1 Governace Crossroads : An Empirical Perspective Daniel Kaufmann Background Slides. It draws from the Chapter in WEF’s GCR (forthcoming)

2 National 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

3 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 for almost 200 countries:

4 Inputs for Governance indicators PublisherPublicationSourceCoverage Standard and Poor’s Country Risk ReviewPoll106 developed and developing Countries DRI/McGraw-Hill Wall Street JournalCentral EuropeanSurvey27 transition economies Economic Review EBRDTransition ReportPoll26 transition economies Economist Intelligence Unit Country Risk Service &Poll 114 developed and developing Country Forecast Freedom HouseFreedom in the WorldPoll172 developed and developing Freedom HouseNations in TransitPoll24 transition economies Political Economic |Asia IntelligenceSurvey11 Asian countries Risk Consultancy Gallup International50 th Anniversary SurveySurvey44 mostly developed countries World Ec Forum / CIDGlobal Competitiveness Survey75 developed and developing Heritage Foundation/Economic Freedom IndexPoll154 developed and developing Wall Street Journal Political Risk ServicesIntern’tnl Country Risk GuidePoll140 developed and developing World BankWorld Business EnvironmentSurvey 80 developed and developing World Bank/EBRDBEEPSSurvey 22 transition economies IMD, LausanneWorld Competitiveness Yrbk Survey 46 developed and developing CUDColumbia U. State Failure Poll100 developed and developing PriceWtrhseCoopersOpacity IndexPoll60 developed and developing

5 Governance stagnation worldwide? Evidence points to little progress worldwide on key dimensions of governance. This is in contrast with other developmental variables, (such as macro-stability, quality of infrastructure, science education, effective absorption of new technologies, etc.), where there is evidence of progress. This matters, since the developmental and growth ‘ dividend ’ of good governance is enormous. There is high variation cross-country (even within each region), and thus averages mask selective improvements in governance, from which we also learn.

6 Strides in Macro-Economic Indicators over past 12 years Average Inflation Rate (in log)

7 Quality of Infrastructure -- Improving (Regional Averages of High/Low Quality every year, EOS-WEF firm surveys -- GCR ‘97-’02) Low High

8 Effective Absorption of New Technologies -- Progress (Regional Averages of High/Low Absorption every year, GCR ) Note: No data exists for Low High

9 Source: ICRG, Averages for shown periods and across countries for OECD & New Industrialized Countries in East Asia; for former socialist Transition Economies, and Emerging Economies. Control of Corruption: On average, lack of progress Good Control of Corruption Low

10 Source: ICRG, Averages for shown periods and across countries for OECD & New Industrialized Countries in East Asia; for former socialist Transition Economies, and Emerging Economies. Quality of Rule of Law: Little Progress in recent years High Low

11 Extent of Independence of the Judiciary -- stagnant (Regional Averages of Extent/Lack of Independence every year, GCR ) Non- Independent Independent

12 Unbundling Corruption – Regional Averages Based on EOS-WEF firm survey 2002, 80 countries Extent of Bribery for: %

13 The ‘Dividend’ of Good Governance Infant Mortality and Corruption 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 WeakAverageGood Rule of Law x Development Dividend Per Capita Income and Voice and Accountability 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

14 Soundness of Banks vs. Control of Corruption Sound Relatively Unsound Source: Executive Opinon Survey 2002; KKZ 2000/01Governance Indicators, The Sample of 80 countries has been divided into 3 sub-samples according to their rating in Control of Corruption. The 3 columns therefore represent the average ratings for Soundness of Banks within each sub-sample. The fitted line instead represents the predicted value of Bank Soundness controlling for the effects of GDP per capita and Regulatory Quality through an OLS regression. Each fitted value is computed as the sum of the estimated constant plus the value of Control of Corruption within each group times the estimated coefficient plus the mean values of Regulatory Quality and GDP per capita times their respective estimated coefficients.

15 Annual GDP Growth (%) Transparency, Ethics and GDP Growth: Closely linked Source: Annual GDP growth over is taken from WDI 2002; GDP is computed in PPP terms. The various transparency / governance variables drawn from Executive Opinion Survey, 2002.

16 -- The Public Sector & Political system not responsible alone for the Governance and investment climate Policies in each country -- Inequality of Influence by segments of private sector in shaping the rules of the game – is key -- ‘State Capture’ as extreme manifestation of undue influence in shaping rules of the game -- Consequently, improving governance requires collective action, w/ major role for private sector Collective Responsibility in Improving Governance

17 High Economic Cost of State Capture (by some firms) for Rest of the Private Sector

18 Also, where Capture/Grand Corruption: Greater Property Rights Insecurity for All Others % Share of Firms with Secure Property Rights Source: J. Hellman, G. Jones, D. Kaufmann “Seize the State, Seize the Day: State Capture, Corruption and Influence in Transition” World Bank Policy Research Working Paper 2444.

19 Bribery in Procurement and Corporate Ethics – linked Source: Source: WEF GCR Firms were asked for their assessment of the extent of bribery within their industry for procurement, as well as their rating of the quality of corporate ethics in their industry. r = LowHigh Low High

20 Corruption in Judiciary and Corporate Ethics closely linked Source: WEF GCR Firms were asked for their assessment of the extent of bribes in their industry for the judiciary, as well as their rating of the quality of corporate ethics in their industry. r = LowHigh Low High

21 Governance: Rethinking Main Tenets (1) Governance: broader & integrated approach needed (2) Power of Data – Quantification, analysis & monitoring (3) Sobering Evidence: Little progress recently (on average) (4) Challenge of Localizing Know-How – Diagnostic tools (5) Promoting Voice, Participation & Transparency is key (6) Imperative of Incentives (& less exhortation/PR) (7) Private-Public Sector Governance Nexus: Institutions of Capture/Elite Influence – not just focus on Public Sector (8) Rethink ‘Investment Climate’: linking corporate-public governance – elite firms and MNCs help shape I-climate (9) Governance in Finance, in Natural Resources, Social (10) Impact on the Ground – Collective Action, Nat’l & Int’l

22 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. 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, who benefited in this work from collaboration with World Bank, WEF and others.