Home / Opinion / Columns /  Durable and robust institutions are a must for long-run growth

Recently, there has been a spate of discussions on evolving a vision for India’s economy in 2047. The bulk of these have been attempts to project the size of the domestic economy and its relative position in the global economy, with less emphasis on means and methods to alter our economy’s growth path and propel it to a higher trajectory. While these empirical exercises have an important role of creating certain long-term goals, they rely heavily on assumptions and could miss out some non-tangible intricacies which impact long- run growth. As economic growth is a cumulative outcome, many factors contribute in shaping its size and character. An important ingredient is the role of institutions, discussions on which have been rather limited while forecasting India’s future growth.

Long-run economic growth is contingent on the capacity and durability of institutions that govern economic activity. The empirical evidence on this is ample. The most cited example is the role played by resilient institutions in Southeast Asian economies as they made their transition to economies capable of consistent high-growth. Cross- country evidence reveals that the ability to achieve big leaps in economic performance is contingent upon creating the necessary institutional frameworks, which together provide the preconditions for generating rapid growth over long periods.

What are institutions?: Nobel laureate Douglas North provides, perhaps, the most comprehensive definition. He defined them as follows: “Institutions are the rules of the game in a society, or, more formally, are the humanly devised constraints that shape human interaction." Institutions are established to reduce obstacles arising from imperfect and asymmetrical information. The obstacles that institutions are meant to overcome are described as transaction costs. North distinguished two kinds of constraints: formal and informal. Together, these constraints comprise what he called the “rules of the game". Viewed from this perspective, institutions essentially govern how an economy functions and shape long-run outcomes. The link between robust institutions and economic performance is through their ability to facilitate enhanced economic activity, reduction in frictions and bottlenecks, and extraction of economic performance. In their book Why Nations Fail, Daron Acemoglou and James Robinson argue that institutions are the most important determinants of economic performance and economies which have almost similar endowments can have different economic trajectories as a result of differently developed institutions. Analysis of the development of many emerging economies has highlighted their importance in escaping a poverty trap and preventing political instability.

Institutions do not function as discrete entities but as dynamic forces which are constantly shaping and are getting shaped by the environment in which they operate. Robust political institutions can go a long way in facilitating better economic performance, while well-functioning economic institutions have enormous social implications. This synergy of institutions must be carefully understood and implemented in institutional design. Long-run economic performance depends on generating institutional capacity as a result of efficient institutional design. It is in this context that the state has a very important role in designing institutions. The role of the state stems not only from its democratic legitimacy, but also as a social contract between a country and its citizens.

Institutions, however, tend to bear a degree of ‘path dependence’ and hence utmost care must be taken to create new institutions and reform existing ones. Path dependence implies that institutions have high levels of inertia to change and adapt and once an institution gets embedded in the system, it is difficult to change its trajectory. Institutional design hence must ensure that they have the right elements, which will go a long way in extracting economic benefits over the long run. Robust institutional designs also require a level of reflexivity in terms of their ability to change and adapt to exogenous shocks, given how the economy must frequently grapple with uncertainties. It is here that the durability of institutions becomes important.

A vision for India in 2047 must revolve around important elements of institution design. While the growth examples of other successful economies could be incorporated, we must ensure assimilation of the Indian economy’s unique aspects. Any such vision must also incorporate the economy’s federal realities, and hence must seek to achieve synergy between the Centre and states. Our challenges are two-fold. First is the need to create new institutions to address the issues of an economy undergoing rapid structural change. Second is the challenge of reforming and reinforcing existing institutions to minimize their path dependence, as they have to adapt to a changing environment. The first requires clarity on India’s long-term vision and the precise objectives to be accomplished. Expanding the size of the economy and increasing per-capita incomes, for example. Tackling the second challenge needs an approach of continuous cumulative actions, with information flowing to various stakeholders. This requires consultations and engagements with participating agents, who need to be convinced of the changes in the concerned institution. Addressing issues of resource mobilization and sharing are examples of areas that require continuous engagement with all stakeholders. The state’s role in addressing both the above challenges assumes significance as it has to shoulder the dual role of a facilitator and an overall governing agency.

For imagining India in 2047, the task ahead is to build and enhance institutional capacity which can create the necessary milieu for achieving higher growth over the long run. For this, recognition of the fact that economic growth over the long run is driven by how well the necessary institutions— social, political and economic—come together to facilitate economic activity is an imperative as much as an important starting point.

M. Suresh Babu & Mausam Kumar are, respectively, advisor to the Economic Advisory Council to the Prime Minister and professor of economics at IIT Madras; and researcher at the Economic Advisory Council to the Prime Minister.

These are the authors’ personal views.

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