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Entrepreneurship and the rule of law

October 16, 2009

President Yar’Adua, during the official opening of the new head office of the Corporate Affairs Commission (CAC), has called for it. Kofi Anan, former UN Secretary General, in a recent interview, did same. The world is abuzz with transparency, a consequence of the rule of law. Rule of law, as a political concept, puts order in the jungle. Checks and balances that check unruly politicians and balance interests.

Broadly defined, it means a just society where human rights eg, free speech and association are guaranteed. Narrowly defined, rule of law constitutes property rights and efficient judicial administration. That is, the rule of law provides stability. Stable laws mean businesses can predict, to some extent, future outcomes of risks embarked on today. Where rules are foggy, daring entrepreneurs (kamikaze) will price this instability into their risk, thereby raising transaction costs. Hence, some economists say institutions matter, others opine that institutions rule.

Legal institutions that curtail corruption, enforce property rights (assuming land ownership is properly titled) and enforce contracts presuppose that the rules are public, comprehensible and relevant. Otherwise asymmetry of information about the rules gives undue advantage to those who have access to such information.

Disclosure or transparency in social, economic or political relations is a desirable good. Nigerian banks are now being haunted for not providing sufficient financial information. Disclosure is now the new valuation benchmark. Their foreign peers, especially those in the lightly regulated shadow banking sector eg, hedge funds, are now under regulatory fog light. But there are exceptions to the rule of law. China’s growth story defies the notion that the rule of law causes economic growth. China’s legal system hardly matches that of most western countries.

The rule of law is better considered as one more jigsaw piece in the puzzle of understanding how countries grow rich – it aids, not cause, economic growth. Nonetheless the ability of Chinese technocrats, to devise and implement good policies, and recognition of some property rights are noteworthy. In Shanghai, China’s business capital, “judges are better trained and foreign investors sometimes win cases against Chinese companies” notes Michael Skapinker, of the Financial Times, in a special report on Shanghai.

This lends credence to positive relation between GDP per person and the rule of law. In other words, a well equipped judiciary, police force and civil service count. Thus investments in enhancing governance, the quality of bureaucracy and reform of law enforcement agencies are justified. Beyond these, the improper tinkering of macro and micro economic policies makes a mess of the rules and produces undesirable results.

Micro and macro matters

After fifty years of development aid to developing countries, the verdict is that there’s being more pain than gain. Neither has dependence on income from commodity booms helped. Paul Collier, professor of Economics at Oxford University, says aid hasn’t worked because the focus has been on macro issues.”It’s largely a microeconomic agenda and so the macro depends upon the micro.”

The micro agenda is what Federic Sautet, of the Mercatus Centre at the George Mason University, calls “the local institutional context faced by economic agents”. Economic agents ie, firms and consumers, in developing economies, in addition to sound macroeconomic policies, need institutions cognisant of domestic business realities.

To Collier, “The micro agenda that seems to work there involves freeing up firms to be able to enter quickly and exit quickly. Using the database from the World Bank’s Doing Business surveys, this is what we find. Where countries have easy entry and exit for firms, the consequence of a falling commodity price is much smaller for GDP.”

Multilateral organisations, economists and analysts say Africa needs a prolonged phase of investment – in physical infrastructure through public and private capital – to catch-up with the rest of the world. According to Prof Collier, “To catch up, to converge with other economies, [investment in Africa] needs to be over 30 percent. So they must move from under 20 to over 30. That’s a big change.”

Concretely, catching up means investing in investing ie, building capacity (public expenditure, honestly, efficiently, and up to standard) to make better investment; to live down the past era of bad reputation by committing to certain actions that can build credibility. This requires both multilateral and local institutions.

The road to entrepreneurship

Nigeria hardly lacks entrepreneurs, but to dismiss that the right institutional context: definition and enforcement of rules eg, property rights, overlooks what drives entrepreneurs to takes risks.

Institutions provide guidance and allow for routine. Both reduce uncertainty. A businesswoman will thus likely take unimaginable risks to start and nurture a business. That willingness to take risks is a simple but powerful fact that cannot be overlooked if Nigeria genuinely seeks to grow economically.

In other words, the road to domestic entrepreneurship is not only paved with asphalt (one day business registration at the CAC). Road signs (comprehensible and convenient taxes, tariffs and trade requirements) which are neither changed overnight nor visible to a select few and traffic wardens (government officials) that facilitate, not frustrate the flow of cars, matter. In short, everyone knows and follows the rules. And those who don’t are prosecuted.

Still, the argument on either side of the entrepreneurship divide mixes issues. The government urges and cajoles for private initiative making promises of “machinery, policy reform etc” – sound bites that signify nothing. On the other side, would-be entrepreneurs are galled by the lack of capital to fund their ideas – banks are the culprits. These same banks are also known to bilk entrepreneurs of their business plans. With such a scene, chances are that fewer businesses will be set-up.

The problem is neither the absence of capital or ideas. Both will find themselves where requisite institutions exist – particularly legal institutions that curb corruption, enforce contracts and property rights thus ensuring the risk taker keeps the fruit of risk-taking.

Entrepreneurship is being tagged the sure-fire means of escaping the downturn. Though entrepreneurs are not unique to a particular economy, some economies, however, have an advantage – institutions that demand and ensure business is done according to the rules have matured overtime. Such institutions define and enforce the rules of the game eg, the level of information disclosure.

Alas, in Nigeria this isn’t the case. Information asymmetry: incomplete, irrelevant incomprehensible and not publicly available is the oil with which most transactions are greased. When information is ambiguous or costly to obtain or subject to whims and caprices of a few – politicians, bureaucrats and business organisations, society suffers.

Formal and informal rules

Informal norms matter as much as formal rules. Economic performance is hindered when formal and informal rules don’t overlap. For instance Lagos State’s geographic digital mapping is planned to create a database of every piece of land in Lagos. However, in identifying who owns what, where and why, it’ll be mistaken to ignore traditional family rules that govern land ownership in Lagos. Without an overlap, enforcement becomes costly – justice delayed is justice denied.

Non-enforcement of formal rules means informal rules take priority. When disputing parties resort to formal rules, the divergence between formal and informal rules is likely to hamper amicable or just settlement.  Both formal rules informal values and norms can also degenerate. Local representatives of Tafa Balogun rose to his defence after he was charged for pilfering (grand larceny?). Perhaps explaining why his indictment was not punitive. Thus, rather than deter antisocial behaviour, divergence of formal and informal rules reinforces reoccurrence. People are likely to abuse this gap.

If entrepreneurship is never in short supply and is a veritable source of economic growth, why are some countries rich while others are poor? Is the lack of increase in knowledge, that prerequisite for increased productivity, is one reason. But the context of the rules that structure how the economic game is played matters; even when the business person is knowledgeable and able to discover and exploit a profit opportunity.

If the gains from an exchange will be fairly distributed, better still gives credit to whom it is due, productive entrepreneurs will thrive. When the formal rules capture most of the gains or value generated, entrepreneurs are likely to spend time and money dodging the system – resources better invested in increasing productivity. But an exchange has nasty consequences when the rules eg, dodgy award of fuel import licenses, legally permits rent seeking at the expense of consumers and tax payers.

If the rules of the game: formal laws and informal norms over conduct, are poles apart and can be twisted to one’s gain – a zero-sum game ensues. That is one, man’s gain is another man’s loss; a mentality typical of Nigerian politics. Little or no room is made for mutually benefiting exchange. Counterparties, motivated by materialistic self-regard, rely on ‘connections’ as their competitive advantage. Public officials, in utter disregard for rules, will dole out contracts to the highest bidder (though not necessary the most competent, and certainly not the most honest).

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