Strengthening Institutions for economic growth

– This article was originally published by Roopali Bista in the Himalayan Times on the June 16, 2019.

According to renowned economist Douglas C. North institutions are defined as socially constructed constraints that shape the political, economic and social interaction. They consist of both informal constraints such as sanctions, taboos, customs and codes of conduct and formal rules such as laws, constitutions and property rights. The major purpose of existence of these institution throughout history is to create order and reduce uncertainty in an economy. 

These Institution provide the incentive structure of an economy; as that structure evolves it shapes the direction of economic change towards growth, stagnation or decline. Institutions form a backbone to any society by shaping the ways in which individuals organize themselves and their economic transactions. The differences among institutions explain many of the underlying reasons for the differences in technology and in physical and human capital between countries, which in turn explain a large part of cross-country differences in income and development. In short, a country’s institutional structure has long been considered a major determining factor for its growth and prosperity. 

The present day formal Institutional setup of Nepal explains why our economy is stagnant. There is a lack of enabling environment for wealth creation and increasing productivity in the country. Weak institutions like lack of rule of law, cumbersome process of enforcing a contract, uninsured rights to property, lack of transparency and accountability just to name a few continues to hinder competitiveness, development and growth in Nepal. 

Rule of law                                                                                                                      

For proper implementation of rule of law there needs to be four basic principle; a) Accountability: The government as well as the private sector are accountable under the law. b) Just Laws: The laws are clear, publicized, and stable; are applied evenly; and protect fundamental rights, including the security of persons and contract, property, and human rights. c) Open Government:The processes by which the laws are enacted, administered, and enforced are accessible, fair, and efficient. d) Accessible & Impartial Dispute Resolution: Justice is delivered timely by competent, ethical, and independent representatives and neutrals who are accessible, have adequate resources, and reflect the makeup of the communities they serve.  Nepal needs to strongly follow the above mentioned four principles to strengthen institutions which in turn enhances economic growth. 

Contract Enforcement 

According to the 2019 World Bank’s Ease of Doing Business Index, enforcing a contract in Nepal takes an average of 910 days, which equivalents to approximately 2.5 years, and costs 26.8% of the value of the claim. Economic agents will invest only if they believe that they will reap expected benefits and returns on their work or investment without needing to spend excessive amounts of time and money on monitoring the fulfillment of others’ contractual obligations. This depends, informally, on adequate levels of trust in society; it also depends, formally, on the existence of institutions capable of ensuring a basic level of security and enforcing contracts. 

Securing Property Rights 

Secured property rights is one of the basic foundation of economic prosperity. When property rights are strongly enforced in the sense that the owner of the property has all the rights to use his/her in the way he/ she desires, it creates a strong incentive not only to protect and preserve the property but even to expand it. When the individuals have incentives to expand their property, they are willing to use the properties they have to make investments. The investments, not only help expand their own property but also create jobs, increase productivity and contribute to the overall economic growth.

The explanation of the importance of property rights would be incomplete without taking reference from the seminal work of Peruvian economist Hernando De Soto. De Soto, in his book, ‘The Mystery of Capital’ explains the role of strongly enforced property rights in bringing prosperity in the west. He further explains that the poor all over the underdeveloped world possess 9.3 trillion dollars’ worth of property, however due to lack of well-defined property rights, they have not been able to use it to create more wealth.