One of the most interesting aspects of the prolonged economic crisis inEurope, and of the even longer crisis in Japan, is the absence of serioussocial conflict – at least thus far. Yes, there have been strikes, marches, andgrowing anger at political leaders, but protests have been largely peaceful.

While that may change, the credit for social peace must go to institutionssuch as elections (“throwing the rascals out” is a non-violent way to ventpopular anger), responsive democratic legislatures, and effective judiciaries.All of these institutions have successfully mediated political conflict duringa time of great adversity in advanced countries.

This suggests that a major reason for underdevelopment may be that suchinstitutions, which allow countries to cope with distress, are missing in pooreconomies. Economic growth permits conflict between social actors to be paperedover. A downturn, however, usually exposes or sharpens latent social tension.

Why do the benefits of growth seemto be easier to share than are the burdens of adversity? This is not a trivial question. Perhaps the answer liesin human psychology. If consumption is shaped by habit, an income loss is veryhard to bear and one might fight to avoid it, while fighting for additionalgain when one is doing well is less important. Also, because conflict maydestroy growth opportunities, it may be seen as costlier when growth is strong.For example, squabbling between workers and management may drive away investors– and thus the chance to start new projects. But if there are no new investmentopportunities on the horizon, squabbling is less costly, because the existingplant and machinery are already sunk costs.

Regardless of why conflicts are greater in times of economic adversity,how a society deals with them depends on the scope and quality of itsconflict-management institutions. The Oxford University economist Paul Collier has shown that years ofweak economic growth typically precede civil war in poor countries. Even afterestablishing peace, the probability that these countries will relapse intoconflict is high.

Not surprisingly, these states typically have weak conflict-managementinstitutions – patchy law enforcement, limited adherence to democraticprinciples, and few meaningful checks and balances on the government.Similarly, Dani Rodrik of Harvard University has found that thecountries that experienced the sharpest declines in growth after 1975 haddivided societies and weak conflict-management institutions.

Societies with well-functioning institutions allocate the burden ofdistress in predictable ways. For example, people who suffer the most adversitycan fall back on an explicit social safety net – a minimum level ofunemployment insurance, for example. In the United States in recent years,federal and state legislatures prolonged unemployment benefits as joblessnesspersisted.

Similarly, debtors and creditors can rely on credible bankruptcyproceedings to determine their relative shares. With an explicit institutionalmechanism in place to dictate the division of pain, there is no need to take tothe streets.

By contrast, when institutions are too weak to offer predictable andacceptable settlements, or to protect existing shares, everyone has anincentive to jockey for a larger slice of the pie. Outcomes will be mediatedmore by actors’ relative bargaining power than by pre-existing implicit orexplicit contracts. Often, bargaining will break down. Everyone is made worseoff by strikes, lockouts, and even violent conflict.

Can countries without a reliable and effective legislature or legal systemdo better to protect against downturns?

One answer may be to use arrangements that depend in a limited way on thelegal system for enforcement. For example, labor contracts in many developingcountries effectively prohibit employers from firing workers. This is regardedas inefficient because firms cannot adjust quickly to changing business conditions.

Often, such prohibitions are attributed to overly strong unions that holdthe economy hostage. But, if slow or corrupt courts mean that a worker who iswrongfully dismissed has no legal recourse, perhaps the prohibition on firing – enforced by massprotests against violations, which are easily and publicly observable – is theonly way to protect workers from arbitrary decisions by employers.

Job tenure may also serve as a form of social security, because the governmentperforms miserably on providing a safety net and private insurance markets donot exist. Thus, an inflexible contract can protect workers when thepreponderance of bargaining power is with firms.

Such inflexible arrangements are not without cost. In a downturn, too manyfirms will fail, because they cannot shed labor. Alternatively, knowing thatthey cannot fire permanent workers, firms may remain tiny in order to remainbelow the authorities’ radar. Or they may hire informal workers who have norights, or pay inspectors to look the other way (a related point could be madeabout workplace safety in Bangladesh’s garment factories).

Thus, the attempt to protect workers with rigid labor laws may have theunintended consequence of generating too few protected jobs. This may be thesituation in India, where most workers have few rights, and the few large firmsthat are established in the formal sector tend to use a lot of labor-savingcapital in order to avoid hiring protected workers.

Change is not easy. Protected workers have no reason to give up theirbenefits. Moreover, removing rigid protections without offering alternative,contingent safety nets and judicial redress is a recipe for conflict. At the same time, someprotection is better than none, and if most workers are unprotected, changebecomes necessary to avoid even worse conflict.

Sustainable change in developing countries requires reforming not onlyspecific arrangements, such as rigid labor laws, but also more basicinstitutions, such as the legislature and the judiciary, to make them moreresponsive to people’s needs. If developed countries’ citizens want to feelslightly better about their economies’ slow growth and high unemployment, theyshould contemplate how much worse matters could be without the institutionsthat they have.