How the financial crisis has killed the governance reform agenda

There was a time when economists believed that institutional reform--improving governance--was a key ingredient in improving living standards in the developing world.  "Good governance" is surely a good thing in its own right.  But a lot of recent academic and policy research has focused of late on its instrumental value for growth. 

The argument is simple and appealing. Rich countries are those characterized by democracy, rule of law, political competition, and low levels of corruption.  So poor countries have to emulate them in all these respects if they want to get rich too.

Oddly, some of the most vociferous advocates of this view have apparently given up on it in the aftermath of the financial crisis. Not consciously, perhaps.  But a repudiation is implicit in the arguments that they now make about the central role of governance failures in the current crisis in the U.S.   

Exhibit no. 1 is Simon Johnson, who as part of the famous AJR (Acemoglu-Johnson-Robinson) triumvirate, has done as much as anyone to cement the view that better institutions cause higher incomes.  In this view, the reason that the U.S. is richer than, say, Russia, is that the former is run by a democratic, accountable political authority that is not in the pockets of narrow interests.  The AJR story presumes that institutional quality is a very slow-moving attribute, with events lodged deep in history still exerting strong effects today.  Yet in his recent Atlantic piece, Johnson argues that U.S. economic policies have been captured by a (financial) oligarchy, in much the same way that business elites corrupt policy-making in much poorer countries such as Russia.  The U.S., it turns out, is not that different. 

Exhibit no.2 is Dani Kaufmann, who led the World Bank's work on governance and has done probably more than any other living soul to bring governance issues to the top of the policy agenda in the developing world.  In a recent lecture, he takes pretty much the same line as Johnson, arguing that the financial crisis in the U.S. was the by-product of capture and corruption: "If anybody thought that the governance and corruption challenge was a monopoly of the developing world ... that notion has been disposed of completely."  (I owe the reference to the Dani Kaufmann lecture to this very interesting paper by Bo Rothstein, a political scientist.) 

Now I am a fan of Simon's and Dani's work, and I count them both among my friends. They may well be right about their diagnosis of the origins of the crisis.  But an implication of their recent arguments is that we need to significantly downplay the role of improved governance as a causal mechanism for economic growth. 

After all, no-one can deny that the United States, for all its financial follies, is a rich country.  It turns out that it is possible to be corrupt in a fundamental way and still be rich.   

My own view is that there was never a strong theoretical or empirical argument for relying on governance reform, as conventionally understood, as an engine of higher growth.  The case for governance reform is that it is a good thing to do in and of itself.  But don't confuse it for a growth strategy.

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