GLOBELICS ACADEMY 2015

PhD School on Innovation Systems and Economic Development

University of Tampere, Finland
June 1-12, 2015

Political settlements, state capacity and technological

change: a theoretical framework

Keston K. Perry1*
Department of Development Studies, SOAS, University of London,
WC1 0XG, London, United Kingdom
* kk_perry@soas.ac.uk

ABSTRACT

This paper draws upon the author’s doctoral thesis which centers on the political and institutional dynamics of
governance of science technology and innovation (STI) policy in a developing country context. The work
adopts a qualitative case study approach that employs process tracing, in-depth interview and historical
techniques to appropriately understand the governance trajectory of the STI policy process, design,
implementation and enforcement. The paper outlines the major aspects of the theoretical framework, namely
‘political settlements’ (PS) employed to highlight certain blind spots in conventional policy-related academic
work on STI. First, we present and evaluate two generations of mainstream institutional economics literature
i.e. New Institutional Economics (NIE) proposed primarily by Douglass North and colleagues. We proceed
with an analysis of the national innovation systems (NIS) literature, ostensibly rooted in the first generation
NIE models, which tangentially addresses the political, institutional and historical aspects of the capitalist
transformation of developing countries. We acknowledge the important insights of NIS given its combinatory
evolutionary and its institutional moorings, which has become a highly influential conceptual framework in
policy circles. We then present the PS framework as a political economy theory of institutions that eschews
normative claims and mischaracterizations present in both the NIE and NIS scholarship, and is grounded in
the experience of developing countries.

Keywords: Political Settlements; Science Technology and Innovation Policy; Political

Coalitions; Governance; National Innovation Systems; Developing Countries

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 Political settlements, state capacity and technological change: a theoretical framework

Introduction

This paper outlines the main objectives of the study and develops an alternative analytical

framework that reconciles the macro and micro level features of science, technology and innovation

policy within the political economy of a small developing state. The thesis aims to identify and assess

the institutional factors that contribute to the emergence science, technology and innovation (STI)

policy, to deepen understanding of the STI policy process, and assess the effectiveness of the process

in Trinidad and Tobago. We ask the following questions:

1. How do political, administrative, economic, international organizations with various

interests interact in designing and implementing reforms and policies promoting STI

as a development strategy?

2. What are the implications of these interactions?

3. How does the country’s political settlement influence the emergence of STI policy and

governance capacity of relevant government agencies?

To answer these questions, the study is primarily qualitative, employing case study approaches and

applying process tracing and historical methods. We collect data primarily from interviews with the

main actors and organizational representatives, as well as relevant historical documents, strategy and

policy reports. We adopt the theory of ‘political settlements’ as an appropriate framework, which

encompasses the role of power distributions, factional coalitions and organizational dynamics in the

design and implementation processes of government policy and institutional reform strategies (Khan,

1995, 2004, 2010). We hope to extend the PS framework, which hitherto has been applied to mostly

case studies of large developing countries in Asia, Africa and to a lesser extent Latin America (Khan,

2010; Khan and Blankenberg, 2009; Di John 2009), to incorporate the intervening factors of state

capability, specifically as it relates to the size of economies, heterogeneity of groups, the role of

international organizations and related industrial structure of less advanced economies. Ultimately,

the researcher hopes to develop a policy-oriented governance capability framework, the beginnings

of which is presented here.

 Globelics Academy 2015: PhD School on Innovation Systems and Economic Development

In the paper, we first assess the New Institutional Economics (NIE) literature, which has been

found wanting in accurately explaining the nature and performance of institutions, organizational

trajectories and policy processes in developing countries. In addition, we discuss the Innovation

systems literature as it specifically related to science, technology and innovation policy and micro-

level capability building processes that have successfully determined technological development in

East and Southeast Asian states (Amsden, 1989, 2001; Chang, 2006; Evans, 1995; Fu, 2015; Hobday,

1995; Kim, 1998; Kim and Nelson, 2000; Wade, 1990). We offer an assessment of innovation

systems as it related to late development, a construct rooted in the evolutionary and NIE literatures

that have become very influential in policy circles (Freeman, 1987; Lundvall, 2010 [1992], Nelson,

1993, 2005; Niosi, 2010; Metcalfe, 1995; OECD, 1997; UNCTAD, 2007). We note that these

conceptual developments are inadequate to explain contemporary late developers’ growth

performance, given their specific political context, economic characteristics, geopolitical position in

global processes, and governance capacities to enforce science and technology policies (Breznitz,

2007; Cozzens, 2010; Khan, 2008, 2013; Sen, 2013)

The present paper provides a political economy assessment of the conventional framework of

analysis i.e. National Systems of Innovation (NSI), ostensibly rooted in the NIE literature, that

undermine the specific role of political dynamics (Bell, 2009; Khan, 1995), and emphasizes the value

of formal rights, structural deficiencies, the need for low expropriation and rent-seeking opportunities

and ‘good governance’ (Fagerberg and Schrolec, 2008; Alternberg, 2009). These conceptions

consequently proffer ideal-type Weberian structures and alternative institutional paths embedded in

the realities of advanced economies, insensitive to the appropriate transition costs and political

economy idiosyncrasies, thereby undermining their analytical rigor and applicability to developing

countries (Breznitz, 2007; Gray, forthcoming; Khan, 1995). As a result, appropriate policy guidance

for developing country actors remains stymied (Marcelle, 2015). Our approach thus demonstrates the

need to appropriately examine how the prevailing institutional context, bargaining power and

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 Political settlements, state capacity and technological change: a theoretical framework

governance capacities of state agencies relative to other actors in the system, characterized by the

political settlement, shape the performance of institutions and policy processes in such countries.

1. New Institutional Economics and its successors: an assessment

The early insights of classical political economy and more recent accounts highlight the

importance of material/non-material productive forces and related social institutions (sometimes

transmitted through colonial conquest) as major determinants in the accumulation of wealth and

capitalist transformation of nations (Acemoglu et al., 2008; Khan, 2005; List, 1841; Marx, 1858;

North, 1990; Smith, 1774; Williams, 1944). Institutions are thus inherent features of all economies

through which production and other economic activities are undertaken, and have become central to

the New Institutional Economics (NIE) literature developed by its main proponent, Douglass North

(1973, 1990, 1995). Institutions as “the rules of the game in society or, more formally, are the

humanly devised constraints that shape human interaction” (North, 1990, pp. 3). Drawing upon

neoclassical economics based on rational actor and transaction cost analysis, North and supporters

developed the first generation of NIE models in which the price mechanism provide incentives that

signal to individuals what actions were necessary to achieve best economic outcomes (North, 1990;

North and Thomas, 1973; Williamson, 2000). North (1990) further argued that capitalism emerged

in advanced countries through changes in property rights that enabled the smooth functioning of the

market economy. In a widely cited paper, Acemoglu and colleagues (2001) contend that the

attainment of strong property rights and good market conditions facilitated higher levels of prosperity

in some countries, compared to others given different modes of institutional transplantation.

Therefore, in developing countries, market economies did not successfully evolve, and once

impediment to the operation of markets are removed, the result will be productivity growth and

improved standards of living (North, 1995). In this manner, North advances an analysis of market

efficiency based on institutional factors that determine the long-run growth of the economy based

upon economic institutions, i.e. property and other legal structures, which are further made efficient
 Globelics Academy 2015: PhD School on Innovation Systems and Economic Development
through the right incentives and low transaction costs (North, 1997). North further proposes that

important policy decisions are made by culture-bound rational individuals who possess mental

models and can act according to changing circumstances based upon incomplete information (North,

1995). These proponents are concerned with minimizing transaction costs that lead to what North

(1990) and Williamson (1985) consider the harmful effects of rent-seeking behavior whereby costs

outweigh benefits and delay economic growth. Weberian ideal-type structures of property rights,

democratic rule, and low expropriation by government that remove uncertainties market strictures

encourage individual action, and are thus critical to market-enhancing improvements in capital

accumulation and economic growth. The analysis of transaction costs and the political conditions

under which institutions are growth enhancing is based on certain assumptions and empirical

examples of economic systems and the institutional mechanism via which economic activities lead

to Pareto-efficient outcomes. In this model, essentially only the fittest market actors survive and can

benefit from monopolistic advantages (Schumpeter, 1934). In this manner, the control of resources

and nature of its distribution (usually diffused by the market in this framework) according to some

scholars, be instrumental in the political genealogy and economic development trajectory of societies

(Sokoloff and Engerman, 2000).

Taking their inspiration from the first generation NIE models, Acemoglu and Johnson (2005)

extend the historical and subsequently political dimensions of North’s work, placing elite

compromises at the core of economic and social change in societies. First, using a mixture of

econometric and historical methods and datasets, they demonstrate that colonial experience has given

rise to different types of economic institutions that determine developing countries’ growth and

development trajectory (Acemoglu and Johnson, 2001). In this approach, where the risk of

expropriation is considered the instrumental value, property rights established by different forms of

colonial settlement persisted to present times and gave rise to a divergence in growth of incomes per

capita across countries (Acemoglu, Johnson and Robinson, 2005). After the fundamental

establishment of democratic institutions and political checks and balances on government, merchants

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 Political settlements, state capacity and technological change: a theoretical framework

and other capitalists were able to act as a counterbalance to European states and demand changes to

secure property rights at home and in the Western hemisphere (ibid.). Further, politics as an add-on

to their theoretical construction, is viewed as core to these developments and seen as a process by

which elites with disproportionate influence engage in the bargaining process, motivated by the profit

maximization principle (Amsden et al., 2012; Acemoglu and Johnson, 2005). Institutional choices

become subject to the influence exercised by political elites to the exclusion of other groups

(Acemoglu and Johnson, 2002). Extending the public choice/rational actor hypothesis, Breznitz

(2007) posit that the policy agents are able to determine the direction of science and technology based

industrial policies that have led to positive development outcomes, notwithstanding their existence at

the periphery of political battles. In fact, these studies emphasize that in some countries it is largely

due to the fact that relationship of policy champions with central units of power is tenuous that these

agencies with small budgets and consequent limited opportunity for rent-seeking, in which political

power brokers are less interested, that they are able to achieve rapid industrial development and

develop competitive advantages in innovation-driven industries (Breznitz and Ornston, 2013). It is

thus believed that ‘political interference’ that destabilizes the market equilibrium can play a persistent

harmful role in retarding growth and resisting the emergence of new institutions which can offer

better opportunities for industrial development based upon stable property rights and the rule of law

in developing countries (Acemoglu et al., 2005; Acemoglu and Johnson, 2012). Thus, according to

these scholars, developing countries are with significant economic hardship and social decadence

because they lack the 'right' institutions to encourage investments in human capital and productive

capabilities. They thus argue that there are two type of power in operation: de jure and de facto power,

which need to be in alignment to bring about economic development. The distribution of resources

determines the pattern of de facto power in society while de jure power is derived from formal political

institutions. Over time, formal political institutions are only sustainable if they reflect the pattern of de

facto power in society. When the distribution of resources is concentrated in few hands, they contend that

authoritarianism emerges, which undermines the state’s commitment to secure property rights. On the
 Globelics Academy 2015: PhD School on Innovation Systems and Economic Development
other hand, when democracy becomes the norm, political power is better diffuse across society and this

encourages the strengthening of property rights and generates higher levels of productive investment

(Acemoglu and Robinson, 2012). We now relate these models to the work on innovation systems

evincing significant points of convergence in addressing the question of development.

Innovation systems and policy in developing countries: the limits of conventional analysis

The emergence of scholarly work on innovation systems (see box 1) in its initial formulations

primarily hitherto considered the specific economic and institutional circumstances, concerns and

constraints of fast industrializing and industrialized countries (Freeman, 1987; Lundvall, 1987, 1992;

Nelson, 1993). The framework developed from combined theoretical starting points in evolutionary

theory of the firm (Nelson and Winter, 1982) and institutional economics (Hodgson, 1988), to

measure the rate of innovative performance in economies. Nelson (2002) made the case for a

revisionist approach whereby both disciplines could be harmoniously married as in classical political

economy. Ostensibly, its parameters were determined in large respect upon insights from NIE first

generation model (North, 1990) and transaction cost economics (Williamson, 1985), both of which it

was believed had shaken off neoclassical tenets of rational expectations and utility maximization to

adopt more dynamic perspectives on capitalism associated with Schumpeter. According to Nelson

(2002, pp. 19)

There certainly are strong natural affinities, in the form of common core assumptions and
perceptions, between institutional economists, at least those in the school of North, and
modern evolutionary economists. There also are very strong reasons more generally why they
should join forces.

Even though these schools diverged on the source of economic performance, where

institutionalists believed that institutions were responsible for growth performance and

Schumpeterians argued that technological progress created conditions for growth, they agreed that

economic change could have been brought about by the elimination of transaction costs that would

lead to efficiencies and improved market/actor interactions (Nelson, 2002; North, 1990; Williamson,
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 Political settlements, state capacity and technological change: a theoretical framework

1985). According to Dosi (1982), the interplay of institutional, economic and technological factors

create continuities that determine the progress along technological paradigms, while critical events

can create disequilibria. From this point of view, institutions co-evolve with technologies and

industries in a self-reinforcing manner to advance economic growth (Nelson, 1995). Thus innovation

policy is seen as a mix of instruments and decisions that enforce formal institutions and arrangements

such science-industry relationships, intellectual property rights, and industrial networks and clusters

(OECD, 2005b). Even as the evolutionary work on technological change progressed, led by major

proponents, the specific conditions that led capitalist transition in developing countries seemed to

have been not well accounted for (Khan, 2005).

Box 1 National innovation systems: definitions

Author / year Definitions
Freeman (1987) “ .. the network of institutions in the public and private sectors
whose activities and interactions initiate, import, modify and diffuse
new technologies.”

Lundvall (1992) “ .. the elements and relationships which interact in the production,
diffusion and use of new, and economically useful, knowledge ... and
are either located within or rooted inside the borders of a nation
state.”

Nelson, (1993) “... a set of institutions whose interactions determine the innovative
performance ... of national firms.”

Patel and Pavitt (1994) “ .. the national institutions, their incentive structures and their
competencies, that determine the rate and direction of technological
learning (or the volume and composition of change generating
activities) in a country.”

“... The set of institutions whose interactions determine the innovative

Nelson and Rosenberg, (1993) performance of national firms”

“... The national system of innovation is constituted by the institutions

Edquist and Lundvall, (1993) and economic structures affecting the
rate and direction of technological change in the society”

“... A national system of innovation is the system of interacting private

Niosi et al. (1993)
and public firms (either large or
small), universities, and government agencies aiming at the production
of science and technology within
national borders. Interaction among these units may be technical,
commercial, legal, social, and financial,
in as much as the goal of the interaction is the development, protection,
financing or regulation of new science and technology”
 Globelics Academy 2015: PhD School on Innovation Systems and Economic Development

Metcalfe (1995)
Source: (OECD, 1997).
“.. that set of distinct institutions which jointly and individually
contribute to the development and diffusion of new technologies and
which provides the framework within which governments form and
implement policies to influence the innovation process. As such it is
a system of interconnected institutions to create, store and transfer
the knowledge, skills and artefacts which define new technologies.”

Since the 1980s the growing popularity of innovation policy with academia and policy circles

adopted sine qua non innovation systems as its conceptual basis (OECD, 1997). In developing

countries, innovation systems are considered disjointed constellations of private and public actors

and institutions that do not allow for efficient-driven innovative outcomes (Arcena and Sutz, 2000).

From a Southern perspective, innovation can be defined as

an intentional process of generating, acquiring and applying knowledge aimed at producing

economic and/or social value. In developing countries, this process typically takes place
through the unfolding over time of a wide variety of learning and capability building
processes, rather than through the mastery of science and technological knowledge.
Innovation is an investment effort in which, knowledge, financial capital, and other resources
including cultural and social capital are deployed over time to create value. Deftly undertaken
innovation can lead to the transformation of systems, values and culture as well as the
production of new and/or improved products or processes (Marcelle, 2015, pp. 2)

The costs and process of absorbing and appropriating knowledge in the production process still poses

tremendous challenges and remains elusive, given that organizational systems and capabilities differ

from their industrialized counterparts (Cooper, 1972; Khan, 2013). Consequently, as Rosenberg

(1982) described in his early work on the linkages between technologies and production systems, it

can be similarly seen as a significant “black box” in development theorising, and what Bell (2006)

considers a theoretical gap in the innovation systems approach. As such, it has been believed that by

adopting production and institutional systems and designing policy instruments based upon systemic

conditions based in developed countries may bring about more productive outcomes (Smits et al,

2004). Similarly, it is thus understood that developing countries’ innovation systems are not ‘mature’

and thus are predisposed by prevalent systemic failures which account for their poor innovative

performance (Chaminade et al., 2008). These failures originate in both structural and functional

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 Political settlements, state capacity and technological change: a theoretical framework

aspects of their innovation systems, namely bottlenecks that retard innovation processes (Hekkert et

al., 2007; Edquist 2011). Borras and Edquist (2013) suggest that selecting the ‘right’ policy

instruments for the context-specific failures can address the low level of innovation intensities or the

productive capacity to develop innovations. Thus, these instruments can in fact appeal to functions

of innovation systems regarding (1) management of interfaces, (2) (de)construction and organizing

(innovation) systems, (3) providing a platform for learning and experimenting, (4) providing an

infrastructure for strategic intelligence and (5) stimulating demand articulation, strategy and vision

development (Smits and Kuhlmann, 2004). Innovation policy design should address any

discrepancies that prevent optimal learning at the firm-level and interactivity amongst various actors

within the supportive framework (Woolthuis et al, 2005, Chaminade and Edquist, 2006). Thus,

systems and institutions which have historically been responsible for generating new technologies

from industrialized countries seem irrelevant, given that hitherto underdeveloped economic and

technological systems based on mercantilism, unequal trade arrangements, and low technology

production for export still persist in many developing countries, resulting in asymmetrical industrial

capabilities (Chang, 2010; Cooper, 1973; Saad-Filho, 2013; Prebisch, 1950). According to this

framework, development is seen as a technical matter of fixing the policy “instruments” and failures,

and not related to the wider political and social processes of change (Khan, 2013; Saad Filho and

Fine, 2014).

Engagement with wider social concerns has been considered by some innovation scholars. In

this respect, Cozzens (2010) has examined the distributive effects of innovations on developing

countries and their innovation systems, which have created asymmetrical levels of wealth, incomes

and growth across geographical boundaries. Similarly, Sutz and Srinivas’ (2008) theoretical work

point out the resource challenges and scarcity conditions in developing countries as the primary

source of innovation performance that requires specific policy attention. They argue that such a focus

will give rise to recognizing new forms of innovation as well as bring about social inclusion and

expansion of human capabilities (Arocena and Sutz, 2012). Work on inclusiveness has been a primary
 Globelics Academy 2015: PhD School on Innovation Systems and Economic Development
consideration for Latin American scholars, given the pervasive inequalities that plague the region.

Utilizing insights from Amartya Sen and others, they seek to understand how and under what

conditions innovation policies can bring about distributive justice and expanded freedoms (Detrunit

et al., 2014). This approach coheres with influential global policy frameworks and efforts at the

United Nations, including the Millennium Development Goals (MDGs), and Human Development

Index (HDI) and its human development reports (HDRs) (UNDP, 2001). In addition, these scholars

have emphasized that the capacity to learn and apply new knowledge, rather than use new technical

instruments, is the differentiating factor in developing country innovation systems (Cassiolato et. al.,

2003). In addition to scarcity considerations and directing efforts to assist in health, power generation

and environment, scholars focusing on African countries have discussed that innovation policies need

to consider the capability failures that can impede new growth trajectories (Juma et al, 2014). The

attendant social and institutional systems have evolved in limited measure, except perhaps in the

cases of four Asian Tigers that do not give any important universal theoretical cues in technological

development (Khan, 2007; Cassiolato et al., 2014). The vast majority of countries in the postwar

period have remained laggard in their economic development (Ocampo, 2008), though specific

policies and institutional frameworks seemed to have contributed to growth rates and periodic

collapses (Commission on Growth and Development, 2008). Breakthrough innovation associated

with expensive research and efforts and infrastructures thus seem out of reach of and wasteful in low

income countries and can lead to major failures (UNCTAD, 2007; Siyanbola et. al, 2012). In large

measure, this reality has paradoxically resulted in the ‘transfer’ of technologies paradigm from

advanced industrial states to developing countries as a policy tool with limited absorptive capacity to

generate technological change (Humbert, 2003, cited in Cassiolato, 2003; Perez and Soete, 1988) and

improve technological learning and innovative capabilities that can drive economic transformation

(Bell, 2009; Bell and Pavitt, 1997; Lall, 1992).

The widespread impact of globalization in the fragmentation of production and the resulting

diffusion of innovation capabilities across the developed and developing world, some countries like

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 Political settlements, state capacity and technological change: a theoretical framework

China and India are progressing in the direction of enhanced technological development (Altenburg

et al., 2008; Fu, 2015). It is believed that technological uncertainties occasion the need for innovation

policies that approach technological gaps and improve the adaptive capability of firms (Edquist,

2011). Some scholars view the process as the concentration of knowledge bases and strategic efforts,

rather than its diffusion to developing regions (Humbert, 2003). This phenomenon seems consistent

with existing critical scholarship on the possibilities of universal convergence between developing

and developed countries over time (Saad Filho, 2013). In this way technological change is

characterized by endogenous institutional characteristics and political systems, whereby the extent of

policy efficacy in some respect can be attributed to the following:

While we might sense undiscovered insights and options behind borders, we tend to be

impeded by vested interests and inertia of existing institutional, political and organizational

structures by exploring such options and becoming exposed to unknown consequences (Smits

et al., 2010)

Similarly, Ramlogan and Metcalfe (2008) highlight that benefits of innovative activity can be

misappropriated through political intervention. Thus capitalist transitions towards improved

performance may not be well understood, and the theoretical regularities that condition

developmental improvements do not seem solely point to the strategic orientation of firms, notably

their learning capabilities and characteristics (Smith, 2000; see Marcelle, 2015 for firm-centered

arguments). As the OECD and World Bank have pointed out, detailing its new theoretical departure

on innovation policy, such “turf wars” are equally characteristic of developed countries’ policy

environments (OECD, 2005a). In addition, in the Asian case, where successful policy interventions

have brought about rapid technological development, the nature of their political economies and the

presence of strong governance capacities which disciplined firms and placed emphasis on forging

important coalitions among various actors in the economy (Amsden, 1989; Wade, 1990). It is noted

that even in weak governance structures, technological capability development can take place in

supposedly low technology sectors, which comprise the productive sectors in most developing
 Globelics Academy 2015: PhD School on Innovation Systems and Economic Development
regions in the world (Khan, 2010). Given the above stated definitions of innovation in developing

country contexts, where high technology and rapid breakthroughs may not always be possible in the

early stages of capitalist development of countries, especially given the liberalization of developing

countries that truncated technological learning during the 1990s (Katz, 2001), nuanced and

appropriate analyses need consider the appropriate governance arrangements and policy interventions

are formulated that incrementally increase and improve innovative capacities in developing countries.

These arrangements do not only respond to institutional failures by reducing transaction costs but

considering the political costs of transitioning to other paths that are determined by political

processes (Khan, 1995, 2010). NIS approaches have hitherto lacked appropriate analytical insights

that account for the prevailing institutional characteristics based on informal rules beyond norms,

values and cultures (Lundvall, 2010; North, 2010) that are seen to prop up formal institutions. Instead,

these type of informal institutions act as important determinate structures that offer important vehicles

for economic, social and political outcomes, due to the personalized relationships among various.

They create conditions in which real distribution effects on the benefits from government efforts can

support the burgeoning capitalist structure and contribute to technological development and policy

effectiveness.

3.1 Towards a political settlements approach to economic change and governance

In societies where “the rules of the game” are patently different and are not consistent with

the stylized facts of the contemporary industrialized world purported by NIE and some NIS scholars,

important historical and political nuances can be glossed over and institutional dynamics

mischaracterized. Adopting the ontological premise that developing countries are qualitatively

different on their own terms in political, economic and social dimensions, though connected by

historical processes of capitalist expansion, we can begin to dissect certain misguided assumptions

and put things into better perspective. In this way, we deviate from normative claims in the

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 Political settlements, state capacity and technological change: a theoretical framework

institutional economics literature to consider how institutions interact with the political economy to

produce particular economic and distributive outcomes. Configurations of power, which are

historically rooted and shaped by politics, can be evident at both at the societal level, across industries,

within organizational settings, or across institutional boundaries; and they ultimately influence how

economic policy decisions are made, and how various incentives therefrom are effectively

appropriated (Khan, 2010, 2011). In developing and developed countries, institutions are critical to

how these factors ultimately influence the allocation of benefits based upon a number of prevailing

characteristics and to what extent they are put to productive uses. In both developing and more

advanced economies, these institutions varyingly contribute to the growth of the capitalist sector and

are very peculiar to their type of political and economic arrangements in force (Khan, 2005). On the

other hand, they become subject to both formal and informal mechanisms that operate in the wider

polity that are path dependent and evolve over time. Institutions thus constitute the organizing

mechanisms via which the state formulates, pursues, and executes strategies for economic

development (Stiglitz, 1998; Rodrik, 2007). From this perspective, this study draws upon the

theoretical framework of political settlements by Mushtaq Khan, which posits that institutions are the

source of conflicts and collaborative efforts encapsulated as 'social order' insofar as the macro-level

distribution of power influences their viability, the efficacy of economic policies and the overall

performance of economies (Khan, 2010). Defined further, a political settlement refers to

“an interdependent combination of a structure of power and institutions at the level of a

society that is mutually ‘compatible’ and also ‘sustainable’ in terms of economic and political

viability….[this] combination of institutions and organizations can reproduce itself over time.

Once a reproducible social order emerges, the relative power of different organizations is

relatively stable and evolves along stable paths. The macro-level political economy can help

to explain a fundamentally important observation: particular formal institutions appear to

perform differently across countries and over time (Khan, 2010, pp. 20; 2011, pp. 17).
 Globelics Academy 2015: PhD School on Innovation Systems and Economic Development
Political settlements thus describe the macro political equilibrium between institutions and the

distribution of bargaining power across organizations (Khan, 2011). Khan further argues that the

distribution of benefits supported by a country’s institutions is consistent with the distribution of

power in society and the economic and political outcomes of these institutions are sustainable over

time (Khan, 2010).

The structure of politics and rent-seeking are invariably linked to demands for redistributive

benefits from societal groups:

The general result is that politics in the typical developing country is personalized, based on

constructing coalitions of the powerful who are given access to rents on a privileged basis to

achieve a more or less sustainable ruling coalition (Khan, 2011, pp. 161).

In developed countries, the distribution of power reflects the income-generating capacity of elite

groups and the ability to affect the necessary formal institutions, whereas in developing societies

these bargains are based upon informal relationships and institutional mechanisms that evolve over

time (Khan, 2010). In this sense rents are understood as incomes that are greater in value than the

next best opportunity (Khan, 2000). In orthodox analysis, rent-seeking is damaging for efficiency and

growth (Krueger, 1974; Chaudry and Garner, 2007). While rents in developing countries are often

off-budget claims (Gray and Whitley, 2014), they can also operate as subsidies, or in the case of

developed countries are legalized instruments. Rent-seeking activities are part of both to processes

and outcomes in this type of analysis, and can be important for growth, political stability and capitalist

accumulation (Jomo and Khan, 2000). In Schumpeterian terms, rents are considered super-normal

profits based upon the monopolistic advantages of innovative firms (Galunic and Rodan, 1998).

However, as some scholars have shown state created rents are critical for firms in new industries

develop and to compensate for limited or no profitability during early years (Chang et. al, 2002; Khan,

2009). Without state intervention to support firms in late developers, they do not achieve the high

levels of productive capability and technological learning that will enable employment creation and

sustain economic growth with limited oragnisational capabilities (Khan, 2011; Nübler and Ernst,

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 Political settlements, state capacity and technological change: a theoretical framework

2013). In contrast, Khan (2005) points out that the removal of market restrictions to limit the state’s

role that occurred during the 1980s and 90s in developing states through liberalization to enable

greater efficiency and lower expropriation, had contradictory effects and were misguided institutional

reforms to impel higher productivity growth.

Figure 1.1 - The two-way relationship between power and institutions

Source: (Khan 2010: Figure 7)

Early NIE models neglected the role of politics and relative power, as a shaping force in the

formation and dynamics of institutions (Burlamaqui et al., 2000). Moreover, Ha-Joon Chang argues

that the state and are complementary institutions, including the market, are politically crafted and

particularly relevant since the 1980s given the wide deployment of neoliberal policies in developing

countries (Chang, 2001). It is thus argued that economic performance is not perched upon on the state

and market or the state versus market, but also incorporates other institutions within the socio-

economic system (Hodgson, 2006). Belonging to this framework, referred to as the developmental

state paradigm, are proponents such as Robert Wade and Alice Amsden, who suggested that state-

crafted institutions are largely responsible for the rise of the East and the well noted performance of

the economies like Taiwan and Korea (Amsden, 1989; Wade, 1990). As such, a critical feature of

successful developmental states is that incentives and resources that governments provide to stimulate
 Globelics Academy 2015: PhD School on Innovation Systems and Economic Development
and direct private sector activities were contingent upon performance (Amsden, 2001). East Asian

countries thus successfully utilized activist industrial and protectionist policies that have been largely

undermined by advanced economies through the IMF and World Bank, which prevent their

developing country counterparts from achieving (Chang, 2010). A corollary theoretical perspective

is in Chang (2011) who postulates that economic development is not necessarily the result of ‘right’

institutions but the inverse can also be true, where economic development gives rise to new and

improved institutions via a number of drivers such as increased income, which can spur demands for

better institutions; better institutions also consequently become more attainable from increased

wealth; and ‘middle class’ change agents emerge as a result of improved economic performance.

These developmentalist perspectives thus acknowledge the need for a capable and confident state and

public institutions which help drive growth (Reinert, 1999). Increasingly, coupled with this are new

perspectives on the importance of industrial policy, which have received theoretical treatment from

a variety of perspectives, associated with the preponderance of market failures and the need for

different configurations of state and market interactions in the emergence and structuring of dynamic

economies (Khan, 2008; Rodrik, 2004; Stiglitz et. al., 2013; Stigltiz and Greenwald 2014). In this

vein, Warwick (2013) posits that the need for industrial policies and state intervention (associated

with the developmental state paradigm – see Chang and Evans, 2005, and Chang, 2006) should be

based upon a system approach in which state institutions play a coordinating role and where sectoral

targeting can bring about economic progress. Similar to Chang (2003) and Wade (2003), Weiss

(2011) views state intervention in developing countries as an equalizing tool to bring about just

development comparable to historical experiences of growth, technological change and innovation in

the advanced economies. According to Murtha and Lenway (1994):

“to implement an industrial strategy, a government must have capabilities to integrate and

motivate the complex organizational structure of its country's political and economic

institutions to take concerted action” (Katzenstein, 1977; Hall, 1986, cited in Murtha and

Lenway, 1994, pp. ).

17
 Political settlements, state capacity and technological change: a theoretical framework

Overall, this treatment emphasizes both the need for institutional structures and human agency

(Hodgson, 2006). It proffers a need for systematic and productive interaction to occur which takes

cognizance of the power dynamics and evolutionary change of institutions, towards a ‘strategic

theoretical alliance’ (Burlamaqui et al., 2000). Khan perspective suggests that identifying key market

failures is a vital role for state agencies, but further argues that the state apparatus that stimulated high

levels of economic growth and development in North and South East Asian countries cannot be

replicated in the present global environment (Khan, 2011, 2013b). More than that, the ‘developmental

governance’ capabilities associated with these large developing countries in Asia is difficult to

acquire by other developing societies with different initial conditions and political organisation that

impinge upon effectively appropriating and enforcing growth-enhancing rent and technology

acquisition strategies (Khan, 2009, 2013a).

Effective governance capabilities are required in addressing structural deficiencies and the

insufficiency of market mechanisms to bring about sustainable growth, especially as they pertain to

in developing countries (Khan, 2006). In such contexts, these structural limitations are entrenched as

market failures abound; the need to address such market failures must take account of the power

constellations of institutions which impinge upon the nature of institutional performance and

economic growth trajectories (Khan, 2007). Moreover, since formal institutions are not principally

where power is exercised in developing countries, agency is primarily structured around informal

institutions or ‘clientilist’ organisations such as political parties (Khan 2010). These patron-client

networks, namely informal relationships or organizations that comprise individuals holding varying

degrees of power are likely to provide the institutional setting within which credible commitment

problems to do with investment can be addressed in an environment where formal institutions i.e.

property rights are absent or unenforceable (Khan, 2010). Khan’s definition of “holding power” is

therefore important here: “how long a particular organization can hold out in actual or potential

conflicts against other organizations or the state”, as:

 Globelics Academy 2015: PhD School on Innovation Systems and Economic Development
“a function of a number of characteristics of an organization, including its economic capability

to sustain itself during conflicts, its capability to mobilize supporters to be able to absorb costs

and its ability to mobilize prevalent ideologies and symbols of legitimacy to consolidate its

mobilization and keep its members committed” (ibid., pp. 20).

The political settlements approach indeed links human agency with structural factors (Hodgson,

2006; Chang, 2011) but acknowledges other key variables such as power distribution and patron-

client networks which emerge within societies and influence the political and economic viability.

Figure 1.2 - Patron-Client Factions and the Structure of the Ruling Coalition
Source: (Khan, 2010, Fig. 17, pp. 65.)

As such, the differences in political settlements can potentially explain the performance of economic

institutions, the dynamics of the policy process and effectiveness of enforcement strategies, as well

as the attendant governance capabilities and structures within which development oriented policies

are devised and implemented. This leads us to a theoretical discussion of the institutional

requirements and capabilities inherent in such processes to achieve positive developmental outcomes

which can be encapsulated under the term governance.

Governance can be defined as

the processes through which individuals and State officials interact to express their interests,
exercise their rights and obligations, work out their differences and cooperate to produce public
goods (Brinkerhoff and Goldsmith, 2005, pp. 200).

19
 Political settlements, state capacity and technological change: a theoretical framework

It is no doubt that governance reform is central to the implementation of development-enhancing

economic policies, including technology and industrial policies (Khan, 2010, 2013). It is the meaning

of the term governance which has come into major scrutiny from the 1990s subsequent to the failure

of structural adjustment that had befallen several developing countries in Latin America, Africa, and

the Caribbean and to a lesser extent Asia (Leftwich, 1993). The shifts in thinking that occurred post-

1980s, associated with the good governance and liberalization agenda have come to exercise great

influence on government economic policies and have been to a large degree prioritized as important

ends in themselves (Khan, 2009). The good governance agenda is based on a set of principles that

promote market efficiency and the entrenchment of standard property rights that prevent rent-seeking

and corruption by reducing transaction costs associated with regulatory practices (North, 1990). As a

result, the state has been circumscribed as simply provider of public goods (Khan, 2004) which is

pervasive in World Bank research and policy outputs and has widely inspired reforms in developing

countries describing this approach:

These changes have been accompanied by changes in the role of the state to reflect a greater
preoccupation with the creation of an enabling environment for development, larger
responsibilities for the private sector, a reduction in direct government involvement in
production and commercial activity… [thus] only governments can provide two sorts of
public goods: rules to make markets work more efficiently and corrective interventions where
there are market failures (World Bank, 1992, p. 5-6).
This perspective is consistent with the market-enhancing role of the state and with economic

theory that emphasizes transaction costs as the major impediment to better economic performance

(Khan, 2011). It is perceived that government’s failure to arrest corruption, curtail expropriation

risks, enforce property rights and ensure accountability has delegitimized its role as the principal actor

in bringing about economic growth (Krueger, 1990). According to Leftwich (1993), this approach

has been left void of important historical lessons, which show that successful state-led development

is driven by political factors that prioritize development alongside advance capitalist-driven

 Globelics Academy 2015: PhD School on Innovation Systems and Economic Development
development. Employing the political settlements framework, Whitfield and Burr (2014) argue that

government’s role goes well beyond simply creating institutions but likewise ensuring its political

capital through alignment of mutual interests with the capitalist class, and the effective enforcement

of contested decisions. Thus, promoting and investing in important state capacities are essential for

sustained growth in developing countries (Khan, 2012). These governance capacities can be defined

as

“the ability to make intelligent policy choices….[by] the political system [and] to decide or

compromise on the best approach to technological and economic development, or to

distinguish between what is ‘desirable’ and what is ‘feasible’ though he processes of policy

debate and interest coordination (both within the bureaucracy and political institutions and

between public and private actors” (Karo and Kattel, 2014, pp. 84)

UNCTAD (2009) suggests that these governance capacities are important to generate productive and

technological capabilities and help create the conditions for long-term learning and capability

development for firms. Similarly, Rodrik (2004) has highlighted important conceptual underpinnings

of modern industrial policy which takes specific learning requirements in which developing countries

discover capabilities and pursue particular courses of action. According to Khan (2010, pp. 132)

Growth in developing countries requires catching up through the acquisition of new

technologies and learning to use these new technologies rapidly. Markets, even the most

efficient ones possible in a developing country, are typically inadequate on their own for

attracting capital and new technologies in high value-added sectors.

Thus, there are stark differences between the good governance model of development associated with

the first generation NIE model, or the market-enhancing approach, and the developmental governance

approach which focus on the capacities of the state to ensure capitalist accumulation, and creating the

compulsions within the private sector to upgrade their capabilities and enhance technological learning

necessary for economic growth and transformation (UNCTAD, 2009; Khan, 2008, 2010, 2013).

21
 Political settlements, state capacity and technological change: a theoretical framework

Objectives of Governance capabilities

▪ to manage the structurally weak property rights

▪ to manage incentives and opportunities for technological catching up, while
creating compulsions for capitalists not to waste resources.
▪ to manage patron-client politics in ways that allow political stability sufficient
for capitalist accumulation to continue
▪ to generate political capital and institutional mechanisms that allow non-market
transfers to be invested in productive enterprises
Source: (Khan, 2007)

Figure 5.4 Differences between market-enhancing and growth-enhancing governance

Khan’s (2010, 2012) theoretical contribution to heterodox political economy of institutions,

governance capabilities of the state (2007, 2009) thus articulate precise mechanisms of divergent

institutional outcomes, how the prevailing political context within organizations and at a macro level,

and the relative bargaining power among actors and organizations can influence the emergence,

evolution and change within institutions, and the consequent degree in efficacy of enforcement,

design and implementation processes of various policies.

Conclusion

Consideration of the specific characteristics of governance and economic change in developing

states is a useful endeavor that breaks away from normative and standard institutional analyses. These

analytical cues and characteristics have been significantly missed in NIS-based approaches. The

approach developed here problematizes frameworks such as the Systems of Innovation that seek to

meet lowered transaction costs and efficiency targets. In the area of science, technology and

innovation, no less than in other policy domains, political and institutional orientations that are

derived from historical processes help define new possibilities. Institutional realities in developing

countries that are based on clientilist networks and personalized politics thus matter for the nature

and emergence of coalitions that can drive learning processes and innovation at the firm level in such

small capitalist sectors. The advancement of capitalist development can thus be better understood
 Globelics Academy 2015: PhD School on Innovation Systems and Economic Development
from institutional analyses that take into account the dynamics of socio-political processes, including

the distribution of rents that are subject to the powerful contestation.

23
 Political settlements, state capacity and technological change: a theoretical framework

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