14353

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Aori;(I qq
PRO C E ED ING S OF T HE W OR L D B AN K ANN U AL CON FE RE NC E
ON DEVELOPM ENT ECO NO M I CS 1989

The Role of Institutions in Development

Brian Van Arkadie

Economists interpret "institutions" in at least two ways. Institutions can be the "rules
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of the game" (which provide the context-such as markets-in which actors make
decisions), or they can be organizations (typically, systems of nonmarket relations).
What is the role of public policy in influencing the rules of the game, and what is its
role in public sector economic organizations? Informal conventions and informal rules
of the game make institutions function differently than their formal structure might
lead us to expect. Governments can intervene and influence the rules of the game, but
their interventions should be based on an adequate perception of existing formal and
informal arrangements and on processes of adaptation that were under way before
intervention was initiated. The literature does not adequately explore the normative
arguments for public economic organizations, nor has there been enough rigorous
analysis of the causes of public sector failure. Many institutions are dysfunctional in
terms of development, however, not because they are inefficient but because their
intended purposes conflict with the requirements of economic growth. Diagnosing the
causes of good or bad performance by public organizations could provide the basis for
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exploring a rational public sector organizational strategy.

Which government institutions and institutional interventions seem essential

to growth, which can be helpful, and which are likely to obstruct growth? Such
questions cannot be answered definitively, and answers cannot be applied uni-
versally: the observed failure or success of an institution in one national setting
may reveal little about its potential performance elsewhere. But short of a check-
list of "good" and "bad" institutions, a good deal of light can be thrown on
what should be considered in appraising them. Strong institutional assumptions
are often implicit in the design of programs and projects. The logical and em-
pirical basis for such assumptions should be explored, even if the result is far
from a cook book of recipes for effective institutions.
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1. INSTITUTIONS:Two DEFINITIONS
Two different, although related, meanings are given to the term "institutions"
in discussions of development. The first is as rules of the game. The second is
as organizations.

Brian Van Arkadie is a professor of economics at the Universityof Dar es Salaam,Tanzania.

(©1990 The International Bank for Reconstructionand Development/ THE WORLD BANK.

153
154 The Role of Institutions

Rules of the Game

The general meaning that informs much of the academic discussion of insti-
tutions is captured by Ruttan and Hayami (1984):
Institutions are the rules of a society or of organizations that facilitate co-
ordination among people by helping them form expectations which each
person can reasonably hold in dealing with each other. They reflect the
conventions that have evolved in different societies regarding the behavior
of individuals and groups relative to their own behavior and the behavior
of others. In the area of economic relations they have a crucial role in
establishing expectations about the rights to use resources in economic
activities and about the partitioning of income streams resulting from eco-
nomic activity.
Similarly, Feeny (1988) quotes Douglas North (1981):
Institutions are a set of rules, compliance procedures, and moral and ethical
behavioral norms designed to constrain the behavior of individuals.
In this definition "institutions" encompass the fundamental rules of the game
within which the economic system operates. Economic historians have been
particularly concerned with the broad changes in these rules that accompanied
the emergence of modern capitalism-for example, the change in land tenure
systems, the decline of serfdom, and the emergence of "free" labor.
Such broad issues might seem to have little operational interest for contem-
porary policymakers. But in fact the institutional context determining access to
land, and relationships between farmers, landlords, workers, traders, and mon-
eylenders has been long recognized as critical for rural project design. And the
current fashionable concern with an "enabling environment" in which nongov-
ernment actors can contribute to development emphasizes the importance of
institutional factors in this sense (see Aga Khan Foundation 1987).
Organizations
Donor agencies tend to define institutions somewhat more narrowly, essen-
tially as synonyms for organizations-government departments, state enter-
prises, banks, armies, hospitals, and the like (seevan Rennin and Waisfisz 1988).
Discussions of "institutional development" and "institution building" are there-
fore typically concerned with how to make organizations work.
The difference between the concepts has some interest from an analytical as
well as a semantic point of view. Institutions in the "rules of the game" sense
provide the context in which markets operate-influencing both their efficiency
and distributive impact. Institutions define the terms under which the various
actors in the market confront each other, molding their expectations and defining
their rights. In this sense, economists should be very much at home with insti-
tutional questions, relating as they do to the central concern of neoclassical
economics: the operation of markets.
 Van Arkadie 155

The institution as organization is another matter. From the point of view of

an economist an organization can be usefully defined as an area of activity
within which the market does not coordinate the activities of the participants.
An organization may be externally constrained by market factors, but its internal
arrangements are coordinated by nonmarket instruments. Internal decision rules
and incentive systems may be chosen to simulate the market, but even then the
relationship between the actors is inherently different from that between inde-
pendent actors in the marketplace.
The principal strengths of neoclassical economics derive from propositions of
widespread applicability about markets. Not only is the underlying assumption
of maximizing behavior plausible, but also the pressures of competitive markets
force actors to perform in ways approximating such behavior as a condition for
survival.
The tools of neoclassical economics cannot, however, be readily used to ex-
plain behavior within organizations. Bureaucratic (or organization) man is not
different in inherent motivation or psychology, but the incentives and constraints
he faces differ from those facing the actor in the market. (Hence, Israel 1987
seeks a prescription for improving institutional performance by creating a "com-
petitive" institutional character.)
This being so, it is not surprising that early models used in the development
of the study of business administration were borrowed from engineering (Turn-
erism), the military (line and staff organizational structures), and the social
psychology of nonmarket behavior (Elton Mayo) rather than from economics,
and that subsequent explorations by economists took account of nonmaximizing
managerial behavior within the large firm.
The Influence of Informal Factors
In either definition of institutions there are both formal and informal char-
acteristics to be considered. Access to land, tenant-landlord arrangements, and
so on may be subject to legal provisions, but they may also incorporate informal
conventions and understandings either not incorporated in the law or even at
variance with formal legal provisions. And the behavior of organizations with
the same formal structure (chain of command, job descriptions, and so on) may
vary enormously depending on the informal environment.
Those of us who had the experience of working in the postcolonial twilight
know that the operational characteristics of systems changed often when the
formal structure did not because informal assumptions altered. Colonial civil
servants were bound together by an "old boy" network from "home," informally
exchanged information in the club, were little dependent on status in the local
society, and had no family responsibilities in the local community. The local
bureaucracy were connected by a different "old boy" network (although often
a copy of the metropolitan model), were able to exchange information informally
in a different social setting, were dependent on local society for status, and were
faced with a network of extended family obligations.
156 The Role of Institutions

Assumptions or expectations of behavior, in general currency but informally

based, influence organizational behavior. In a system with little or no corruption,
it will be equally difficult to ask for or to offer a bribe; in one where corruption
is the norm it becomes routine to ask for a bribe and impossible to conduct
business without offering one.
The influence of informal factors makes the transfer of organizational models
from one setting to another risky. A particular "success" may be based on a
successful congruence between the formal model and the informal setting, or it
may even result from particularly propitious informal circumstances actually
transcending inadequacies in the formal structure (for instance, charismatic lead-
ership sustaining a flawed organization).
The same formal model may mean very different things in different settings.
Cooperatives, for example, with a fairly standard legal constitution, perform
quite differently in terms of operational efficiency and distributional conse-
quences not only between countries but even within the same country.
This suggests that the design of programs on the basis of successful models
should be approached with caution, be it the Kenya Tea Development Authority,
the Grameen Bank, the Uganda Development Corporation (of the early
1960s)-all of which at one time or another have been proposed or used as
organizational models. This caveat is particularly relevant for itinerant advisers,
who may be well informed about "success stories" but not about the specific
origin of the observed success or the relevant informal characteristics of the
setting to which the model is to be transferred.
The absence of any single driving force (analogous to the market) determining
organizational behavior plus the impact of informal factors on formal structures
makes generalization difficult. It is therefore, as Nellis (1980, p. 413) notes, not
surprising that early efforts to create a general theory of development admin-
istration failed.
The best line of attack, therefore, is probably not to seek out a grand theory
of the role of institutions but to sort out the questions about that role relevant
to the design and implementation of development programs. This is done here
by first considering the general approach of economists to the role of institutions
(section II). A discussion of institutions in the two senses defined above follows,
with consideration of the rules of the game that influence and constrain the
behavior of the various actors in the economy (section III) and of the effectiveness
of government organizations (section IV). The discussion concludes with a com-
mentary on the political economy of government approaches to institutional
issues (section V).

II. SOME ECONOMIC INTERPRETATIONS OF INSTITUTIONS

Broadly, economists' questions about institutions cluster around four themes.

The first concerns the origins of institutions. How far can economists offer an
endogenous explanation of the origins of institutions? Explanation of origin may
 Van Arkadie 157

in turn relate to the identification of current function, although there is no

necessary connection. Institutions may in their actual operation serve purposes
quite different from those intended by their creators. Moreover, their role may
change in response to a changing environment.
Economic institutions as rules of the game can be seen as defining the terrain
over which economic actors maneuver. The second theme concerns how eco-
nomic actors behave in a particular institutional setting, and how their behavior,
as affected by that setting, determines the economic outcomes.
The third theme is normative. How does one evaluate the economic effec-
tiveness of institutions? A straightforward response would be to apply the normal
criteria of welfare economics. However, insofar as some institutions exist to
meet social objectives which transcend, or are separate from individual welfare
maximization, evaluation against individualist, utilitarian criteria is not uncon-
troversial.
The fourth theme relates to the practical concerns of policymaking. How can
institutions be changed to perform better according to chosen criteria of eval-
uation? Exploration of the first three issues-the origins of institutions, the
motivation and behavior of economic actors in the existing institutional setting,
and institutional effectiveness-provides a foundation on which to tackle the
fourth: institutional engineering.
The initial brief for this conference paper asked what light the various par-
adigms in economics throw on the role of institutions in development. An ad-
equate answer to that question would demand a long essay on the history of
ideas outside the competence of this author, but there is room to locate the
issues in the context of at least some economists' ideas. Because, in a Kuhnian
sense (Kuhn 1970), most of the literature usually identified in the World Bank
milieu as "economics" falls within the neoclassical paradigm, approaches from
within that paradigm are emphasized.
The issue of "institutions" was raised by the U.S. institutionalists, following
an earlier tradition of the German historical school, arguing that propositions
of economic theory (that is, of mainstream neoclassical economics) were highly
relative and were based upon unstated institutional assumptions much less uni-
versal than implied by the theorizing. "Institutionalism" therefore challenged
economic theory in its dominant form.

The Neoclassical Positions

In contrast to the institutionalist view, the "purist" defense of neoclassical
economics, set out in great clarity over fifty years ago by Lionel Robbins (1931),
defined economics as the study of the interrelation between means and ends
through theories of choice of general applicability-potentially useful in ex-
ploring economic decisionmaking in all institutional settings. Within that vision,
the concept of "institutions" can be applied to aspects of human organization
that may be accepted as important but are not the subject of economic analysis
as such. Like technology, tastes, or resource endowments, they were seen as
158 The Role of Institutions

exogenous to the economic model-data that influence parameters, constraints,

or the definition of a social welfare function without themselves being a subject
of study by the economist.
No economist would have claimed that political institutions or social attitudes
are unimportant; the argument was rather that in the intellectual division of
labor they were not the appropriate subject of study for the economist. The
approach might be seen either as modest in the limited scope it claims for
economics, or arrogant in its view of "economic analysis" as being sufficient to
handle the "hard" issues.
There continues to be a great deal of work-even some practical analysis of
policy and projects-within that "purist" tradition,' but neoclassical economics
has also vigorously developed beyond the overly restrictive boundaries envisaged
by Robbins, through what Jack Hirshleifer (1985) has described as "imperialist
economics" (an unintended double entendre in this context).
The rational choice approach has thrust neoclassical economics in the direction
of issues once considered noneconomic. Thus Hirshleifer quotes Gary Becker
(1976):
The combined assumptions of maximizing behavior, market equilibrium
and stable preferences, used relentlessly and unflinchingly, form the heart
of the economic approach
and goes on to add:
It is this approach that has powered the imperialist expansion of economics
into the traditional domains of sociology, political science, anthropology,
law and social biology-with more to come.
This approach has both a positive and a normative element. Positively, it
attempts to explain the behavior of a wide range of institutions in terms of the
maximizing pursuit of self-interest by the actors in those institutional settings.
Normatively, in light of such behavior, institutional performance is evaluated
against the individualistic and utilitarian objectives that underpin neoclassical
welfare economics.
In the development literature, the rational choice approach has informed the
discussion of rent seeking in general and the analysis of state agricultural mar-
keting in particular, and it has been extended to the analysis of household
behavior, and so on.
Although its adherents are often drawn from the other end of the political
spectrum, rational choice explanations of political and social behavior share
many of the strengths and weaknesses of Marxist analysis. In particular, the
attempt to endogenize institutional factors through explanations based on a

1. An important part of the thrust of Gunnar Myrdal's critique of the work of economistsin Asia was
concerned with economists' neglect of institutional questions. It is not difficult to find work equally
subject to that earlier criticism.
 Van Arkadie 159

strong element of economic determinism are shared characteristics of rational

choice and Marxist analysis.
At its best, this sort of analysis provides powerful insights into the ways
economic actors pursue their interests both through the market and through
nonmarket institutions, and how this in turn affects the institutional context in
which markets operate. It may, however, claim too much, taking too little
account of factors other than the pursuit of economic self-interest that determine
political and social behavior.
Another contribution within the neoclassical tradition is the market-failure-
transactions-cost approach, which sees the existence and behavior of a number
of economic institutions as resulting not from the effective operation of markets
but from market failures that require nonmarket institutions (and sometimes
nonmaximizing behavior) for their resolution. (On this point, see the discussion
of institutions below and Bardhan 1988.)
This approach was developed in the context of the theory of the firm, following
R. H. Coase, and has been used to explore such issues as vertical integration
and antitrust policy in the context of the U.S. economy (see Williamson 1985,
1986). It has also provided the intellectual underpinnings for a burst of recent
literature on rural institutions.
Some economists faced with institutional questions have called on other dis-
ciplines for a joint attack on the problem. In some heroic cases, the economist
has taken on the task of acquiring the skills of those other professions (see, for
instance, Hill 1986). Whether, in practice, multidisciplinary work has typically
meant cross-fertilization or cross-sterilization of ideas can be debated. But it
would take a very robust imperialist of economics to believe that the economist's
tools are uniquely appropriate for analyzing all important development insti-
tutions.
Structuralist and Marxist Challenges
In the development debate, the earlier institutionalist criticisms of neoclassical
economics were echoed in the structuralist2 critique. Two observations were par-
ticularly influential: (1) that "Western" economics had many implicit assump-
tions regarding institutions, among other things, that undermined its applica-
bility to economies in the developing world; and (2) that insofar as certain
institutional factors constrained the effectiveness of policies, such rigidities had
to be either incorporated into the analysis of policy or tackled by political or
social reform.
Some aspects of the structural approach have similarities with, or even roots
in, Keynesian economics. The structuralist differs from the strict neoclassicist in

2. This imprecisedesignation covers an enormous potential range of literature.Meier identifies Lewis,

Myrdal, Prebisch, Singer,and Rosenstein-Rodan-six of the ten authors covered in Pioneers in Devel-
opment (Meier and Seers 1984) as "introducing elements of structural analysis into their work." See
also Furtado (1964) and Seers (1963).
160 The Role of Institutions

regarding what the latter sees as transitory "market distortions" as fundamental

characteristics of the system, for which neoclassical solutions are impracticable,
at least in the absence of profound structural change (for a neoclassicist's view,
see Little 1982).
Structuralists have been concerned with the persistence of archaic rural in-
stitutions (for instance, in the Latin American literature of the 1960s a backward
rural institutional structure was seen to inhibit response to price incentives and
thus contribute to inflation), which suggests the need for active land reform;
with skewed distribution of wealth, which requires active redistributive policies;
and with weak entrepreneurial institutions, which justify strong state interven-
tion and protectionism.
Central to the structuralist policy agenda was the need for deep-seated insti-
tutional reform. The reforms in question demanded explicit examination of the
political conditions in which they would be implemented. But when conducted,
such analyses often revealed a pessimistic outlook for the reform agenda. (See
de Janvry 1981, p. 146, for a succinct criticism of the structuralist thesis on
agricultural stagnation in Latin America.)
Evidently the term "structuralist" as used here covers a wide range of ideas,
united more by a common deviation from tenets of neoclassical economics than
by a shared theoretical approach. In such terms, much early development eco-
nomics (say 1945-65) could be described as structuralist (see Meier and Seers
1984). Since the mid-1960s there has been a revival and consolidation of a
neoclassical approach to the subject (see Little 1982).
The other main challenge to the neoclassical paradigm is from Marxist analy-
sis. Its strength lies precisely in its holistic ambitions, which have never allowed
it to accept the boundaries traditionally defined for neoclassical economics.
Four strands of Marxist thought throw light on the question: 3 (1) the emphasis
on the historical setting and the historical process of change; (2) the exploration
of the interaction between institutions (superstructure), economic forces (forces
of production), and social relations (the relations of production); (3) the focus
on class interests and class struggles (rather than individual interest and welfare
maximization through exchange); and (4) explicit consideration of the role of
ideology.
Yet there is no more unanimity in the Marxist than in the neoclassical par-
adigm on any of the basic issues facing development economists. Thus Marxism,
as much as neoclassicism, can inform both an activist and a deeply skeptical
view of the potential role of the state in the reality of the developing world (see
Baran 1957). In this regard, the neoconservative critique of the rent-seeking
bureaucracy resembles that of Marxists who emphasize the corruption of the

3. The quick characterization of paradigms demanded by limits of space runs the obvious risk of
vulgarization. The only way to do justice to each of the paradigms is to illustrate their use in tackling
the problems discussed here: for instance, de Janvry's (1981) study of the agrarian questions in Latin
America demonstrates the sensitive use of Marxist concepts.
 Van Arkadie 161

neocolonial state: the pessimism of both is based on an economically determined

explanation of political behavior, although for one the mainspring is individual
or pressure group interest, and for the other the pursuit of class interest and the
international context.

III. GOVERNMENT, INSTITUTIONS, AND THE MARKET

It is by now generally accepted that a critical task of government, neglected

in earlier models of economic planning, is to provide the "right" incentives to
stimulate and guide the various actors in the economy-though views may differ
as to what the right incentives are. A corollary to this view is that development
policy must focus on the institutional arrangements that provide the setting in
which the incentive system will operate.
Rules of the game which stand out as susceptible to government influence
include: (1) rules defining private property rights and their allocation; (2) other
rules and conventions governing the relationships between participants in the
economic process (for example, those affecting the operation of the labor
market); (3) rules and conventions defining the economic role of a hierarchy of
social institutions (for example, local governments, trade unions, cooperatives
and peasant associations, and churches); and (4) rules and conventions restricting
participation in the economic process.
Potential government influence on the rules of the game is illustrated by
reference to three important areas: property rights and rural development, in-
stitutional pluralism in decisionmaking, and the promotion of entrepreneurship.
Property Rights and Rural Development
Property rights (land rights and their interrelations with other institutional
arrangements) have figured prominently in the discussions of agricultural de-
velopment (Bardhan 1988). Changes in rural property rights, encompassing such
issues as the decline (or survival) of serfdom and the enclosure of common land,
have been central concerns for the historian, whether the neoclassicist exploring
responses to changing economic opportunities and factor scarcities or the Marx-
ist for whom relations of production in the rural sector are seen as defining the
mode of production. Two questions particularly intrigue economists: (1) Why
do differing property rights emerge to provide the framework within which
economic decisions are made in rural areas? (2) What are the relative merits of
alternative systems on both efficiency and distributive grounds?
One view is that, on the one hand, economic development has meant the
displacement of one set of rural property rights by others more adapted to the
emerging economic requirements, whereas, on the other hand, existing arrange-
ments can and should be improved both in efficiency and distribution. This view
has fueled the argument for rural institutional (land) reform. In reaction, the
rationale of existing institutions has been explored to question whether they are
as atavistic, inefficient, and disequalizing, as the reform agenda implies.
162 The Role of Institutions

Property rights determining access to land are part of a complex of institutional

arrangements providing the context for rural economic activity. These include
institutional arrangements determining labor contracts and access to land, credit,
and commodity markets; that is, the set of rules and conventions that define
the relations between the various actors in the rural economy. A critical analytical
concern is with the interlinkages between markets. Thus neoclassical economists
have explored such institutions as sharecropping as part of a more general
attempt to understand the role of property rights in light of transactions costs,
or alternatively under conditions of imperfect information in interlinked factor
markets. For the Marxists, the critical characteristic of the changing labor mar-
ket, the emergence of "free" labor, is related in turn to changes in access to land
and the expansion of commodity production.
There is a body of empirical literature which provides useful insights into the
effectiveness of rural institutions. But the neoclassical theoretical literature has
recently become so complex that it yields little policy guidance for the applied
economist, other than that existing institutional arrangements are likely to be a
good deal more complex, and their efficiency and distributional implications
less straightforward, than at first sight.
It is particularly tricky to establish the actual status of rural institutions (see
Feder and Noronha 1987). The concept of property rights in land is far from
clear cut: often the requirements of rural economic activity lead to the useful
development of a range of differing property rights relating to differing attributes
of land; de facto practice may vary greatly from the de jure system; and the
national system of statutory laws may coexist with local law and customs. The
likely impact of statutory reform is therefore particularly hard to predict, since
it is both difficult to delineate the existing structure to be replaced and even
harder to forecast the de facto outcome of de jure proposals.
Thus while there has been a widespread presumption that a movement toward
securely held registered title is economically desirable, recognition of the prob-
lems involved has been slower to emerge. For example, conferring land tenure
rights on sedentary agriculturalists (already apparent occupants) may disrupt a
system of pastoral seminomadism, based on rights of passage and of dry season
grazing, which represented a sophisticated response to a particular ecological
problem. Likewise, the allocation of land rights to an individual may misinterpret
and disrupt arrangements within the family (displacing the rights of women, for
example).
Views on what the best institutional structure may be for fostering growth
vary and change; indeed, research on rural institutions seems to be widening
the range of debate, as institutions earlier seen as barriers to progress are re-
habilitated in light of a more sophisticated interpretation of their function.
Theories of endogenous institutional change, which argue that the institutions
that provide the framework for the market tend to adapt themselves to changing
market conditions, such as changing factor scarcity and relative factor produc-
tivity, suggest that informal institutional arrangements are likely to adjust to
 Van Arkadie 163

new conditions even without official sanction. This suggests that one official
task should be to adjust formal rules to accommodate changes under way so as
to improve the certainty of transactions by making them official. But there are
dangers: formalizing informal arrangements-for instance, through land regis-
tration-will have its own effects, by shifting the access of different economic
actors to the formal system-for instance, through land grabbing.
Institutional Pluralism
The rules of the game, besides defining property rights and acceptable con-
tractual relationships, also define how and by whom the rules themselves are
made. A recent collection of essays on institutional analysis and development
(Ostrum, Feeny, and Picht 1988) argues that the institutional choice should be
presented not as a dichotomy of state or market but as a pluralism of possible
contractual relationships, both explicit and implicit. To quote (p. 456):
Systems of governance can be constituted by conceptually simple but so-
cially complex configurations of implicit or explicit contractual relation-
ships. There is no theoretical reason why there must be a single centre that
has exclusive authority to formulate and enforce rules in a society.
The volume is in the tradition of U.S. pluralism, favoring a diversity of social
institutions as the desirable base for a democratic order, with a place for ini-
tiatives from many levels of society and not providing central government with
undue concentration of power. Systems of decentralized decisionmaking and
control might bring to bear user pressures as stimuli to performance not possible
in a centralized bureaucracy.
Skepticism about the concentration of power in centralized institutions is not
confined to neoconservatives: on the left, popular participation, workers' and
peasants' movements, and other forms of grass-roots mobilization are seen both
as virtues in themselves and as mechanisms to make institutions responsive to
local conditions and needs.
Of course, while decentralized institutions may be more susceptible to local
participation and control, by the same token they may be captive to the local
structure of power. The drawbacks of centralized power-insensitivity to local
needs and ignorance of local capacities-have their counterparts in the skewed
access that can arise from local systems of power and prejudice.
The Promotion of Entrepreneurship
Another area to explore is the possible impact of government molding of the
rules of the game on entrepreneurial initiatives. While not all would share the
Schumpeterian view that entrepreneurship is central to capitalist development,
entrepreneurial capacity is clearly important, and particular development suc-
cesses seem to be associated with a concentration of entrepreneurial flair or
capitalist "animal spirits."
Given their pivotal role in capitalism, entrepreneurship and entrepreneurial
164 The Role of Institutions

institutions would be expected to be central in neoclassical treatments of de-

velopment. Yet entrepreneurship has found a more prominent place in the work
of economic and business historians (see, for example, Iliffe 1983) than in the
neoclassical theoretical tradition. This lack leaves at least some free market
advocacy with a strange lacuna: the market sets the stage for successful private
initiatives, but it is unclear from where the cast of characters is to be supplied.
The lack of an endogenous economic theory of entrepreneurship has made
this an area in which economists have often been willing to traverse the mul-
tidisciplinary route. And in practice folk wisdom, which identifies particular
social groups as being "entrepreneurial" in culture, is often influential. But folk
characterization, and even learned identification of entrepreneurial groups, tends
to be based on ex post recognition of performance. Stereotypes change very fast
with changes in performance (see, for instance, Elkan's (1988) contrast of Taw-
ney's negative characterization of Chinese entrepreneurship in 1932 with current
perceptions). What is lacking is a good predictive model of entrepreneurial
capacity to bring out ways of enhancing entrepreneurship through policy meas-
ures.
Theories that emphasize deep-seated psychological or cultural characteristics
(see, for instance, McClelland 1961) do not seem particularly relevant for policy,
as these variables are unlikely to be subject to policy influence over any useful
time horizon (though McClelland's psychological interpretation of entrepreneur-
ial capacity was incorporated in business training in India and elsewhere).
Are there specific ways in which government can influence the institutional
context of entrepreneurship (other than the obvious panoply of economic policies
and commercial laws that determine the broad incentives and constraints)? Elkan
(1988) broadly concludes that there is none: the best policy is laissez-faire.
An acceptable role for private entrepreneurs is defined both by formal rules
and informal signals. Here, not only the stated intentions of governments but
the outcomes expected by the entrepreneurs are important. One interesting his-
torical insight relates to the entrepreneurial role played by cultural, ethnic, or
religious minorities, whose entry into certain entrepreneurial areas may be re-
stricted but who, by the same token, in being politically excluded from easier
avenues of advancement, are sometimes stimulated into a risk-taking innovative
role.4
These considerations could lead to a bizarre (dialectical) conclusion about the
virtues of discriminating against potentially entrepreneurial groups. More seri-
ously, it would be interesting to know what conditions would be conducive to
a nice balance in which a minority, pushed into entrepreneurship, is nevertheless

4. The East African Asians, for example, have had repeated experience as a minority community, first
under British colonial rule, then in independent Africa, and now in Britain and North America, and have
shown a high degree of entrepreneurial ingenuity in all three situations. At the same time, of course, the
culture of a minority group may be more or less consistent with taking on a successful entrepreneurial
role.
 Van Arkadie 165

sufficiently accepted to be allowed to play the part effectively, and secure enough
to take a long view of investment opportunities-as against a common situation
of insecurity in which suspicion engenders precisely the short-term, capital-
exporting behavior that reinforces the initial suspicion.
The view that entrepreneurship is likely to appear when other avenues of
advance are blocked relates to two other observations. The first is that entre-
preneurship often seems not to be highly correlated with formal educational
achievement, in part because the able but uneducated are excluded from more
secure avenues of social advance. Second, crises that erode bureaucratic incomes
and frustrate the expectations of the educated elite may call forth considerable
entrepreneurial response. This seems to be the case in the recent experience of
a number of African countries.
Strangely, Marxist and related literature has tackled the long-term institutional
issue of capitalist development more explicitly than neoclassical writing. The
main thrust of the Marxist (and dependency) literature is to see the development
of national capital and multinational enterprise as essentially antagonistic-with
indigenous capital trapped in a stunted, essentially comprador role (see Baran
1957). In some Marxist writing this comprador role is extended to the state
sector (Shivji 1973). But the opposite view has also been expressed in the Marxist
literature (see Warren 1980; Sender and Smith 1986). It has been suggested, for
example, that multinational business supported indigenous capital in the colonial
period (as compared to settler colonialism; see Cowen 1979).
The propositions of neoclassical economics are most strongly developed in
relation to the virtues of liberal international commodity markets. While no
doubt for most neoclassical economists, the commitment to freely operating
markets would extend to capital markets, there are different issues involved from
those related to free trade in commodities. Albert Hirschman (1969) made the
interesting point that quite different issues are at stake when a country specializes
in the supply of one factor of production, labor, than when it specializes in
producing a particular commodity.
The assumption implicit in much pro-free-market analysis is that there is a
potentially complementary and supportive relation between multinational busi-
ness and indigenous private enterprises, while in contrast the relation between
state and private enterprise is likely to be competitive and antagonistic. Hence
an institutional choice must be made between state and private enterprise.
Such a view is not, however, necessarily consistent with rent-seeking inter-
pretations of political processes, which could equally well suggest that public
corporations are likely to be responsive to private interests either bringing pres-
sure through the political or administrative process, or engaging in commercial
manipulation to gain access to potential rents. A large scale public sector, even
if conceived in the context of a transition to socialism, can as well provide one
path toward capitalism, depending on the role of the state system vis-a-vis
incipient national capital.
166 The Role of Institutions

IV. GOVERNMENT ECONOMIC ORGANIZATIONS

The discussion in World Development Report 1983 (World Bank 1983) on

"Management in Development" described the role of the state as follows:

Some economic activities are universally recognized as the sole responsi-

bility of the state; others, it is widely agreed, are best left to private initiative.
Between these extremes governments have tended to expand their sphere
of activity for a variety of reasons.

This statement implies some consensus about the state role in a considerable
range of activities. Such consensus may exist from time to time, and in particular
countries, but it often changes when big political shifts occur. In Britain, for
example, there have been two major shifts since World War II.
Even activities on most "commonsense" lists of state responsibilities may in
practice be far from universal state monopolies. Cases in point are police services,
supplemented in many countries by booming private security services, and postal
services, virtually displaced in some lines of business by private courier services.
On the other hand, international experience yields examples of government
involvement in virtually all areas of economic activity.
The origins of public economic organizations are extraordinarily diverse. Some
spring from a systematic initiative to extend state influence; some emerge to
handle problems of private bankruptcy, or as vehicles for political patronage;
and aid donors themselves sometimes generate new institutions as a conduit for
external funding. Many have probably been created for conventional reasons-in
the colonial period, for example, reflecting metropolitan practice as much as
local requirements or local interests. And perhaps as important as their origin
is the tenacity with which public institutions, once created, defend their own
survival (on this topic, see Bernard Schaffer, quoted in Lamb 1985).
Thus there is a wide diversity of government economic organizations. Among
the reasons for this diversity are political factors, both ideological and, more
prosaically, those that respond to the day-to-day needs of the political system.
It is surely a mistake to avoid recognizing this openly, by presenting the issue
as largely technocratic-particularly since shifts in the international climate of
opinion on this issue reflect shifting political winds in the industrial countries.
Nevertheless, the question of the appropriate form and role for government
economic organizations cannot be sidestepped as simply political. Good or bad
performance by government organizations is critical to growth, and particularly
important for aid donors, because these organizations are the preponderant
channel for aid. Despite the difficulties, the task of improving the performance
of public economic organizations must be confronted.
The messy array of issues is tackled here by addressing three sets of questions:
(1) What are the arguments for the existence of public economic organizations?
(2) How should aid donors relate to institutional performance? (3) What are
the factors that influence performance?
 Van Arkadie 167

Arguments for Public Economic Organization

The most widely accepted role for public economic organizations is that of
supplying goods-such as road services, public health, and agricultural exten-
sion-that the market cannot supply efficiently (because of externalities, the
"free rider" problem, natural monopoly, and the like).
A second function, argued for specifically in relation to development, is for
government enterprise to supplement an inadequate supply of private entrepre-
neurship: to demonstrate the viability of an activity so as to encourage involve-
ment by nongovernment actors. Government enterprise here is seen as necessary
to reduce the risk, lower the cost, and increase the profitability of private ventures
in the context of economic backwardness.
A third view sees government organizations as an instrument for the transfer
of surplus-in effect to tax or subsidize (for example, through agricultural mnar-
keting boards or state cigarette, match, and liquor monopolies). Here the jus-
tification may be administrative-that without the involvement of government
organizations, the tax system would be inadequate to achieve the desired result.
More cynically, it is easier to tax agriculture under the guise of providing a
service, or stabilizing prices, than through overt levies.
A fourth function of public sector economic institutions is to further some
policy intended to affect patterns of property holding in a society-either to
encourage a general commitment to social ownership or to shift the balance of
property ownership between different national or ethnic groups.
There are also regional arguments for public economic institutions, in the two
different senses of promoting the development of backward regions or promoting
cooperation between different nation-states in a regional grouping.
Other arguments could be listed, but these five encompass the main economic
justifications for government economic organizations, and as such provide a
basis for judging what is to be done about the complex array of them that exist.
Where there is a need that cannot be met by the market, the task of achieving
efficient nonmarket economic management solutions must be confronted. That
the state should undertake an activity does not guarantee that it will be able to
do so effectively.
Where the objective is to change the balance of property ownership or the
distribution of income, different lines of reasoning are possible. One possibility
is that public economic organizations be subject to the market, along the lines
of the Lange-Lerner model of market socialism: public managers having to
respond to the market on the same terms as private managers, the public interest
being that of a shareholder, and any deviation from a "pure" market solution
being handled by explicit public subsidies or taxes.
Alternatively, the option of government intervention to achieve the intended
result without the existence of a public economic organization could be ex-
plored-taxing, subsidizing, licensing, private ventures-or where the objective
is wealth redistribution a once-and-for-all reallocation among private economic
actors might be seen as an alternative (as in some land reforms).
168 The Role of Institutions

Donors and Institutional Performance

Some governments command public economic organizations capable of im-
plementing the government's intentions, others not. Bureaucracy may be rea-
sonably effective in one ministry, parastatal, or sector, and quite ineffective in
others. Why? And what determined changes in performance over time? For an
institution such as the World Bank, acting as it does primarily through govern-
ment institutions, appropriate answers to these questions are crucial, and errors
of judgment in assessing administrative capacity are probably as important a
cause of project failure as mistakes of economic calculus or technical design.
Israel (1987), analyzing the evidence on institutional performance from the
World Bank's own project experience, found that institutional performance
varied more across sectors and activities than among countries. He summarized
the record as follows (p. 4):
The most successful were found in industry, telecommunications, utilities
and finance; the least successful in agriculture, education and services.
Within institutions, technical and financial activities fared the best, while
maintenance, personnel issues, and co-ordination were the least successful.
The study recounts the piecemeal explanations of differential performance
found in the Bank's own operational evaluations and, finding them wanting,
identifies two factors which he argues are decisive in explaining institutional
performance in practice: "specificity" and "competition." Specificity is defined
in terms of concreteness of objectives, means, and rewards, and the immediacy
and transparency of the effects of an activity. Competition covers the influences
that impel an organization to improve its performance. These are seen as in-
cluding market pressure but also encompassing pressure from clients, benefici-
aries, or suppliers, from the political and bureaucratic establishment, and from
internal managerial measures to stimulate a competitive atmosphere within an
organization.
Israel uses the empirical record of Bank projects to draw some plausible
conclusions about ways to improve the performance of most institutions. But
there are problems with using this evidence to judge the appropriateness of
public institutions.
The first is that the evidence seems to suggest that institutions that work best
more or less approximate to a modern industrial plant. Thus plantation projects
in the Bank portfolio have worked better in Africa than projects that support
smallholder agriculture.
Unfortunately, this does not tell us whether plantations or smallholder agri-
culture are the more reasonable vehicle for agricultural development in Africa.
Smallholder agriculture might be (and, indeed, I believe is) superior on both
efficiency and distributional grounds, although it does not respond readily to
direct public institutional interventions. The fact that "modern institutions" have
the characteristics of specificity and competitiveness does not mean that the best
 Van Arkadie 169

growth path is found by emphasizing such institutions, any more than the fact
that wealthy countries are industrialized means that at a particular moment
industrial investment should be emphasized.
A second problem is that the identified characteristics of effective institutions
and the characteristics of institutions that would be considered appropriate for
public sector attention often do not match-for instance, it is in the nature of
some public goods that their supply lacks specificity. One is left with the awk-
ward conclusion that the public sector is in part the residual legatee of activities
that do not lend themselves to effective institutional performance.
But this need not be so alarming, as some of these activities may be quite
satisfactorily handled by governments, even if they do not respond to systematic
efforts to improve productivity, nor are plausible candidates for external assis-
tance. Even though primary education is a low-specificity, low-competition ac-
tivity, in most countries it is done quite well, sometimes in extremely difficult
conditions. But there is no very good reason for external funding to be mobilized
for primary education (except for textbook production-which can be organized
in ways to meet the Israel criteria).
This brings out an important point that is sometimes overlooked: there is a
difference between a worthwhile organization or activity and one that is an
appropriate object for external assistance. The institutions that can productively
use external support form a specialized subset of the group of viable or potentially
successful institutions. Analysis is required at two stages. Is a public economic
institution desirable, or likely to be effective? If so, is external assistance required,
and does a candidate-funding institution have the competence (comparative
advantage) to supply that assistance?
Evaluating the institutional performance of aided projects is tricky. Elaborately
designed externally funded projects sometimes fail because they demand an
unattainable level of managerial performance. And those that succeed might do
so because they divert scarce managerial talent from other activities. If so, there
are hidden costs, particularly where the response to a weak implementation
structure is to use external funds to set up parallel institutions.

A Summary of Factors Affecting Performance

A bureaucracy can only be as effective as the tasks delegated to it allow: if it
is called upon to undertake economic management tasks that are incoherent or
inconsistent, and generate considerable potential rents, it is not surprising if its
effectiveness or honesty is impaired. Declining institutional capacity can result
when the state's efforts to control economic activity are overextended. Admin-
istrative performance is also likely to be correlated with a realistic system of
material incentives, and with a decision system within the administrative struc-
ture that is able to locate responsibility and reward effective performance.
However, the capacity, loyalty, and honesty of bureaucracies vary for reasons
that are not simply to be explained by material incentives or the availability of
170 The Role of Institutions

"rents." Organizations, including private businesses, survive because they can

command a loyalty beyond what can be induced by the material incentives of
a strictly market transaction.
In this regard, professionalism can be an asset to be used by public institutions.
The continued delivery of some public services under the most appalling con-
ditions is evidence of that. A professional ethic of commitment and service can
generate performance in excess of that explainable by material incentives. The
university at which this paper is being drafted survives, for example, through a
combination of economic ingenuity and professional commitment of its academic
staff in the face of a collapse in real salary levels. This is not to say that profes-
sional commitment is an inexhaustible asset, nor that professionals are imper-
vious to material conditions. It would, however, be of interest to consider the
conditions under which professional commitment can be created and nurtured,
and those under which it is likely to be eroded or destroyed.
Understanding factors that affect the morale of organizations is the province
of sociologists and management specialists. In practice those concerned with
economic policy and the design of programs have to react to the observed
operational capacity of organizations. Where there is weakness, the crucial judg-
ment will be whether performance can be raised or not, which in turn depends
on the diagnosis of sources of poor performance. Many explanations of orga-
nizational failure fall into three categories: the inadequacy of available inputs,
inherent incapability, and avoidable inefficiency.

The inadequacy of available inputs. An example of the inadequacy of avail-

able inputs is that organizational weakness is often attributed to a lack of trained
labor and weak management. Certainly many countries have labor shortages,
and the case for training and technical assistance is unassailable-presumably
most organizations in the world would perform better with more qualified
personnel, and superlative management might make the most hopeless venture
viable. But, after two or more decades of training and technical assistance,
shortage of high-level labor is no longer so obviously the problem. For donors
there is a real danger that inadequate labor supply is an attractive diagnosis
because apparent cures (technical assistance and training) are readily at hand.

Inherent incapability. There are some economic tasks that public institutions
may be inherently ill-adapted to handle-in particular, activities requiring de-
centralized risk-taking (some forms of agriculture; shopkeeping), combined with
the need for considerable labor commitment. But this is no more than a casual
observation. Unlike market failure, analyzed exhaustively by economists starting
from the assumption that market solutions are best unless proved otherwise,
"public institution failure"-identification of those activities that public eco-
nomic organizations are not, a priori, likely to be able to handle efficiently-has
attracted remarkably little systematic examination.
Such factors as risk, economies of scale, and standardization of the process
 Van Arkadie 171

determine the comparative advantage of public institutions. This is of some

interest to donors, as the same question could be asked of their own interven-
tions: what determines donor comparative advantage?

Avoidableinefficiency. Many activities that are properly the province of pub-

lic institutions are not performed very well because of poor management. Avail-
able trained labor is used badly because of poor incentives, inefficient organi-
zation of work, inappropriate delegation of responsibility, and inadequate
accountability.
Inherited civil service practices were often poorly designed to manage public
economic activities in the first place and have deteriorated further under eco-
nomic stress. Examples are rare of decisions to expand the role of public eco-
nomic institutions that have been matched by adequate consideration of the
managerial requirements.
Indeed incentive systems are often so poorly constructed and managerial prac-
tice so evidently inadequate that it is often surprising that public institutions
work as well as they do. This makes it hard to use the empirical record to assess
the intrinisic value of an organization, since more effective performance might
be achieved with perfectly plausible managerial improvements.

V. THE POLITICAL ECONOMY OF PUBLIC INSTITUTIONAL INTERVENTIONS

The most telling case against many institutions is not that they are technically
inefficient or poorly managed (although they may be) but that, in the political
and administrative reality in which they operate, they end up pursuing objectives
inconsistent with development.
For example, there are two quite distinct strands in the criticism of marketing
boards in Africa. One is that they are expensive and inefficient, perhaps inevitably
so. They are dysfunctional because they place a burden of bureaucratic overhead
costs on the farmer. A quite separate argument is that their basic objective is to
shift the terms of trade against agriculture, serving a political economy weighted
against the farmer (see Bates 1981).
In other words, one must go beyond the assumption that government insti-
tutions are by definition pursuing the goals of national development to explore
what determines the interests organizations work for in practice. This propo-
sition applies as much to international institutions, and to bilateral donors, as
to institutions in the recipient countries. "Interests" can relate to the play of
foreign policy concerns of states, sectional economic interests brought to bear
on aid programs, and the interests of aid officials, departments, and agencies in
perpetuating their roles.
The view taken of the determinants of government behavior obviously influ-
ences normative judgment about the role appropriate for government institu-
tions. One "rational choice" approach to the political economy of public insti-
tutions emphasizes "rent seeking" as a powerful motive force. If the main
172 The Role of Institutions

determinant of government behavior is pressure from rent seekers, it is not

difficult to support a strategy of liberalization through confronting or buying
out the vested interests in question (see Lal 1987).
A more structuralist (but still normative) view might explore the issue of
market failure in a dynamic context, defining the appropriate role of government
as promoting desirable structural change which would not spring from the
unhindered play of market forces.
In the era of structural adjustment and privatization the view that the state
needs to play an interventionist role in a backward economy is not fashionable,
despite its respectable intellectual antecedents. And the question remains why
governments would take on the task of structural transformation expected of
them, rather than just using the vocabulary of "development" to cloak the
practice of "rent allocation."
There is no simple answer to that question. Kleptocracies in which those who
run government seem largely concerned to enrich themselves are not rare, but
then again they are not typical.
Where the political process is such that leaders must satisfy competing interests
to remain in power, the question to be addressed is the circumstances in which
those interests coincide with a "developmentalist" rather than a parasitic rentier
strategy (see Bates 1988). If leaders are more secure and enjoy some autonomy
in decisionmaking, they will be much freer to make choices without reference
to the short-term interests of pressure groups.
The counterpart in Marxist theory for the neoclassical concept of "rent" has
been the role of "surplus" in the "accumulation process." Surplus is seen as a
typical and necessary component of capitalist development, not as a transitory
rent resulting from a deviation from an abstract, optimal rent-free equilibrium.
The issue to be addressed is in what circumstances are surpluses likely to be
channeled to productive uses. The purpose of many public sector initiatives
could be seen not so much as creating rents as shifting the control of surplus
from one group to another-for example, from multinational corporations to
national hands, or from one national group to another.
In these terms, Marxist analysts might be roughly in agreement with neo-
classical rent-seeking theorists about the interests served by particular policy
initiatives, but the interpretation would differ in at least one profound respect.
For the Marxist, state interventionism is understood as necessary to capitalist
development. Whether capitalist development can succeed depends on whether
the political and economic process is such that the surplus is at the disposal of
national capital-either state or private-and as a result is used productively,
or whether it is transferred outside the country or flows to domestic groups
incapable of making productive investments.
John Kenneth Galbraith (1987) claims:
Japanese who become business executives and high civil servants frequently
began their lives as Marxists. There is no serious expectation of revolution,
but the Marxian influence does have a significant consequence: it relieves
 Van Arkadie 173

Japanese economic and political thought of the notion of a social dichot-

omy, even conflict, between the market economy and the state, a theoretical
conflict that has a strong hold on all American and British economic think-
ing. In Japan the state is indeed, as Marx held, the executive committee of
the capitalist class; this is normal and natural. The result is an accepted
cooperation between industry and government . . . that is unthinkable, to
the extent that it is not thought subversive, in the American and British
tradition.
Irrespective of whether this is an accurate description of the intellectual for-
mation of the Japanese elite, the ideas are intriguing.
Examining the determinants of government policymaking leads into a related
question-what are the political and institutional prerequisites for implementing
a particular economic policy regime?
Advocates of free markets sometimes associate economic "freedom" with
political freedom. There seems little empirical basis for such a view in poor
countries where, often, the inequalities associated with freely operating markets
and the austerities required for market-based macroeconomic solutions are as
likely to be associated with authoritarian control as with democratic processes.
As a corollary, where pluralistic or fairly open political processes stand in the
way of "correct" economic policies (removal of subsidies, devaluation, and so
on) such policies could either be not politically sustainable or imply a change
in political regime, which should be understood as an integral part of the policy
package.
Normative assessment should take account not only of the impact of govern-
ment institutions on economic outcomes, but also of the impact of economic
developments on the evolution of institutions. Public economic institutions are
not just to be seen as good or bad instruments for achieving an economic policy
goal; they are also active in the choice of policy goals. As part of the social
fabric, an institution may be seen as good or bad in itself, or in terms of social
objectives not translatable into economic calculus.
The concept of "rent" depends on the acceptability of criteria for the definition
of rent-free, earned factor income, in turn dependent on a view of policy as
being concerned with maximization of individual welfare. While that provides
a powerful tool for much policy analysis, it does not provide a basis for evaluating
all social institutions.
There are also nonmaterial determinants of policy, which are not handled
very well by neoclassical or Marxist analysis. Ethnicity, religion, and nationalism
are much more influential than their place in the policy literature implies. This
is conspicuous in dramatic events such as the breakup of Pakistan, the expulsion
of the Ugandan Asians, the displacement of European farmers from the Kenya
White Highlands, the recent conflict in Fiji, and the conflict in Sri Lanka; less
obvious are the tensions from similar causes that underlie an often hidden po-
litical agenda in a much wider range of countries. Likewise, the relative ethnic
and cultural homogeneity of the sucessful East Asian economies may be a crucial
174 The Role of Institutions

factor in their performance. Yet economists neglect these ethnic, religious, and
nationalist influences, important and wide-ranging as they are. Partly, in the
official literature, this is a matter of etiquette. But it is also true that economists
find such matters hard to handle. Neither neoclassical economics, with its em-
phasis on individualism, nor Marxist economics, focusing on class interest, are
well geared to analyze economic behavior motivated by awareness of ethnic or
religious identities.

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PROCEED ING S OF THE W O RL D B AN K ANN U AL CON F EREN CE
ON DEVELOPMENT ECONOMICS 1989

COMMENT ON "THEROLE OF INSTITUTIONS IN DEVELOPMENT,

BY VAN ARKADIE

John Nellis

Professor Van Arkadie's paper presents useful, nonobvious reflectionsand

insights on the relation between institutions and economic development.His
analysisof a range of problemsconfirmsthat the topic is at once difficultand
worth wrestlingwith.
The first problem, cogently confronted in the paper, is the breadth of the
conceptof institution.At the more concreteand applied end of the spectrum is
the notion of institution as a synonymfor organization: a power company, a
departmentof a ministry,a developmentbank, a project managementunit. When
governments,the World Bank, and other donor agenciesspeak of institutions,
this is normallywhat they mean. Analyzingthe capacity of such organizations
or institutions, diagnosingtheir deficiencies,and proposing reinforcingor cor-
rective measures-this has been the standard practice of "institutional devel-
opment," at any rate in the World Bank.
But there is a quite distinct, more abstract definitionof institutions:as rules
of the game-patterns of norms specificto a society,"complianceprocedures"
that lend predictabilityto expectationsand, in ProfessorVan Arkadie's words,
define "the terrain over which economicactors maneuver." Examplesof these
broader sorts of institutions are land tenure patterns, property rights, and legal
systems.Less easy to define and far less easy to reform, these institutions are
nonethelessprofoundly important.
Thus, the analyst of institutions is confronted at once by the nitty-gritty of
diagnosingdeficienciesand changingdetailedmanagementand production pro-
ceduresat the level of the firm, and by sweeping,near metaphysicalissuessuch
as the extent to which cultural variablesinfluenceeconomicoutcomes.Conclu-
sion one: the topic is enormous.
The second problem is that the question in its entirety lacks an analytical
method, a conceptualframework capableof renderingit coherent. There is no
organizing mechanism,such as the market, to order the different portions of
the topic. Certainly,there is a lot of thinking going on, both in and outside the
disciplineof economics,to deriveor construct such a device,and reamsof paper
have been produced on what is called "organizational economics,"on public

The author is on the staff of the Country Economics Department of the World Bank.

C 1990 The International Bank for Reconstruction and Development / THE WORLD BANK.

177
178 Comment

choice theories, analyses of transaction costs-various strands of "the new in-

stitutional economics." So far, by their own admission, they have produced a
metaphor-suggestive, admittedly productive-but nonetheless a "metaphor for
organizing thinking about technological and institutional change" (Feeny 1988,
p. 162). Metaphors may be a necessary starting point, but: "If institutions
matter-if they affect the performance of an economy-then . . . a theory of
economic change must include a theory of institutional change" (Feeny 1988,
p. 161). I believe the author and I would concur that we do not yet have such
a construct. Conclusion two: the theory of the topic is underdeveloped. Whether
it is "developable" remains to be seen.
The third and principal problem, very well handled in the paper, is that despite
its intractability, the topic's importance is incontestable. And probably growing.
The paper correctly notes that internal and external observers, from all per-
spectives, left, right, and center, are critical of institutional performance in de-
veloping countries. Criticisms now extend to all types of institutions, homing
in more and more on the need to deal with and reform the broader, less tangible
institutions-for example, the overwhelming need to ensure the enforceability
of contracts; to establish operational notions of property, and how it can be
used, consumed, and exchanged; the need to break the hold of excessive,counter-
productive regulations, rent-seeking or otherwise.
I welcome Van Arkadie's insistence that the issue is not going to go away. It
cannot be set aside by economists with the reductionist claim that institutions
and their impact are someone else's concern; it cannot be ignored by developing-
country governments that face increasing pressures to deliver a modicum of
services to their populations; it cannot be overlooked by the World Bank in the
hope that we can take the high road of defining policies and leave it to someone
else-the borrower governments? the bilateral donors?-to implement them. So,
a third conclusion: we in the Bank are in this messy business for the long haul,
irrespective of whether we continue to emphasize adjustment or find our way
back to primarily investment lending. Thus those who might prefer their de-
velopment economics unsullied have been overtaken by events.
In illustration, an anecdote. In 1962, it was suggested to Arthur Lewis that a
set of Indian cultural norms and institutions, the caste system, constituted a
powerful and perhaps impenetrable barrier to economic development. Sir Arthur
disagreed: "The love of money," he declared, "is a powerful institutional solvent.
Many countries have indeed attitudes and institutions which inhibit growth, but
they will rid themselves of these attitudes and institutions once their people
discover that they stand in the way of economic opportunity" (Lewis 1962).
The prose is splendid but the sentiment is simplistic and, alas, dated: a quarter
of a century later many economists are inclined, with Van Arkadie, to admit
that institutions, like prices, matter; that we have not paid sufficient attention
to ways and means of improving the performance of organizations and the
appropriateness of the broader institutions.
 Nellis 179

This brings me to my last point: the next and most crucial step in the process
(and here, not surprisingly, the Van Arkadie paper is not too helpful) is to specify
precise operational methods and tools by which to improve performance in
institutions. A great deal of analytical review of how technical assistance for
institutional development has been used-and misused-is about to come to
fruition. Guidelines may reasonably be expected to come out of this work, a
distillation of "best practice" in this subfield that will be of use to governments
and donors. Such guidelines already exist for the reform of public enterprises,
a comparatively manageable element of public sector institutional reform (see
Shirley 1989 and Nellis 1989). And efforts are under way to do the same for
budgeting and public expenditure (see Lacey 1989). Devising the appropriate
techniques is perhaps less the job of the academic economist than of the gov-
ernment bureaucrat, the World Bank staff, and management specialists-though
we in the practitioner community would gratefully accept any further assistance
Van Arkadie and other academic economists might care to offer.

REFERENCES

Feeny,David. 1988. "The Demand and Supply of Institutional Arrangements." In Vincent

Ostrom, David Feeny, and Hartmut Picht, eds., Rethinking Institutional Analysis and
Development. San Francisco: International Center for Economic Growth.
Lacey, Robert M. 1989. Managing Public Expenditure: An Evolving World Bank Per-
spective. World Bank Discussion Paper 56. Washington, D.C.
Lewis, W. Arthur. 1962. "Foreword." In T. S. Epstein, Economic Development and
Social Change in South India. Manchester: Manchester University Press.
Nellis, John. 1989. "Public Enterprise Reform in Adjustment Lending." World Bank
PPR Working Papers 223. Washington, D.C. Processed.
Shirley, Mary. 1989. The Reform of State-Owned Enterprises: Lessons from World
Bank Lending. Policy and Research Series 4. Washington, D.C.: World Bank.
PRO C E ED ING S OF T HE W OR L D B AN K ANN U AL CON F ERE NC E
ON DEVELOPMENT ECONOMICS 1989

COMMENT ON "THEROLE OF INSTITUTIONS IN DEVELOPMENT,"

BY VAN ARKADIE

Pranab Bardhan

I agree with most of what is said in the paper. Essentially this critique sup-
plements the paper, emphasizing institutional issues that Professor Van Arkadie
did not go into very much-particularly from the point of view of rural devel-
opment. I will try to discuss these issues in the perspective of economic theory,
keeping in mind our primary focus on policy issues and empirical matters.
Until recently, mainstream economic theory has by and large ignored insti-
tutional issues-often stating central propositions with a false air of institutional
neutrality. Of course, radical economists, economic historians, and other such
wishy-washy characters among us have always made a noise about institutions
being important, but much of mainstream economic theory has kept a safe
distance from such polluting influences.
Fortunately that's no longer true. In the last ten or fifteen years, economic
theory-particularly non-Walrasian neoclassical and non-neoclassical theory-
is increasingly recognizing a whole range of problems that come up in analyzing
institutions. We are now in the process of developing an endogenous theory of
institutions that will help us understand the forces behind them. Our focus is,
of course, on economic factors because our comparative advantage lies in ana-
lyzing them.
There is now a vast literature, which includes several points of view. The
transactions costs theorists have taken one line, largely flowing from the seminal
work of Ronald Coase; somewhat different, though related, is Oliver William-
son's work (1985). The Coase-Williamson literature on transaction costs con-
centrates on corporate structure and practices; more recently, the literature (see,
for example, Bardhan 1989) has tended to focus on things like imperfect infor-
mation, usually emphasizing the emergence of institutions as substitutes for
missing markets-particularly for credit, insurance, and futures transactions-
in an environment of pervasive risks, moral hazard, information asymmetries,
and so on. The theme was first taken up in the literature on sharecropping, but
now a whole range of rural institutions has been analyzed-in the labor, credit,
and other markets.

The author is a professor of economics at the University of California, Berkeley, and editor of the
Journal of Development Economics.
© 1990 The International Bank for Reconstruction and Development / THE WORLD BANK.

181
182 Comment

Radical economists often speak of institutional obstacles to development in

poor agrarian economies and overlook the microeconomic rationale of these
institutions' formation. Under certain informational constraints and missing
markets, a given agrarian institution such as sharecropping may actually be
serving a real economic function. Its simple abolition-often called for by rad-
icals, who ignore the factors that gave rise to the institution in the first place-
may not improve the conditions of the intended beneficiaries. The economics
of what may be called "second-best reformism" may offer some important
political lessons here, which are applicable to land reform, credit reform, and
so on.
Although I generally favor the development in this fast-growing literature, I
am increasingly doubtful about the direction it is taking. In the first place, this
literature (with some notable exceptions) tends to assume the optimality of
persistent institutions. That is, if you can explain an institution in terms of
imperfect information and the like, something must be right with that institution,
so we shouldn't tinker with it. Sometimes that is the right conclusion to draw
but often it is not. It is possible to construct models in which you can show that
dysfunctional institutions may persist for a very long time. All kinds of self-
reinforcing processes are increasingly recognized now-not so much in devel-
opment economics but in the new institutional economics literature-processes
of the kind, for example, that George Akerlof (1984) has discussed in terms of
social sanctions. Other self-reinforcing mechanisms have been recognized in a
completely different literature, in the theory of technological innovations. There
is the idea of what is called path dependence, for example, where a path chosen
initially because it suited particular interests may lock the system in for a long
time because of increasing returns to adoption, learning, and other kinds of
bandwagon effects. These self-reinforcing mechanisms are just as important to
the literature on institutional innovations as to that on technological innovations.
The new institutional literature also sometimes ignores that the new theory
cannot completely supersede some of the emphasis of the earlier reformists.
Much of the new literature assumes, for example, the framework of information
symmetry and risk-sharing. But it cannot on that basis deny that a redistribution
of assets or reorganization of the work process might lead to a superior equi-
librium, since sometimes there would be less asymmetry of information and less
need for risk-sharing.
The different strands in this literature share another methodological problem,
having to do with functionalism-a problem not exclusive to development eco-
nomics. If we can show that an institution helps a large number of people, we
assume that somehow it will come about; we try to explain an institution by
pointing to its benefits. The assumption of course ignores the enormous difficulty
of getting the potential gainers to get their act together to somehow defeat the
potential losers or vested interests. This collective action problem is familiar in
the literature on the political economy of trade policy.
 Bardhan 183

There are two kinds of collective action problem here. One is the well-known
free-rider problem about sharing the costs of bringing about change. The other,
less often talked about, has to do with bargaining about sharing not the costs
but the potential benefits from the change, disputes about which may lead to a
breakdown of the necessary coordination.
The collective action dilemma brings to mind another general problem of this
literature: much of the focus is on efficiency-improving institutions, whereas
historically considerations of efficiency have been less important than redistrib-
utive issues in processes of institutional change. Take the eighteenth-century
enclosure movement in England, for example, which some literature in economic
history has tried to explain. Enclosures have been explained as more efficient
than the open field system that prevailed before. Now, there is no doubt that
if an institution improves efficiency, pressures will be generated to bring it
about-but redistribution has often been the crucial factor in this particular
collective action problem. Mobilizing the relevant interest groups and tackling
the bargaining and free-rider problems often turn on the redistributive effects
of the particular institutional change, which are at least as important, if not
more so, than the efficiency-improving effects.
There is an identification problem here. Hayami and Ruttan (1985) distinguish
between demand for and supply of institutional change-demand coming from
demographic and technological changes which generate pressures for institu-
tional change; supply from political entrepreneurs who try to resolve the col-
lective action problem. Although they recognize this distinction, Hayami and
Ruttan often try to show how demographic and technological changes have
brought about institutional changes in agriculture. There are several examples
in the book and also in Hayami and Kikuchi (1982). Let me take just one
example. The rapid expansion of labor-tying arrangements such as kedokan in
many parts of Java in the late 1960s, which Hayami and Kikuchi attribute to
population growth, can be explained from the "supply side" by reference to the
drastic changes in the collective strength of the poor peasantry brought about
by the bloody political changes of the 1960s. I am not saying that the supply
side is more important than the demand side, but in observed historical instances
sometimes it is difficult to identify whether demand for institutional change or
resolution of the collective action problem in some way was responsible for the
outcome. Often the two are interdependent.
Identification is a general problem in applying some of the rather sophisticated
theoretical models from the institutional literature. When I was a student in
development economics, one of the major issues that used to be discussed was
"Are peasants rational?"-which always sounded a little silly to me. Now we
have moved full circle: we have superclever peasants solving multistage, mul-
tiperiod game-theory models. I am in favor of applying more sophisticated
reasoning to understanding processes we do not understand otherwise, but there
are significant empirical difficulties. As we know, many of these game-theoretical
184 Comment

results are highly model-specific and are not robust at all. An empirical testing
of these models is extremely difficult: for the same observed phenomenon that
you explain by one intricate game-theoretical model, you can find five other
intricate or not-so-intricate models. There is a disproportion between theoretical
and empirical work in this area which will crop up in all sorts of ways as we
start testing the theoretical models.
Finally, on the role of the state, which is the real focus of Van Arkadie's
paper: sometimes the literature is unduly preoccupied with the extent of state
intervention when the more interesting subject is how, given the extent, the
nature or quality of the intervention varies; even the same amount of intervention
can bring about completely different outcomes.
I also think that the literature focuses too much on state versus private property
regimes. In many aspects of development-including rural development and
many of the looming environmental problems-we should pay more attention
to "intermediate" institutions, such as small-group cooperatives, formal or in-
formal. The history of cooperatives is by and large dismal: they have failed in
many parts of the world. I am not talking about large collectives or the kind of
cooperatives in Kenya discussed in Van Arkadie's paper. (In fact, one reason
cooperative history is so often a history of failure is that cooperatives are often
essentially the lower end of a big state bureaucracy or a front organization to
milk the state cow.) I am talking about more genuine voluntary, small-group,
self-help cooperatives that may get help from others but are more self-generative
and self-sustaining. Successful examples of such groups exist in different coun-
tries.
Water management is one area that generates many externalities. How do
village societies cope with internalizing them? How do farmers get together
locally to resolve conflicts-or sometimes fail to resolve them-in allocation?
East Asian history has many success stories about informal, traditional village
community organizations in which all kinds of implicit cooperation have been
going on for some time. Even in different parts of India I have seen scattered
evidence of a remarkable amount of informal cooperation among farmers. These
institutions are not listed as cooperative societies, and they often take rather
soft institutional forms, but they have survived for a long time. Unfortunately,
informal cooperatives are now fading away as the state, as a patronage-giver,
becomes more important and intrudes into village life. Externalities of this kind
are important in many other areas-environmental issues particularly come to
mind.
We should study informal institutions involving cooperation to try to under-
stand why they fail in many areas and why they succeed in some. I would urge
those who are interested in these issues not to try to resolve them at general
theoretical or aggregate statistical levels. I think this calls for many microlevel
studies that include analyses of processes. We economists in our surveys are not
very good at understanding processes. We get observation points on outcomes
and analyze those outcomes. To understand processes, I think we have to give
 Bardhan 185

up our somewhat arrogant imperialist attitude toward other social studies and
collaborate with others, such as anthropologists, and get on with more such
microstudies.

REFERENCES

Akerlof,George. 1984.An EconomicTheorist'sBook of Tales. Cambridge:Cambridge

UniversityPress.
Bardhan, Pranab, ed. 1989. The Economic Theory of AgrarianInstitutions. Oxford:
Oxford UniversityPress.
Hayami, Y., and V.W. Ruttan. 1985.AgriculturalDevelopment.Baltimore,Md.: Johns
Hopkins UniversityPress.
Hayami,Y.,and M. Kikuchi.1982.Asian VillageEconomyat the Crossroads.Baltimore,
Md.: Johns Hopkins UniversityPress.
Williamson,0. 1985. The EconomicInstitutions of Capitalism.New York: Free Press.
PRO C E ED ING S OF T HE W OR L D B AN K ANN U AL CON FE RE NC E
ON DEVELOP ME NT EC ONO MI CS 1989

FLOOR DIscuSSION OF VAN ARKADIE PAPER

Expanding on a theme in Van Arkadie's paper, one participant observed that

economists tend to export into other countries organizations that do not fit the
norms of people in those countries, yet expect them to succeed. Similarly, often
the people are maximizing one thing and government imposes an organizational
structure designed to maximize something else, producing inconsistencies. It
would be more appropriate first to focus on what we are trying to maximize in
a society and then to find the type of organizational structure to support that
objective. Cooperatives are often well-matched to societal norms, but other
institutions may not be. In a typical rural area in Africa, for example, credit and
saving are linked. Individuals put their money together and give it to a person
who needs capital, and it passes around. This informal system is an institution,
one that links saving and investment with the objective of providing capital to
generate production. Introduce a bank in a rural area where that system exists
and you will get no saving, and economists will say the people and banks are
risk averse-because they do not understand the system.
Acknowledging the validity of this observation, which he had also made in
his paper, Van Arkadie suggested that in some situations one has to ignore or
try to change the norms. The World Bank is in the business of lending to
governments, for example, and does so on the assumption that the governments
are not crooked. What happens when governments will not repay loans and are
crooked? You could say, "That's their norm," or you could conclude that you
are in the business of changing norms and trying to assert norms that may be
at variance with the existing system.
Bardhan (discussant) elaborated on the subject of norms, noting their impor-
tance in the game-theoretic literature, particularly for repeated cooperative
games of the prisoner's dilemma type. In repeated transactions, some codes of
conduct become norms that people accept without thinking. The problem is,
norms change. Economists don't have a very good theory of changing norms.
They have interesting ideas about how norms change, but many economists'
models of norms assume that all social norms are reducible to economic ra-
tionality, which is questionable.
One Bank participant thought that confusion about the meaning of "insti-
tutions" might be the result of historical accident, of someone somewhere using
the term institutions when they meant organizations. Van Arkadie had developed

This session was chaired by Visvanathan Rajagopalan, vicc president, Sector Policy and Rcsearch,
World Bank.
C)1990 The International Bank for Reconstruction and Development/ THE WORLD BANK.

187
188 Floor Discussion of Van Arkadie Paper

the two definitions along parallel tracks-with marriage, societal norms, and
the like along one track and with diagnoses of organizations along another-
but perhaps there is no real link between the two meanings. Does one follow
the other in terms of the sequence of development? Does the development and
effectiveness of organizations-particularly the kinds of agencies the World Bank
works with-depend upon a certain level of development of norms? If there is
no such link, perhaps it would be more productive to discuss them separately,
and we could get on with the task of considering organizational alternatives for
development programs. Admitting that his work on this subject was new and
transitional, Van Arkadie said he would have to think about whether the two
subjects deserved separate discussion. His two definitions of "institutions" were
an empirical reaction to the discourse; if separated, the question would be how
the two meanings could be related at the analytical or theoretical level.
Nellis (discussant) said that the Bank working group that is producing a policy
paper on institutional development is receiving many comments along two lines:
(1) what you are attempting is ludicrously broad and (2) how could you have
left out local government, decentralization, finance, tax administration, and so
on?
A participant offered an explanation of why this field is theoretically under-
developed and how to improve matters. Economists writing about rural insti-
tutions, for example, speak of utility-maximizing producers, production func-
tions, risk, and asymmetric information-all elements of an urban sector theory,
none of them specific to agriculture. Once you get specific about agriculture,
suddenly, without a great deal of analytical apparatus, implications become
apparent. In his own work, by looking at elements such as covariance of risk
and the spatial dispersion of agriculture, the participant had shown that crop
insurance is not likely to work and that rural financial institutions that confine
their operations to agriculture would have trouble operating successfully. Intro-
duce agroclimatic differences-for example, the high degree of covariant risk
in semiarid, highly seasonal climates and the low degree of risk in humid climates
that are not very seasonal-and you arrive at the differences anthropologists
have long observed between the hierarchical family structures found in semiarid
areas and the nonhierarchical family structures found in humid areas. Introduce
differences among crops-whether the crop can be stored before being processed,
for example-and you can predict which crops are suited for plantations and
which are not. He strongly felt that economists writing about institutions sys-
tematically ignore simple technological and material conditions.
While agreeing with this comment, Van Arkadie felt that the difficulty lay in
knowing which were the right questions for economists to look at. Take the
plantation example just cited, for instance. In the 1960s Van Arkadie saw that
sisal was a plantation crop, and coffee a smallholder crop in Tanzania. To him
it seemed obvious and logical why this was so. Then he went to Brazil where
he found coffee to be a relatively large-scale and sisal a relatively small-scale
crop. As an economist one can say that some crops probably can't be produced
 Floor Discussion of Van Arkadie Paper 189

by plantations, given various factor endowments or costs, or can only be pro-

duced inefficiently, so that under competition the plantation will not succeed
and the smallholder will. But that does not explain why in some parts of the
world certain crops are grown in plantations and others are not, without looking
at the issues Bardhan introduced in his panel comments-about the nature of
power in those societies at particular historical moments and the persistence of
institutions once they're created, regardless of inefficiency or inequity.
Bardhan found covariant risks to be important for looking at rural institutions,
but unlike the earlier participant, believed that many models already do use
covariant risks, implicitly or explicitly. In the literature on credit markets, for
example, covariant risk came up in considerations of whether the lender should
be a village resident or someone from outside. This is related to the demographic
question: when do we go to the village moneylender for credit and when to
relatives far away who do not face the same covariant risks? In rural India
(where, as in much of the world, marriage is an economic institution), it is
assumed that a village bridegroom or bride will marry a distant villager, partly
because in times of crisis you can fall back upon your new relatives or other
relatives who are not facing the same risks.
A participant felt that institutions in the two senses that Van Arkadie had
defined were clearly important, but it seemed to him unproductive to talk si-
multaneously about credit markets, marriage, and the way different parts of
agriculture work. He recognized that there were many serious issues that needed
positive analysis-for example, how the Indian caste system might function if
it changed radically under economic pressure, or how people provide for social
security without specific government intervention-but found it unsatisfactory
to consider all of these things together, and suspected that was why Van Arkadie
found it so difficult to write his paper. Economists should be more problem-
oriented. He added a plea to avoid terms like "new institutional economics" or
"new" anything as being pretentious, inaccurate (they were seldom new), and
certain to go out of date quickly.
Bardhan concurred that concrete studies and more problem-specific discus-
sions were preferable, but he felt that a general discussion made people more
aware of the complexity of problems for which economists sometimes give
simple-minded policy suggestions. Van Arkadie agreed with Bardhan, pointing
out that economists attack particular problems carrying their own intellectual
baggage, which every now and then they should examine.
A participant from the Bank asked Van Arkadie to elaborate on his statement
that there are some things institutions can do that markets cannot do, and some
things neither do well, since Van Arkadie had also talked about the importance
of political economy for determining institutional purpose. Van Arkadie ex-
plained that he was talking about bias in judgment. He was amazed after twenty-
five years' experience in Africa, at the persistent support for certain agricultural
policies despite the lack of any empirical evidence that those policies were work-
ing. Why was that? If it was highly desirable to increase agricultural productivity,
190 Floor Discussion of Van Arkadie Paper

and it was evident that market forces would not do so, policymakers decide that
something ought to-and therefore could-be done. The wish then fathers the
support, and the persistence of support, often despite the lack of positive results.
Citing Harold Lasswell's definition of political science as the study of who
gets what, when, where, and how, a participant suggested that if one accepts
that institutions like the World Bank have been effective in specifying who, what,
where, and when one transforms resource inputs into outputs, what the topic
was addressing seemed to a political scientist to be simple: the feasibility of the
question of how, which the Bank had addressed less successfully. The key vari-
ables are motivations and incentives (which, when expanded, cross over into
culture, psychology, rules of the game, and so on). Institutions are simply the
collective mechanism by which people pursuing their own interests transform
inputs into outputs. Outcomes are more rational if the collective action is pur-
poseful and less rational when it is the sum of anarchic activities-or something
in between. If we assume that to accomplish our institutional ends we must
control all the variables and come up with generic prescriptions, this may seem
to be an unmanageable field. By focusing on process and recognizing that the
complexity is largely in the location-specific way motivations and incentives
manifest themselves, we can find out what motivates people in a particular
context and come up with adaptive institutional solutions. Agreeing with this
assessment, Van Arkadie observed that complaints are more often about action
(or inaction) than about the analysis. As an observer of Bank policy missions
he is struck by how often perfectly sensible, straightforward advice is not taken.
Another participant expressed the need for more guidance on how to conduct
meaningful institutional appraisals. If in the absence of a theory of institutional
change, one were to decide on a case-by-case basis whether or not to recommend
institutional interventions-analyzing institutional microprocesses, the institu-
tion's political and technical purpose, its historical origins, its public and private
influence, and various social, anthropological, cultural, ethnic, and political
factors-what should the methodology be?
Two participants offered constructive criticism on current approaches to in-
stitutional change. The first participant suggested that economists at the World
Bank and elsewhere should probably concentrate on public economic and fi-
nancial organizations-concerning themselves with noneconomic organizations
only to the extent of helping them use resources optimally. He believed there
had not been enough empirical studies about optimal cost structures for non-
economic public organizations. When such an organization applies for grants
or aid, lending institutions look at its financial profile and conclude that it is
inefficient if they see that personnel costs and overheads exceed certain ratios.
He felt that these ratios were drawn from the developed market economy ex-
perience and he wondered if these cost profiles can be applied without adaptation
to noneconomic public organizations in developing countries. The participant
also seconded Van Arkadie's recommendation that the World Bank support
research into entrepreneurship, particularly studies about how to predict entre-
 Floor Discussion of Van Arkadie Paper 191

preneurial responses to policies in developing countries.

The second participant urged a distinction between individual institutions and
the structure of institutions. The performance of an individual institution de-
pends on the structural arrangement of institutions. Under different arrange-
ments performance will differ; this is probably one of the main reasons why an
institution works in one society and not in another. He also urged more careful
consideration of the cost of institutional change. A particular institutional ar-
rangement may not appear rational, but if analysis suggests that the cost of
change is prohibitive, the wiser course may be to live with inefficiency.
After observing that the Bank has paid increasing attention to institutional
behavior important to policy change, Rajagopalan (chair) suggested that inter-
disciplinary research and analysis focus on giving development practitioners
paradigms and criteria for evaluating institutional structures. Particular emphasis
needs to be given to the efficient management of the public sector. Ownership
was not the issue so much as performance, so he urged researchers to find ways
to improve performance under different ownership patterns. Researchers should
also try to identify the conditions that encourage entrepreneurs to emerge in
underdeveloped economies. Analysts should clarify the effect of interactions
between economic and noneconomic (including ethnic, religious, and nationalist)
factors and their effect on such activities as regulation of public utilities and
privatization. Finally, Rajagopalan urged more study of the implications of the
increasing role of multinational corporations, trade unions, and international
credit in the economies of developing countries.