Sunday, August 19, 2007

The Importance of Governance

Last week I wrote about the distinction between the goals of development (health, environment, culture, and human rights) and the means for achieving those goals (economy, education, governance). Based on what I've seen in Latin America as well as what I've read, the single most important means is governance.

It is almost impossible to achieve lasting change in a country with a bad government. There are the obvious reasons: bad governments plunder the economy and steal aid. But even worse there are the subtle reasons: bad governments create a climate in which individuals are hampered from taking action that will make their lives better. In a country with a good government however, there is little else that needs to be done. The economy will boom, wealth will increase, and educated people will be rewarded for their knowledge. We need look no further than Asia to see how quickly good government policies can bring people out of poverty.

Governments go bad in two ways. They are can be corrupt, and they can be incompetent.

Corrupt governments are mainly interested in enriching themselves and they are all too common in the developing world. In the worst cases, like the Sudan, the rulers simply take aid away from the intended recipients. In Zimbabwe for example, aid agencies are forced to buy local currency at outrageously inflated exchange rates from the central bank. As a result most of the money spent on aid in Zimbabwe ends up directly in the hands of that unspeakable monster Robert Mugabe.

I think we've seen enough of human nature over the last few centuries to safely say that most governments, including those in the western democracies, will be corrupt if given the chance. In Canada the ruling Liberal Party spent years enriching their cronies with advertising contracts. In the United States the Iraq war has created incredible wealth for those with the right connections. In China, the head of the food and medicine department was recently executed for bribery. In Mexico a typical road building contract involves a large kickback to the government.

The difference between countries that are seen as very corrupt and those that are not, is the degree to which those in power are held accountable. In Canada the Liberals were investigated by the RCMP and punished in the polls. In the United States numerous senators and government officials are currently under investigation for bribery and corruption. In Guatemala, there is silence. In Africa those that fight corruption sometimes have to flee the country. Fighting corruption requires three things: a free press that can shine a light on dirty activities, a strong democracy that allows people to replace governments that get too greedy, and a court system that can investigate the worst offenders.

The second problem facing a lot of countries is government incompetence. Most people, including many of those in government, have only the slightest understanding of how economies work and wealth is created. This means that well meaning governments can often create laws that have exactly the opposite effect of what they intend. Nowhere is this more apparent than with labor laws.

Labor laws are intended to protect people from exploitation, but laws that make it difficult to fire somebody also make it risky to hire somebody. Imagine that you owned a small business and you just got a big order and want to hire an assistant. In some countries you could hire that person and keep them as long as their was work. It would be a no-brainer because if there were no more big orders you could fire them and not go bankrupt. In other countries, when you hire that person you would not be able to get rid of them without an extremely lengthy and expensive severance process. In these countries it is often easier simply not hire somebody. The ease with which you can hire and fire people is called labor-market flexibility, and it has a tremendous impact on how easily jobs are created.

The best way to create wealth is to set up an environment where people can be rewarded for hard work and cleverness. This is what got the United States so rich and this is what is lifting a billion Asians out of poverty. It may not be glamorous work, but the work of creating legal systems and training judges is even more important than building hospitals and schools. Good governments will free people to solve their own problems and will open up a world of opportunities to provide effective aid.


Michael Gallagher said...

Nice overview - but you might point out that at present, the tools that assistance providers can use to "fight corruption" and "promote governmental competences" are weak. Instead of pounding the table to argue that such things are needed, why not start a discussion of how to do it better? I hope the answer will not be that this would require an investment in institutionalizing assistance.

Patrick said...

Labor Market flexibility provides benefits to corporations, and is necessary for the fluidity of the market. However, One should not overlook the negative consequences associated with labor market flexibility.
In comparison, unpredictability of expected future cash flows for a company increases its risk, and makes it more costly to acquire funds. The same applies to workers. Unpredictability in future wages makes consumption more risky, because of risk of future unemployment.
Unflexible labor markets can also have benefits (government jobs for instance). They have a counter-cyclical property; meaning in times of recession their wages are guaranteed. These people can stimulate demand and kick-start the economy.
Furthermore, their is a human element to economics. Flexible labor markets can be harmful to people. Studies show that financial problems are one of the top causes of divorce, and unhappiness. It is hard to be content with constant fear of unemployment.
I am not arguing for socialist employment (the other side of the pendulum has just as many problems); but, perhaps we should be a little more aware of the negative aspects of our beloved flexible labor market.