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date: 24 February 2020

Institutions and Development: An Overview of Case Studies in China and India

Summary and Keywords

In contrast with the existing cross-country literature on institutions and development the overview in this article focuses instead on case studies of institutions at the disaggregated level that help or hinder productivity growth. It also shows how along with rule-based systems institutional systems based on social relations and networks and community organizations can resolve some issues of collective action in development. At the level of the state, our discussion focuses on incentive issues in the internal organization of government and how the nature of accountability structures at different levels of government can help or hinder development. In view of the breadth of the relevant literature we have deliberately confined ourselves to the available empirical case studies in only the two largest developing countries, China and India.

Keywords: rules, institutions, land tenure, relation-based, governance

Domain of Discussion

Institutions are commonly defined, following North (1990) as the rules of the game that societies play, which according to a shared understanding, act as constraints on and guidelines for economic performance. While keeping mainly to this definition, the taxonomic domain can be expanded somewhat to include a slightly larger field.

While keeping to the analogy of games, one can distinguish between

  1. a) the overall game context (i.e., systemic issues, or the question of which game we are talking about),

  2. b) the rules of the game, both formal and informal, and

  3. c) various moves in the game (such as policies) that are allowed within a set of given rules.

As regards (a), the main context in the discussion will be the capitalist framework, even though some precapitalist and state-socialist forms may sometimes hover in the background. As regards (c) policies are, of course, different from institutions, but sometimes policies push the boundaries of the game and accumulated policy experience can contribute to how the institutional rules are shaped.

The main research questions discussed in the general literature on institutions and development have concentrated on the aggregative effects of property-rights regimes on productivity and growth, and on the political-legal mechanisms of credible commitments for securing property rights and enforcing contracts. In this article we also discuss, apart from those issues, alternative social, and sometimes informal, mechanisms for ensuring predictable production relations, particularly those at the disaggregated level, which can be conducive to development. In addition we discuss the development impact of internal organization of government at different levels of centralization and how governance mechanisms are sometimes distorted or abused in ways that hurt development.

History of Thought Issues

Much of the recent institutional economics literature starts with North (1990), or at most with Williamson (1985), which of course entails ignoring a long tradition of institutionalist literature going all the way back to:

  • the German Historical School in the latter part of the 19th century,

  • the role played by Marxist economics (as a major discourse on how economic institutions—“relations of production”—are shaped by technology—“forces of production”—and changed by collective action –“class struggle”), and

  • the American institutionalists (like Veblen) of the early part of the 20th century.

In the field of development economics, most discussion of institutions these days also starts with North, and then jumps to the cross-country empirical literature, the most widely cited of which is Acemoglu, Johnson, and Robinson (2001).

Professional memory or attention span in economics is always rather short, but most remarkably so in this case, as North (1990) was immediately preceded by at least two decades of vigorous economic analysis of institutions in developing countries at the micro-level, and particularly of how they affect productivity and how some dysfunctional institutions persist.

This started with the literature on the age-old institution of sharecropping in the early 1970s, followed by a proliferation of analyses of institutional arrangements in rural land, labor, credit, insurance, and some general interlinked markets. By the early 1990s two multiauthored volumes of essays on rural institutions, edited by Bardhan (1989) and by Hoff, Braverman, and Stiglitz (1993), had put together and expanded on the results of the rich literature on rural institutions in developing countries that had come up in the preceding two decades. Another collection of essays, edited by Nabli and Nugent (1989), applied transaction cost analysis to an understanding of rural and urban institutions in Tunisia. There was also a 1989 symposium on institutions and development edited by Adelman and Thorbecke for World Development.

There is hardly any trace of this literature in the recent outpourings on the institutional economics of development. Even a relatively recent survey article by Pande and Udry (2005) which starts from the cross-country literature and then moves on to their micro “view from below” almost completely ignores the existence of the micro literature of just two or three decades back.

Three Types of Institutional Case Studies

For at least the first two decades of this century it has been widely recognized that the vast macro-economic empirical literature on institutions on the basis of cross-country regressions is seriously flawed, largely on account of unobserved heterogeneity, use of necessarily coarse instrument variables, and poor data quality and cross-country comparability. Besides, as Pande and Udry (2005) point out, the cross-country empirical strategy usually cannot disentangle the specific institutional channels through which an outcome is affected, or the impact of institutional or historical changes on it.

This article moves entirely away from the cross-country regressions literature, and mainly discusses empirical case studies on institutions and development. As such studies are now numerous across the globe, it confines itself to an overview of case studies from the two largest developing countries, China and India. It is not, however, a comparative study of the two countries, as in Bardhan (2013), but an account of case studies in these two large countries taken mostly separately and independently. Even in this circumscribed field it deals primarily with institutions at three levels:

  • the micro-level of the individual household or farm or firm

  • the meso-level of a community or social network, and

  • at a somewhat higher level of governance institutions.

The institutional literature (part-theoretical, part-descriptive, and part-econometric) covering different aspects at these three levels is large, but here the article will mainly mention topics in cases where there are some empirical case studies relating to China and India, largely bypassing the theoretical literature, as well as areas on which there has not been many empirical studies.1 Also, it obviously confines itself to institutions that have major economic consequences, leaving aside many primarily social and political institutions.

Micro-Level Institutions

The empirical literature at the micro-level mainly involves institutions in the factor markets, particularly property rights relating to land and relational arrangements in labor and other interlinked markets. Most of the questions asked were either about the determinants or the consequences of particular institutions. On determinants, the discussion here will focus particularly on three cases of micro institutions: (a) agricultural tenancy, (b) labor-tying in the employer–employee relation, and (c) interlinkage of relations in factor markets.

Incidence of Land-Lease Tenancy Across Farmer Households

On the basis of disaggregated National Sample Survey (NSS) data, Bardhan (1984) shows that the incidence of tenancy across cultivator households in rural West Bengal varies positively with access to irrigation and endowment of family labor for the household, and with the amount of normal rainfall in the district, and negatively with some index of production uncertainty (measured by yield variability around the trend line in the whole district).

On the basis of Farm Management Survey data for the district of Hooghly in West Bengal, Bardhan (1984) shows that across farms, again the incidence of tenancy varies positively with irrigation and endowment of family labor, and also with ownership of bullock labor, for which data were available for this sample of farms.

Labor-Tying as an Institution Structuring Employer–Employee Relations

A historically important agrarian institution has been the case of long-term labor relations or contracts, whereby the worker is tied to a particular employer for a relatively long period of time; the standard cases are those of labor contracts for a year or a season, but with extreme cases bordering on debt-bondage.2 Such workers have coexisted with more casual, day laborers for many decades in India. For alternative theoretical explanations of the institution in situations of voluntary contracts, see Bardhan (1983), Eswaran and Kotwal (1985), Mukherjee and Ray (1995), and Caselli (1997). Bardhan (1983) has also analyzed the variations of the incidence of such long-term “attached” labor across agro-climatic regions in India from Agricultural Labor Enquiry and also National Sample Survey data in rural India, and also across labor households in West Bengal. It is shown that the incidence of attached labor varies positively with indicators of labor scarcity, seasonal peaks of wages, land concentration, employer-provided credit, and in general with better irrigation and rainfall in the area.

Interlinkage of Land, Labor, and Credit Relations

In traditional agriculture there are often cases of landlord–tenant relations being intertwined with creditor–borrower relations existing between the same parties, or of employers hiring workers on terms that are interlocked with those on which the former provide credit (or land) to the latter. See Bardhan and Rudra (1978, 1981) for case studies of such interlinkage in a sample of 110 villages in West Bengal. Drawing upon the literature on interlinked markets, Wang (2006) shows that such preexisting interlinked relational contracts played an important role in the gradualist economic transition in China in the 1980s. For an overview of the theoretical analysis of the emergence and persistence of such interlinked relations when markets (particularly of credit) are imperfect or nonexistent, see Bell (1988), Bardhan (1989), and Bardhan and Udry (1999).

We shall now move on to the consequences of agrarian institutions. Three kinds of consequences will be discussed: (i) those of sharecropping in India, and land reforms aimed at reducing the tenurial insecurity associated with this; (ii) those of the transition in China to private land-cultivation rights, albeit with considerable restrictions on security of tenure and on the operation of the land-rental markets; and (iii) on how some of the effects of tenurial arrangements last until long after the original formal arrangements have been discontinued.

Impact of the Institution of Sharecropping on Farm Productivity

Bell (1977), in his sample of farmers in Purnea district in Bihar, and Shaban (1987) using International Crops Research Institute for the Semi-Arid Tropics (ICRISAT) farm-level data in the semi-arid areas of Deccan Plateau, compared output and inputs between owned and sharecropped land plots on the same farms, and found some inefficiency of resource use in sharecropping. Bell contrasts his findings with those of Cheung (1969) for pre-war China.

Banerjee, Gertler, and Ghatak (2002) and Bardhan and Mookherjee (2011) have studied the impact of the protection of sharecropper rights against eviction by landlords in West Bengal. The former worked with district-level data, and their results show that the tenancy-reform program, which consisted of registration of the tenant’s rights, thereby enhancing security of tenure and improving the tenant’s output share, had a substantial positive effect on rice productivity. Banerjee et al paper ends by saying that given the aggregative nature of their data (for a whole district) they could not separate the direct and indirect effects of the reform. The latter paper by Bardhan and Mookherjee (2011), with more micro farm-level panel data collected by means of a farm-management type survey from 90 sample villages over the period 1982–1995, is able to do this, however, and shows, even after controlling for endogeneity of program implementation, a significant positive impact of the reform on farm productivity. However, some of the productivity effects of other ongoing programs (like those of subsidized agricultural inputs by the local village government) were shown to be much greater.

Effects of Property Rights Institutions in a Transition Economy

Lin (1992) uses province-level panel data in China to show that de-collectivization of agriculture after 1978 and granting of land-use rights to farmers under the household responsibility system led to a substantial improvement in factor productivity.

Since an individual farmer’s land can be administratively reallocated in Chinese villages, there is tenurial insecurity. Using a hazard model, Jacoby, Li, and Rozelle (2002) estimate an exogenous risk of land expropriation from plot-tenure data in 31 villages in northeast China. They find that in villages with higher expropriation risk, there is less investment in use of organic fertilizers (which, more than chemical fertilizers, have long-lasting effects on soil quality). But these effects are not quantitatively large in this part of China.

While a land-rental market is growing in China, there are still many restrictions and transaction costs associated with renting. Using panel data from 110 villages in three of China’s poorest provinces, Deininger and Jin (2005) show how land-rental markets can have greater productivity-enhancing effects than the usual administrative reallocation of land. There is also some evidence that market transactions transfer land to those with lower initial endowments, suggesting that land-rental markets may not leave out the poor.

Historical Legacy of Land-Tenure Systems

Banerjee and Iyer (2005) show the long-lasting effects of different land tenure systems in India in the British colonial period. Areas under a landlord-based land tenure system have significantly lower agricultural investments and productivity, compared to areas where control rights in land were with cultivators. The former also lagged in provision of public goods (like schools and roads). These effects have persisted even four decades after the end of colonial rule and three decades after the abolition of the landlord-based system.

Besley, Leight, Pande, and Rao (2016), exploiting the quasi-random assignment of linguistically similar areas to different South Indian states that subsequently varied in tenancy regulation policies, find that thirty years after the tenancy reforms, land inequality is lower in areas that saw a greater intensity of reform, but the impact differs across caste groups.

So far we have looked at case studies in India and China that focus on the determinants of some agrarian institutions and their consequences. But one general question is: in cases where the consequences are negative should they not, over time, interfere with the determinants? In other words, if an institution is dysfunctional, why does it persist?

The theoretical literature on sharecropping discusses why this ancient agrarian institution survives in spite of its adverse effects on productivity (particularly in the context of credit-market imperfections and the need for risk-sharing), but there is not much empirical literature on this. Similarly, the literature on interlinkage of relations shows that it can act as a barrier to entry for unlinked parties, but where there are imperfections, particularly in the credit market, interlinkage does serve a purpose under the constrained circumstances.

Meso-Level Institutions

Above the micro-level of firms or farms there are community institutions which can have substantial effects on economic performance. Keeping to cases where empirical studies are available, three types of such institutions will be discussed: (1) business group institutions, (2) social networks, and (3) rural, often informal, organizations for the management of the local commons (like irrigation, fisheries, forests, and grazing lands).

Relation-Based Business Institutions

China and India have a long history of indigenous mercantile institutions of trust and commitment, based on multilateral reputation mechanisms and informal codes of conduct and enforcement. Some of these institutions have been in regular use in long-distance trade and credit.

Many business historians—some of them referred to in the recent account by Greif and Tabellini (2015)—have shown how clan- and lineage-based institutions in China have for centuries substituted for weak formal institutions, resolved private disputes, and provided local public goods and services and mutual-aid arrangements. Even in the last three decades, after economic reform started in the 1990s allowing private firms to thrive, what Nee and Opper (2012) have documented and described as “capitalism from below” is based in general on guanxi relations and intra-clan help in finance, and protection of property rights from official predation. Allen, Qian and Qian (2005), on the basis of a survey of 17 firms in Zhejiang and Jiangsu provinces, have shown how in contrast to that for state enterprises, the much higher growth of private firms has been supported by alternative financing channels and governance mechanisms, such as those based on reputation and community relationships.

In precolonial India Bayly (1983) cites many cases of caste-based (and sometimes even multi-caste) mercantile associations and panchayats (or local tribunals or arbitration panels), which respectively acted much like the merchant guilds and the law-merchant system of medieval Europe in a vigorous and far-flung mercantile economy. Credit instruments like the hundi (or bills of exchange), even though their negotiability was not always recognized in formal courts of law (in British India) governed trade across thousands of miles. Firms kept lists of creditable merchants whose credit notes—sahajog hundi’s—could expect a rapid discount in the bazaar. While Bayly writes about community institutions that flourished primarily around the so-called burgher cities of Allahabad and Benares in precolonial north India, Rudner (1994) studies the south Indian caste-based mercantile organization of the Nattukottai Chettiars in the colonial period, whose elaborate system of hundi’s over long distances (with the caste elite firms or adathis acting as the clearing houses), collective decisions on standardization of interest rates, and caste panchayats with customary sanctions provided the basis of indigenous banking networks spread across large swathes of south India and British southeast Asia.

In clan- and other community-based organizations, goal congruence (and thus low opportunism) is achieved through various processes of socialization; performance evaluation takes place through the kind of subtle reading of signals that are observable by other clan members but not verifiable by a third-party authority. Punishment for breach of implicit contracts is usually through social sanctions and reputation mechanisms. Clan-based organizations are also characterized by more flexibility and ease of renegotiation than more impersonal and formal organizations.

On the other hand, informal community- or family-based business arrangements are constrained by too much reliance on centralized decision-making and control, internal finance, a small pool of managerial talent to draw on, a relatively small scale of operations, and in the case of large organizations, a tendency to subdivide into more or less separate units, each with its own products and markets. A major problem of such community-based enforcement is that the boundaries of the community within which rewards and punishment are practiced may not be the most efficient ones and therefore may inhibit potentially profitable transactions with people outside the community. So as the scale of economic activity expands, as the need for external finance and managerial talent becomes imperative, and large sunk investments increase the temptation of one party to renege, relational implicit contracts and reputational incentives become weaker. As Li (2003) has pointed out, relation-based systems of governance may have low fixed costs (given the preexisting social relationships among the parties and the avoidance of the elaborate legal-juridical costs, public information costs, and verification costs of more rule-based systems), but may have high and rising marginal costs (particularly of private monitoring) as business expansion involves successively weaker relational links. The latter effect will be stronger in more contract-intensive activities. Amirapu (2015) provides evidence from India that more efficiently functioning formal judicial institutions (as measured by state-level variations in the speed of courts) significantly determine growth among private manufacturing firms, particularly in more contract-intensive industries.

The tension between information, transaction cost, and coinsurance advantages of relation-based systems and the scale economies and transparency and mitigation of collusiveness advantage of formal rule-based systems is reflected in the business group literature for the corporate sector. Bertrand, Mehta, and Mullainathan (2002) give evidence of “tunneling” of value and abuse of minority-shareholder interests in pyramidal business groups in India. Khanna and Yafeh (2007), on the other hand, discuss some advantages of diversified business groups in the context of weak legal and judicial systems and imperfections of both capital and labor markets.

Fisman and Wang (2010) point to reduction of transaction costs and risks in business groups in Chinese listed firms. With data from over 10,000 of the largest domestic companies in India for the period 1998–2008, Kolasa (2013) shows that in industries where relationship-specific inputs are used extensively, membership of a business group helped firms overcome the market imperfections associated with a poor legal environment.

Social Insurance and Information Networks

Caste, or more particularly, the subcaste or jati, has been historically the most important social network in India in the context of support in the face of all kinds of risks in Indian villages. Munshi and Rosenzweig (2009) provide quantitative evidence on the basis of National Council of Applied Economic Research (NCAER) data that caste is the most important source of financial support, more important than banks or moneylenders, for major events such as illness and marriage, as well as for consumption-smoothing in rural India. Mazzocco and Saini (2012), using the ICRISAT data set, conclude that the caste rather than the village is the social unit around which insurance is organized in rural India. Even in urban India, chain migration from villages and job referrals (particularly in traditional blue-collar occupations) function on the basis of caste networks—Munshi and Rosenzweig (2006) provide evidence for this from their survey in Mumbai.

Based on detailed demographic and social network data from 43 villages in south India, Banerjee, Chandrasekhar, Duflo, and Jackson (2013) show how a microfinance program diffuses significantly through social networks. Cai, de Janvry, and Sadoulet (2015), using data from a randomized experiment involving 5300 households across 185 villages in China, study the influence of social networks on weather-insurance adoption for rice farmers and the mechanisms through which they operate; in particular, networks are found to effectively transfer information about the functions and benefits of insurance.

Institutions for Local Commons Management

Baland, Bardhan, Mookherjee, and Das (2010) assess the degradation of forests managed by local communities (Van Panchayats, VPs [local forest councils]), relative to state-protected and open-access forests in the Indian state of Uttaranchal. The study is based on ground-level ecological measures of forest quality (including canopy cover, biomass, lopping, and regeneration) in forest areas adjoining a random sample of 83 villages covering the entire mid-Himalayan region in the state. It controls for unobserved village heterogeneity, possible endogeneity of management regimes, and cross-forest spillovers. Controlling for these factors, VP forests are found to be 20–30% less lopped, and similar on other dimensions. The lopping differences are greater the longer the forest has been under a VP. The results are, of course, consistent with the hypothesis that more degraded forests are more likely to be converted to a VP forest. They indicate the importance of recognizing the potential endogeneity of forest type, and attempting to understand the process by which forests are transferred to VPs. The evidence suggests that local communities are more motivated to form a VP and manage forest areas under their control more effectively when these forests are more valuable to them and have become degraded. The bias that results from failing to incorporate this source of endogeneity involves significant underestimation of the benefits of VP management when forest quality is compared across VP and non-VP forest areas without controlling for the relevant characteristics of these forests and the local community.

The history of local community-level institutions for cooperation in water management in India is rather mixed. There are several documented examples of successful local community water management (although usually at a rather low level of organizational form) in different parts of the country, some of them going back many hundreds of years back in history and which still survive, but there are also numerous cases of failure of institutions of cooperation, leading sometimes to an anarchical scramble for water. There are not too many quantitative studies of the determinants of such success or failure. Bardhan (2000) is one such study, which looks into the determinants of cooperation in resolving water conflicts in irrigation communities, drawing upon a primary survey of 48 villages spread over 6 districts in Tamil Nadu. The study suggests that cooperative behavior in an irrigation community is by and large significantly related (negatively) to inequality of landholding, to urban or market connections (providing an exit option), and (positively) to duration of access to water, monitoring by guards, and in some cases to social homogeneity, small group size, proportional cost-sharing rule, and collective adversarial relations with other villages over water. When the rules are crafted by the village elite, the latter violate the water allocation rules less; otherwise the elite is the more frequent violator of rules. Sometimes, when inflexible rules are made or enforced by the government, their violations are not necessarily inconsistent with cooperative behavior among farmers themselves. When an average farmer believes that the water rules have been crafted jointly (as opposed to by the elite or by the government) he is more likely to have a positive view of the water-allocation system and about rule compliance by other farmers.

Broadly similar results are available from a study of irrigation management in rural Yunnan in China. Ito (2012), using data collected from 104 communities, shows that collective action is forthcoming in rural communities when few nonfarm job opportunities are available, the degree of income disparity is quite small, and resource restrictions are moderately problematic. Communities without local government intervention seem to outperform those with intervention. For a similar finding from canal irrigation in India, see Meinzen-Dick, Raju, and Gulati (2002).

Macro-Level Governance Institutions

Governance institutions are very old in both countries. But the nature of their functioning and their built-in organizational features and incentives are different in many ways, and they have differential effects independent of those following from the obvious regime-type differences (one being a democracy, the other not). This article can only discuss aspects of governance for which there are empirical case studies in either country. In particular it takes up three of these aspects, related to internal organization of the bureaucracy, accountability structure and devolution of power, and the problem of abuse of governance institutions giving rise to corruption that has been an ancient bane of governance in both countries, and the organizational incentive issues involved.

Career Incentives in Government Organizations

The Chinese system of bureaucratic promotion, unlike the Indian (which is based more on seniority than on performance), gives considerable weight to the performance of the local economy that the official is in charge of (along with the maintenance of political “stability” in the area), thus combining political centralization with local bureaucratic performance incentives. Jia, Kudamatsu, and Seim (2015) use data from the CVs of political leaders in China between 1993 and 2009 to show the interesting complementary roles of political patronage connection and local growth performance in the promotion of provincial leaders. This complementarity is found to be stronger the younger the provincial leaders are, relative to their connected top leaders. But while connections with their patron/mentors increases the likelihood of promotion, provincial leaders with weak local economic performance are unlikely to be promoted. The Chinese system thus allows for a rather rare combination of political loyalty and meritocracy.

Landry, Lu, and Duan (2017) using a comprehensive panel data set of provincial, prefectural, and county-level Communist party secretaries and government executives appointed between 1999 and 2007, bring out a nuanced feature of this rare combination. They find that the link between economic performance—GDP and revenue growth—and promotion is the strongest for county officials, significant for municipal officials, and insignificant for provincial officials. This suggests that a minimal level of competence is required for lower-level officials. After several rounds of mainly merit-based selection, even when political loyalty may predominate in higher-level promotions, they do not sacrifice too much on competence of the official. This feature of what Yao (2017) calls an encompassing “selectocracy,” with institutionalized procedures of selection and promotion with a long-term horizon, distinguishes China from most other non-democracies.

There are also quid pro quo transactions in some of those promotions. Using data for over a million land transactions during the period 2004–2016, Chen and Kung (2019) have recently shown that provincial Party secretaries, when selling local government land, gave firms linked with Politburo members nearly 60% price discounts compared to others, and in return such discount-givers were estimated to be 23% more likely to be promoted to positions of national leadership—in general, the larger the discount, the higher the chance of promotion. The recent anti-corruption crackdowns have somewhat reduced the incidence of such promotions.

In India the autonomy of a meritocratically recruited bureaucracy is often eroded by politicians through discretionary transfers and promotion of officers. Using the career histories of 2800 officers in the Indian Administrative Services between 1980 and 2004, Iyer and Mani (2012) have produced evidence on the use of manipulative transfers of officers. The study showed that over their entire career, officers of high initial ability are no more likely to be assigned to important posts than other (loyal) officers. This also means that junior officers underinvest in acquiring expertise. A randomized experimental study in the police department in Rajasthan, India by Banerjee et al. (2014) showed that a freeze on the transfer of police staff increased police effectiveness.

Decentralization and Structures of Local Accountability of Government

The general literature has been surveyed in Bardhan (2002), Mansuri and Rao (2013), Bardhan and Mookherjee (2015), and Mookherjee (2015). This article takes up only some of the selected key issues, with respect to China and India.

Decentralized delivery of public services has been advocated in order to promote better utilization of local information. A growing literature has, however, pointed to the problem of capture of local governments by the elite (including officials and intermediaries) and the frequent diversion of benefits and resources to nontarget groups. Kochar (2008) shows evidence gathered from NCAER data on rural India of how landed elites, whose profits are reduced by the schooling of the poor, have blocked investment in local public education. Anderson, Francois, and Kotwal (2015) from their survey data in rural Maharashtra show how the landed elites undermine pro-poor government programs. In rural West Bengal, where some degree of land reform had been successfully carried out, Bardhan and Mookherjee (2006) found that intra-village services delivered by local governments were relatively pro-poor, but in allocations of funds from higher-level government, poorer jurisdictions suffered in general.

The empirical literature suggests that the preconditions of local capture depend on

  • degree of initial social and economic inequality in the local area (hence the importance of redistributive measures like land reforms and expansion of mass literacy),

  • degree of political competition in the area,

  • how regular and well-functioning the deliberative processes of local democracy are (public hearings, village council meetings, etc.)—see, for example, Besley, Pande, and Rao (2005, 2012) for South Indian villages,

  • how free the flow of information is in terms of the functioning of governments and in terms of entitlements and allocations at the local level—here the importance of information campaigns (and media exposure) about resources allocated to local governments, and how they have been spent and audited (if there are provisions of periodic independent audits of accounts), is clear. Banerjee et al. (2011) carried out experiments among slum residents in Delhi to which showed that when they were provided with citizen report cards (evaluating legislator performance and characteristics), this improved the vote shares of better-performing incumbent politicians.

Even when public services are delivered to poor people, decentralization sometimes degenerates into political clientelism by which some underprivileged beneficiaries are selected with a view to political support in exchange, at the expense of other poor potential beneficiaries or other long-term investments in public goods. This is explored further in a Bardhan–Mookherjee overview on clientelism.

Attempts at mitigation of the effects of elite capture have included political reservation of seats at local councils and their headships for disadvantaged social groups—such as mandatory posts for lower castes, tribes, and women in India. The empirical literature on the impact of this practice on targeting of benefits began with Chattopadhyay and Duflo (2004), which found significant positive effects when the position of village council head was reserved for a woman. The subsequent literature, including our own work—see Bardhan, Mookherjee, and Parra Torrado (2010) and the literature cited there—has not confirmed the effectiveness of this in the case of women, although there is evidence that political reservation for some ethnic minority groups improves the targeting of some benefits.

Of course, apart from immediate benefit-targeting, the more important consideration may be that political reservation may have positive effects in terms of empowering and confidence-building potential leaders from disadvantaged groups over a longer period, and this has been shown to be the case for women in the study by Beaman, Chattopadhyay, Duflo, Pande, and Topalova (2009). The way to reconcile the apparently contrasting empirical findings in this literature may be to recognize the initial handicaps that leaders from disadvantaged groups in reserved positions suffer from, particularly in terms of information, networks, contacts with higher-up authorities, and administrative experience; in all of these areas, the leaders may gain strength over time and generate self-confidence in their leadership (and the confidence of others in that leadership).

In China, decentralization has been used not just for delivery of public services but also for local business development. Jin, Qian, and Weingast (2005) use data for the period 1982–1992 for approximately 30 provinces to show that fiscal decentralization was positively related to growth of per capita regional GDP and other economic outcomes. This indicates the positive incentives of decentralization, as local governments were allowed to retain a higher fraction of tax revenues collected, whereas competitive pressures from businesses in other localities acted as a check on rent extractions.

Compared to decentralization in India, Chinese decentralization has involved better modes of management of infrastructure financing and construction. In China, urban infrastructure is constructed, operated, and maintained by separate companies set up by the city government, whereas in India the municipal government itself does this through its own departments. The latter are financially strapped, as they do not have much taxation power and are perpetually dependent on the state government for funds. In general the fiscal system is much more decentralized in China, where sub-provincial levels of government tend to spend nearly 60% of total government expenditure, compared to less than 10% in India.

But jurisdictional competition of business and mobile resources have not been enough to prevent local elite capture in China. China’s more egalitarian land-use rights distribution since de-collectivization may have prevented the rise of a landed oligarchy of the type that has often captured local governments in parts of rural India. But in recent years Chinese local business in collusion with local officials has been at the root of problems of arbitrary land acquisition, toxic pollution, and violation of safety standards in factories and mines. (Incidentally, Chinese coal-mine death rates are reported to be 15 times higher than those in India.)

On the basis of provincial-level panel data on key state coal mines in China from 1995 to 2005, Jia and Nie (2015) provide evidence that decentralization makes collusion between official regulators and firms more likely (in the Chinese media such collusion is called guan-mei goujie) and is correlated with increases in coal-mine fatality rates. This is also consistent with the general finding of Fisman and Wang (2015) that politically connected firms in China have higher rates of workplace fatalities, based on firm-level data collected from different industries between 2008 and 2011. (While Jia and Nie focus on the characteristics of regulators, Fisman and Wang focus on those of firms.) There is also suggestive evidence in the Jia and Nie paper that media exposure can act as a deterrent against collusion. Martinez-Bravo, Padró i Mique, Qian, and Yao (2014) provide evidence, on the basis of village panel data, that local officials are better controlled by local elections than by central monitoring.

Abuse of Governance Institutions: Corruption

Types of Corruption

  • Facilitating corruption—an example of this is “speed money”—the standard kind of corruption whereby an official is paid to “speed up” the processing of the payer’s file. This means that, effectively, one pays the official to do what they were supposed to do anyway.

  • Collusive corruption—whereby an official is paid to do what they are not supposed to do, that is, the official connives at or looks the other way when goods are smuggled, taxes are evaded, income or property value is under-assessed, driver’s licences or other kinds of government-issued certificates are given to unqualified people, bids in public auctions are rigged, lower-quality materials are substituted in government procurement, and so on.

These cases involve collusion between the bribe-giver and the bribe-taker in order to evade laws, and both parties gain, thus neither is likely to report this to investigators.

Case-Study Examples

Bertrand, Djankov, Hanna, and Mullainathan (2007) followed 822 applicants for driver’s licenses in Delhi and carried out some experiments. Seventy-one percent of those who got the license had not taken the driving test, and 62% of them had failed an independent driving test. The dangerous consequences for society of this kind of corruption are obvious.

Niehaus, Attanassova, Bertrand, and Mullainathan (2013) carried out a survey of 14,074 households in rural Karnataka to find out about the process of obtaining a below-poverty-line (BPL) card which renders the cardholder eligible for many of the public benefits targeted at the poor. They found that 70% of BPL cardholders were actually ineligible according to the official criteria, and 13% of eligible households did not have the card. Such corruption leads to large leakages in programs meant for the poor.

Lewis-Faupel, Neggers, Olken, and Pande (2016), drawing on a random sample of road contracts issued by the state of Uttar Pradesh, India, find that in most cases corrupt officials rig the procurement process to favor a predetermined winner of the bid.

Cai, Henderson, and Zhang (2009) show how certain types of land auctions in China are subject to collusion between the auctioneers and participants.

Fisman and Wei (2004) investigated tax evasion and found that the gap between reported exports from Hong Kong and the corresponding reported imports into China is increasing in tariff rates.

Fisman and Wang (2014) detected corruption in state asset sales by comparing the prices of publicly traded assets to those of non-publicly traded assets.

Bureaucratic Versus Political Corruption

Ignoring the Chinese case whereby the distinction between an administrator and a Party official is often blurred, and the cases in many countries of collusion between administrators and politicians, it may be possible in some cases to distinguish between two types of corruption. Some economists have also made a related distinction between “petty” and “grand” corruption, the latter usually involving at least the complicity of politicians, while much of the economic literature is preoccupied with the former, which is mostly associated with day-to-day administrative transactions with bureaucrats.

In India there is some circumstantial evidence—reported in Sukhtankar and Vaishnav (2015)— that in more developed regions, as large rental opportunities open up (say in infrastructure and construction), the importance of old-style petty corruption in the regular delivery of social services declines. From conversations with builders in Gujarat and Maharashtra they also find that in building contracts compensation for favorable decisions is often demanded by officials and politicians in the form not of cash bribes, but equity stakes in the new projects.

By all accounts, illicit financing of the increasingly expensive elections in India is often found to be at the root of grand corruption. The Association of Democratic Reforms reported that in 2014, 70% of the income of India’s six major political parties came from undocumented sources. Rent extraction as a means of paying back election funding is difficult to unearth. However, some indirect studies have been carried out.

Min and Golden (2014) examine electoral cycles in relation to electricity theft in India. Drawing upon geographically disaggregated data for the period 2000–2009 in Uttar Pradesh, they document that electricity losses from public distribution utilities tended to increase in periods immediately prior to state assembly elections. Sukhtankar (2012) finds evidence of electoral cycles reflecting on the input prices paid for sugarcane among politically controlled sugar mills in Maharashtra. Kapur and Vaishnav (2015) found that cement consumption by builders fluctuated according to the exigencies of state elections, how competitive the elections were, and so on. Yadav’s (2011) survey of business groups in India found that 60% of these groups reported the corrupt selling of parliamentary votes in their sectors.

In India, under the Right to Information Act, political candidates in elections are required to disclose the value and composition of their financial assets. Even though the investigative and punitive powers of the Election Commission on this matter are limited, Fisman, Schulz, and Vig (2019) have found that at state-level elections, these disclosures have had a significant effect on politician self-selection, in the form of post-disclosure exit of winning candidates.

Non-Monetary Forms of Corruption

Non-monetary forms of corruption include the following:

  • when connections, not direct bribes, are used to land a job or a contract (connections are sustained by social forms of “gift exchange”),

  • when a politician does a favor not in exchange for money, but, say, political support,

  • when an official steals not money but time, through absenteeism or shirking—the most widely cited evidence for the absenteeism of health and education workers in India is found in a paper by Chaudhury, Hammer, Kremer, Muralidharan, and Rogers (2006).

Concluding Observations: Many Research Gaps in the Existing Literature

In contrast to the cross-country literature on institutions and development the overview in this article focuses on institutions at the disaggregated level that help or hinder productivity growth. It also shows how, along with rule-based systems, institutional systems based on social relations and networks and community organizations can for a time resolve some issues of collective action in development. At the level of the state, our discussion focuses on incentive issues in the internal organization of government and how the nature of accountability structures at different levels of government can help or hinder development. We have, of course, deliberately confined ourselves to available empirical case studies in the two largest developing countries, China and India. This approach also leaves out many important empirical institutional issues in these two countries that are yet to be studied—an idea of some of these lacunae may be discerned from our discussion of the research gaps in the rest of this section.

North, Greif, Weingast, and others in their historical accounts of the rise of the West have shown how traditional institutions of long-distance trade and credit evolved into more complex impersonal, legal-rational institutions, drawing upon the growing sense of “generalized morality” in society (as opposed to particularistic allegiances and sanctions), and these institutions helped large-scale industrial development. The question is whether this is the only institutional path to large-scale development in countries like China and India.

As we have suggested before, these two countries have had long experience with indigenous mercantile institutions based on multilateral reputation and enforcement mechanisms, but industrial development has been rather slow until recently. Nationalist historiography has usually blamed this on colonial or neocolonial policies. Without denying the importance of these policies and the lasting wounds of colonialism, it is nevertheless important to examine the indigenous institutional impediments to development (which may be equally valid and significant for those poor countries that do not share a colonial history).

It is possible that clan-based or caste-based organizations that serve the needs of short-horizon trade and commerce are often not adequate for supporting the much larger risks of longer-gestation, large-sunk-cost industrial investment. These organizations may have limited capacity (either in finance or specialized skills) to pool risks and mobilize the capital of the society at large in high-risk high-return industrial ventures. The technological and pecuniary externalities in investment between firms (and industries) and the “strategic complementarities” that they give rise to are difficult to internalize and coordinate on a large scale in the underdeveloped private (or even state-controlled) financial markets at early stages of industrialization.

Here a great deal of case studies are needed to analyze the few instances of industrial success (more in East Asia, but some in South Asia as well) in recent history and the many cases of failure. Are there any patterns in this which have implications for institutional economics? What are the ingredients of state capacity involved in making industrial policy more of a success in East Asia than elsewhere? (The current literature on state capacity that emphasizes fiscal and military capacity is not very helpful in answering this, particularly because it does not address the capacity for resolving collective action and coordination failures.)3

Further advances in the industrial policy literature are needed to explore the particular institutional combinations of domestic political coalitions and market structure and the design of particular policies which make the difference between success and failure; also needed are rigorous empirical and experimental studies to discern the link between policy and outcome. It is important to understand why, in some cases, a close state–business relationship was historically “developmental” in some cases (e.g., South Korea), but not in others (e.g., the Philippines).

Even when there are convincing cases of successful institutions fostering industrial development and “catch-up” with the West (and Japan) as in the case of China, some scholars—for example, Acemoglu and Robinson (2012)—have doubted whether these institutions can deliver on innovations and “creative destruction.” When state support is important in industrial policy, there is always a danger that too-big-to-fail organizations (private or public) may ultimately turn into rental havens, with incumbents having a vested interest in raising barriers to entry for new firms. The role of large incumbent organizations in stimulating R & D and the innovation process may also vary depending on the type of innovation one has in mind, whether it is of the “disruptive” kind that challenges incumbent firms (which the US private innovators in collaboration with venture capitalists are good at, and a large entrenched organization usually is not), or the steady “incremental” kind which adds up to significant gains (the Japanese call this kaizen), which some large organizations in Germany and East Asia have excelled in. We have too few case studies on these issues in developing countries.

The literature is as yet in its infancy in terms of understanding the forces and motivations behind formations of political coalitions and different kinds of elite bargains in different historical contexts, which underpin the process of institutional change or atrophy. Not merely should the theory be linked up with the general literature on coalitions, but more empirical analysis and historical case studies on formation and breakdowns of political coalitions will be valuable. The declining role of unions of unskilled labor in political coalitions, given the nature of technological progress and globalization in recent years, and the impact of this decline on state policy and governance and (the already weak) welfare regimes in poorer countries, while labor politics is also coming to be partially replaced by machine politics,4 is a neglected area that needs to be discussed in this context.

Studies of the theory of collective action, its roles in bringing about institutional change, and its various determinants need to be far richer than they have hitherto been, and to focus on a wider range of aspects than the free-rider issues emphasized originally by Olson. For example, collective action may break down if there is a bargaining impasse on the perceived fairness of distribution of gains among different groups, and this and other distributive conflicts are likely to play a role in the political coalition formation issues mentioned above.

In the discussion of institutions of political accountability the original hopes attached to the decentralization and devolution of power that have been attempted in many developing countries has faded somewhat, on account of the various capture and dysfunctionality issues discussed above in the section on Decentralization and Structures of Local Accountability of Government. The empirical findings in the literature are mixed, primarily because the political and institutional context of decentralization, and hence the design and implementation of devolution projects, are widely divergent. It is time we dig a little deeper and use micro empirical and experimental studies in order to try to decipher whether there are any patterns in the jumble. Also, there are as yet very few empirical studies which clearly demonstrate the contrasting benefits and costs of centralization vis-à-vis decentralization, even though that has been a primary concern in the theoretical and policy literature.

The puzzle of how the Chinese authoritarian system has, in general, been able to maintain some sort of a balance between patronage and political loyalty considerations in career promotion on the one hand, and a reasonably competent meritocracy on the other, requires more analysis from historical and current case studies. This balance has been difficult to achieve in other autocracies.

Most of the case studies in the literature on institutions of local commons management do not tackle the endogeneity problems involved. More in-depth studies of such institutions would throw light onto how they come into being, and how they function. This would be useful in enabling policymakers to predict the kind of circumstances whereby successful community management initiatives can or cannot be expected to emerge.

At the micro-level, much of the empirical literature focuses on agrarian institutions. There has been very little work in developing countries on issues such as the following: firm-level workplace arrangements; supplier networks and credit, insurance and marketing relations in the vast informal sector; the potential of introducing institutions of shop-floor democracy and worker participation in decision-making; how institutions of worker rights merge into those for citizen welfare rights in primarily self-employed entities; the many incentive and organizational problems in the functioning of cooperatives which have kept the cooperative movement in most developing countries rather weak (or captured); to name but a few.

Much of the theoretical micro-level institutional literature grew out of the theory of complete or incomplete contracts. This, however, leaves out other possible forms of institutional evolution. Many years back Menger (1883), the founder of the Austrian School of Economics, made the distinction between what he called “organic” and “pragmatic” institutions. In contrast with the institutions discussed in the contractarian approach, organic institutions are comparatively undesigned, and they evolve gradually as the unintended and unforeseeable result of the pursuit of individual interests. As the historian Francois Furet (1978) observed, “men make history but they do not know which one.” It is thus important to research historical cases of the evolution of organic institutions in the development process.

Menger’s theory of the origin of money, according to which the self-interested actions of traders led to the evolution from a barter economy to one in which a single commodity became the universal medium of exchange, is a prime example of the evolution of an organic institution. Buchanan (1975), in his explanation of the rise of property and law, and Nozick (1974), in his discussion of the hypothetical emergence of the minimal state from a Lockean state of nature, have used the idea of unintended outcomes of voluntary negotiations. On the other side of the political spectrum, Elster (1985) has given an insightful interpretation of Marxian dialectics in terms of unintended consequences in history. It is also possible to think of cases in which an institution is created organically but preserved pragmatically: the actors eventually become aware of the function an institution serves for them and then consciously maintain it even though it came into being unintentionally. Taking stock of case studies of these various processes from empirical and historical data will be a valuable exercise.

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(1.) For some theoretical references on the literature on institutions and development see Bardhan (1989), Mookherjee (1997), Bardhan and Udry (1999), Bardhan (2005), Acemoglu and Robinson (2008), and Besley and Ghatak (2010).

(2.) For details of terms of conditions of a whole range of different types of such labor contracts from a sample of West Bengal villages, see Bardhan and Rudra (1981).

(3.) Acemoglu, Robinson, and Torvik (2016) recently emphasized how elites may not, for strategic reasons, want political centralization, but there are many cases in developing countries whereby elites cannot achieve such centralization even if they want to.

(4.) For an example of this in Argentina, see Levitsky (2003).