Economic Growth

Why retaining trust in institutions matters

A man passes the Swiss RE building, also known as the Gherkin, in the financial district City of London June 22, 2010. Britain's Chancellor of the Exchequer George Osborne announced the harshest budget in a generation on Tuesday, promising to bring a record budget deficit of 11 percent of GDP down to 1 percent in 5 years. REUTERS/Luke MacGregor (BRITAIN - Tags: BUSINESS POLITICS) - LM1E66M17EI01

The standing of private and public institutions with significant systemic influence has declined in recent years. Image: REUTERS/Luke MacGregor

Mohamed A. El-Erian
Chairman, President Barack Obama’s Global Development Council
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Economic Progress

Institutions matter, especially in a period of economic, political, and social fluidity, when they shield countries from frequent volatility and reduce the risk of costly shocks. The longer it takes to restore confidence in them, the greater the impediments to our wellbeing and that of our children.

London – Deeply rooted, credible, accountable, and effective institutions have long been deemed crucial for a society’s lasting wellbeing and prosperity. They shield countries from frequent and unsettling volatility, be it economic, political, or social, and they reduce the risk of costly shocks. But, nowadays, key political and economic institutions are being pressured by unusual fluidity in their operating environments and the effects of a cumulative loss of trust on the part of their constituencies.

The implications vary, with a much higher probability of adaptation, including through a relatively orderly process of creative destruction and re-creation, for private entities compared to public ones. The latter require an intensification of reform efforts, lest they constitute another obstacle to the global economy’s ability to deliver high and inclusive growth on a lasting basis.

Like a well-designed, well-functioning road network, strong institutions empower economies by ensuring a stable operating environment, smoother transmission mechanisms, less costly and less risky economic interactions, a credible set of property rights, and respect for the rule of law. They act not only as enablers of a wide range of win-win relationships, but also as trusted gatekeepers. Accordingly, for decades such institutions were widely viewed as the main feature differentiating advanced economies from developing countries that are still subject to a much larger array of damaging cyclical and structural shocks.

In recent years, however, this characterization has been challenged, as the standing of private and public institutions with significant systemic influence has declined.

For an expanding set of private firms, the main source of pressure has been technological, particularly those advances underpinned by the increasingly powerful mix of artificial intelligence, big data, and mobility. The challenge has proven particularly severe, if not fatal, for those facing intense competition from entrants able to combine disruptive content and big platforms – the most notable examples being Amazon, Facebook, Google, Netflix, and Uber. As illustrated by the increased regulatory interest they are now attracting, as well as the increased media attention devoted to various controversies (such as those relating to “fake news” and internal corporate cultures), these companies must adapt and remain agile as they gain greater systemic influence and notice.

The adjustment process is even trickier for public institutions, especially given their wide-ranging roles as gatekeepers, enablers, and regulators. Often embodying the properties of “natural monopolies,” they are not only shielded from disruption but can also repress and delay beneficial innovations. Internal inertia, incomplete information, risk aversion, and conscious and unconscious biases combine to impede recognition of the urgency and importance of adaptation. Even more benign shortcomings – such as slowness in modernizing laws to catch up to changing realities – detract from economic wellbeing.

The visible and persistent failure of education systems to adopt exciting technological breakthroughs is a well-known example of this inertia. Less obvious is the lag among economic institutions in updating policy approaches, including through faster incorporation of important insights and tools from behavioral science, AI, neuroscience, and other disciplines. Then there are the persistent slippages in skill acquisition programs.

As a result, there has been a notable erosion of trust in the effectiveness of public institutions. And the damage to their credibility risks further undermining their effectiveness and perpetuating a vicious circle set in motion by their failure to generate high and inclusive growth.

Our understanding of how public institutions should adapt and reform is still evolving. As such, a complete solution is yet to emerge. But a few imperatives are already clear.

· Limit harm, including by resisting the natural inclination to promulgate increasingly ineffective, albeit established approaches, entities, and mindsets.

· Be much more open to the lessons that can be learned from external disruptors, and be willing to revisit the underpinnings of processes and entire business models.

· Enhance public-private interactions, not just for direct content, but also as a way to broaden the scope for greater cross-fertilization of best practices.

· Improve methods of public communications, lest continued information failures, aging channels, and the cumulative erosion of trust compound operational shortcomings.

Up to now, too many inherently influential institutions have lagged in identifying and implementing reforms. This has amplified the disappointment, alienation, and marginalization felt by segments of the population vis-à-vis governments that do not hear or respond to a deeply entrenched fear of economic insecurity. It is a phenomenon that has been many years in the making, that cannot be eliminated overnight, and that increasingly fuels social and political disruptions.

Institutions matter, especially in a period of economic, political, and social fluidity. The longer it takes to restore confidence in key public and, to a lesser extent, private institutions, the greater the impediments to our wellbeing and that of our children.

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