Global Policy Forum

By G. Kochendorfer-Lucius and K. Van De Sand

A strategically significant shift in focus is currently taking place in development cooperation, a shift away from conventional project promotion and towards institutional development. Why? The development cooperation of the last 30 years was all about promoting projects, projects of limited duration with a sectorial or regional focus. It was claimed that these projects generated broad-based impacts, and were replicable. Yet only in relatively few cases was this claim borne out. The proclaimed aim of development was asset creation, especially in poverty alleviation, it was not the creation of structures enabling the poor to gain access to resources. In recent years there has been discussion of how projects might also address the problem of structural constraints to development.

Nevertheless, the attempt to use projects as a lever to change such structures has not proved successful, because it has adhered too closely to conventional approaches with limited outreach. On the other hand, structural adjustment and sector investment programs did not meet the high expectations placed in them, primarily because they failed to create the necessary institutional structures for policy reforms. What are institutions? The term "institutions" often refers to the so called "rules of the game", i.e. rules governing human behavior within a given society, and reflected in the structure and disposition of organizations.

Bruno S. Frey provides three elements that define institutions: i. Rules or procedures followed in a given society in order to make decisions; ii. Legal norms, traditions and other behavioral rules; iii. Organisations like the state, associations in the private sector or civil society and families. Recently, institutions have come to be seen consistently as the missing link in development cooperation. There has, of course, always been institution building and organizational development, but rather within the framework of projects and programs, and not as a strategic approach of development cooperation per se.

Currently, the issue of promoting political, social and economic institutions in the context of poverty alleviation is arising as a matter of top concern. In the context of the extended debt cancellation for the Heavily Indebted Poor Countries (HIPC) countries, Poverty Reduction Strategies (PRS) attempt a new approach to structural reforms, designed to sustainably eliminate mass poverty.

The policy of the Bretton Woods institutions has clearly exposed both the limits of traditional policy at the national and international levels and the need to identify new ways of approaching development. New approaches are even more necessary if the process of globalization is taken into consideration, a process that should not be taken as a given fact but rather be influenced. This calls for the establishment and interplay of democratic institutions that go beyond national borders. Institutions are therefore of prime significance for continued economic and social development.

1. Institutions and Growth

Why are the economic and social opportunities that allow a small proportion of humanity a high standard of living not available to all? As recently as two hundred years ago, the lives of most people around the globe still bore a much closer resemblance to each other: they were usually miserable, laborious and short. Since then, a spectacular process of economic growth has been unfolding in the western world. Since 1820, global GNP has grown by a factor of fifty, whilst by comparison the global population has expanded by a factor of "only" six. Yet the distribution of this immense growth in wealth was highly inequitable, both within societies and between them.

At the beginning of the 19th century, the ratio of per capita income between the richest and the poorest countries was around three to one. At the beginning of the 20th century it was ten to one. Now, at the beginning of the 21st century, it has risen to sixty to one. Today, one billion people in the industrialized countries amass close to 60% of global income, one-and-a-half billion people in the middle-income countries earn 20 percent, and the three-and-a-half billion people in the poor and poorest countries the remaining 20 percent! In other words: whilst the average GDP is around $6,000 per capita, the figure for the richest countries is $29,000, and for the poorest countries $500.

Why this enormous and growing disparity? One explanation can be found by analyzing the institutional resources of a country: they make the process of economic development possible in the first place and, once it has begun, steer it in the right direction. Institutions can enable political stability, effective and responsible administration, good governance and secure property rights, the presence of a competitive financial sector and finally can ensure provision of basic health care and education.

Michel Camdessus, the former Managing Director of the International Monetary Fund, has made a number of points concerning the task now faced by the IMF of linking the goals of stability, growth and poverty alleviation within the "second generation reforms". He has stated that viable social, political and economic institutions are a necessary, albeit not the sole precondition for macroeconomic stability and growth. Furthermore, in his view institutions and economic policy frameworks are the common denominator, which needs to be incorporated into all further development efforts, in addition to macroeconomic stabilization and reform.

Camdessus refers to the economic historian Douglas C. North, one of the founding fathers of the new economics of institutions. In his speech at the Nobel Prize award ceremony, North pointed out that while much attention has been given to date to the modus operandi of markets, the analysis of the historic development of market institutions has been rather neglected. In North's view, the institutional structure of functioning markets is crucial for developing countries and countries in transition, and therefore of major practical relevance to development cooperation as well.

2. Institutions and Markets

The common acknowledgement of the importance of relative prices for well-functioning markets and consequently of the significant contribution that the neoclassical economic analysis could provide to development policy unfortunately led at least the Bretton Woods organizations to concentrate their attention on relative prices for a considerable time. The reformers of the eighties called for "setting the prices right" in foreign trade, product and labor markets, as well as in the financial and fiscal sectors, coupled with the one-sided dictate of stability and privatization. In the nineties, however, the shortcomings of this overemphasis on price reform became all too evident. Macroeconomic stability alone did not prove to be a sufficient determinant of growth.

To the extent that neoclassical economics was confronted with the realities of developing societies, it came to light that the institutional underpinnings of the market economy are essential for well-functioning markets. The term "institutional underpinnings" includes a system of clearly defined and enforceable property rights, a regulatory mechanism for competition, designed to keep in check the worst excesses of corruption, violation of competition rules and moral hazard. It also includes a minimum of social cohesion, of politically legitimated institutions that are able to channel social conflicts, of the rule of law and of public accountability.

These are the essential milestones of a society, often taken for granted by economists. Yet in poor countries, the presence or absence of these very structural arrangements crucially affects the balance of power. Unless they are in place, even the most well designed policies will fail and economic incentives do not produce the expected impact.

Some of the implications of these conclusions were integrated into the development-policy debate early on, for instance, while facing the issue of rent-seeking behavior (or, less euphemistically, corruption) in the trade-policy context. Nevertheless, it has taken a good while for this shift in thinking to take place. First price reforms and privatization in Russia had to fail, because they were unable to draw on the resources of a functioning legal, political and regulatory apparatus within the transition process. Furthermore, the market-oriented reforms in Latin America had to come under criticism for failing to create access to markets and safety nets for the poor population. More recently, the Asian financial crisis had to demonstrate that the liberalization of financial markets leads towards disaster, if it is not carried out on the basis of rigorous regulation, and above all, effective control of the banking system.

The new discourse also concerns issues of the social capital of a society. The quality of an institution, that is its performance capability vis-í -vis the purpose of its establishment, is dependent not only on how the institution itself is designed and structured, but also on the extent to which it is, or can be, utilized by people. Institutions should not be seen in isolation from the people who utilize or are supposed to utilize them, from those people's education, skills and competence or from the information available to them. Culture, social norms and values largely shape these factors. A feedback effect comes into play here: no matter how well-designed a legal system might be, if it is not applied or if only certain groups have access to it, that system is not a capable one in terms of the tasks which it was designed to perform.

3. Institutions and Poverty Alleviation

Today, the role of institutions in creating conditions conducive to growth and economic development is largely acknowledged. However the importance of institutional development for poverty reduction is much less well understood. For too long, development policy has labored under the false assumption that scarce resources are the main cause of poverty and underdevelopment. Today, a consensus exists in international discourse on development policy that the major problem is access to resources. This applies to natural resources (water, land), means of production, financial resources, marketing infrastructures, technical expertise, education and training. Nonetheless, this consensus still has to be translated into the practice of development cooperation.

The traditional project approach, which prevails to this day, sees the elimination of resource scarcity as the point of departure for development. Although there is growing acknowledgement of the significance of the policy and institutional environments, the majority of projects still view these aspects as "frameworks", and not as starting points per se. The conventional project is based on a misleading concept that perceives the relationship between input and output as a linear one. By contrast, a modern understanding sees development as a sequence of interrelated and open processes. This concept of development seeks to reconcile the interests of different social groups competing which each other on an essentially equitable basis. Those players' capability to act is reflected in institutions that define the rules stipulating who has access to resources, on what scale and on which terms. These institutions can help eliminate poverty or contribute to maintain it.

Hence the major problem in the context of poverty alleviation is not necessarily the absence of institutions. The real issue is that those institutions which most strongly affect the lives of the poor are not accessible to them - and they generally do not serve the welfare of the poor groups in the society. The government and administration, the military (or also guerilla movements), political parties and labor unions (if they exist at all), parastatal and private service organizations, banks and commercial enterprises create structures enabling them to pursue the interests of privileged (mostly urban) minorities. Unless the poor - i.e. the majority- are organized, they remain excluded from the political and economic "system" , politically powerless and economically unattractive. This does not mean that "the poor" are a homogeneous group without any conflicting interests.

However, it does mean that an inequitable distribution of resources and inequitable access to economic opportunities act as constraints to economic growth and cause mass poverty.

An analysis of rural poverty in Eastern and Southern Africa, for instance, corroborates this consideration. Most of the poor in this region live in areas with medium to high potential for agricultural development, but this potential is not being exploited. If the lack of natural resources does not provide an explanation of the rural poverty, then the reasons must include the access to production inputs and markets. In this part of Africa at least, production and marketing structures were tailored to the specific interests and needs of the colonial rulers. The indigenous population was excluded from the independent production of marketable agricultural produce, in order to meet the demand for labor on farms and in mines (while women remained in the villages, which significantly increased the feminization of poverty).

After independence, these structures changed in that a small, politically and economically dominant elite replaced the colonial rulers, and by utilizing parastatal distribution and marketing organizations, regulated access to these structures such that primarily their own best interests were secured. The development of rural areas was thus driven by an institutional system that the rural poor could not control or be served by.

Corruption and misallocation of production factors are fundamental and inherent components of this system, and should not be seen just as undesired concomitant phenomena. In many countries of Africa, state monopolies of the agricultural sector have been dismantled in the recent past. The result is an institutional vacuum, which is gradually being filled by private enterprises. In this situation, the challenge consists in promoting private-sector solutions such that the interests of small farmers are institutionally secured. Yet the vision should be wider than that: in the age of economic globalization, the primary task of public investment in poverty alleviation, including development aid, is to create conditions which guarantee the poor access to the formal private sector.

This intermediary and linking function should enable not only the access to the national and international markets, but also the creation of an institutional and environmental framework allowing the poor to exploit the development potentials of the private sector.

The International Fund for Agricultural Development (IFAD), for instance, adhered closely to the traditional understanding of projects for a long time. However, the experiences and insights outlined above have led to completely new approaches. The overriding objective is no longer to develop "agriculture", but to promote the rural poor.

The most recent projects in Zimbabwe, Mozambique and Zambia have completely abandoned the direct support to agricultural production and direct investment in the physical infrastructure. Instead, they promote the development of the institutional structure by helping organize the rural poor and their relations with the rural private sector (in particular, by supporting the process of input provision as well as service and marketing enterprises).

As regards the issue of access to technical know-how, the traditional project approach involved supplying technologies and expertise that experts considered being necessary and appropriate, and transferring the skills and knowledge required to apply those technologies. By contrast, the institutional approach considers the rural poor as individuals demanding and assessing alternative options on offer and organizing the effective use of technologies.

On the matter of financial resources, the main problem for rural development is, as it has been widely recognized, not the lack of credit funds or the level of interest rates. It is rather one of organizing access to financial resources, and establishing conditions of production that allow saving and make investment profitable. The conventional approach usually implied the design of credit-line projects, executed by state banks that generally dictated to the borrower the conditions and purposes of the use of funds, often incorporating obligatory input packages into the terms.

The new way paved by the institutional development approach aims at helping the poor mobilize their own resources and establish local savings and credit systems. It empowers the poor to take their own decisions concerning the terms and designated use of credits, and it facilitates their link with commercial financial institutions. The financial autonomy of microfinance organizations and financial intermediaries, i.e. their independence from external subsidies, is a key prerequisite for broad-based poverty reduction. The success of external assistance is to be measured both on the basis of the number of households that sustainably cross the poverty threshold and on the economic viability of the involved institutions. The lack of these institutional underpinnings explains why the development policy landscape, above all in the financial sector, is strewn with the ruins of pilot projects.

As regards marketing activities, the institutional aspect also plays a crucial role. In Africa, access to transport routes is often a critical point. The traditional projects envisaged building roads, but their maintenance was not institutionally guaranteed, not least because the issue of incentives was misjudged. National and local elites often "benefit" from donor-financed road construction, and therefore have a stronger interest in construction of new roads than in road maintenance carried out by local authorities. Despite the lack of infrastructure, the opening of markets is also impacting in poorer rural regions.

What the market participant needs, in addition to guaranteed transport routes, is above all appropriate prices, adequate services and information on market potentials and requirements. These elements constitute an enabling economic environment for rural producers and can be created and influenced by the work of institutions, not by projects of limited duration.

4. Instruments to Promote Institutions: New Challenges for Development Cooperation

How does a country or a society establish institutions that are conducive to development and growth? As the history of the West has shown, the development of institutions is neither an accidental nor a natural process. It was interests that drove the institution-building process. What does this mean for development cooperation?

The interests of the poor are the starting points for designing a strategy for institutional development, which would need to include the following elements: Existing institutions must be reviewed to establish whether and to what extent they involve the poor themselves. This can help avoid situations in which donors - as it has often been the case in the past - support institutions that conflict with the interests of the poor. With respect to governments, this includes the issue of whether a poverty alleviation policy is in place, and how that is reflected in budgetary expenditure.

Institutional assistance at the local level must first provide training and capacity building to enable the poor to organize themselves within various institutions, and secure their influence through their participation in local governments. It will then be appropriate to support local authorities in advocating their own interests vis-a-vis the higher levels of the government and administration, and in planning and organizing the tasks of local governments.

At the national government level, institutional reforms (e.g. decentralization) must be promoted in order to create scope for the poor to influence decision-making processes. This is where it becomes clear how vital good governance is for poverty alleviation. Donor organizations must contribute that state organizations become accountable to citizens and that people through institutions get access to resources. These are prerequisites for strengthening the competitiveness of the poor. Donor organizations must be "advocates" of the poor. They can support poor oriented institutions in a given region by providing targeted assistance and by their political clout, which could be enhanced through coordinated policy dialogue.

Ultimately, development cooperation can foster the vertical and horizontal institutional links between the micro and macro levels that are needed for a peaceful reconciliation of interests. They involve, for example, the legal system, the communication and information structures, as well as the networking of microfinance institutions with the banking sector. Efforts must be made to develop the bargaining power of the poor by strengthening their position as market participants, and by institutionalizing the accountability of public organizations. This is all the more necessary in the face of the globalization process, which continues to concentrate and centralize economic power - taking it further away from the local level and the poor.

At the global level, an important issue is how to balance the considerable differences in social, political and economic institutions within a given country and how to match them with the requirements of the international competition and global cooperation (e.g. harmonization of standards and norms). Many of the efforts made to improve the international financial system include the development of internationally recognized standards, in order to give the system more stability and transparency. These standards and rules can also strengthen the national institutional framework involved in the processes of reform and development, subject to two preconditions: the first is the ownership of the reform process by the respective countries, and the second is the participation of the poor in this very process.

The issues of development of standards, relationship between the public and private sector, structure of the fiscal system, regulation of competition, affect the core social and political decision making of a country. In order to face these issues, democratic elections do not suffice. Mechanisms have to be designed to involve the civil society - labor unions, employers' associations, national NGOs, religious groups and other associations - in the decision-making on development issues. Not least parliaments must build up competence necessary to perform their supervisory function on a more consistent and efficient basis.

Projects of institutional development must take into account the specific cultural and social conditions of the country concerned. There will be no blueprints in the future either. The thoughts outlined above are designed to help stimulate the development of a conceptual strategy for institutional development, a theme that has also been neglected by development-policy research. None of the basic ideas expressed above are completely new. In fact, some donors approached development issues on the basis of such ideas.

The German development cooperation, for instance, followed them in projects implemented by German political foundations that helped establish pluralistic social structures in developing countries, as well as in the promotion of local and intermediary institutions carried out by GTZ and DSE. One concrete example is the Indo-German Watershed Management Program in Maharashtra, India. The program began with the training of village self-help associations provided by an Indian NGO. Then a network of relevant sectorial authorities, local NGOs, an agricultural bank, KfW, GTZ and Misereor (a Catholic development NGO) was established with the aim of delivering contractually agreed services to the village communities, thus enabling them to perform local tasks on their own responsibility. As a result, not only watersheds were sustainably developed, but also substantial changes in the relevant state legislation were made. In fact, the Indian Government elaborated a common guideline for watershed development, enacted in March 2000, that basically adopted the institution-building concept of the Indo-German program.

What has to be put on top of the international development agenda now is mainstreaming institution building; that is, development cooperation needs to be systematically oriented towards the creation of enabling institutional frameworks for development. The multilateral development organizations, led by the World Bank and UNDP, are evidently moving in this direction. The World Development Report 1999/2000 "Entering the 21st Century" defined some fields of action replacing those addressed in the Washington Consensus and considered as valid for many years. The conceptual framework presented in the Report incorporates the analysis of the institutional structure in the formulation and implementation of macroeconomic reform policies. Such an analysis focuses on the following four elements: (1) governance; (2) legal system; (3) financial institutions; (4) competition and regulation.

The Report emphasizes that the process of creating policies and institutions within a country is just as important as the policy itself. In poverty alleviation in particular, process-orientation plays a special role. In the future, partner countries should focus on development strategies that are implemented on the basis of mutual consensus, either by means of international agreements between countries, or through constitutional and institutional arrangements between the various levels of the government and sections of the civil society of a country. According to the Report, institutional development must be founded on partnership, negotiation, coordination and regulation.

The International Fund for Agricultural Development provides another example for steps being taken towards mainstreaming institutional development. As a result of the Consultation on the Fifth Replenishment, IFAD's Action Plan 2000-2002 considers the assessment and influence of policies and institutions relevant to rural poverty alleviation as a major focus for IFAD's future activities.

Conclusion

Poverty alleviation must tackle those structures that constrain development and cause poverty. Poverty means powerlessness. If this is so, then it follows that assistance must focus on developing institutions that the poor can use to assert their interests, and to organize access to resources. To achieve this, development assistance will need to be turned upside down. The bottom line must be the local institutions that empower the poor to take part in defining the rules that determine their lives. Yet, local empowerment and the development of institutions of the poor alone will not be sufficient. Only when the poor and their interests are represented in institutions at the national level will there be a policy for the poor.

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