Definitions

There are several definitions of institutions. Ranis (1989) says “institutions define how people inhabiting a certain land space and having command over given resources decide to organize themselves for economic activity.” Others see institutions as “a set of structures, lasting patterns of behaviors and relationships (roles) that are guided and supported by broad societal values, regulated by certain norms of conduct (rules) and made operational by organizations” (Dia, 1996). Masahiko Aoki (2001) proposes a game-theory view, whereby institutions can be categorized as players (the state, judicial courts, associations, and the like), as rules (laws and regulations), or as the equilibrium of the game. North (1991) defines institutions as the “humanly devised constraints that structure political, economic, and social interaction.” Institutions have also been defined to refer to “rules, enforcement mechanisms, and organizations” (World Bank, 2002).

Institutions can be formal or informal. Quite often, formal and informal institutions coexist, either in a mutually reinforcing or conflicting manner. Whereas formal institutions are relatively easy and quick to establish or to change, informal institutions are, on the contrary, relatively more difficult to establish and slower to change. Informal institutions can sometimes seriously undermine the effectiveness of formal institutions or even divert or derail their official objectives and functions. Some authors distinguish between institutional arrangements and institutional structure, with the former referring to behavior, norms, and rules. Also, dysfunctional institutions may persist over a long span; and even in the face of an institutional disequilibrium, institutional changes may not be easy to effect. For example, Bardham (2001) identifies two main obstacles to institutional reforms—first, the tenacity of vested interests and, second, the size of the collective action problem (free-rider and bargaining issues).

Ruttan and Hayami (1984) quite correctly warn that “the supply of major institutional innovations necessarily involves the mobilization of substantial political resources by political entrepreneurs and innovators. … The supply of institutional innovations depends critically on the power structure or balance among vested interests in a society.”

The Role of Institutions in Economic and Social Development

Few now question the critical role of institutions, institution building, and institutional reform in economic and social development. Beyond the controversies on the role of the state in the East Asian miracle, there is broad consensus that market-friendly institutions explain not only the growth and development performance of the East Asia region, but also the between-country growth differentials among the East Asian economies. By contrast, the suboptimal economic growth of African countries and, more important still, the economic and financial crises that rocked East Asia at the end of the 1990s (as well as the recent accounting scandals in corporate America) have been blamed on institutional inadequacies, shortcomings, or even sheer institutional deficit or vacuum.

As aptly summed up by Nsouli (2002), “There are three important and interrelated components that are essential to economic development: capacity building, governance, and economic reform. Capacity building—the development of skills and institutions—is critical to sustained economic growth. But acquired skills cannot be exploited fully and institutions cannot be implemented properly without well-functioning institutions.” In the same vein, even a market economy needs to be supported by nonmarket institutions in order to perform adequately (Rodrik, 1999). Yet not all institutions or institutional changes are conducive to economic growth and development. So, how to identify and bring about those institutions that promote, or at least are conducive to, economic growth and development? And how to change and reform those institutions that hinder development? In this context, a distinction is often made between the efficiency effects and the distributional consequences of institutions and institutional reforms.

By general consensus, the relevant development policy questions are no longer whether institutions matter, but which institutions are more efficient and effective for economic and social development, and how to build, reform, and nurture such institutions in a developing country context. In the process of economic reforms, Winiecki (1992) argues that “getting the institutions right is as critical as getting the prices right.” According to Lin and Nugent (1995), institutions and economic development interact in a two-way relationship whereby institutions can help accelerate the level and the rate of economic development, whereas the latter may also trigger institutional reforms. As Reynolds (1983) has it, after comparing the development of 40 least-developed countries over a 130-year span, “The single most important explanatory variable is political organization and the administrative competence of government.” Anne Krueger (1993) goes even further. She observes that “the adoption of the same economic policies in response to the same (economic) circumstances will have different consequences under a politically strong leadership of a government with a well-functioning bureaucracy capable of carrying out the wishes of the leadership than it will when a weak leadership of a coalition attempts to do the same things in circumstances when bureaucracies believe that they can generate support for opposition to those policies.”

The NEPAD initiative clearly assumes that Africa’s development will be based on market economies; so it is important to put in place those institutions that are most likely to support market-based development strategies. In this context, Rodrik (1999) proposes five broad categories: property rights, regulatory institutions, institutions for macroeconomic stabilization, institutions for social insurance, and institutions for conflict management.

Property rights. The establishment and enforcement of secure and stable property rights was a key factor behind the economic growth and development of Western countries. Property rights, including intellectual property rights, determine not only ownership, but perhaps more important, control over economic assets. They also determine circumstances under which private property rights can be curbed in the public interest.

A key concern is how to ensure that the state uses its power to enforce contracts and property rights but does not behave in a predatory or confiscatory manner toward the private owners of those rights (Bardham, 2001). Herein lies the philosophical underpinning of the minimalist state: that government is best that governs least.

Regulatory institutions. The need for strong regulatory institutions arises from recognizing the existence of market imperfections and market failures. Thus, institutions are needed to lower transaction costs and to mitigate the consequences of imperfect information. According to Rodrik (1999), “the freer the markets, the greater is the burden on the regulatory institutions,” and “market freedom requires regulatory vigilance.” A strong, efficient, and effective regulatory institutional framework is needed to regulate the conduct of business in goods, services, labor, and asset and financial markets. Effective rules and procedures must be enacted and enforced to promote competition and social responsibility in such critical areas as communications, consumer goods and services, and health, food, and environmental protection.

The effectiveness of regulatory institutions, including central banks, is largely a function of their degree of independence and professionalism. However, regulatory institutions can easily become sources of red tape and economic inefficiency. Moreover, they are vulnerable to principal-agent problems and are thus prone to corruption and collusion with the regulated businesses. Indeed, as Rodrik (1996) says, “Bureaucracies are prone to two problems that are fatal to economic performance: they can be captured by the interests they are supposed to regulate, and they can create extreme red tape discouraging economic activity.”

Institutions for macroeconomic policy and public management. Governments can seldom rely on the market to be self-stabilizing. Strong and effective public institutions must develop the capacity to design and implement fiscal and monetary policies that are predictable as well as market- and growth-friendly.

Although effective public administrations must manage taxation and expenditure, it is worth bearing in mind that most democratic constitutions give legislatures the power and authority to levy taxes and approve public expenditure. Also, the role of independent audit agencies can hardly be overstated in ensuring transparent and accountable revenue and expenditure management.

The public bureaucracy needs to develop an adequate institutional and human-resources capacity to effectively and efficiently design, deliver, and evaluate public programs and key social services. Although it is critical for the state to strengthen its capacity in such traditional areas as regulatory, administrative, and technical capacity, it must at the same time pay close attention to building new capabilities to meet the challenges of globalization, to foster citizen participation, and to address intergenerational equity issues underlining the search for sustainable development.

Institutions for social risk insurance. Rodrik argues that social insurance schemes perform a legitimizing function in support of a market economy. Relying solely on market forces can expose a country to large economic inequalities and unstable economic outcomes. Social insurance schemes thus contribute to social cohesion and stability. However, proper balance is needed between the redistributive and risk-mitigating functions of the social insurance schemes in order to prevent the latter from inhibiting market development and economic progress in general.

Institutions of conflict management and resolution. Life in a group requires social cooperation to foster mutually beneficial projects and activities. Societies must equip themselves with laws, rules, and regulations. These must be transparent and enforceable through effective, rule-bound enforcement agencies and an independent, clean, and fair judiciary. Also, countries need well-functioning, transparent, and representative systems for accessing and transmitting political power, as well as institutional avenues for expression available to groups and to individuals.

Current Status of Institutions and Institution-Building Efforts in Africa

In the immediate postindependence era, most institution-building efforts consisted of efforts to transplant Western-style institutions to newly independent African countries. To fill the vacuum of skills and trained professionals, governments relied on foreign technical assistance provided by bilateral and multilateral aid agencies, including long-term resident experts and overseas training and study tours. Yet as Lin and Nugent (1995) warned, “Mere transplantations of successful institutions from DCs [developed countries] to LDCs [less-developed countries] is no automatic guarantee of success.” As a matter of fact, as Dia (1996) has pointed out, these efforts resulted in an institutional disconnect between the state and civil society, between formal and informal institutions, and between corporate and societal cultures. Among the negative aspects of this disconnect are the privatization of state institutions; the shift of resources and functions to favor client networks; and the substitution of personal loyalty, patrimonial incentives, and management for achievement and merit-based incentive systems.

In many African countries, public institutions quickly turned into oversized patrimonial and predatory organs riddled with corruption, mismanagement, inefficiency, ineffectiveness, and rent-seeking behavior, all the more so since, regardless of ideological bent, the state had a tendency to be all-encompassing. To compound this situation, donor-driven and donor-funded projects further fragmented and weakened the state bureaucracy overall (Sako, 1996). Also, by emphasizing personnel retrenchment and payroll budget cuts at the expense of a comprehensive review of the missions and conditions for enhanced efficiency and effectiveness of the public bureaucracies, the first generations of public sector and civil service reforms failed to contribute to the improved effectiveness and enhanced legitimacy of the state.

The end result was—and largely remains—African states struggling to live up to the basic functions of capable statehood but with weak capacity to design, implement, and coordinate development policies. Typically, they are saddled with huge external (and, at times, internal) debt and debt-service burdens. As a result of the double process of economic liberalization and political democratization, the private sector, civil society, and decentralized entities have emerged as new institutional players. More often than not, they directly challenge the legitimacy of the state and its capacity to conduct development policy and regulate the market. Indeed, in critical sectors such as telecommunications, energy, and transport, the rhythm of privatization and economic liberalization has dangerously outpaced the capacity of the state to establish efficient, effective, and credible regulatory agencies. Moreover, in new areas such as the environment and consumer protection, the regulatory vacuum puts future generations at serious risk through health hazards and environmental depletion and degradation. Accelerated globalization and the intrusion of the revolution in information technology have caught many African states unprepared. Consequently, they are finding it difficult and painful to adjust to new systems, processes, and behaviors of political, economic, and social governance.

Despite the brain drain, the absolute supply and sectoral and disciplinary diversity of trained professionals has significantly increased. Nevertheless, a paradox of postindependence Africa is that this has not translated into equivalent increase in the capacity of the state to discharge its basic functions. Moreover, the advent of multiparty democracy in many countries has resulted in the marginalization and de facto sterilization of large numbers of professionals and managers who do not hold membership cards in the ruling majority. To make matters worse, to cut costs or attract nationals for overseas duty, many donors have lured top civil servants to local resident missions or donor-funded projects, thereby reducing the supply of competent staff available for public service assignments.

Although supply and demand factors may help to explain why donors can lure professionals away from the public sector (and accordingly, it can be argued that it is up to African governments to address incentive issues), the net effect is further weakening of public sector capacity by the same donor community that then laments the weaknesses of public administration in Africa. At the level of national economies, the matter is further compounded when donor countries offer incentive packages to African engineers, medical staff, computer specialists, researchers, and other professionals, fueling the brain drain. In either case, donor countries are reaping huge, unearned, and untaxed “windfall profits” stemming from positive externalities in an imperfect market of skilled African professionals.

In recent years, both the donor community and African countries have recognized the need to build endogenous institutions and human resources, and that key functions of macroeconomic management and development policy cannot be entrusted to long-term, resident, expatriate experts. Also, efforts to build endogenous capacity should benefit not only the public sector, but civil society and private sector organizations.

Economic and Corporate Governance

The Durban declaration recognizes that good economic and corporate governance values and practices contribute to economic growth and development through market efficiency and controlling wasteful spending, and through their positive impact on consolidating democracy and encouraging private financial inflows. It identifies the following priority set of norms, codes, and standards:

• A code of good practices on transparency in monetary and financial policies

• A code of good practices on fiscal transparency

• Best practices for budget transparency

• Guidelines for public debt management

• Principles of corporate governance (business ethics)

• International accounting standards

• International standards on auditing

• Core principles for effective banking supervision.

Among the key desirable economic and corporate values that should underpin the APRM, several are particularly important.

Sound macroeconomic and public financial management and accountability. Here the emphasis is on macroeconomic stability, budgetary discipline, fiscal transparency, equity, and efficiency in public revenue mobilization and public resource use.

Integrity of the monetary and financial sector. The declaration recognizes that monetary and financial transparency, independence of the central bank, and effective regulatory and supervisory institutions make for the integrity and transparency of the monetary and financial system.

Sound, effective, and reliable accounting and auditing systems. The declaration envisions the establishment of comprehensive, integrated, and reliable accounting systems, which would provide for, among other things, the independence of the supreme audit institution and the communication of reliable and objective reports to public authorities and the general public.

Effective corporate governance framework. Among the institutional arrangements intended to ensure transparency, accountability, efficiency, effectiveness, integrity, and fairness, the declaration emphasizes a legal framework protecting property rights as well as the rights and obligations of companies, their boards, managements, shareholders, and other stakeholders; and a regulatory framework for effective supervision and transparent financial disclosure.

The Overarching Importance of Political Governance

Although economic and corporate governance are obviously legitimate areas of concern for sustainable development and poverty reduction, they must be cast within the broader need to build strong and effective institutions of political governance. The declaration reflects this close linkage. Moreover, the African Peer Review Mechanism is grounded in an integrated approach to an integrated set of fundamental political, economic, and corporate governance values to which African countries are called upon to adhere to voluntarily, and to which governments are encouraged to strive to observe within their capacity capabilities. NEPAD posits the following key political governance values as a minimum.

Democratic constitutionalism. While recognizing that cross-country variances stemming from diverse cultural and historical contexts are inevitable, the NEPAD initiative considers that a democratic constitution will contain defining rights—fundamental civil and political rights, such as liberty and security, political participation, and democratic election to and transition from political power; freedom of assembly and association; equality before the law; and equal opportunity. Beyond this statement of conventional, if not universally acknowledged, political and civil rights and liberties, NEPAD suggests that where resources permit, constitutions in Africa should contain provisions pertaining to “economic democracy” or a “welfare state,” such as enhanced health care, education, and expansion of employment opportunities.

Fair and open democratic processes. Two institutions are seen as key building blocks of a fair and open democratic process, namely an independent electoral commission and a legal opposition. It is important, however, not to equate democracy with the simple fact of these two institutions. Democratic formalities, without concrete avenues of popular participation and with a large majority of illiterate urban and rural masses, can breed political corruption and political disenfranchisement by the majority of the electorate. Furthermore, a formalistically, democratic process does not necessarily guarantee a democratic outcome. Corrupt dictators and a greedy, predatory elite may gain access or cling to political power through a process that has all the visible trappings of a democratic process.

Independent judiciary. The rule of law, as well as the rights, liberties, and freedoms of the individual, require an independent, strong, and courageous judiciary that is protected from executive branch interference by the constitutional separation of powers. A key issue is the justification of the principle of nemo censetur ignorare legum (“no one is considered ignorant of the law”) when the majority of the citizenry is illiterate, written codes are not up to date or are insufficient, a readily available supply of and the access to defense lawyers is not universal, and the geographical reach of the formal judicial system is limited to the capital city and a few urban centers.

Free and independent media. A free, independent, and responsible media fosters transparency in the management of public affairs and public resources, keeping in check governmental excesses, corruption, and mismanagement; empowering people; and providing independent information. In many African countries, however, equal access of political groups and opinions to the official media remains unresolved. Given their legal status as civil servants, the staff of the official media are under pressure politically to apply more or less subtle forms of censorship and self-censorship to protect the “official line.” The private media are often dependent on powerful business and political interests, compromising their independence, professionalism, and potential to contribute to policy debate and give voice to citizens.

Civil society. The NEPAD initiative acknowledges the role and contribution of civil society in the democratic process and as a force for socioeconomic development and transparency, responsiveness, and accountability in the management of public affairs. However, NEPAD challenges African civil society to live up to the same high moral and political standards as those expected from governments.

African countries must develop institutional mechanisms to foster and nurture a spirit and practice of partnerships and constructive, mutual engagement between the state and civil society. These partnerships should recognize the state’s ultimate and legitimate privilege to decide matters in the national interest, whereas civil society expresses organized yet segmented interests of particular groups in the policy arena or in access to public services and donor resources.

Institutional capacity. The NEPAD initiative identifies capacity deficits—and implementation capacity deficits in particular—as a common factor explaining unsatisfactory governance across Africa. It calls, therefore, for capacity building as a key priority for sustainable development. At stake, first and foremost, is the capacity deficit of the public sector to design sound and responsive public policies and programs and to implement them in an efficient, effective, equitable, and transparent manner. Equitable access to public services remains a key issue where privileged social groups, most of which may be evading taxation, nonetheless enjoy preferential access to government resources.

As demonstrated in Southeast Asia, it is also important to insulate the public bureaucracy from political interference, especially in the context of nascent multiparty political systems. In particular, every effort should be made to shield economic management from the deleterious impact of political patronage and clientelism. Yet, as Dia (1996) observes, “Bureaucratic insulation can be a double-edged sword. Hence the crucial need for control mechanisms to nurture accountability, competence, and honesty and to prevent bureaucrats from becoming a law unto themselves.” Dia emphasizes competitive merit-based recruitment and promotion, competitive compensation packages, and security of tenure for high-level bureaucratic officials as means for preventing political intrusion in the management of state bureaucracy. The importance of developing, nurturing, motivating, and protecting a cadre of honest, competent, committed, and unselfish professionals can hardly be overstated if the best-designed institutions are not to become empty shells at best, or a huge drag on limited economic resources that undermines the state’s capacity and legitimacy.

A lingering question concerns whether the APRM provides NEPAD with an adequate, if any, enforcement mandate and the capacity to ensure that African countries live up to the norms and codes of behavior underpinning the Declaration on Political, Economic, and Corporate Governance.