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Institutions and Economic Development

A. New Institutional Economics

Simply put, New Institutional Economics (NIE) endeavors to integrate a theory of institutions into economics. Ronald Coase, who explicitly introduced transaction costs into economic analysis (Coase, 1937), is cited as a central figure for the field. The term was introduced by Oliver Williamson in a paper he wrote in 1975. It has since become a standard or banner uniting a diverse group of economists who shared one common intellectual ground: institutions matter, the relationship between institutional structure and economic behavior requires attention, and the determinants of institutions can be analyzed with the aid of economic theory (Richter, 2005). NIE is inherently an interdisciplinary field of study (Williamson, 1998). It includes work in property rights analysis, the economic analysis of the law, public choice theory, constitutional economics, the theory of collective action, transaction cost economics, the principal-agent approach, the theory of relational contracts, and comparative economic systems. The commonality of all these approaches is that, unlike neoclassical economics, the institutional framework is not assumed as given but is explicitly treated as an object of research, and the implications of any given institutional arrangements for economic behavior are taken into account (Richter, 2005).

According to Douglass North, another seminal contributor to or primary proponent of NIE, institutions “form the incentive structure of a society, and the political and economic institutions, in consequence, are the underlying determinants of economic performance” (North, 1994: 360). He defines institutions as “the humanly devised constraints that structure human interaction. They are made up of formal constraints (such as rules, laws, constitutions), informal constraints (such as norms of behavior, conventions, self-imposed codes of conduct), and their enforcement characteristics” (North, 1994: 360).

North then defines organizations as “groups of individuals bound together by some common purpose to achieve certain objectives. Organizations include political bodies (political parties, regulatory agencies), economic bodies (firms, trade unions), social bodies (churches, clubs), and educational bodies (schools, universities)” (North, 1994: 361). Thus, he refers to institutions as the rules of the game, and to organizations and their entrepreneurs as the players. These are the institutions of foremost interest to NIE—the institutional environment (or North’s rules of the game—the polity, judiciary, laws of contract and property), and the institutional arrangement that deals with the institutions of governance (or play of the game—the use of markets, hybrids, firms, bureaus) (Williamson, 1998).

Formal rules must be securely nested in hospitable informal norms for them to function well, since it is the latter that legitimizes the former. Also, appropriate political institutions must be supportive of economic institutions (Chu, 2003). Economic performance is influenced by polities since they define and enforce the economic rules of the game. Thus, the formation of polities that will create and enforce property rights is a critical component of development policy (North, 1994). Fukuyama (2006) also noted that formal institutions are embedded in a political culture, that is, the matrix of informal norms, values, traditions, and historical path- dependencies. Even the best institutions will not work well in the absence of a supportive political culture. Alternatively, seemingly less optimal formal institutions can often be made to work given the right leadership, judgment, and political will. There are times when it is preferable to work within the context of imperfect existing institutions, rather than use up political capital on long-term institutional reforms.

Although there is now a consensus that institutions “matter,” the process of integrating institutions and institutional change into economic theory is still fairly new (Aron, 2000). Thus, the causality of the various links and channels of influence between the institutional set-up and development outcome is still not well or fully understood (Jütting, 2003).

Institutions and economic performance. Only efficient institutions are growth- promoting. They encourage individuals to engage in productive activities by providing appropriate incentives and establishing a stable structure of human interactions, which reduce uncertainty. Posner (1998; in Chu, 2003) defined two types of efficiency: substantive efficiency (i.e., a rule promotes allocative efficiency), and procedural efficiency (i.e., a rule is designed to reduce the cost or increase the accuracy of using the system of rules). Thus, Chu (2003) argues that affluence in developed countries is a cumulative result of efficient institutions; poverty in poor countries is a result of inefficient institutions. According to Greif (2005; in Carden, 2005), successful institutions are both contract-enforcing and coercion- constraining; that is, they reward production and exchange rather than expropriation and redistribution. However, the institutional frameworks in developing countries “overwhelmingly favor activities that promote redistributive rather than productive activity, that create monopolies rather than competitive conditions, and that restrict opportunities rather than expand them” (North, 1990: 9; in Hasan et al., 2006).

Thus, NIE posits that countries need two distinct and not necessarily complementary sets of institutions to meet the challenge of development: (i) those that promote exchange by lowering transaction costs and promoting trust, and (ii) those that induce the state to protect rather than expropriate private property. Included under the first set of institutions are contracts and contract enforcement mechanisms, commercial norms and rules, and habits and beliefs favoring shared values and the accumulation of human capital. Constitutions, electoral rules, laws governing speech and education, and legal and civic norms are among those under the second set of institutions (Shirley, 2005).

Identifying the institutions that significantly explain observed disparities in living standards across countries has also become the focus of recent development and growth literature (Aron, 2000). There has been a huge growth in empirical literature that measures the impact of institutions on development outcomes, particularly growth.9 Easterly and Levine (2003) and Acemoglu et al. (2002), for instance, have shown that resource endowments are important for growth only as mediated through institutions, for instance by providing more or less favorable conditions for the emergence or survival of certain types of institutions. Fukuyama (2006) argues that the proximate causes of growth are still the institutions, which can be shown in many cases to be exogenous to the material conditions under which a given society develops. However, serious problems with data, methodology, and identification plague the growth literature (Aron, 2000). That being said, while studies may define “institutions” differently, the results are consistent and strong overall: “institutions explain economically and statistically significant differences in per capita incomes across countries” (Eicher and Leukert, 2006: 2). The literature typically examines either the global sample or developing countries. The consensus institutions that have been associated with economic performance commonly relate to measures of government risk of expropriation, rule of law, bureaucratic quality, corruption, government repudiation of contracts, civil liberties, and openness to trade (Eicher and Leukert, 2006).

Institutional development/reform. In previous years, the issue of institutional development or “governance reform” has become more prominent (Chang, 2005). If developing countries are poor because their current institutions provide a weak basis in terms of incentives that promote growth, this raised the question not only of what type of institutions they should acquire, but more importantly of how they could develop such institutions. There is more agreement in the literature on former rather than on the latter (Hasan et al., 2006).

As Shirley (2005) concedes, NIE has had less to say about institutional change, except that it is hard to accomplish. This is due in particular to the complex interactions between the different typologies of institutions (i.e., interaction between formal and informal institutions, between different levels of institutions, and between economic and political institutions), which have different horizons for change and are therefore subject to very different evolutionary dynamics. Institutional reforms typically deal with formal institutions, which can be changed immediately. But informal institutions that serve to legitimize any set of formal rules, such as beliefs and norms, change only gradually. Thus, if a country chooses to adopt the formal rules of another country, it will have very different performance characteristics compared to the original country if both the informal norms and the enforcement characteristics are different. This implies that transferring successful western market economies’ formal political and economic rules to developing economies is not a sufficient condition for generating good economic performance (North, 2002). Another reason why underdevelopment cannot be overcome by simply importing institutions that were successful in other countries is institutional path dependency. That is, those who make policy and design institutions have a stake in the framework they created, and will therefore resist changes that may rob them of power or property (Shirley, 2005). North (1992) does note that path reversal is possible, and has occurred. However, it is a difficult process given that too little is still known about the dynamics of institutional change, especially the interplay between economic and political markets.

Taken to its logical conclusion, then, the focus on institutions could be debilitating for those advocating policy reforms. Since institutions are naturally deeply embedded in society, and if growth truly necessitates major institutional transformation in such areas as rule of law, property rights protection and governance, among others, then the prospects for growth would seem to be dismal in poor countries (Rodrik, 2006).

But institutions are brought into the analysis precisely to expose the limits of the “one-size- fits-all” argument deployed by orthodox economists regarding economic policy. Even the World Bank and the IMF have started emphasizing the role of institutions in economic development. But according to Chang (2005), this should be seen as an attempt to contend with the continued failures of orthodox policies in the real world. In explaining why “good” economic policies based on “correct” economic theories have so consistently failed, orthodox economists now invoke institutions. That is, the countries that implemented their policies did not have the right institutions, which is why they did not work and not because they were wrong to begin with. As a result, the original Washington Consensus of “stabilize, privatize, and liberalize” has now been augmented by a long list of so-called “second- generation” reforms that are heavily institutional in nature (Rodrik, 2006).

Chang (2005) points out the importance of making a clear distinction between the forms and functions of institutions. Citing the compilation of major “governance” indexes (or the indexes of institutional quality) by Kaufmann et al. (1999, 2002, 2003), he noted that the indexes often mixed up variables that capture the differences in the forms of institutions (e.g., democracy, independent judiciary, absence of state ownership) and the functions that they perform (e.g., rule of law, respect for private property, enforceability of contracts, maintenance of price stability, the restraint on corruption). He also argues that the orthodox literature is overly fixated with particular forms of institutions, as shown in the so-called “global standard institutions” (GSIs) argument.

According to the proponents of the GSI argument, particular forms of institutions (mostly Anglo-American) must be adopted by all countries in order to survive in an increasingly globalized world. They include “political democracy; an independent judiciary; a professional bureaucracy, ideally with open and flexible recruitments; a small public-enterprise sector, supervised by a politically independent regulator; a developed stock market with rules that facilitate hostile mergers and acquisitions; a regime of financial regulation that encourages prudence and stability, through things like the politically-independent central bank and the Bank for International Settlements capital adequacy ratio; a shareholder-oriented corporate governance system; labor market institutions that guarantee flexibility” (Chang, 2005: 6). But this transforms the discussion on institutions into another “one-size-fits-all” paradigm. It becomes more problematic if the preferred institutional forms are propagated through what Kapur and Weber (2000) refer to as “governance-related conditionalities” of the Bretton Woods institutions and the donor governments. Thus, Chang (2005) calls for some balance between forms and functions—the importance of institutional forms should not be ignored, but institutional diversity should not be denied either.

Rodrik (2006) also pointed out that institutional form is not uniquely determined by institutional function. This is very much apparent even in the developed countries where important institutional differences persist. But he also points out that this does not mean that economic principles work differently in different places. A distinction needs to be made between economic principles and their institutional embodiment. Most first-order economic principles, such as incentives, competition, hard-budget constraints, sound money and property rights, come institution-free. They do not map directly into institutional forms. For instance, it is possible to implement property rights through common law, civil law, or even Chinese-type socialism. Furthermore, policymakers always operate in second-best environments. So even in apparently straightforward cases such as price reform, optimal reform trajectories cannot be designed without considering prevailing conditions. The bottom-line is that there is still a lot to be learned about what improving institutional quality means on the ground (Rodrik et al., 2004).

This is not to say that developing countries cannot learn from the experience of developed economies. Just that pure institutional imitation is rarely enough. Making imported institutions work would require some degree of adaptation. Some institutional innovation would also be required, that is, coming up with “unique” institutions (Chang, 2005). This is where local knowledge is vital, since good institutions are heavily dependent on local context, traditions, habits, and political culture. Without local knowledge, it would be difficult to even understand how existing institutions actually work, much more how to reform them (Fukuyama, 2006). Thus, for institutional reforms to be successful, what is required is what Levy and Spiller (1994; in Shirley, 2005) refer to as “goodness of fit” between the specific innovation and the country’s broader institutional environment. In particular, Shirley (2005) describes a “good fitting” institutional innovation as one that is not dependent on absent or weak institutions, and is as much as possible insulated from or adapted to perverse institutions. The successful developing countries such as the People’s Republic of China; the Republic of Korea; and Taipei, China, which have almost always combined unorthodox elements with orthodox policies (Rodrik et al., 2004), bear this out.

This was also another key theme that Rodrik (2003) identified from a collection of analytical country narratives. That is, “Good institutions can be acquired, but doing so often requires experimentation, willingness to depart from orthodoxy, and attention to local conditions” (p. 12). Ignoring the role of local variation and institutional innovation would be adequate at best, and harmful at worse. Since institutional and governance shortcomings vary across national contexts, the focus of institutional reform agendas must be on the most binding local constraints.

This is closely related to the third theme identified by Rodrik (2003: 15): “The onset of economic growth does not require deep and extensive institutional reform.” According to conventional wisdom on institutional reforms, they have to be pursued simultaneously because they are complementary by nature. Fortunately, there are successful reform experiences that show otherwise; that is, kick-starting growth does not require an ambitious agenda of complementary institutional reforms. This has been the case in the People’s Republic of China and India, the world’s largest two developing economies, where modest changes in institutional arrangements and in official attitudes towards the economy have produced huge growth payoffs. Their experience also accords with the earlier point on focusing reform efforts on the most binding domestic constraint on growth. Thus, their “transitional institutions” are also very different.

Turning to the role of policy, it is also as important as institutions. Kolodko (2005) points out that it is not enough just to undertake market-economy institution building. Without confusing the means with the aims, the other necessary component is an appropriately designed and implemented economic policy. Even the best institutions will not automatically lead to good policy. Conversely, when there is a shortage of institutional capital, a policy will fail to better utilize existing social, human, financial and fixed capital. A dual approach is therefore necessary. The evolution of institutions must be kept on the desired path at all times, even as the process is facilitated for the moment by sensible policies to maintain momentum.

Rodrik et al. (2004) concurs with this point, arguing that the primacy of institutional quality in explaining income levels around the world does not signify policy ineffectiveness. They also note the murky distinction between institutions and policies. For instance, institutional reforms that were undertaken by Japan, the Republic of Korea, and People’s Republic of China could be characterized as “policy innovations that eventually resulted in a fundamental change in the institutional underpinning of their economies” (p. 156). To delineate the two, policies can be seen as a flow variable, and institutions as a stock variable; institutions then are the cumulative outcome of past policy actions. Quibria (2002; in Hasan et al., 2006: p. 3) defines institutions as encompassing “the formal and informal rules and customs within which individuals and firms operate,” and policies as “the various strategies and measures a government adopts to achieve its goals and objectives within a country’s institutional framework.” Viewed in this context, policies then become government’s instruments to change the “rules of the game.” Policies can therefore have a significant impact on a country’s institutions, which is what efforts at policy reform in developing countries are all about (Hasan et al., 2006).

Finally, Rodrik (2006) proposes a practical approach for formulating growth strategies consisting of three sequential elements: first, a diagnostic analysis must be undertaken to identify the most significant constraints on economic growth in a given setting; second, a creative and imaginative policy design needs to be formulated to suitably target the identified constraints; and third, the process of diagnosis and policy response must be institutionalized to make sure the economy remains dynamic and growth is sustained. The requirements for growth to be sustained should not be confused with the requirements to initiate it, since the nature of the binding constraint will expectedly change over time. If the concern of a policymaker is to ignite economic growth, targeting the most binding constraints on economic growth—where the return would be highest—may be better than investing scarce political and administrative capital on large-scale institutional reforms. It would be necessary to undertake institutional reform eventually to sustain economic growth. But doing that would be easier and more effective with an already growing economy, so its costs can be spread over time. Rodrik’s caution is against any obsession with comprehensive institutional reform that could lead to an overly ambitious policy agenda that is virtually impossible to fulfill.

B. Overview of the Philippines’ Institutional Quality and Economic Performance

In a collection of selected analytic country narratives that examined the respective roles of microeconomic and macroeconomic policies, institutions, political economy, and initial conditions in determining technological convergence and accumulation patterns, Rodrik (2003) questioned why the Philippines and Bolivia “continue to stagnate despite a sharp improvement in their ‘fundamentals’ since the 1980s” (p. 2). According to Pritchett (2003), the paradox is that the Philippines, whose policies and institutions best fit today’s conventional wisdom, is doing poorly. He then contrasts the Philippines to Vietnam, which has divergent institutions and yet is doing very well.

According to David (2004), “A strong republic is a political order that rests on strong institutions rather than on charismatic or benevolent leaders. It draws its life from the participation and submission to authority of mature citizens rather than from any ability to buy or coerce the loyalty of powerless subjects. It is a system of rational administration based on legal authority.” That is, modern governance is rule of law and not rule of the patron. Therein lies the root of the Philippine debacle.

Simply put, the Philippine state is weak. This stemmed from its lack of relative autonomy from the vested interests of dominant Filipino social classes, powerful political families and clans, an influential landed elite, and wealthy Filipino capitalists. 10 The result of a weak Philippine state was “politics of privilege” (Hutchcroft, 1997; in Banloi, 2004), a rent-seeking activity that causes corruption and mismanagement of the Philippine political economy.

Hutchroft (1998; in Banloi, 2004) describes this as “booty” or “crony” capitalism, in which private interests are pursued using public resources, and the apparatus of the state is exploited by economic and political oligarchs. Not surprisingly, a premature and weak Philippine state has produced weak institutions of governance. Weak institutions and governance structures, in turn, have contributed to the poor economic performance of the country, and its lagging behind its Southeast Asian neighbors.

Pritchett (2003) noted the dramatic improvement in Philippine institutions after Marcos. Elections are free and reasonably fair, and there are more civil rights and press freedom. These have presumably led to improved “transparency” and “accountability.” Then why is the Philippines’ per capita GDP lower than it was in the last “pre-crisis” year 1982? The democratic governments following Marcos have not only failed to achieve rapid growth like other economies in the region, but have failed to restore per capita output to levels prevailing during Marcos’ time. Lim and Pascual (2000) attribute this to the failure of post-Marcos regimes to qualitatively change state institutions and governance structures. There have been substantial improvements from the Marcos regime, but they did not explicitly deal with the institutions of governance and systemic roots of corruption and bureaucratic inefficiencies. Because the basic institutions and governance structures remained intact, patronage politics and clientelism were preserved.

While the state institutions and governance structures did not qualitatively change, Lim and Pascual (2000) noted that the post-Marcos governments significantly changed the economic program into domestic and external liberalization, deregulation and privatization under the aegis of the multilateral institutions. The aim was exactly to replace the state with the private sector and markets, thus reduce the state’s possible areas of intervention in the economy, and ultimately improve efficiency and productivity. But according to Lim and Pascual (2000), “The view that reducing the areas of state intervention, without initiating state and institutional reforms to reduce clientelism in governance structures, would at best be a valid short-term policy for a corrupt and inept state, … but would definitely fail in the medium and long term” (p. 13).

This is because economic liberalization demands more from the state: effective enforcement of property rights and contracts; ensuring competitive and fair market processes; market regulation to check socially undesirable activities (pollution, over-risky transactions, monopoly and predatory pricing, low quality and standards of goods, etc.); and to undertake or promote socially productive ones (infrastructure, access to quality education, research and development). The cooperation of more domestic and foreign players, who need to be convinced of fair play and adequate handling by the state of the macroeconomy, is also required under liberalization and deregulation. In the Philippine case, clientelism directly clashed with the post-Marcos governments’ economic thrust, and became a major stumbling block to the country’s economic development for the country. In particular, when the liberalization thrust of an economic sector went against vested interests, regulatory institutions became susceptible to reversals and flip-flopping of policies. When there is a high degree of arbitrariness in the political and legal spheres, instilling long-term investor confidence would be very difficult to achieve (Lim and Pascual, 2000).

De Dios and Hutchcroft (2003) also noted that the Philippines’ political system has not kept pace with the requirements of economic development. That is, the Philippines has not achieved the proper combination of political institutions to provide the required responsiveness to public interest on the one hand, and flexibility with respect to changing economic conditions on the other. That being said, they also point out that years of deregulation and liberalization have resulted in a more diversified economy and more participants in the policy arena. Large family conglomerates still exist and dominate the economy. However, monopolistic power has been tempered by external openness, which has provided a fairer and more even test for new entrants in various activities like manufactured exports and information technology.

The most recent economic reforms undertaken in the mid-1990s transformed important sectors of the economy, particularly the services sector (i.e., telecommunications, public utilities, transportation, and banking), and induced a stronger pro-market orientation among many leading members of the business community. However, the weak character of the political and institutional foundations upon which the program of liberalization rested has again been affirmed by subsequent experience, particularly under the Estrada administration, and some would argue under the Arroyo administration. Even a sound policy agenda promulgated at the national level is not sustainable without careful and sustained nurturing of the country’s institutional and political foundations (de Dios and Hutchcroft, 2003).

Pritchett (2003) concurs with the view that the post-Marcos governments have failed to create a credible alternative set of policies and institutions necessary to kick off a growth boom to a higher level of income. Pritchett further argues that, although there has been some improvement in institutional quality under democracy, there has also been an increase in “institutional uncertainty” (that is, the reliability with which economic actors can anticipate the rules of the game, whether those rules are considered good or bad). And it is this increase in institutional uncertainty that could account for the stagnation in the country’s output level. Thus, a fundamental roadblock to sustained economic growth is uncertainty over the rules of the game that accompanies comprehensive, but poorly managed, institutional change.

Indicators of institutional quality. The index published in Economic Freedom of the World (EFW) by the Frasier Institute measures the degree to which the policies and institutions of countries are supportive of economic freedom. The components of economic freedom include personal choice, voluntary exchange, freedom to compete, and security of privately owned property. The EFW index measures the degree of economic freedom present in five major areas: (1) size of government; (2) legal structure and security of property rights; (3) access to sound money; (4) freedom to trade internationally; and (5) regulation of credit, labor and business.

The five major areas are in turn composed of 21 components, which in turn are made up of several sub-components. Counting the various sub-components, the EFW index comprises 38 distinct pieces of data. Each component and sub-component is rated on a scale from 0 to 10 (a higher index value represents a better quality of institutions) that reflects the distribution of the underlying data. The component ratings within each area are averaged to derive ratings for each of the five areas. Finally, the summary rating is the average of the five area ratings. A chain-linked summary index is also constructed to allow comparison over time (Gwartney and Lawson, 2006).11

Figure 4 [ PDF 85.7KB | 1 pages ] shows the evolution of some institutional variables since 1970 in selected Association of Southeast Asian Nations (ASEAN) economies. In particular, it confirms the significant worsening of institutional quality in the Philippines during the 1970s under martial law; a reversal of trends with the restoration of democracy in the mid-1980s; and some weakening in recent years.

The Heritage Foundation/Wall Street Journal Index of Economic Freedom measures countries against a list of 50 independent variables divided into 10 broad factors of economic freedom: (i) trade policy, (ii) fiscal burden of government, (iii) government intervention in the economy, (iv) monetary policy, (v) capital flows and foreign investment, (vi) banking and finance, (vii) wages and prices, (viii) property rights, (ix) regulation, and (x) informal market activity.12 Each factor is graded according to a unique scale, which runs from 1 to 5: A score of 1 signifies an economic environment or set of policies that are most conducive to economic freedom, while a score of 5 signifies a set of policies that are least conducive to economic freedom.13 Finally, the 10 factors are added and averaged, and an overall score is assigned to a country. The index is available from 1995 (Miles et al., 2006).

Table 12 [ PDF 93.9KB | 1 pages ] shows the scores of selected ASEAN economies in 2006. In particular, the Philippines scored poorly with respect to property rights and regulation. The variables for property rights included: freedom from government influence over the judicial system, commercial code defining contracts, sanctioning of foreign arbitration of contract disputes, government expropriation of property, corruption within the judiciary, delays in receiving judicial decisions and/or enforcement, and legally granted and protected private property. A score of 4 indicates a low level of protection; i.e., property ownership weakly is protected; court system is inefficient; corruption is present; judiciary is influenced by other branches of government; and expropriation possible.

The report noted the Philippines’ “slow judicial system, hampered by lack of funding and an insufficient number of judges to handle court cases … and a series of contract reversals” (p. 320) especially from 2002 that further undermined the security of contractual arrangements. Both are viewed as serious disincentives to foreign investment. Also, its 2006 score represented a worsening compared to its 1995 score of 3.

The variables for regulation included: licensing requirements to operate a business; ease of obtaining a business license; corruption within the bureaucracy; labor regulations, such as established workweeks, paid vacations, and parental leave, as well as selected labor regulations; environmental, consumer safety, and worker health regulations; and regulations that impose a burden on business. A score of 4 indicates a high level of regulatory burden; i.e., highly complicated licensing procedures; regulations impose heavy burden on business; existing regulations applied haphazardly and in some instances are not even published by the government; corruption present and poses a substantial burden on businesses. In particular, the report noted the lack of transparency and haphazard enforcement of regulations by the country’s regulatory agencies, extensive bureaucratic corruption. There has been no improvement in the country’s score since 1995.

Finally, the World Bank also estimates worldwide governance indicators, which measure six dimensions of governance (Kaufmann et al., 2006):

  1. Voice and accountability, the extent to which a country’s citizens are able to participate in selecting their government, as well as freedom of expression, freedom of association, and free media;
  2. Political stability and absence of violence, perceptions of the likelihood that the government will be destabilized or overthrown by unconstitutional or violent means, including political violence and terrorism;
  3. Government effectiveness, the quality of public services, the quality of the civil service and the degree of its independence from political pressures, the quality of policy formulation and implementation, and the credibility of the government’s commitment to such policies;
  4. Regulatory quality, the ability of the government to formulate and implement sound policies and regulations that permit and promote private sector development;
  5. Rule of law, the extent to which agents have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, the police, and the courts, as well as the likelihood of crime and violence; and
  6. Control of corruption, the extent to which public power is exercised for private gain, including both petty and grand forms of corruption, as well as “capture” of the state by elites and private interests; voice and accountability, political stability and absence of violence, government effectiveness, regulatory quality, rule of law, and control of corruption.

The indicators are based on a large number of individual data sources that provide information on perceptions of governance. These data sources consist of surveys of firms and individuals, as well as the assessments of commercial risk rating agencies, non- governmental organizations, and a number of multilateral aid agencies.14 The six governance indicators are measured in units ranging from about -2.5 to 2.5, with higher values corresponding to better governance outcomes. Figure 5 [ PDF 76.9KB | 1 pages ] shows the average of the six governance indicators for the ASEAN economies from 1996 to 2005. Again, the figure confirms some weakening in the Philippines’ institutional quality in recent years.

Overall, the different institutional indicators show a positive relationship between economic performance and institutional quality in the ASEAN member countries. That is, the countries that have been doing well economically are also the ones that scored well in terms of institutional quality (e.g., Singapore, Malaysia, and Thailand). Also, it is noteworthy how Viet Nam has come close to, and even exceeded at times, the Philippine scores.

Therefore, de Dios and Hutchcroft (2003) argue that the most fundamental need in the Philippines is to improve the overall performance of government, insulate it from the plunder of oligarchic groups, and promote new types of private sector initiative. In particular, sustained economic growth requires significantly improving the quality of the bureaucracy. It is probably unlikely for the Philippine bureaucracy to achieve for instance Singapore’s level of coherence and capacity. But even incremental changes can enhance provision of the basic legal and administrative underpinnings necessary for the effective functioning of markets. In any institution building program, it is particularly important to concentrate on the enhancement of key agencies’ administrative capacity, including the new Central Bank, the Securities and Exchange Commission, and the Bureau of Internal Revenue. To date, economic reform efforts that merely remove restrictions on competition have been the most successful. Initiatives that would require sustained administrative capacity are more complex. For instance, simply liberalizing the banking sector does not resolve ongoing deficiencies in regulatory capacity. More generally, broader programs of economic reform do not obviate the need to address other political and institutional problems (de Dios and Hutchcroft, 2003).

Institutions can also be characterized according to the economic roles they perform. In particular, Tavares (2002) identified three different areas of institutional development, which affect the growth of an economy—the legal system, the governance of the firm and financial markets. The next subsection presents a broad diagnostic of the level of institutional development of financial markets and economic performance.

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