Second-Best Institutions

Date Published:

May 1, 2008

Abstract:

The focus of reforms in the developing world has moved from getting prices right to getting institutions right. This reflects the recognition that markets are unlikely to work well in the absence of a predictable and legitimate set of rules that support economic activity and dispense its fruits. "Governance reforms" have become the buzzword for bilateral donors and multilateral institutions, in much the same way that liberalization, privatization and stabilization were the mantras of the 1980s.

But what kind of institutions should reformers strive to build? It is easier to list the functions that good institutions perform than it is to describe the shape they should take. Desirable institutions provide security of property rights, enforce contracts, stimulate entrepreneurship, foster integration in the world economy, maintain macroeconomic stability, manage risk-taking by financial intermediaries, supply social insurance and safety nets, and enhance voice and accountability. But as the variety of institutional forms that prevail in the advanced countries themselves suggests (Richard Freeman 2000, Peter Hall and David Soskice 2001), each one of these ends can be achieved in a large number of different ways (Dani Rodrik 2007).

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