The Third Pillar: How Markets and the State Leave the Community Behind

by Raghuram G. Rajan

This point sometimes gets lost in the debate about the role of institutions in development. There is a strong correlation between the existence of ‘good’ institutions in a country and its economic growth and prosperity, so much so that one of the more influential recent papers on the subject is titled triumphantly, ‘Institutions Rule’.38 While institutions matter, they rest on a bedrock of an underlying distribution of power among the constituencies in a country, which may have its sources largely elsewhere. For instance, the independent power of the gentry came from their commercial aptitude, their wealth, and their closeness to their tenants, who looked to them for sound management and good livelihoods. Unlike the landed magnates, no member of the gentry was extremely powerful on their own, hence they needed transparent rules and law to protect them, as well as a body like the House of Commons to help them coordinate their actions. At the same time, their numbers meant they could not be expropriated with the stroke of a pen or collectively accused of treason. The mistake when institutions function well is to believe that they would function similarly well elsewhere, ignoring the possibly different underlying distribution of power. The United States Constitution, when adopted by Liberia, turned out to be just a piece of paper, with none of the effective checks and balances that fill the Federalist Papers and characterize how the United States works.39 While we know a fair...

Institutions & distribution of power