Economic Development and the Limits of Institutionalism

There is a new recognition of the importance of institutions and institutional change in the process of economic development. The central insight of this new consensus is that markets do not just evolve on their own but that their development and effective functioning is dependent upon the existence of well structured institutions, including legal, financial, and banking systems. In short, it is institutions which matter in this new view, not just economic policies, and it is the state that plays an indispensable role in creating the right institutional environment for economic development and sustained economic growth.

Though the phrases “economic development” and “economic growth” are often used interchangeably in discussions of the problems facing less-developed countries, they actually refer to two distinct but related processes. ¹ All economies experience fluctuations in economic growth, but not all countries are economically developed. Economic development seems to refer to a process whereby an economy becomes larger, more complex, and more diverse. The concepts are related in that economic growth, despite short-term fluctuations in its rate, is much more sustainable in developed economies.

Distinguishing between economic development and economic growth is not just a matter of achieving conceptual clarity; rather, it is that the two processes might involve development agencies in different tasks. Assisting the development of a complex and diverse economy is not the same thing as stimulating economic growth, even though complex and diversified economies appear to experience more stable rates of growth. Separating the exact causal connections between economic growth and economic development is difficult, but the Post-War experience of many developing countries indicates that periods of economic growth do not lead automatically to economic development.

Indeed, economic development is a vastly more complicated process than economic growth. Despite the best efforts of countless historians, economists, sociologists, anthropologists and political scientists - as well as innumerable other development experts - we seem far from being able to adequately explain how and why countries become economically developed. As the decidedly mixed record of development assistance shows, this is far from an academic problem. Rather, it is a practitioner’s problem that has hampered the ability of international development agencies and governments to prescribe adequate solutions to the development problems which much of the world faces.

One of the most persistent ways of explaining the differences between developed and less developed economies has been to track certain key economic variables familiar from economic theory. This “economistic” view of economic development has had a number of manifestations, including much of the pioneering work in development economics. This work stressed, for example, the scarcity of capital in developing countries, as well as concern that developing countries “get the prices right” and allow markets to allocate resources free from government intervention. In other words, it was thought that the economic development of less-developed economies would result from changes in certain economic variables, such as the level of investment or the operation of market forces.

Accompanying these development strategies were attempts to increase the technical capacity of government agencies, particularly those involved in project implementation. This usually took the form of training, equipment, and technical assistance by outside consultants. Now, however, a consensus seems to be emerging within the development community - most notably the World Bank - that transcends the economistic understanding of the process of economic development and stresses the importance of a wider “macro-institutional” context. This change started in the second half of the 1980s, and accelerated in the early 1990s as it became clear that structural adjustment programs were not leading to sustained economic growth. As the problems facing the developing economies became clear, advances in economic theory and economic history pointed toward the vital importance of institutional change in the process of economic development.

This paper discusses the background out of which this new consensus - the new institutionalism - emerged and tries to show the extent to which it is an innovative step toward understanding the problems faced by less-developed countries. It also examines a number of practical problems that development agencies face in attempting to translate this new understanding of economic development into practice...