Every nation regardless of its level of development (or lack of it) has before it the urgent task of reforming its financial system and remedying deficiencies in its institutions.
By Piya Mahtaney
Part of the Globalization and Sustainable Economic Development series
Compare the process of reform in any country to the process of human evolution. The commonality is that both are unending. At various levels of development a country has to adapt and reorient its systems to newer sources of economic progress.
The distinguishing feature is that the kind of reforms a country needs to undertake in accordance with the prevalent socio-economic and political structures in each nation. The fundamental function of economic reform in every country is similar -- create or transform systems and sustain structures that will support higher levels of growth and development.
Institutional Framework And Investment Climate
Two important aspects of economic reform in any nation are the institutional framework and investment climate. The institutional framework consists of government agencies, financial institutions, business enterprises and civil society. According to a 2005 World Development report, a good investment climate is one that serves society as a whole though its impact on job creation, lower prices and broadening the tax base.
Economic reform will play an important role in steering the course of economic progress in the global economy by promoting a quicker pace of recovery for those nations most impacted by the crisis of 2008 and enabling the fastest growing nations of India and China to overcome present challenges.
For a further exploration of this point let’s recall some of the causes underlying the meltdown.
The Meltdown of 2008: A Crisis of Reform
When capital is scarce, it represents a constraint; however, when an abundance of finance capital is squandered, it represents a serious systemic flaw. This fact is epitomized by the financial crisis of 2008, which was an outcome of capital mismanagement and failure to reform the financial system.
When the Asian economic crisis occurred over a decade ago, it was a wake call not just for South East Asia but also for the global financial system. As is evident, the warning was not heeded and the consequence was an abundance of capital on one hand and a shortage of capital on the other.
Further, the proliferation of risky financial products was not matched by a corresponding increase in productive capacity or the creation of real assets, such as the expansion of infrastructure, skills development and employment creation.
It must be emphasized that reform entails much more than putting into place an effective regulatory framework because, even if a country has this in place, it does not take away the responsibility for being cautious and exercising regulatory authority in a non-discriminatory, objective manner and avoiding the unnecessary dilution of regulatory safeguards.
The crisis of 2008 arose also as a result of a non-enforcement of regulatory authority and negligible scrutiny where it was required the most. Institutions and incentives (policy and non-policy) were not aligned to the objectives of either sustaining higher levels of economic progress or achieving higher levels of competitiveness.
India: The Politics of Underdevelopment
Sound rationale and good intent can get sidetracked by the politics of underdevelopment, as it has in the Indian context. The inherent constraint confronting India does not stem from an inadequacy of financial capital because India has overcome situations that were more difficult than the current one it confronts.
For instance, the critical role that the Indian government played in the country’s development during the first 15 years after independence (1947) and the 1980s is undeniable. Both were phases during which the Indian economy had constraints more acute than it does now but governance was a vital facilitator of the positive outcomes that occurred thereafter.
China: Will it Manage Institutional Reform?
Contemporary China has witnessed an increase in incomes, educational attainment and a generation of young adults who have grown up at a time when liberalization was one of the most important aspects of China’s economic process.
Those living in cities experienced more of the changes of liberalization. Even so, residents of the far-flung regions of China today watch television, listen to the radio, read the local newspaper and know who Jackie Chan is even if they have never seen a movie of his. In fact, the imposition of controls on the access to information from certain quarters has not made a dent in the growing number of Internet users in China. Attempts to keep out the winds of change will not alter course of events, although they may temper its pace.
A Chinese Version of Democracy?
Changing the nature of intervention so that it becomes less draconian without becoming less effective is the lynch pin of sustainable economic progress in China. Unlike India, institutional reform is a more complex task in China because it requires putting into place a regulatory and institutional context that would be more compatible with the levels of progress that the nation has witnessed.
This fact resonates in almost every analysis about China.
Two factors will propel institutional reform in China -- the emergence of the private sector and various kinds of civil society organizations that barely existed in China a few years ago, and the prevalence of income disparities and rampant corruption.
The intersection between the two may not result in the establishment of what can be described as a conventional democratic political system but it will see the evolution of a much more liberal political system. If the nation could have its fusion of market based socialism, it is possible that it can also have its own variant of democracy.
Governance And Policy Can Trump Cronyism
It is seldom that one finds societies and nations that are without the collusion of vested interests or unaffected by the ills of cronyism (be it crony capitalism or any other).
However, effective governance and policy orientation decisively focused toward development can outweigh the forces of crony capitalism. If this were not the case, the nations of Far East and South East Asia would not have made the significant strides towards development that they have.
Next: Why the potential for innovation remains untapped in most developing nations.
Part III: The Building Blocks Of Sustainable Economic Development
Part II: The 'New Normal': What Will Lead The Next Phase of Globalization?
Part I: Searching for Sustainable Economic Development In Our Rush For Globalization