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Organizations do not exist in a vacuum. Each organization is set in a particular environment to which it is inextricably linked. This environment provides multiple contexts that affect the organization and its performance, what it produces, and how it operates (Nabli and Nugent, 1989). As we refine and extend the original framework for organizational assessment, the concept of an enabling environment is key to understanding and explaining the forces that help shape the character and performance of organizations (Scott, 1995).

Many development projects implemented within organizations either partially or fully fail because the intervention does not adequately address the enabling environment within which the organization operates (UNDP, 1993). For example, some development loans have channelled resources into new equipment, and then into training staff to use the new equipment. However, when this is carried out in the context of a centralized civil service that lacks the policies to keep trained people on the job, the new equipment and training may become counter-productive. Some loan projects fail because the executing agencies are operating in tumultuous environments that limit their ability to carry the project out.

Any effort to diagnose and improve the performance of an organization requires an understanding of the forces outside the organization that can facilitate or inhibit that performance (Savedoff, 1998). Enabling environments support effective and efficient organizations and individuals, and creating such environments is becoming an increasingly important aspect of development assistance (Picciotto and Weisner, 1998).

This chapter describes the enabling environment and examines it from a diagnostic perspective. It clarifies what are often hazy concepts and relationships between organizations and the environments in which they operate. The chapter also touches briefly on issues that emerge in analyzing an organization’s environment, and provides guiding questions for the challenging task of examining that environment.

DEFINITIONS

Chapter One posited that the enabling environment is made up of the administrative, technological, political, economic, socio-cultural, and stakeholder factors (Lusthaus, Anderson and Murphy, 1995). This was consistent with the strategic management literature and served as a helpful categorization system. As we worked with international financial institutions that were more involved at the sectoral and institutional levels, we became more aware of the important interaction that occurs when banks intervene at the systems and organizational level. Organizations need to be able to diagnose the enabling environment, and also build competence to both influence and adapt to it as that environment evolves (Savedoff, 1998).

In this context, we built a matrix to better understand the link between our past approach and a more institutionally grounded approach to assessment that includes the components of rules, ethos and capabilities, each of which will be discussed in this chapter.

Rules are referred to in institutional economics literature as “institutions” (North, 1995). Rules or institutions are the formal laws and codes that positively or negatively influence the behavior of organizations through the incentives and constraints they provide or impose. There are rules for all dimensions of the environment: some rules are formal while others are informal and accepted by everybody. Some rules are explicit, while some are implicit. Some are codified, others less so. The codified rules tend to be found in political and administrative environments.

Institutional ethos embraces the largely informal rules of a society; that is, the history, cultural values, norms and taboos of the milieu within which organizations function. Like rules and other unwritten societal expectations, the institutional ethos imposes constraints on the behavior of organizations and the people who work within them. Although the various aspects of institutional ethos are difficult to measure and evaluate, they are nonetheless extremely important in molding the behavior and performance of organizations that evolve within a given environment.

Capabilities include labor market pools, the natural resources and geographic assets or limitations of a country or region, as well as the infrastructure and technology available. The significance

of these capabilities for development has long been recognized. They were often the reason for imperial or colonial relationships. We use the term “capability” to denote the internal resources at a given point in time. We also use the term capability in the environment section to distinguish it from our use of “capacity”—a term reserved in this book for discussions on organizations. In characterizing these resources, we prefer the active term “capability,” which denotes power or the ability to do something (Morgan, 1998). Thus, countries want to build on their capabilities and organizations on their capacities to create an enabling environment generally targeted for them.

To the extent that an environment lacks adequate labor market pools, infrastructure and technology, the availability of these valuable resources to organizations will be limited. This is likely to affect the way they function and what they can achieve. While it is not impossible for an organization to import or develop these resources on its own, this may come with a high cost that will erode organizational efficiency (Datta and Nugent, 1998).

These three components of the enabling environment are inter-dependent in very significant ways. For example, the capability of a nation to develop its own infrastructure or to adapt and effectively use foreign technology is often affected by rules such as cultural and intellectual property rights, patents or copyrights. These are not the only factors in the external environment that affect organizations, but are among the most important identifiable factors that can help us understand and explain organizational performance.

RULES

The “rules of the game” of a society are one of the most important ingredients of the enabling environment (Datta and Nugent, 1998). They oil the economic and social machinery. All societies require appropriate rules, as well as fair and efficient mechanisms by which they can be enforced. Organizations must pursue their goals within a legal or regulatory structure that facilitates or inhibits their work. Governments and governance have significant influence on the nature of rules in society and how effectively these rules are enforced.

Administrative and Political Rules

Administrative and political rules are embedded in constitutions, traditional and common laws, charters, statutes and civil codes, some of which have significant economic implications. All organizations have special functions within a society. They exist to meet certain needs of society. For example, governments legally set up Ministries of the Environment because of a functional need to protect the environment. The government sets out the rules that define the ministry, and by so doing, outlines the relationship other organizations have with that ministry (Desormeaux, 1998).

Donors and lenders generally agree that political economy issues are important determinants of the success of programs that they support in the developing world. But while donors and lenders often require economic reforms as a condition for their support, they seldom provide the direct assistance needed to carry out and institutionalize such reforms. These organizations need to translate their concerns into action by allocating more assistance for institutional reforms (Weisner, 1998).

Political economy variables that affect the likelihood of successful development reforms are covered extensively in the political economy literature (Tommasi and Velasco, 1995; Bates and Krueger, 1993; Haggard and Kaufman, 1992). These variables include social conflicts, political instability, the type of government (dictatorship, free market, conservative, liberal, populist), whether the government is democratically elected, the tenure of the government in office, and government transparency.

In undertaking institutional reform, it is important to understand the country’s constitution and laws, and to determine who has the power to change them. It is considered good policy to focus on reforming incentive structures to empower beneficiaries and to provide choices.

Economic Rules

Economic rules are embedded in contract, partnership and corporate laws, the financial order, and other regular and ad-hoc rules promulgated by bodies such as central banks to control interest rates, imports, exports and local and foreign investments (Clague et al., 1997).

Property rights profoundly affect organizations and the markets within which they operate. The rules governing property rights give individuals, groups or organizations power to control scarce resources and to enjoy their valuable attributes (Eggertsson, 1996). Land laws, for example, give individuals and organizations the power to control and enjoy the benefits of a piece of land (Ensminger, 1997; Nye, 1997).

Labor contracts, also based on law, give an organization the right or power to enjoy the services of a valuable scarce resource—labor. Contracts are a means by which organizations and individuals protect their property rights, and these contracts are grounded in law (Engerman, 1997; Nabli and Nugent, 1989). In fact, an organization can be perceived of as a set of contracts—among shareholders and owners, between shareholders and managers, between managers and workers, and between managers and other stakeholders (creditors, clients, customers, etc.). Thus, the failure or lack of enforce-

ment of rules governing contracts and property rights can seriously affect organizational performance (Chhibber, 1998; Nugent, 1998).

Transaction costs include the costs of privately enforcing property rights, among other costs (North, 1990). When the public mechanisms that officially enforce property rights in society are inefficient or unreliable, organizations and individuals must privately institute internal controls to preserve their rights over the resources in question, raising their transaction costs. In such situations, informal rules and enforcement devices often evolve and operate outside the purview of the official or formal institutional structure (Eriksson, 1998; Greenhill, 1995).

Economic rules and their enforcement actually play a significant role in determining the structure of organizations in an economy, as seen in the accompanying box about Brazil.

Enforcement of Rules

The enforcement of rules or institutions is at least as important as the rules themselves (Kaji, 1998). Nowhere is this more apparent than in the financial sector, where banks must be reasonably sure that loan contracts can and will be enforced in the event that clients default (Nugent, 1998). As is evident in many developing countries, unsound rules and enforcement systems in the financial sector can have negative ripple effects on the willingness of lending organizations to lend, on the borrowing organization’s ability to borrow and invest, and hence on the performance of the entire economy. Problems of rural credit in many developing countries underscore the importance of the enforceability of rules, as seen in the accompanying box.

Necessary Attributes of Rules

Enforcement of formal rules is largely based on legally sanctioned coercion or force, or the threat of it (Chong and Claderon, 1997). The effectiveness of enforcement, however, depends to some extent on whether people see the rules as being worthy of respect. If rules are not seen as fair or fairly enforced, individuals and organizations have greater incentive to evade them, increasing the difficulty and cost of enforcement. Therefore, among other attributes, good rules should be credible, fairly and evenly enforced, predictable and flexible (Burki and Perry, 1998).

Credibility refers to the extent to which rules and their enforcement systems command respect from those affected by them. The credibility of rules or institutions depends partly on low transaction costs and fairness. In this context, low transaction costs refer to the capacity of rules and enforcement of them to facilitate and accelerate economic exchanges and interactions using minimal resources. Fairness

is the degree to which rules and their enforcement are applied consistently and impartially from one person or group to another (Hunter and Lewis, 1997).

Predictability is the extent to which actors within the environment have to cope with unexpected changes in rules and policies. Flexibility is the extent to which rules and their enforcement mechanisms change over time in response to the needs of society. An important consideration in guaranteeing ownership of the rules is to ensure those affected by them actively participate in creating them, either directly or indirectly (Lal, 1996). This point is best illustrated in the accompanying box by contrasting two irrigation systems in Nepal in the early 1990s.

Assessing Rules

An important empirical question of interest to development practitioners and agencies is how to analyze a given institutional framework and its rule enforcement mechanisms (Clague et al., 1997). Clearly, development agencies and international financial institutions have devised a wide assortment of methodologies to assess the national and sectoral rules within which organizations operate. It is the direct effect of rules on the organization that affects organizational life.

Thus, organizational assessments by development agencies and international financial institutions should examine the quality of rules. This should be done when evaluating the performance of projects these institutions already support, when analyzing the capacities of a potential executing agency for a loan, and even when search-

ing for promising organizational candidates with whom to work. Indeed, the key to successful development lending is to identify effective organizational partners to support. Good candidates for such partnerships are organizations that genuinely seek reform, and that already either have a conducive institutional environment or are honestly committed to creating one (Chhibber, 1998).

In this regard, international agencies must be prepared to devote part of their assistance to institutional diagnosis and reform, without which many of the other development efforts they support are doomed to produce less than satisfactory results. Indeed, some international agencies—particularly the World Bank—have focused their development efforts toward interventions at the institutional level, moving away from several decades of support at the individual and organizational levels.

The importance of using objective quantitative measures to evaluate or assess rules and their enforcement systems is well recognized by development practitioners. But the difficulty in obtaining such measures is also noted (Burki and Perry, 1998), although less rigorous, subjective quantitative measures compiled by credit risk agencies do exist for many countries. These measures are computed on various scales, and they include indices of corruption, red tape, efficiency of legal systems, and political stability. Although there is increasing interest in the rules of the game, and a number of instruments have been developed to assess them, many of these are too detailed and require modification if they are to be used for assessing the environment within which organizations operate (Manning, 2000).

At a more pragmatic level, assessing the rules means identifying the extent to which the existing rules are helping or inhibiting organizations, or facilitating the loan or project execution. Assessment always must examine the degree to which the risk level for the loan or the project is associated with enforcement of the rules.

One aspect of an organizational assessment is to characterize the rules and enforcement mechanisms in the organization’s environment. The questions in the accompanying box should be included in assessment of an organization’s environment.

INSTITUTIONAL ETHOS

As societies evolve over time, they gather unique historical experiences and acquire a set of cultural values, norms, religious precepts and taboos. These implicit or unwritten codes of conduct can be grouped together with the history of the society under the broad heading institutional ethos. In the literature on institutions, this is also referred to as the “informal rules of the game.” It is these informal rules that often give insights into why some rules are enforced and others are not; or why some people have power, when their organizational position indicates that they should not. The informal rules of society help seemingly irrational behavior appear rational.

History

The history of a society is the totality of its experiences—successes, failures, wars, disasters, and the emergence of great leaders and their influence on the society. Indeed, history matters. These events and experiences influence the attitudes, beliefs, determination and moral principles of individuals and organizations within the society or environment.

Thus, history helps to shape the cultural values, religious beliefs, ethics and taboos that directly affect what individuals and organizations do or can do in a society, and how

they do it. Examples of how this happens abound, ranging from America’s liberalism and economic prowess, to the influence of Japanese culture on that nation’s industrial success, to economic stagnation in some developing countries that has been attributed to factors such as inhibiting traditional cultures or even colonialism (Silos, 1991).

Enforcement of Institutional Ethos

Unlike formal rules, which generally derive their legitimacy from the law, the components of institutional ethos gain legitimacy from the fact they are morally governed and culturally supported (Engerman, 1997). The enforcement of formal rules tends to be based on legal sanctions, whereas cultural values and mores are generally enforced through the prescriptive and evaluative processes inherent in social life (Skinner, 1996).

Sometimes cultural considerations are more important than formal legal considerations in creating an effective framework for enforcement mechanisms for rules. As development agencies target and evaluate the performance of their partners and executing agencies in developing countries, it is essential that they identify the aspects of institutional ethos that facilitate or constrain the work of the organizations they support.

As seen in the accompanying box, the case of the Grameen Bank illustrates how socio-cultural factors have been crucial to creating a successful rural banking system in Bangladesh (Khandker, Khalily and Khan, 1995).

Culture

Cultural norms and mores include a society’s habits, ways of thinking, values, and informal unwritten standards. These socio-cultural forces operate at local, national

and regional levels, and have a profound influence on the way organizations conduct their business and what they value in terms of outputs and effects (Mauro, 1995). For example, the mores of an indigenous culture have a bearing on the work ethic and on the way in which people relate to one another in that culture. Cultural traits affect society’s degree of risk tolerance (or risk avoidance), as well as support for individual initiative, and such traits in turn can have negative or positive influences on organizations (Engerman, 1997).

CAPABILITIES

In addition to rules and ethos, every society has a certain combination of resources that influences the type and scale of activities undertaken by individuals and organizations, as well as how successful their efforts are likely to be. These include natural resources, human resources, financial resources, infrastructure (transport, roads, electricity, telecommunications), and technology. Together they form what we call “capabilities.” They combine with rules and institutional ethos to create an enabling or inhibiting environment for organizations and development.

Of importance to all countries is the worldwide concern about the environment. Modern societies view protection of the environment as an essential objective. In developing countries, explicit environmental approval is frequently required before an organization develops a new project. Failure by the organization to comply with any of the regulations pertaining to the environment may result in political pressures from domestic or foreign environmental activists.

Dimensions

Perceptions about which of these capabilities or resources is more critical for development has shifted over time from natural resources to human resources, capital and technology. The emerging consensus is that an enabling environment is a combination of all the resources and the institutional framework (rules and ethos). There is no single ideal combination. Experience shows that in a highly interdependent world, it is possible to make up for the shortage of one resource (e.g., natural resources in Japan) by creating linkages and strengthening or developing other resources (e.g., human capital and technology).

Thus, from a macro perspective for development assistance, the question is no longer whether more training or more transfer of equipment and technology is most crucial for development in developing countries. Rather, the question is, what combination of training, technology, institutional reform and so forth is appropriate for creating an enabling macro-environment that maximizes resource utilization within a specific context?

Resources

These issues are discussed in the growing literature on capacity building and development, and it is not our objective to review them here. It is important to understand, however, that the availability or shortage of these capabilities at the macro level can influence the performance of specific organizations at the micro level. Organizations need good human resources and other core resources (infrastructure, technology and finance) to improve their capacity to perform (see Chapter Three). However, they must rely to a great extent on the macro environment to provide these resources. The amount and quality of available resources will depend on the institutional and policy environment.

Labor Force

The quantity and quality of the basic labor force available to both public and private sector organizations is influenced to some extent by the quality of the country’s formal and technical education. This, in turn, is a function of the policies and rules the government puts in place over time to create the necessary incentives to develop an effective system of education. In other words, a sustained long-term solution to solving human resource capacity gaps in developing countries requires much more than providing scholarships to a handful of citizens to study in universities in developed countries. A more radical approach is needed, requiring institutional reforms to create the right incentives.

Access to Technology and Systems

The same argument applies to the development of indigenous technology and efficient financial systems. This point illustrates the overriding influence of rules and, as noted earlier, the interdependence of the various components of an enabling environment. Before launching ambitious programs to develop capabilities, it is important to conduct a thorough institutional analysis. This involves mapping the institutional environment in terms of politics, administrative capacity, culture, etc. in a manner that includes all stakeholders and measures their level of ownership and commitment to reform.

CONCLUSIONS

To summarize, there are various factors outside the organization that profoundly influence its structure, performance and, in some cases, its very existence. These factors combine to create an enabling environment within which individuals and organizations achieve their goals in a more or less efficient manner. To facilitate discussion within the context of our evolving institutional and organizational framework, we identified three forces in the enabling environment: the formal rules of the game, the institutional ethos, and capabilities

The discussion of the enabling environment focused primarily on the distal environment, which relates to rules that are not specific to any one organization or set of organizations, but bear on the activities and performance of all organizations. From the point of view of a particular organization, however, it is useful to distinguish the proximal environment from the distal environment. This proximal environment comprises rules that are designed to regulate a specific organization or the sector to which it belongs (private sector, public sector, NGO, manufacturing sector, service sector, etc.).

In conclusion, the concepts in this chapter suggest a number of questions that are of crucial importance to donors and development agencies, and to the success of their existing and future interventions in developing countries:

• To what extent, and in what ways, can external investment agencies change the enabling environment?
• Under what conditions would those agencies want to support an organization, or a set of organizations, without investing in creating an enabling environment?
• How receptive to change is the target group or groups likely to be?
• How receptive are the politicians and other beneficiaries of the existing system likely to be?
• To what extent would resistance to change from various groups deter the required change?

A fuller list of questions concerning all of the issues regarding an enabling environment may be found in Appendix 1.

Document(s) 4 of 13