Aims of the chapter • To understand the role of institutions, both formal and informal, in promoting

Aims of the chapter • To understand the role of institutions, both formal and informal, in promoting

economic development and human flourishing. • To analyse markets as institutions in themselves and as regulated by social institutions. • To draw the policy implications of this institutionalist view of markets. • To assess the relationship between the human development approach and the role

of institutions in development in general, and in markets in particular. Key Points

• Institutions are rules and norms that enable human interaction to take place. How they operate is critical if economic development is to be achieved. ‘Getting institutions right’ has become a key priority in development policy. Thus the main focus of mainstream economists has been on particular rules, such as property rights, regulatory institutions, macroeconomic stability and social insurance as the main institutions enabling the economy – especially markets – to work well.

• There are also social conventions, moral rules and informal norms that underpin how people interact and influence how the economy works. These rules and norms may often be discriminatory. Social identities and differences based on gender, age, ethnicity, race, religion, caste and so on affect how people engage with institutions and markets.

• Mainstream economics has neglected to analyse the ways in which actual markets

operate. Its support for markets as the best mechanism for delivering the greatest welfare is based on unrealistic assumptions that do not always take into account the actual institutions markets involve. Other economic approaches demonstrate that social identity and power relations matter and that markets are ‘socially regulated.’

INSTITUTIONS, MARKETS AND ECONOMIC DEVELOPMENT

• The human development approach recognizes that valuable capabilities can be expanded through institutions but also that institutions can constrain the achievement of capabilities, particularly in contexts where social norms discriminate between people.

• The human development approach is not for or against markets but recognizes that they may assist in promoting freedom and equity. However, markets are affected by deeply-rooted social norms and social identities that may enable some people to do well while discriminating against others. Addressing such inequities requires not only rules and regulations agreed through democratic processes but also a sustained effort to reverse the underlying power relations, as well as the attitudes and beliefs, based on the informal norms from which they arise.

The core argument of this book is that the objective of development is to promote human flourishing. Chapter 4 discussed economic growth as an important means for achieving that very objective. This chapter examines two other key means for promoting human flourishing: institutions and markets. Institutions are the rules and norms that enable human interaction to take place in all spheres of social, economic, political and cultural life. Thus the institutions of society range from formal rules, such as a national constitution, which may define the specific rights and obligations of citizens to representation and voice, to national laws, such as those of property rights, criminal law and so on. The informal institutions encompass social norms of interaction, such as what is moral, good or bad behaviour, or what are acceptable ways of undertaking certain activities, such as what side of the road to drive on, how to queue, or what it is an appropriate tip in a restaurant.

The idea that it is necessary to ‘get institutions right for development’ has become a critical component of contemporary development discourse. This focus strongly converges with the concerns for good governance in the political sphere and encompasses, for example, the need to define and enforce property rights so the economy can function effectively. In the economy itself, markets in most countries play a key role in the allocation of resources, along with the state and other mechanisms within families and communities for the management and sharing of resources. From the 1980s onwards, development policy was focused on ‘getting prices right’ in markets as a means to jump-start economic growth. At the time, it was thought that the de-regulation of markets from government control would enable everyone to seek the highest returns for their goods. The broad failure of these policies to produce the expected increases in production and income led to the identification of key institutions that were deficient, particularly those pertaining to the ownership of private property and the rule of law that would enforce these rights. These specific concerns were framed more broadly within the general need for improvements in transparency and accountability in government.

From the point of view of economic analysis, institutions are seen as important because of their role in supporting markets. However, markets can also be seen as institutions in themselves, which operate within a wide set of

TOPICS

formal and informal rules and norms. Hence we can also examine ways in which markets can contribute, because of their intrinsic ability to enhance freedoms, to human flourishing. In order to command higher wages, people need to be able to have access to labour markets that are non-discriminatory and non-exploitative. Labour markets that discriminate against women or ethnic minorities or that pay below minimum wage enhance human flourishing inadequately. Similarly, access to commodity markets are a crucial means for poor people to sell their produce and to buy the goods necessary for their lives. But when markets function in a macroeconomic climate of hyper-inflation, or when they do not rely on the basic norms of trust that guarantee a fair transaction, they are not conducive to promoting greater well-being.

This chapter begins by exploring the role of institutions in economic development in greater depth, reviewing the dominant approach developed by the economist Douglass North. We then discuss the view that markets in themselves can be considered as institutions and use this to question the idea of ‘free’ or ‘self-regulating’ markets. Once markets are understood to be institutions connected to a whole range of formal and informal institutions – including being embedded in deeper social and cultural norms and networks – the importance of enabling them to enhance human freedoms and well-being, however difficult, becomes apparent. We conclude with analysing the specific contribution of the human development and capability approach to the analysis of institutions and markets.

Institutions in economic development