nstitutional economic voids denote the missing or under-developed formal institutions, e.g., market imperfections, financial under-development, bureaucratic inefficiencies, weak legal structures and missing regulatory frameworks. Institutional voids raise transaction costs, hinder sustained growth and lead to sub-optimal economic outcomes.

These voids often plague developing and emerging economies. They pose challenges for businesses to be profitable and make new investments. On the other hand, the prevalence of such voids also provides opportunities to build new institutions and develop entrepreneurship in underdeveloped economies through creative destruction, while also initiating risky endeavours and developing innovative strategies to bridge gaps and synthesise markets through technical and managerial expertise.

The desirable economic outcomes cannot be achieved without addressing the institutional voids. Inefficient or weak institutions trade off growth and overall welfare. Well-developed institutions are essential to reduce the market friction, enhance economic efficiency and uplift the economy.

Improvement in economic fundamentals alone cannot determine the sustained growth path as suggested by economic orthodoxy, where savings lead to capital accumulation and drive economic growth. The traditional or classic economic development theories, including the Harrod-Domar Growth Model, the Lewis two-sector development model, the Neo-classical Growth Theory and the New Growth Theory, mainly signify the role of economic factors, such as savings, investment, optimal utilisation of resources and technological progress. Nevertheless, economic, social and political institutions play a key role in the economic development and quality of life in a region.

Orthodox economic philosophy advocates free-market mechanisms, structural adjustment and a decentralised system to organise economic activity and promote economic growth. The conventional or classic development approaches roughly reflect the historical economic development experience of the developed countries which do not fit the economic and institutional realities of most contemporary developing economies.

On the other hand, developed countries are, by and large, characterised by relatively stronger political stability, better socioeconomic conditions and well-developed institutions.

In an eminent empirical structural change and patterns of development analysis for numerous developing countries during the post-World War era, Hollis B Chenery and his associates identified various distinguishing features of the development process and patterns.

The differences in the development level depend on resource endowments, pace and pattern of transition from a traditional economy dominated by agriculture to a more mechanised and industrialised economy, technological progress, growth of cities and urbanisation. 

The differences in the development, they concluded, depend on resource endowments, pace and pattern of transition from a traditional economy dominated by agriculture to a more mechanised and industrialised economy; technological progress; growth of cities and urbanisation; consistent physical and human capital accumulation; low population growth rates; trade openness; and government policies. Importantly, the availability of funds, mobilisation of resources and capital accumulation are necessary but not sufficient conditions for economic growth.

Empirical evidence showed that national (and international) restraints on economic progress largely account for differences in the level of development among countries. On the domestic front, institutional bottlenecks — notably poor governance structure, frequently altering government priorities and policy inconsistencies - are the paramount causes of underdevelopment. International impediments include the economic factors, such as international trade, acquisition/ transfer of technology and access to foreign capital.

Based on economic development theory and historical facts, notable economists such as Douglass North, Daron Acemoglu and James Robinson have established the nexus between economic development, political progress and institutional reforms, notably the rule of law and protecting human and property rights. Accordingly, poor institutions and policy inconsistencies, patronage, rent seeking and extraction cause low productivity and retard growth.

According to North, “the inability of societies to develop effective low-cost enforcement of contracts is the most important source of both historical stagnation and contemporary underdevelopment.” Hence, development cannot be sustained with institutional weaknesses, vested interests and elite capture.

The economic crises in the developing countries since World War II have mostly been caused by weak social and economic institutions, financial underdevelopment, a lack of formal markets, poor governance, inconsistent policies and political instability.

Importantly, the solution to each crisis for the affected countries should not merely entail liberalising and opening their economies, eliminating regulations, cutting subsidies and protecting infant industries and the privatisation of state-owned enterprises (SoEs) as required under agreements with international financial institutions (IFIs) such as the IMF and the World Bank. Pakistan has been undergoing such regulation under the current IMF programme. Balanced reforms and regulation mechanisms are required to achieve the optimal outcome.

The right mix of economic policies, coupled with high-quality institutions and good governance, can foster inclusive and sustainable development. For example, securing property rights and contract enforcement provides incentives to investors, producers and traders that shape benefits and costs and, in turn, determine the development trajectory.

The efficacy of indigenous economic, social and political institutions plays a pivotal role in the development process. To avoid bubble bust growth and to keep the economy on the right track, a country needs to put its economic house in order. Accordingly, quality institutions, good governance, rule of law and secure economic environment can effectively address the institutional voids and facilitate ease of doing business, raise investment and subsequently sustained development. An economy may grow without strong institutions for a short period, but it cannot develop sustainably.

The writer is the director of the Centre for Aerospace & Security Studies, Lahore. He can be reached at [email protected]