Politics, institutional diversity and economic performance

A recent rereading of a 1995 chapter by the SOAS economist Mushtaq Khan, ‘State Failure in Weak States: A Critique of New Institutionalist Explanations’ has given me new hope that national economies can achieve their goals in terms of the material progress represented by economic growth and social justice. It has been the belief of social democrats that the capitalist economy should serve human need by providing for full employment, avoiding extreme inequality and poverty, promoting social justice, and advancing material well-being. Social democratic policies seek to avoid what it sees as the flaws in both a laissez-faire or free market economy and a socialist one. The dynamics of markets are thereby harnessed to achieve social ends, rather than free markets simply being an end in themselves or purporting to promote a particular kind of individual freedom.

In the chapter mentioned above, Khan stresses the importance of the balance of power in society and the resulting political settlement in being a determinant of institutional and hence economic performance. While more mainstream new institutional economists have emphasised the importance of particular institutions as being the key to economic success, they avoid confronting the political determinants of institutional performance and institutional change. These economists thus try to study particular institutional configurations in particular countries and then suggest a ranking of institutions in terms of the resulting economic performance. By contrast, it can be pointed out that significantly different institutions have resulted in a successful economic performance across different countries, which undermines the claims of new institutional economics. Khan explains that the political transition costs of institutional change are far more important than the transactions costs in the determination of particular outcomes. Typically, according to the balance of power in a society, if particular classes or social groups are too weak to resist institutional change, the transition costs would be low, and a specifically different institutional configuration will emerge. If the transition costs are high, attempts at institutional change may fail, or lead to social conflict or even civil war. This is not to say that successful change will necessarily lead to improved economic performance, but it is likely to lead to a different economic evolution for a nation state. In many instances of institutional change, the ‘losers’ from such a change are not compensated through the political process, so there may be a sense of unfairness among the losing classes. To quote Khan, “capitalism is not nice, but how else are people going to escape from poverty?”

According to Khan, different power balances in a society, and the resulting political settlements, can lead to different rankings of institutional and the consequent economic performance. In other words, institutional performance rankings can be reversed under different political settlements, leading the way open to different models in political economy achieving equal economic and material success. This gives me hope that states can help to drive successful economic performance in a variety of institutional settings within capitalism, and that there is not simply a one size fits all neo-liberal model which all countries must follow if they want to achieve material progress. There is therefore space for pluralism in political economy, and different models of success, including modern versions of social democracy or ‘middle ways’ between a mythological free market and a socialist economy which can embrace capitalism and still achieve prosperity with social justice.

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