Post-Conflict Economic Transitioning and the War on Terror -- Challenges and Solutions

 The liberation of failed states is a key element of the war on terror.

 The liberation of failed states is a key element of the war on terror. The immediate objective of these campaigns is to eliminate omnipresent security risks associated with failed states. A related objective, addressed in this paper, is to stimulate post-conflict economic development, so as to create environments in which terrorists have difficulty operating and retaining support.

Unfortunately, nation building is very difficult and has a less than desirable record. The fluidity of nation-building events can render reality contextual, as policymakers strive to reconcile suboptimalities through attributing them to "bad people" that provide inappropriate or insufficient governance or "bad laws" that are irrelevant to cultural mores or are prohibitively expensive.

For example, few countries in the former Soviet Union have developed into economically viable and democratic states. Slower-than-expected economic development in some Newly Independent States (NIS) is attributable to a misperception of the former Soviet Union's governance structure. "Soviet Inc." was an unprofitable firm, not an inefficient market. Employing market protocols of regulation and infrastructure to remedy firm maladies added complexity to the preexisting Byzantine structure that thwarted commercial activity in normative markets. These results occurred despite the expenditure of untold billions and the participation of numerous well-intentioned and well-qualified consultants from the top echelons of government agencies, international actors (e.g. World Bank, IMF, USAID, DFID), and prestigious business schools.

The inability to produce economic viability suggests that attributing nation-building disappointments to perceived apathetic or malevolent characteristics of the liberated populaces is an error. As well, we should not automatically blame corruption, the skimming of resources (asset stripping and transfer pricing) and a spiriting off of these resources to other economies for the benefit of a well positioned few. Corruption tends to flourish when incentives are in the wrong place and unevenly applied. Instead of manufacturing excuses, it is incumbent on policymakers to diagnose the flaws in their previous, current, and proposed nation-building efforts, and cultivate solutions.

In our opinion, transitioning economies can be categorized in terms of the incentives and commands that mold the behavior of the populace. Incentives are the potential for a net benefit (i.e., profit). Commands are the package of standards and rules that an administrating body enforces, which reflexively alters behavior in pursuit of profit. Standards and rules are divergent concepts. An inaccurate and/or an inappropriate mixture of the two can cause the nation-building experiment to fail in the post-conflict "laboratory."

What is the difference between standards and rules? Standards are prospective societal policies. They are systemic prescriptions that enable the realization of industry norms relative to cultural values. For example, capital market standards in developed countries are specified in terms of fairness, liquidity, integration, transparency, and efficiency. Rules, on the other hand, are the retrospective codification of best-practice procedures that define operational efficiency.

If standards are too low, the transitioning economy develops balkanized markets where products are overpriced due to excessive "due diligence" and labor costs. If there are too few rules (i.e., best practices), the economy is, effectively, an offshore market that provides unregulated services and permits nontransparent activities. When standards are too high and there are too many rules, the economy develops markets that are controlled by unresponsive oligopolies that compete through excessive rules (regulatory related corruption). In such economies, actors unable or unwilling to bear the cost of the excessive rules are forced either underground or offshore into unregulated markets that produce nonstandard products or are relegated to a balkanized scale.

None of the above scenarios are desirable. Economic transitioning can be stalled by the high transaction costs that result from excessive due diligence, labor, and/or regulatory burden. This results in the governance equivalent of Heisenburg's Uncertainty Principle that posits that the simultaneous measurement of two conjugate variables-such as regulatory commands and the level of commercial activity-entails limitations on the precision of the management for each variable. The more demanding regulatory commands are for a given level of economic activity, the more imprecise the management of commercial activity due to transactional transference to the "shadow economy" of offshore and underground markets.

Excessive and/or mismatched regulation constrains commercial activity and inhibits the formation of economically viable states in which terrorists have difficulty retaining support. Nontransparency hides the activities of the unholy alliance between terrorists and ordinary criminals. This creates a governance disadvantage where police and military are forced to function in the other's capacity. The objective of the policymaker is to find the middle ground: the equilibrium level of standards and rules that avoids excessive regulatory burden, due diligence, and labor, as well as the nontransparency of underground or offshore markets.