The news has been grim. The Deras in Punjab, Gujjars in Rajasthan, farmers in Nandigram and other groups across the country are up in arms. While these are political issues at stake, the impact on the economy can’t be ignored. Each disruption causes delays, hold-ups and wastages. These events erode investor confidence, and the claim that India is a rule-of-law society starts sounding hollow. Within the discipline of law and economics that looks at how property rights are protected and contracts enforced, these conditions are evidence of failing law and order. Avinash Dixit at Princeton is at the forefront of research in this area. Dixit, chairing a recent workshop on governance at the India Development Foundation, defined economic governance as processes that support economic activity by protecting property rights, enforcing contracts, and taking collective action to provide the required physical and organizational infrastructure.
The first question is: Does democracy impede economic growth? Should prosperity precede democracy or should democratic values be instilled first? What is the better option: A strong central power controlling all resources versus private players free to decide where to invest? Economic growth implies the efficient use of scarce resources. The debate on centrally planned and controlled versus efficient market allocation of resources continues. Economists have been looking at this closely. Ronald Coase had argued in his famous transaction cost analysis that society bears a cost when the government allocates resources. Governments have no way of knowing who will use resources most efficiently and, in most cases, allocate resources to inefficient players. Other economists have pointed to the “tragedy of the commons”, where the absence of clearly defined property rights leads to free rider problems and overexploitation of resources.
So, the question is whether markets should be left free to correct themselves or to have a stringent regulatory mechanism that ensures consumer welfare by controlling dominance and capture. Economic freedom, however, most people argue, is a pillar of economic growth. The moot point is whether economic freedom should be accompanied by political freedom.
Amartya Sen has long argued that it is indeed democracy that fosters economic growth. There are only a few counter examples such as Singapore and South Korea, that had impressive growth under authoritarian regimes. Various economists have explained how a strong property rights regime within free markets is the best way to guarantee efficient resource sharing. A political regime that interferes in the market can be steered in inefficient ways through the use of coercive power by a few constituents. But, critics argue, some people tend to capture resources and exploit the underprivileged. Governments, in such cases, are unable to implement rules and the market fails.
Botswana and India have seen spectacular economic growth within democratic frameworks. In Ethiopia, Sudan and even China, famine and hunger took hundreds of lives—their authoritarian regimes could do little.
Institutions of democracy, such as a free press, a vigilant Opposition and regular elections, ensure that the political economy is alert. Lobbies do exist, interest groups do try to steer the political economy, but with the interplay of all stakeholders, democracies throw up issues of common concern. Individuals, groups, classes, states—all participate in the policy process. Their interests guide them, but when they come together, the democratic framework ensures a stable outcome.
Yet, formal institutions are not enough. Through history, informal networks, long-term relationships, arbitration, social networks, authoritarian personalities and enforcement services have emerged even before formal, state-governed institutions did. This is the case in both developing and developed economies.
Sadly, case studies on this aspect of governance in India are rare. Land titles in rural areas are decided through social networks. Institutions that have digitized records and made them publicly available—the Bhoomi project, for example—have reinforced existing networks. The film industry, in the absence of the availability of institutional finance, has evolved its own indigenous mechanism of generating resources and protecting property rights. The stock exchange, before the days of regulation, made use of traditional and personal networks to ensure continuity.
However, such personal and non-formal networks have a flip side, too. There is a limit on the size of social networks. As businesses grow beyond these limits, the networks fail. Inefficiency comes about in enforcement systems that rule tightly over small-scale operations. Transaction costs in enforcement go up. Disputes that emerge cannot be personally handled by authority.
Economies in transition must quickly define the scope of governance and, through this understanding, shape their legal structures so they don’t collide with existing non-state institutions, or allow inefficient, powerful institutions to continue.
Amir Ullah Khan is with the India Development Foundation. Comments are welcome at email@example.com