The political stability is a crucial factor for economic prosperity of a country. The main growth factors, i.e., labour, human and real capital and technology are all mobile and can be easily imported whereas the political system can not be imported.

Since the 1960s, almost all Latin American countries have displayed poor economic performance. This was all due to poor political setup in these countries. Economic progress is possible in a democratic set-up only. However, a farce democracy is worse than dictatorship. The efficiency, innovation and growth of GNP per capita depend mainly on economic, political and legal institutions of a country. A so-called planned social economy with state property is unable to motivate people to work efficiently or to be innovative. Since people cannot earn higher income, they are not motivated to work efficiently.

Free market economies only work if certain conditions are met. These include a legal framework, assured property rights and a stable monetary system which must allow for extensive audit. The absence of extensive government intervention, high taxation and unsustainable budget deficits are further pre-conditions. Where most of these conditions,if not all, are not met, economic efficiency and development will be thwarted as seen in Latin American economies. Political stability is an important determinant of real exchange rate. When there is political trouble, money is the first thing to fly across the border.

In 1992, a study was conducted by the World Bank to discuss the main obstacle to private business developing in Brazil and Chile. The research was based on interviews with 42 firms in each country. The entrepreneurs were confronted with a list of 20 possible problems about the business. There was one area of clear agreement in both countries. The entrepreneurs considered political and policy uncertainty a very serious problem for doing business.

The main obstacle in the eyes of the potential investors was the fear of unpredictable changes in important aspects of the institutional framework. In Nicaragua, out of 50 firms surveyed 72 per cent reported that they lived in constant fear of wide ranging policy changes. Under such uncertainty, firms preferred not to commit their resources to partially irreversible investment projects. There are four dimensions of political stability:

* Stable government * Stable political system * Law and order situation * External stability

Think of a few countries, and it will be apparent that lack of stability is common. Angola for example suffers from a lack of all four stable conditions, Bolivia from first three, Japan although otherwise stable suffers from first and Columbia is stable but lacks third.

The resource rich (RR) strategy was to export their resources and use the rent to build a modern economy. This has proved remarkably difficult. A resource exporting strategy reduces the economic growth rate by about one percent a year. Furthermore, statistics reveal that resource rich countries such as Zair, Zambia or Brazil have performed relatively poorly. In fact some of the richest countries such as Denmark, Switzerland and four Asian Tigers are resource poor. The population of RR country knows that the state is very rich, large scale spending programmes have to be undertaken. This causes wages to rise faster than productivity.

Foreign investment inflows are an excellent gauge of a developing country’s policy credibility. Malaysia, Thailand, Indonesia are major recipients of foreign direct investment and their economic and business policies are highly credible. China, which is attracting more foreign direct investment than any other country is a major exception as its legal and institutional environments lack credibility by international standards. The answer is probably that most foreign investors are of overseas Chinese origin and seem to feel that family and traditional rules and enforcement mechanism provide sufficient comfort. Western and Japanese investors are often attracted by China’s large and expanding market.

Another important factor in the economic development is industrial conflict. Three main measures of industrial conflicts are: (i) Number of conflicts, (ii) number of workers involved, and (iii) number of days lost through strikes. Fewer strikes occur in countries with strong central unions and a well-developed body of labour law.

There is a strong positive correlation between price-wage inflation and the number of industrial conflicts and that this causality works in both directions. Conflicts cause inflation and inflation causes conflicts. This leads to conclude that real growth causes an increase in the number of industrial conflicts and this though making society more volatile, makes it less potentially stable.

Civil servants usually attempt to maximize their total compensation packages through their influence on the political systems. When it became clear that the colonies would be granted independence, the Europeans began a hurried institutional reform programmes that failed to address fundamental issues associated with the effective participation of people in post independence development.

The laws and institutions of the new countries were not developed to reflect domestic realities, needs, traditions or aspirations. To remedy the situation, the senior position in civil service be awarded only to individuals who have the ability to efficiently perform the duties assigned to them and not as political rewards or in exchange for bribes to superiors. The existence of inefficient, unqualified and unprofessional public employees contribute significantly to development failures.

Since government regulations provide bureaucrats with opportunities to extort bribes form entrepreneurs, reforms of the rules can make certain that society will secure the outcomes it desires, that is, the most effective method to eliminate bureaucratic corruption is to reform the rules and rid markets of the incentives to engage in corruption.In many countries national judicial system and police, which are supposed to control corruption through enforcement of the laws, are themselves severely corrupt.

For economic progress, keeping inflation down is essential and to accomplish that the currency needs to stay stable. If that means high interest rate, so be it. A favourable policy environment i.e. low inflation, a sustainable balance of payment situation and clearly established well-enforced rules provide a better investment climate.

There is a very high correlation between saving rates and investment rates. A higher saving rate promotes a higher investment rate, a high investment rate results in a higher growth rate and higher growth rate results in a higher saving rate.

It can be safely concluded that for economic progress, the following steps should be taken by the developing countries.

*Avoidance of large macro-economic imbalance, *Market friendliness: working in co-operation with and in support of the private sector, *Taking maximum advantages of opportunities in foreign trade and for the extraction of foreign investment.

Three changes in government structure in the developing countries are desired:

i) More democracy, ii) Multiple decentralized political units, iii) Flexible government structures.