1. 1 Rethinking G overnance: Empirics Challenges Orthodoxy Daniel Kaufmann, The World Bank * Presentation to Governance & A-C Flagship Course, Washington, DC, April 23rd, 2003 www.worldbank.org/wbi/governance * Collaboration and substantive inputs from many colleagues at the Bank is acknowledged.

2. 2 Legal & Judiciary Reforms The ‘Prohibition’ Era 197019801990199519961997199819992000200120022003 WDR on Institutions 1982 JDW joins WB (7/95) JDW “Cancer of Corruption” Speech (10/96) WDR ‘97 Public Sector Budget, Procurement & FM Reforms Diagnostic/Data/ Monitoring Tools Administrative & Civil Service Reform Civil Society Voice, Accountability, Media & Transparency Mechanisms Judicial/Legal Reform State Capture/Corporate Governance Broadening & Mainstreaming Governance and Anticorruption in the World Bank: Evolution TI CPI (5/95) Anti-corruption Strategy (97) Governance Strategy (00) 1st set of firms Debarred from WB projects 1 st Participatory & Action- Oriented A- C Core Program (Africa – 7 countries) 1999 WB INT created (3/01) Power of Evidence: Development Impact We have traversed and progressed…yet…

3. 3 1.‘Data Power’: Governance can be measured & Matters 2.Reality: Sobering Reality on balance: Lessons? 3.Under-estimated centrality of: i) Politics, unbundled -- especially influence/capture; ii) role of the Private Sector (I-climate); iii) Participatory Collective Action; iv) Selectivity; iv) Role of OECD, and, v) ‘Clubs’ 4.Over-estimated?: i) traditional templates for Public Sector Management; ii) creation of new public sector agencies; iii) traditional legal & judiciary reform 5. Some Implications for moving forward -- debate Some Key Issues and Challenges

4. 4 Governance: A working definition Governance is the process and institutions by which authority in a country is exercised: (1) S -- the process by which governments are selected, held accountable, monitored, and replaced; (2) E -- the capacity of gov’t to manage resources and provide services efficiently, and to formulate and implement sound policies and regulations; and, (3) R -- the respect for the institutions that govern economic and social interactions among them

5. 5 Operationalizing Governance: Unbundling its Definition into Components that can be measured, analyzed, and worked on Each of the 3 main components of Governance Definition is unbundled into 2 subcomponents: Voice and External Accountability Political Stability and lack of Violence&Terror Quality Regulatory Framework Government Effectiveness Control of Corruption Rule of Law We measure these six governance components…

6. 6 Inputs for Governance Indicators 2002 PublisherPublicationSourceCountry Coverage Wefa’s DRI/McGraw-Hill Country Risk ReviewPoll117 developed and developing Business Env. Risk Intelligence BERISurvey50/115 developed and developing Columbia University Columbia U. State Failure Poll84 developed and developing World Bank Country Policy & Institution AssmntPoll 136 developing Gallup International Voice of the PeopleSurvey 47 developed and developing Business Env. Risk Intelligence BERISurvey50/115 developed and developing EBRDTransition ReportPoll27 transition economies Economist Intelligence UnitCountry IndicatorsPoll 115 developed and developing Freedom HouseFreedom in the WorldPoll192 developed and developing Freedom HouseNations in TransitPoll27 transition economies World Economic Forum/CIDGlobal Competitiveness Survey80 developed and developing Heritage FoundationEconomic Freedom IndexPoll156 developed and developing Latino-barometro LBOSurvey17 developing Political Risk ServicesInternational Country Risk GuidePoll140 developed and developing Reporters Without Borders Reporters sans frontieres(RSF)Survey138 developed and developing World Bank/EBRDBEEPSSurvey27 transition economies IMD, LausanneWorld Competitiveness Yearbook Survey 49 developed and developing Binghamton Univ. Human Rights Violations ResearchSurvey 140 developed and developing

7. 7 Control of Corruption: one Aggregate Indicator (selected countries, for illustration, based on 2000/01 research data) Source: KKZ 2000/01 POOR GOOD Corruption Level Margin of Error Good Corruption Control

8. 8 Rule of Law: one Aggregate Indicator (selected countries, for illustration, based on 2000/01 research data) Source: KKZ 2000/01 POOR GOOD Good Corruption Control

9. 9 Rule of Law, 1998 vs. 2000 – Latin America Source for data: http://www.worldbank.org/wbi/governance/govdata2001.htm ; Chart downloaded from : http://info.worldbank.org/governance/kkz/http://www.worldbank.org/wbi/governance/govdata2001.htmhttp://info.worldbank.org/governance/kkz/ Note: the thin lines depict 90% confidence intervals. Colors are assigned according to the following criteria: Red, 25% or less rank worse; Orange, between 25% and 50%; Yellow, between 50% and 75%; Light Green between 75% and 90% ; Dark Green above 90%

10. 10 ‘Traffic Light’ Map: Rule of Law, 2000 Source for data: http://www.worldbank.org/wbi/governance/govdata2001.htm ; Map downloaded from : http://info.worldbank.org/governance/kkz/gov2001map.asphttp://www.worldbank.org/wbi/governance/govdata2001.htmhttp://info.worldbank.org/governance/kkz/gov2001map.asp Colors are assigned according to the following criteria: Red, 25% or less rank worse; Orange, between 25% and 50%; Yellow, between 50% and 75%; Light Green between 75% and 90% ; Dark Green above 90%

11. 11 ‘Traffic Light’ World Map Voice and Accountability – 2000 Source for data: http://www.worldbank.org/wbi/governance/govdata2001.htm ; Map downloaded from : http://info.worldbank.org/governance/kkz/gov2001map.asphttp://www.worldbank.org/wbi/governance/govdata2001.htmhttp://info.worldbank.org/governance/kkz/gov2001map.asp Colors are assigned according to the following criteria: Red, 25% or less rank worse; Orange, between 25% and 50%; Yellow, between 50% and 75%; Light Green between 75% and 90% ; Dark Green above 90%

12. 12 Figure 1: Rule of Law, Voice and Accountability and Control of Corruption, Regional Averages, KKZ 2000 Source: Governance Research Indicators (KKZ) based from data in D. Kaufmann and A. Kraay, 'Growth without Governance', for 175 countries, details at http://www.worldbank.org/wbi/governance/pubs/growthgov.htm. Units in vertical axis are expressed in terms of standard deviations around zero. Country and regional average estimates are subject to margins of error (illustrated by thin line atop each column), implying caution in interpretation of the estimates and that no precise country rating is warranted. See also regional clarifications in note 6. Poor Governance Good Governance

13. 13 Governance Indicators: Indonesia Note: the thin lines depict 90% confidence intervals. Colors are assigned according to the following criteria: Red, 25 th percentile; Orange, between 25 th and 50 th percentile; Yellow, between 50 th and 75 th percentile; Light Green between 75 th and 90 th percentile; Dark Green above 90 th percentile.Chart downloaded from : http://info.worldbank.org/governance/kkz/.

14. 14 Governance Indicators: Chile Note: the thin lines depict 90% confidence intervals. Colors are assigned according to the following criteria: Red, 25 th percentile; Orange, between 25 th and 50 th percentile; Yellow, between 50 th and 75 th percentile; Light Green between 75 th and 90 th percentile; Dark Green above 90 th percentile.Chart downloaded from : http://info.worldbank.org/governance/kkz/.

15. 15 The ‘Dividend’ of Good Governance Infant Mortality and Corruption 0 10 20 30 40 50 60 70 80 90 WeakAverageGood Control of Corruption x Development Dividend 0 2,000 4,000 6,000 8,000 10,000 12,000 WeakAverageGood Regulatory Burden x Development Dividend Per Capita Income and Regulatory Burden Literacy and Rule of Law 0 25 50 75 100 WeakAverageGood Rule of Law x Development Dividend Per Capita Income and Voice and Accountability 0 1000 2000 3000 4000 5000 6000 7000 8000 9000 10000 WeakAverageStrong Voice and Accountability x Development Dividend Note: The bars depict the simple correlation between good governance and development outcomes. The line depicts the predicted value when taking into account the causality effects (“Development Dividend”) from improved governance to better development outcomes. For data and methodological details visit http://www.worldbank.org/wbi/governance.

16. 16 Precision vs. Number of Sources, KKZ Governance Estimates, 2000/01 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 02468101214 Number of Sources Per Country Margin of Error Note: See explanatory details in this slide’s note

17. 17 Measurement Error for Objective Indicators Corrltn: Known: Correlation of objective & subjective; standard error of subjective indicator Unknown: standard error of objective indicator

18. 18 Overall Evidence is Sobering, however: Progress on Governance is modest at best, so far Evidence points to slow, if any, average progress worldwide on key dimensions of governance This contrasts with some other developmental dimensions (e.g. quality of infrastructure; quality of math/science education; effective absorption of new technologies), where progress is apparent At the same time, substantial variation cross-country, even within a region. Some successes. And it is early days.

19. 19 Source: ‘Rethinking Governance’, based on calculations from WDI. Y-axis measures the log value of the average inflation for each region across each period Significant Decline in Inflation Rates Worldwide High Inflation Low (avg. in logs)

20. 20 Quality of Infrastructure (Regional Averages of High/Low Quality every year, GCR 1997-2002) Low High

21. 21 Effective Absorption of New Technologies (Regional Averages of High/Low Absorption every year, GCR 1997-2002) Note: No data exists for 2000. Low High

22. 22 Source: ICRG/PRS, 1984-2001, data subject to margins of error Control of Corruption Over Time for Emerging/Transition Economies – PRS/ICRG Poor Good

23. 23 Extent of Independence of the Judiciary (Regional Averages of Extent/Lack of Independence every year) Non- Independent Independent

24. 24 Effectiveness of Anti-Monopoly Policy (Regional Averages of Effectiveness/Ineffectiveness every year, GCR 1997-2002) Ineffective Effective

25. 25 IFI Responsibility: Firms Evaluate World Bank’s Effectiveness in PSD: (GCR 2002, Emerging Economy sample) Source: GCS 2002. The vertical axis depicts the firms’ net effectiveness evaluation of World Bank’s performance in supporting Private Sector Development (PSD) in their country. Net effectiveness is calculated as the difference between the percentage of respondents reporting the institution to be effective minus the percentage of respondents reporting it to be ineffective. Each set of 2 columns display the net effectiveness ratings provided by countries with a good record in given constraint (in green) versus those provided by countries with a poor performance in such constraint (in red). Calculations based on country averages. Net WB Effectiveness as Rated by Firms (%) Good Poor

26. 26 State Capture Efforts of firms to shape the legal, policy and regulatory environment through illicit, non- transparent provision of private gains to public officials Examples include: –private purchase of legislative votes –private purchase of executive decrees –private purchase of court decisions –illicit political party financing

27. 27 Recognizing the Challenge of State Capture Upon assuming power almost 3 years ago…..: Vladimir Putin’s statement to Russia’s business leaders: “I only want to draw your attention straightaway to the fact that you have yourselves formed this very state, to a large extent through political and quasi-political structures under your control, so perhaps what one should do least of all is blame the mirror.”

28. 28 Unbundling Corruption – [Regional Averages] Preliminary results 2002, View of the Firm, 80 countries Extent of Bribery for:

29. 29 Colombia: Extent of "State Capture" by elite unduly influencing laws and regulations (as reported by public officials, 2001) % public officials report bribes to agency influence business climate Capture by Vested Interests of:

30. 30 Very high Economic Cost of Capture for Private Sector Development and Growth Based on survey of transition economies, 2000

31. 31 Addressing Capture: Economic Reform, Political Competition & Voice/Civil Liberties Matter Pace of Econ Reform Political/Civil Liberties Reforms

32. 32 Working with Competitive Business Associations does Matter Source: J. Hellman, G. Jones, D. Kaufmann. 2000. “Seize the State, Seize the Day: State Capture, Corruption and Influence in Transition” World Bank Policy Research Working Paper 2444.

33. 33 Foreign Firms do not always help improve governance in recipient country Evidence from transition economies – beeps survey, 1999

34. 34 Firms Rate Quality of Parliament, World Bank & the IMF in their Effectiveness in Private Sector Development -- Regional Averages Source: GCS, 2002 % assess highly/ /very highly

35. 35 % of firms that report: Pervasive Not a Constraint Extent of: More broadly: Politics Matters – and it can be measured (GCR, 2002) Selected Regions, based on EOSurvey of 5,000 firms in 80 countries, WEF-GCR

36. 36 On Unequal Influence – Main Hypotheses, Empirically tested Firms who perceive a greater inequality of influence (i.e. political system biased towards political cronies), would: Have a negative perception of the court system in terms of its fairness, impartiality, & enforcement of decisions Be less likely to use courts to resolve business disputes; Have less secure property and contract rights; Pay more bribes; and, Exhibit less tax compliance and engage in unofficial activities …… hence, institutions undermined In turn, inequality of influence is related to the extent of political liberalization, in a non-linear fashion

37. 37 Recent Findings on Unequal Influence Firms who perceive a greater inequality of influence in their country ( where political system biased towards political cronies), exhibit: Negative assessment of Court system -- in terms of its fairness, impartiality, & enforcement of decisions Less use of courts to resolve business disputes; Less secure property and contract rights; Pay more bribes; and, Less tax compliance, more unofficial activities -- Thus, less credibility of formal institutions, which in turn are undermined by behavior of economic agents Inequality of influence is related to the extent of political liberalization -- in a non-linear fashion

38. 38 Tax Compliance (Unofficial Economy) vs. Crony Bias (from EOS, GCR, 80 countries) % Firms Unofficial Crony Bias (1) Crony Bias (1) defined as the difference between Government favoritism and business association effectiveness. Source: Global Competitiveness Survey, 2002 r = 0.64

39. 39 Crony bias vs. Democratic Voice & Accountability (from Executive Survey for the Global Competitiveness Report, 2002/3, for 80 countries)

40. 40 Some Implications for the next stage (1) A Broader Governance Framework (2) The Power of Data, Indicators, Country-Diagnostics (3) Localize Know-how: Diagnose & Differentiate (4) Beyond traditional PSM & Legal measures (5) Unbundling Politics: Influence, Capture, Party Finance (6) Responsibility of IFIs, OECD, MNCs, Private Sector (7) External Accountability: Voice, Transparency, & systemic incentives (with new e*governance tools/data) (8) Capital Market Development, & PSD link (9) International ‘Club’ Membership as motivator (9) Tough & Rigorous Selectivity in aid (10) Intersectoral Mainstreaming: ‘Umbrella’ Issue

41. 41 Transparency within Government Agencies Prevents Purchase of Public Positions Based on 90 national, departmental, and municipal agencies covered in the Public Officials Survey.

42. 42 External Accountability/Feedback Improve Access of Public Services to the Poor (Bolivia diagnostic) Based on Public Officials Survey. The sample of institutions includes 44 national, departmental, and municipal agencies which are a prior anticipated to be accessible to the poor

43. 43 Identifying Institutional Vulnerabilities and Governance-driven Economic Fragility Source: KKZ 2000/01 Governance Indicators, and Kaufmann and Kraay, “Growth without Governance”. High Low

44. 44 Data for Analysis and informing Policy Advise, not for Precise Rankings Data in this presentation is from aggregate governance indicators, surveys, and expert polls and is subject to a margin of error. It is not intended for precise comparative rankings across countries, but to illustrate performance measures to assist in drawing implications for strategy. It does not reflect official views on rankings by the World Bank or its Board of Directors. Errors are responsibility of the author(s), who benefited in this work from collaboration with many Bank staff and outside experts. www.worldbank.org/wbi/governance