is also that these reforms are sufficient to make
allocating resources. Policies also describe rules, and are markets more efficient by reducing the transaction costs of
therefore similar to institutions, but are typically easier to enforcing contracts and providing efficient public goods. The
change on a regular basis than institutions. Governance underlying institutions are clearly defined property rights and
describes how authority is used, and in particular, how public transparent, accountable, and noncorrupt political rules for
authority is used to enforce institutions and policies or to making laws and spending tax revenues. In terms of standard
ensure adherence to these rules. Clearly, institutions, policies, economic theory, these institutions and governance
and governance go together, and poor development capabilities should make markets work better and enable
outcomes can be the result of either: institutions and policies states to provide essential public goods through taxation.
not being enforced because the state lacks appropriate Unfortunately, this institutional agenda does not address
governance capabilities; or the institutions and policies being many substantive constraints that block the achievement of
inappropriate or inadequate for addressing the most broad-based inclusive growth in developing countries. What
important development challenges facing the country. is worse, this agenda identifies a set of institutions and
governance capabilities that is very difficult to enforce in the
It is therefore important to jointly identify the institutions and typical developing country context.
governance capabilities that countries need to develop if they
are to sustain their economic and social transformations. The It is not surprising that the implementation of these “good
institutions should be appropriate for addressing the governance” reforms has not achieved significant results in
economic and political challenges that the country faces. But Africa or elsewhere in the developing world. In particular, the
they should also be such that they will achieve development implementation of good governance has faced two sorts of
results given feasible governance capabilities that the problems.
particular country has, or can feasibly develop. This means
that the design of institutions also has to take into account First, in conditions of substantial economic underdevelop-
specific economic, political, and historical conditions of ment, enforcing these institutions has proved very
particular countries that determine their governance challenging, because enforcing formal property rights and a
capabilities. Institutions have to be effective, and effectiveness rule of law presupposes economic and political conditions
depends on governance capabilities, and this is why the best associated with advanced economies. It assumes that tax
design of institutions can vary from country to country, not revenues are available for enforcing a general structure of
only if we compare Africa with East Asia, but also across rights, which is in fact an expensive proposition.
African countries themselves.
Second, formal institutions like property rights and a rule of
In this paper, I discuss some of the important factors that law can only be effectively enforced if they are sufficiently
determine the characteristics of institutions appropriate for aligned with the interests of dominant economic and political
accelerating the transformation in Africa. This discussion will organizations. Again, in conditions of economic under-
inevitably require some review of the types of development development, the most powerful organizations are not yet
challenges that developing countries face, without which we potentially competitive and often do not support the
cannot discuss institutions and governance capabilities. enforcement of these institutions as they are unable to make
sufficient profits on the basis of market contracting. Instead,
The paper’s central argument is that the social transformation the powerful are often more interested in violating rules as a
required to achieve higher standards of living in developing strategy of accumulation. Thus we see limited enforcement
countries needs a set of transformational or developmental of formal property rights and the rule of law across developing
institutions and governance capabilities that are often at countries. Market institutions on their own are insufficient
variance with the standard market institutions and “good under these conditions, and additional institutions and
governance” capabilities that most development policy advice governance capabilities are required to organize the social
focuses on. We also discuss the types of institutions and transformation through which a productive capitalist sector
governance capabilities that are instead required for such a can emerge. This may require restructuring property rights in
developmental transformation. specific ways to accelerate the emergence of competitive

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firms, and assisting the development of productive capabilities and the generation of new incomes and rents also create
within such firms. A more demanding set of institutions and incentives and opportunities for some parties or groups to
governance capabilities is therefore required for organizing a exclude others from access to power and resources.
developmental transformation. We refer to these as develop- However, lasting political stability requires a continuous
mental or transformational institutions and governance increase in political inclusion, combined with a growth in
capabilities. productive capabilities. There are no blueprints for political
institutions that work across developing countries because
Much of the standard good governance advice on institutions their initial conditions and in particular their political
and governance is based on comparing countries with high settlements (the distributions of organizational power) are
productivity with those with low productivity. When we make different. Nevertheless, political institutions that allow political
this comparison, it is indeed the case that the former have inclusion are important because rapid transformations do not
much stronger market institutions. However, if we investigate just happen, they have to be organized and the changes
the processes that drove the transformation of the former have to have sufficient support for reasonable levels of
from lower- to higher-productivity societies, we find that the enforcement. Otherwise, progress may either be unnecess-
property rights transformations and the development of arily slow because of resistance, or rapid retrogression can
capabilities that underpinned these changes were often driven suddenly happen because significant opposition can
by very different institutions and capabilities. Historically, suddenly erupt. A better understanding of what these
developmental transformations have involved an important transformations involve can help identify the tasks that have
role for politics and the state, not in enforcing some to be accomplished, even if the precise institutional and
preexisting structure of rights, but rather in changing property policy solutions will be different across countries because of
rights structures and creating opportunities for creating new different initial conditions and political settlements.
productive enterprises while managing political stability in
contexts where the potential for conflict is very high. In the rest of this paper, section 2 outlines the arguments for
market-enhancing institutions and governance, which we
Markets, defined as institutions supporting voluntary contract- describe as the good governance agenda. Section 3
ing, have always been important for enabling economic introduces the alternative argument for transformational
activity but have rarely played a dominant role in driving the institutions and governance, followed by three sections
transformations that created a large number of competitive discussing in turn important aspects of transformational
enterprises in a developing country.2 The most damaging governance: section 4 looks at the transformation of property
aspect of the good governance agenda is that it has focused rights, section 5 at the institutions and governance required to
policy attention on a series of reforms that can at best be develop organizational capabilities in emerging firms, and
marginally implemented, and therefore have a marginal effect section 6 at political institutions and political inclusion. Section
on the efficiency of markets, while ignoring the institutions and 7 concludes.
governance capabilities that are necessary to develop the
capabilities and organizations that could benefit from these
market institutions. For developing countries, a small 2 | The limits of the good governance agenda
improvement in the efficiency of markets will not address the
more fundamental problem that they have very limited From the perspective of institutional economics, the “good
productive capabilities to benefit from enhanced market governance” agenda focuses on strengthening institutional
access. What they lack are economic organizations that are rules that could make markets more efficient by reducing
productive enough to be competitive in a global economy. transaction costs. The promotion of good governance can be
described as a “market-enhancing” institutional strategy.
This is why the growth that has recently accelerated in a However, there are other developmental institutions and
number of African countries over the last few decades remains governance capabilities ignored in the good governance
vulnerable. It has often been driven by minerals and relatively approach. We will refer to these as developmental, trans-
few productive sectors, primarily in services and agro- formational, or growth-enhancing institutions and governance
industries. But for broad-based development to be truly capabilities.
sustainable, social, political, and institutional processes have to
support the continuous development of new productive Much confusion has been created by cross-country
capabilities and organizations across the economy, particularly econometric exercises that have found that richer or better-
in manufacturing. This requires strong governance capabilities performing countries score higher in terms of their good
not limited to or focused on the governance capabilities that governance or market institution scores. The problem is that
the good governance agenda concentrates on. even the most sophisticated econometric techniques are
inadequate for conclusively proving causality: was there a
Social transformations are also likely to be periods of prior improvement of property rights, the rule of law and other
elevated levels of social conflict, because these changes good governance institutions in countries that achieved
inevitably create winners and losers. Periods of rapid change growth and development? And, do these improvements
explain their transformation? A careful examination of the case
study evidence on historical transformations suggests that no
2
Brenner 1985; Wood 2002; Khan 2004, 2005b. country achieved significant good governance capabilities

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before they developed their economy, and that other Economic history looked at through the relatively crude
developmental institutions and governance capabilities played methods of econometrics can miss the complex two-way
a significant role in these transformations.3 causality between economic development and market
institutions. It can suggest that market institutions were
This finding is not surprising, because good governance necessary and sufficient for driving development.4 Instead, a
institutions (like broad-based property rights and a rule of law) case-study approach to economic history looking at the
are expensive public goods and it is difficult, if not impossible, transformations of particular countries and the important
to achieve these fully in poor economies with limited fiscal nonmarket processes through which property rights were
resources. Moreover, the effective enforcement of these rules transformed and productive capabilities developed, strongly
is unlikely unless powerful organizations in society support suggests that developmental institutions and governance
enforcement in their own interest. This alignment of interests capabilities were critical in accelerating transformations.5
assumes that many powerful organizations are already
productive enough to be able to benefit from enforcing market
institutions like property rights and a rule of law. In fact, if 3 | Transformation challenges for governance
productivity and competitiveness are sufficiently low, the early
enforcement of market institutions may actually be detrimental Rather than simply attempting to enforce stable property
for many powerful organizations in developing countries. In rights and a good rule of law, successful countries had
contrast, advanced economies with powerful productive firms specific institutions and policies for transforming firm
have the capacity to pay for public goods like property rights structures, adopting technologies, supporting the develop-
and a rule of law, and have an effective demand for these ment of organizational capabilities, and protecting critical
goods because powerful organizations want these institutions rights to sustain rapid transformations. These institutions
in their own interest. and governance capabilities helped implement strategies to
accelerate accumulation and technology acquisition,
The critical policy questions are whether significant improve resource allocation, and achieve political stabi-
improvements in these good governance institutions are lization using pragmatic strategies that differed from country
possible in developing countries before a broad-based to country. Some developers were dramatically successful,
productive economy has emerged, and if significant improve- others less so. However, for very good reasons, the
ments in these institutions are a necessary precondition for governance capabilities and political arrangements in
development. The historical evidence suggests that significant successful countries display considerable variation, implying
improvements in property rights and the rule of law are not that there is no single blueprint for successful trans-
possible except in line with the gradual growth of a broad- formational governance.
based productive economy, and that while the latter is helped
by the development of these institutions, other institutions and Moreover, policies and institutional arrangements that worked
policies are even more important to accelerate this progress. well in one context can be associated with weaker or negative
This is not to deny that improvements in market institutions results in others. For instance, institutions that supported
are possible and that these can make some difference, but capability development in domestic industries had very
these differences are unlikely to explain the huge differences positive effects on productivity growth in countries like the
in developmental outcomes across countries. Republic of Korea, where the political settlement allowed firms
receiving support in these ways to be effectively disciplined.
These nuances are missed by looking at cross-country data In Pakistan in the 1960s, however, similar policies for
on institutions, governance, and economic performance in supporting infant industries had less dramatic effects. Here,
an ahistorical way. The last can suggest that market firms could block subsidy withdrawal using their political
institutions were instrumental in driving growth and networks and had much lower compulsions to raise
prosperity. This is because by looking at end-states, we can productivity. Indeed, in some countries or for some sectors,
easily miss the interactive processes through which both some strategies of protection and subsidies may actually have
economies and market-enhancing institutions jointly had negative effects on productivity growth.
developed over time. How did successful countries improve
their good governance characteristics over time? Did they The large variance in the outcomes associated with targeted
succeed in somehow enforcing market-enhancing property interventions is of course a major reason that orthodox policy
rights and good governance and then develop rapidly as a advisors have tried to reduce the policy space for developing-
result? Or did they have other governance capabilities that country states to implement industrial policy. Instead, they
allowed them to grow, with good governance capabilities encouraged states to focus on reforms to make markets
also developing as productive organizations emerged who more efficient, including good governance reforms. Implicitly,
both demanded and were willing to pay for the enforcement these policies aim to prevent developing countries from
of formal market rules? making mistakes by reducing the discretion of their states.
Yet the attempt to protect developing countries from the
dangers of policy autonomy is both patronizing and deeply
3
Some of this evidence is reviewed in Khan (2004, 2005b), Meisel and Aoudia
(2008), and Khan (2012a). damaging.6 Even if some developing-country states have
4
For instance Acemoglu and others (2001, 2002). made costly mistakes in the past, societies cannot be put on
5
Khan 2012a.
6
Fukuyama 2005. sustainable growth paths by introducing the “right” policies

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from outside and limiting the autonomy of their states to make growth in that country. Cross-country experiences can tell us
variations thereafter. a lot about the types of problems that institutions had to
address to sustain transformation. Similar problems will have
Growth requires a continuous adaptation to changing to be addressed in any developing country, even though the
economic and political circumstances and this most vital particular institutions and governance capabilities that best
capability of experimentation and adaptation can be address these problems will necessarily be somewhat
destroyed or stunted by strategies that aim to constrain the different. This framework allows us to have productive
policy autonomy of policy makers. Even the most ideological discussions about feasible and effective institutional design
supporters of market economics will concede that, within across countries.
broad limits, sustaining growth requires a large amount of
policy autonomy to respond to crises in creative ways. The cross-country evidence of social and economic trans-
Indeed, crisis and challenge can be caused by the operation formations tells us that successful countries addressed a
of markets themselves, a fact we are occasionally reminded number of critical challenges that enabled them to sustain
of during global financial crises. The historical reality is that their social transformation over extended periods. Their
the ability to act autonomously may be even more important institutions and governance arrangements allowed high rates
at earlier stages of development because there is actually a of accumulation, relatively efficient resource allocation to
wide range of variation in successful strategies of social growth sectors, and technology adoption combined with
transformation.7 rapid learning of organizational capabilities to use these
technologies competitively. The historical evidence in Asia and
As societies begin with different political, social, and economic elsewhere suggests that developmental transformations have
conditions, it is not surprising that they do not follow the same required institutions and policies that addressed critical
strategies and paths of transformation. Nevertheless, there market failures that would otherwise have constrained the
have been a variety of strategies of transformation with achievement of these objectives.9
different degrees of success. We can learn from the ways in
which successful countries addressed specific problems We know how particular institutions achieved this in different
during their transformations even though the precise countries. We also know that these institutions worked
instruments and methods cannot be copied and replicated in effectively because of the specific political settlement in each
different contexts.8 The real irony is that none of the country that allowed particular institutions to be effectively
successful transformational economies of the last 50 years enforced. The starting point for a policy discussion is to ask
appeared to have followed the “good governance” strategy in how these problems have been addressed in a particular
making their transition to high levels of productivity and broad- country, if at all. Is there a better way of addressing these
based productive capabilities. By setting apparently plausible problems in our country, given differences in political
but unachievable institutional and governance capabilities as settlements and initial economic conditions? The growth-
policy targets, the global policy discourse has set other enhancing (or transformational) approach to institutions and
developing countries a goal that they cannot possibly achieve governance identifies problems that were addressed by
and that is unlikely to help them to traverse the developmental successful transformation countries. This can help other
transformation any better. countries address these problems with plausible institutions
and policies given their own institutional and political
Societies have to devise their own institutional strategies that conditions, and perhaps with greater social justice and with
can pragmatically address their growth challenges as best as fewer costly mistakes than the earlier developers.
possible given their political constraints. As the political
settlements of countries can be widely different, identical In understanding the challenges facing Africa, we need to
institutional solutions to support transformations will not work. keep in mind the structural features of developing countries
However, this does not mean that country specificity can be that constrain sustained economic and social trans-
used as an argument to justify any institutional strategy. There formation.10 Three areas stand out. First, developing countries
are many flawed institutional strategies that may emerge need to manage the allocation of rights over valuable
either because of poor policy advice or because of rent- resources like land and natural resources, given that property
seeking activities within these countries. That is why even if rights are weakly defined at early stages of development.
blueprints cannot be copied, an institutional analysis of Historical evidence and economic theory both suggest that
feasible growth-enhancing institutions is critically important. contrary to the expectations of economists who believe that
The only general lesson is that developing countries should stable property rights can be created in any context provided
not attempt to implement particular institutional blueprints there is sufficient political will, the weakness of property rights
without first asking if it is feasible to implement and enforce in developing countries is structural and not entirely due to
these institutions in that context, and second whether those the greed of political leaderships or to their inadequate will to
institutions will address the issues that are constraining enforce a rule of law. Second, transformational institutions
need to assist emerging economic organizations like firms
and farms to raise their technical and organizational
7
Khan 2012a, 2012b. capabilities so that they can become competitive using
8
Amsden 2001. modern technologies. This process of learning is subject to
9
Amsden 1989; Wade 1990; Khan and Jomo 2000; Lall 2003.
10
Khan 2005b. significant market failures that need corrective interventions;

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transformative institutions and governance are critical here. transactions will then largely be able to drive development,
Finally, sustaining transformation requires political inclusion with a more limited role for states, transformative institutions,
to be satisfactory, and political institutions are vital in and governance in addressing market failures.
ensuring this.

5 | Technology acquisition and organizational

4 | Transforming and managing property rights capabilities
Developing countries do not already have a good rule of law Successful economic transformation always involves the
and well-defined property rights because they have too few development of many domestic firms that are internationally
competitive organizations that can pay for the provision of competitive. Transformational strategies therefore must
these public goods and that demand these goods as involve institutions and policies for technology acquisition and
essential for their own continuing prosperity. Property rights for capability development within firms. This process could in
and the rule of law therefore become gradually better over theory be organized through private investments based on
time as countries develop an increasing number of productive market contracting if markets were efficient enough. But
and competitive enterprises that can pay to enforce these developing countries suffer from significant market failures.
rules and that can effectively demand the enforcement of This is well recognized, but what is to be done? The problem
these rules as essential for their own prosperity. of market failure is usually attributed to the absence of
institutions like property rights and governance arrangements
Sustaining inclusive growth across a range of sectors and that can enforce a rule of law. However, as argued earlier, it is
firms depends on the effectiveness of states in creating and unlikely that market-enhancing governance reforms that seek
managing institutions that enable the changes in property to address this can be sufficiently well implemented in
rights required for sustaining a viable transformation. developing countries to heavily reduce these market failures.
Transformative institutions that can improve the allocation of
land and other natural resources can therefore play a vital role Instead, the transformational governance approach directly
in sustaining growth. These institutions could, for instance, attacks the most significant market failures constraining the
assist land reform or administrative land allocation processes development of competitive firms. A number of market failures
that follow appropriate rules to direct land toward more can prevent investment in sectors that require the absorption,
productive uses while protecting the vulnerable. In the adaptation, and learning of advanced technologies.11 The
absence of land markets that are already working well, most important is arguably the set of factors that prevents
developing countries need such institutions and governance investment in learning-by-doing through which firms acquire
arrangements to accelerate the property rights transformation organizational capabilities and thereby become competitive.
in ways that have broad social approval, and are as Entrepreneurs and their firms in late developers have to face
transparent and equitable as possible. In particular, the more competitive firms in other countries that are far ahead of
vulnerable have to be protected and adequate compensation them in organizational capabilities. To survive, they have to
paid as land use is changed, while the rights of new users also rapidly acquire the tacit knowledge required for using modern
have to be protected to enable investments to take place. technologies within their organizations at levels of productivity
that make them competitive. The acquisition of these
The pace of development can be seriously slowed—even organizational capabilities through learning-by-doing requires
stopped—if a society lacks rules for land acquisition in high heavy investments in learning, as firms are insufficiently
transaction cost markets and for the transfer of land to new profitable or may even initially be loss-making while acquiring
high-value uses. These rules have to have social acceptance the requisite capabilities.
and not be opposed by significant sections of society. If these
institutions are absent, the supply of land for growth sectors These investments in learning face major contracting failures
can be constrained, as has happened, for instance, in some because investors who may want to invest in these learning
parts of India in the last two decades. High rates of processes cannot be sure that their contracts can be enforced
development require rules for acquiring land and for to protect their money and earn a return. These contracts are
compensating previous users of land, rules for allocating land potentially complex because they have to ensure that teams
to new uses—and perhaps withdrawing rights from new within the firm put in the requisite steep learning effort to make
users who fail to use land in designated ways—and protecting the learning effective. Investors also need to be able to
the rights of high value land users. If these transformative withdraw what is left of their investments if the performance of
institutions are effective, eventually a growing number of land the firm looks unpromising at a later date. As these types of
users will become competitive market players with high complex contracts face enforcement uncertainties in
productivity, and they will eventually be able to pay for and developing countries, market failure can prevent private
demand the protection of property rights as a public good. investors from organizing the financing for learning-by-doing.
At that point, well-working land markets are likely to emerge, This is an important reason why competitive enterprises
and the role of transformative institutions will decline. Market emerge so slowly in these contexts. As explained earlier, it is
not credible to try and address this and other market failures by
attempting to make markets sufficiently efficient using good
11
Khan 2013b. governance institutional reforms.

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Instead, technology adoption and learning are likely to be countries with adverse political settlements. However, here
much faster if the market failures are directly addressed with the institutions and policies have to be carefully designed so
public policies. Effective transformational institutions and that incentives and credible compulsions for high-effort
governance capabilities are needed to provide direct solutions learning are created. In particular, transformational institutions
to critical market failures. With this important market failure, have to be more modestly designed in these contexts, and
transformational institutions and policies have to provide seek to assist the development of competitiveness in only a
public resources for learning with effective withdrawal few sectors at a time. The sectors would have to be carefully
conditions to discipline firms, so as to ensure high levels of chosen, but usually the choice is relatively obvious given the
effort in the learning process.12 It is now widely recognized available skills of the workforce, international market
that the rapid growth of the East Asian tigers was supported conditions, and so on. For instance, in many African
by states that provided resources for learning-by-doing and countries, electronic components assembly, garments and
capability development but with effective capabilities to textiles, footwear, food-processing industries, telecommuni-
withdraw these resources and discipline nonperforming firms cations, and tourism are obvious choices.
in different ways. The experience of East Asia shows that
while the institutions and policies for assisting learning differed The strategies for developing competitiveness by supporting
widely, in the successful cases, institutions and governance learning-by-doing and developing organizational capabilities
arrangements could be effectively enforced to create credible would have to be compatible with existing technocratic and
incentives and compulsions for learning.13 These critical political enforcement capabilities. In many cases, this would
transformational institutions therefore allowed much faster mean that initial experiments would have to be on a relatively
rates of transformation. small scale and scaled up if successful. Undoubtedly, any
country will make mistakes, as all previous countries have.
However, the transformational institutions that intend to Perhaps the most important correction required to our current
provide support for technology and learning can also be poorly way of thinking is that the adoption and learning of
designed. This could either be because the institutions fail to technological and organizational capabilities is an incremental
provide enough support to firms on the right terms to create process that involves making mistakes and learning from them.
incentives for effective learning-by-doing, or it could be that
the rules and associated enforcement arrangements are not Most of the literature on transformational learning strategies
credible in that political settlement because they do not create refers to the Northeast Asian experience, particularly the
compulsions for supported firms to put in high effort. Republic of Korea, during the 1960s and 1970s. During this
period, the financing of capability development took place
For instance, if supported firms are powerfully connected to through institutions and policies that gave sizable upfront
politicians with short time horizons, an institution that provides resources to firms, with enforceable conditions of withdrawal
subsidized credit from public sector banks and sets that ensured high effort in raising competitiveness. However,
conditions for their withdrawal if there is underperformance is for historical reasons, the East Asian economies were unusual
unlikely to be credible. More complex institutions for in that they had political settlements that allowed the
supporting learning are required in these cases, as we see in enforcement of tough conditions on the domestic firms that
the case of successful learning in the Indian automobile received this type of support.14
industry and the Bangladeshi garment industry. Otherwise,
public resources will be unproductively captured by firms and In the Republic of Korea, significant “rents” or policy-created
result in infant industries failing to grow up. These differences incremental incomes were allocated ex ante to large firms to
in institutions and governance capabilities are important provide time and resources for learning-by-doing. The
explanations of developmental differences across countries. financing provided to the chaebols through low-interest loans,
The design of critical transformational institutions so that they protected domestic markets, and export subsidies came with
are effective given the political settlement is therefore one of credible sanctions if export targets were not met. The buoyant
the major challenges for countries attempting to achieve global markets at that time and the ability of diversified
transformation. chaebols to start exporting quickly meant that export
performance was a good indicator of effort. The political and
Relative to the high-growth Northeast Asian countries, the institutional conditions in the Republic of Korea also allowed
initial conditions for implementing strong transformational corrective and sometimes punitive action to be taken against
institutions are relatively adverse in many African countries, recipients of subsidies if export and other evidence suggested
both initial entrepreneurial capabilities and the suitability of low levels of learning effort in the firm. For instance, the state
their political settlements for enforcing discipline on firms. could not only withhold export subsidies if export growth was
Nevertheless, the experience of other Asian countries like not achieved, it could also reallocate the ownership of plants
India and Bangladesh, with political settlements similar to to different chaebols if they were more likely to acquire the
many African countries, shows that challenges of necessary organizational capabilities, ensuring high effort in
developmental transformations can be addressed even in acquiring the requisite productive capabilities by the firms
receiving support.
12
For more details, see Khan (2013b, 2013d, 2015). When other developing countries, such as India and Pakistan,
13
Khan 2000b; Khan and Blankenburg 2009.
14
Khan 2009; Khan and Blankenburg 2009. had attempted similar types of industrial policy support for

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infant industries in the 1950s and 1960s, they discovered that 1980s in the sector, based on a combination of public and
they lacked the institutional and political conditions that could private financing instruments.20 Under the earlier strategies of
impose credible conditions for ensuring high levels of effort centrally administered protection, there was no compulsion
by firms receiving support. As a result, effort was often low on India’s protected automobile manufacturers to make the
and technological and organizational capabilities developed effort to achieve competitiveness in global markets. But the
much more slowly. Indeed, many firms and sectors supported new strategies in the 1980s provided public rents with
at that time never became competitive.15 conditions attached that resulted in credible compulsion for
high effort in building the organizational capabilities of
Today, these instruments for financing capability development producers.
would only make sense if market conditions for a
contemporary late developer allowed a similar export-oriented When domestic companies had received support in the
manufacturing growth strategy, and if the political and 1960s and 1970s, the state failed to impose effective
institutional conditions allowed the enforcement of similar conditions on them. The learning effort, and therefore
conditions on firms receiving support. Not only have the rules productivity growth, was low, resulting in the production of
for participating in global trade changed, but the relevant globally uncompetitive cars. Change came in the 1980s when
features of the political settlement in the Republic of Korea Japan’s Suzuki became a joint venture partner in a public
that allowed its state to monitor and discipline particular types sector Indian automobile company, and Maruti-Suzuki was
of rents were very different from those in most developing born. In contrast to previous strategies for financing, this time
countries.16 If the only instruments available for financing the there were credible conditions that induced high effort. Suzuki
development of organizational capabilities were the ones the was given access to the significant rents in the protected
Republic of Korea used, most developing countries’ domestic market, where tariff protection was still around 85
institutions of industrial policy would fail because they typically percent in the 1980s. However, Suzuki was told it had to
lack the political settlements that would allow the enforcement achieve 60 percent local content within five years. Denying
of relevant conditions on firms receiving support. Suzuki access to the domestic market if the target was not
met was a credible threat given the institutions that the Indian
Fortunately, the Republic of Korea’s model of centralized state possessed, and this forced Suzuki to transfer
subsidy allocation is not the only one for addressing organizational and technological capabilities to local
contracting failures affecting learning.17 The experience of component suppliers. This marked the beginning of India’s
successful sectors in developing countries with very different development of a globally competitive components industry
political settlements shows that other types of financing that allowed it to manufacture its own branded globally
instruments and institutions can be effective, even when competitive cars in the 1990s.
governance conditions appear adverse for the type of
industrial policy used in the Republic of Korea.18 The critical To meet local content requirements, Suzuki had to invest
requirement is only that the institutional and political substantial resources and effort in upgrading organizational
conditions have to be appropriate for creating credible and technical capabilities, not only in its own joint-venture
incentives and compulsions for high effort given the financing plant, but also along the entire Indian supply chain for
instruments that are used. This is borne out by examples of automobile components. Suzuki’s incentive was the
successful technology adoption in some sectors in significant rent it could achieve after meeting the local content
Bangladesh, India, and Thailand.19 target. But to get there, it had to invest in learning and in the
transmission of organizational capabilities to a range of Indian
Effort can be forthcoming if the financing instruments not only component producers. The company had no possibility of
provide the resources for financing learning, but also create capturing the rent without delivering the transfer of
compulsions on firms by imposing conditions for high effort organizational knowledge, and this ensured the success of
that are credible, given the enforcement capacities of the the strategy. Suzuki invested in and worked with its local
state. If this can be done, the state still has to do some suppliers to improve their quality-control procedures and
monitoring and enforcement, but this can be successful if it is internal organization of production to achieve the level of local
restricted to conditions that the state can credibly oversee. content it had committed to. The results of its effort to
transform the productive capabilities of India’s tier-one and
The development of India’s automobile sector is one such tier-two producers were spectacular. Maruti rapidly became
example. In the 1980s and 1990s, it made the transition from the dominant model in the Indian market.
a protected and largely inefficient sector producing low-quality
cars for the domestic market to become a major global player. Clearly, this instrument cannot be used for countries that have
This was made possible by a unique combination of industrial already joined the World Trade Organization, which generally
policy institutions that financed capability development in the does not allow domestic content conditions. Nor would it
work in countries whose domestic automobile market is
relatively small. But this example shows how the design of
15
Little and others 1970; Khan 1999, 2011, 2013c.
16
Khan 2010, 2012c. credible institutions and financing conditions can have a
17
Khan 2000a, 2000b. remarkable effect on learning effort in countries where
18
Khan 2013d.
19
Khan 2009, 2011, 2012c, 2013a. standard infant-industry protection strategies have failed to
20
Khan 2009, 2011. induce much learning effort.

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 AEB 2018 l VOLUME 9 l ISSUE 8 l VICE PRESIDENCY FOR ECONOMIC GOVERNANCE AND KOWLEDGE MANAGEMENT

This institutional arrangement was repeated in subsequent enforceability of a rule of law. They are also argued to be
government-supported deals in India’s automobile sector, essential for achieving political stability and accountability
allowing other major foreign automobile producers access to because political competition is assumed to allow conflicting
the rents in the Indian domestic market in exchange for further demands to be legitimately resolved and for political leaders
investments in the organizational capabilities of domestic to be held to account. However, democracy too has been
component producers over the next decade. By the late 1990s, difficult to institutionalize in developing countries and the
Indian automobile component producers were competitively evidence suggests that it has had anomalous results. Even
entering the export market in their own right, and winning where forms of democracy exist there, it has often proved
international quality recognition, such as Deming Prizes. very difficult to organize elections in rule-following ways such
that the results of elections are widely accepted. Sitting
The viability of a globally competitive but domestically owned governments often tend to use administrative powers to tilt
automobile industry depends on the presence of domestically the playing field in their favor. In other cases, ethnic, tribal, or
owned globally competitive tier-one and tier-two components religious minorities feel permanently disadvantaged, absent
producers who can produce the parts required for a strong enforcement of the rights of citizens. These problems
domestically produced car. By the 2000s, the emergence of of institutionalizing democracy are linked to the general
a broad range of globally competitive Indian components problem of enforcing a rule of law in developing countries.
producers allowed Indian auto companies such as Tata and
Mahindra to launch Indian-branded cars. Beyond these problems, the limited access to resources
through the formal budget means that a ruling coalition rarely
Other examples of successful learning from Bangladesh, wins elections or stays in power simply on the basis of what
India, and Thailand show that organizational capability it promises to do with the budget. Rather, electoral victory or
development can be successfully financed in contexts very even the sustainability of an autocracy typically involves
different from that of the Republic of Korea, provided that patron–client exchanges where supporters of parties or
appropriate institutions and financing instruments exist. The leaders are rewarded with benefits that are off-budget, such
Bangladeshi garments industry emerged in a very similar way as government contracts, access to bank loans, or even in
with incentives created by specific institutional arrangements some cases, opportunities for some types of corruption. For
for a company from the Republic of Korea, Daewoo, to lower-level supporters, there can be a promise of assistance
transfer organizational capabilities to a Bangladeshi-owned with jobs, assistance in legal or other conflicts with other
company, Desh, which rapidly achieved the capabilities of citizens, or occasional cash handouts. All this means that
competitive global production of garments. As Desh was an democracy in developing countries often involves high levels
entirely local company, with local management, many middle of rule violations and corruption, and the outcomes are never
managers of Desh later left to form their own companies, fully satisfactory accountability-wise, given the dominance of
allowing rapid replication and growth of the sector. patron–client politics.
Bangladesh went from being a novice in the garments
industry in the late 1970s to becoming the second-biggest What is relevant from the perspective of transformational
exporter after China today. institutions is that developing countries with Western-types of
democracies are not necessarily more inclusive in their growth,
But unlike East Asia, these examples are limited to single nor do they systematically achieve greater political and
sectors and neither India nor Bangladesh have achieved a economic stability than countries that do not have these
broad-based transformation yet. Nevertheless, their examples institutions. The most dramatic transformational success
may be more relevant for African countries whose political stories, like the Republic of Korea, Taiwan, or China did not have
settlements are closer to the South Asian countries than to democratic institutions of the Western model during the critical
Northeast Asian ones, and developing globally competitive years of growth acceleration and structural transformation.
productive sectors one at a time may be the only feasible
approach in these countries. Successful transformational On the other hand, many other developing countries with
strategies in South Asia were based on combinations of authoritarian regimes did very poorly, with massive resource
institutions and financing instruments that were appropriate capture and outflows of capital. Similarly, some democracies,
for the context, and created incentives and compulsions for like Malaysia or Thailand in the 1980s or some states within
high effort in developing productive capabilities that were India today have achieved sustained high levels of growth and
credible given the enforcement capacities of the state. structural transformation with democratic political institutions,
while other democratic states have faced political instability,
contested elections, capital flight, and high levels of political
6 | Political inclusion corruption.

The good governance approach suggests that the political In other words, the political institutions of democracy appear to
institutions of multiparty democracy are essential for ensuring be neither necessary nor sufficient for successful trans-
the legitimacy of the laws that are passed, and therefore the formation, though they are clearly desirable in their own right.21
Nor do the political institutions of authoritarianism of different
types produce determinate results. We can make sense of
21
Przeworski and Limongi 1993; Przeworski and others 2000; Khan 2005a. this anomalous evidence if we remember that the ways in

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which particular political institutions work in developing Political institutions that provide resource flows to a diversity
countries depend on the distribution of power across different of groups within the country but also ensure that these
stakeholders and organizations in that society. Just like beneficiaries become productive job-creators can create a
economic institutions, political institutions work differently in combination of inclusive politics and growth that is
different political settlements. sustainable. Political institutions therefore have to work in
tandem with economic institutions to ensure that
Like economic institutions (such as those relevant for the entrepreneurs and businesses emerge across all the different
operation of industrial policy), political institutions also matter ethnicities, tribes, religions, and regions of a country, so that
for economic transformation. Political stability and political political resource flows are combined with emerging,
inclusion are important for sustaining transformational sustainable economic activities.
processes. Political institutions set the rules of engagement
for political actors. These rules affect whether groups with the This is a difficult but critical task that has to be achieved by
potential to disrupt growth if they are excluded can access political institutions, regardless of whether the overall
political power to achieve inclusion. The rules also determine characteristics of these institutions are somewhat more
whether the groups included in political power and with democratic or somewhat less democratic along the
access to political resources have the incentives and Western benchmark of competitive multiparty democracy.
compulsions to become productive players, or are only Focusing simply on the latter without asking if these
interested in unproductive resource capture. Meeting both institutions are achieving inclusive political and economic
these conditions of inclusion and incentives for productivity is outcomes can soon generate disappointment. Democracy
not easy, but absent these conditions, both democratic and can lead to significant resource capture by powerful elites
less democratic political institutions can fail to achieve who use these resources unproductively and thereby
sustained transformational success. constrain social transformations. Equally, authoritarian
regimes that politically exclude significant groups without
Political inclusion can be achieved in multiple ways, and some ensuring that businesses and jobs emerge across all
ways of achieving inclusion can be consistent with high rates regions, ethnicities, tribes, and religions may also face
of transformation, while other mechanisms can slow or internal turmoil and even conflict. Indeed, to survive, many
disrupt transformation. Similarly, political exclusion can in the authoritarian regimes engage in the most unproductive
short term enable an acceleration of investment and growth, types of patronage to buy off regional groups, often at the
but in the longer term it almost invariably has a negative effect cost of huge resource wastage.
on the sustainability of growth and transformation. Political
institutions and the political settlement are therefore important The challenge is therefore to design institutions that achieve
determinants of the outcomes achieved. political inclusion across all relevant groups in that particular
society, with strategies of capability development discussed
A common mechanism through which political inclusion is earlier, which can convert a growing number of individuals into
achieved in many developing countries is to incorporate productive entrepreneurs.
political leaders from different ethnic groups, religious
identities, tribes, or castes within the broad “ruling coalition.”
This strategy, which can be broadly described as political 6 | Conclusions
patronage and clientelism, can achieve political stability
because it provides critical intermediaries in different groups Comparative historical evidence based on a more detailed
with access to resources, which they can then use to satisfy process analysis than is possible using econometrics alone
demands from their own clients, and so on, down the political shows that the institutions of good governance, such as
chain. This can undoubtedly create political stability relative broad-based property rights and a rule of law, emerge
to political institutions that do not allow all relevant groups gradually and in line with the social transformation of a society,
within a country a similar access to resources. rather than emerging first and then driving the social
transformation. These institutions are increasingly important
On the other hand, the institutions that enable this type of as societies become more developed and complex, and as a
inclusion can have very different effects on the sustainability of growing number of high-capability productive organizations
growth and transformation. If the patronage to regional or emerge that demand—and can pay for—the enforcement of
tribal leaders results in resource flows used unproductively, these institutions. Growth and social transformation also
the upshot can be very destabilizing in the longer term. depend critically on other transformational institutions and
Growing demands for redistribution are likely to emerge from governance strategies that maintain political stability, achieve
further groups that feel deprived, but the economy may not political inclusion, and assist in creating productive enterprises
be generating enough new resources through growth to meet through capability-development strategies.
these demands. If the political system keeps diverting
resources to emerging power brokers in different regions, Transformational institutions are not easy to develop and their
tribes, or ethnicities, this will eventually divert resources from shape and form vary across countries. This is because the
productive uses, while creating further dissatisfaction lower most appropriate political and economic institutions that can
down in society as people see their leaders getting rich maximize developmental success depend very closely on the
without delivering jobs and prosperity sustainably. distribution of political power in countries, their historically

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inherited political organizations, and the bases on which they higher rates of social transformation. We can then ask in the
are organized and on their initial economic conditions. The context of specific countries in Africa, what the design of
political and economic institutions that worked in East Asia these institutions and governance capabilities need to be to
are no guide to those that may work well in sustaining solve similar problems of property right transformation and
transformation in Africa. protection, capability development of emerging firms, and
political inclusion. Such an approach can help identify and
We can learn a lot, however, from East Asia or even more from develop transformational institutions and governance
South Asia to understand the types of problems that capabilities in countries that are going through their own
economic and political institutions need to solve to achieve processes of social transformation.

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DESIGN & LAYOUT AfDB PCER

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