Towards A Competitive Malaysia #58

Chapter 9: Institutions Matter (Cont'd)

Institutions In a Modern Society

As society becomes complex, we need new mechanisms to guide social relationships; hence the need for institutions. In the words of economist Douglass North, institutions are the rules of the game; they are the humanly devised constraints that shape human interactions.1

With the right policies and institutions, we can take full advantage of whatever attributes a nation has. A generation ago, the Yucatan Peninsula of Mexico was nothing more than the sleepy villages of poverty-stricken fishermen. Today, it is a major tourist destination. The right policies, leadership, and institutions made that possible.

With misguided policies and inept institutions, even sand could be made scarce in Saudi Arabia. Malaysia has over 100 inches of rain annually, yet the taps are frequently dry. In Las Vegas, in the heart of a desert, homes sport fountains and swimming pools.

Humans are social beings; we interact with each other. One manifestation is our propensity to trade, to barter and exchange goods and services. Trading is not a pleasure and an end in itself, unlike sex (also another basic human instinct), rather each party feels that he or she would benefit from the transaction. When the ancient hunter bartered his excess hides for the farmer’s surplus barley, each felt that he was better off after than before the exchange.

Adam Smith philosophized whether the “propensity of men to truck, barter, and exchange one thing [or service] for another be one of the original principles in human nature, or whether it be the necessary consequence of the faculties of reason or speech,” or some other causes, but he was certain that this attribute is common to all men and found in no other specie.7

The insight of modern economics is nothing more than to maximize this primordial of human instincts, to create institutions to facilitate this exchange, reduce its costs, and have mechanisms to resolve and minimize the inevitable conflicts such interactions would generate.

The first such essential institutions would be concerned with public safety and security; another would be conflict prevention and resolution. There must be a reliable, fair and just institution, respected and trusted to adjudicate disputes. The bane of many Third World countries is their inefficient and corrupt judiciary. The decline in direct foreign investments in Malaysia is in part related to the lack of faith in its judicial system

Before people can engage in trade, they must be assured that what they have is rightly theirs and that the ownership can be transferred. Meaning, there must be a mechanism to establish property rights, and the concomitant right to enter into contract with one another—contract rights.

Property and contract rights alone would not be sufficient. There must be mechanisms to facilitate the various parties coming together. Of particular importance are institutions to connect owners and users of capital—the financial intermediaries.

Overseeing all these would be the political institutions to provide for the orderly selection of leaders, or their removal should they prove wanting. To ensure accountability of institutions and to act as their effective checks and balances, the public must be appropriately informed and apprised. This means a free press and a vibrant civil society.

Many countries have well meaning policies and established institutions, but they exist only on paper; the reality is starkly different. The World Bank found that 90 percent of firms in developing countries report gaps between policy and reality. Policies must be effective in their content and in their execution.4

Next: Institutions of Law Enforcement