U 34899 Managing Development: The Governance Dimension A Discussion Paper August 29, 1991 The World Bank Washington, D. C. l l l ! l l l l l~~~~~~~~~~~~~~~~~~~~~~~ I l THE WORLD BANK Washington, D.C. 20433 U.S.A. BARB R B. CONABLE President August 29, 1991 MEMORANDUM TO BANK MANAGERS Subject: Managing Development: The Governance Dimension Attached is a discussion paper, entitled: "Managing Development: The Governance Dimension". The paper was prepared by a Bank- wide Task Force. It follows on the General Counsel's Legal Memorandum on "Issues of Governance in Borrowing Members" dated December 21, 1990. The paper was discussed by Executive Directors meeting as a Committee of the Whole on July 16, 1991. The paper discusses approaches to the governance issue which promote the Bank's work and protect its reputation for technical excellence, professionalism and objectivity. I fully endorse the main messages of the paper. I want to emphasize that this is not a policy paper or a call for a new initiative. It establishes a coherent framework for efforts going on in different parts of the Bank, and reaffirms certain basic propositions: that efficient and accountable public sector management and a predictable and transparent framework for economic activity are critical to the efficiency of both markets and government interventions -- and hence to economic development. A similar message is contained in the 1991 World Development Report. The discussion of the paper in the Committee of the Whole was both lively and thoughtful. Governance is an emotive word, and more importantly, a potentially contentious issue internationally and within many of our member countries. It is not surprising that there were divergent views expressed by Executive Directors on the subject. Despite these differences, the approach taken in the paper received widespread support. In particular, several Executive Directors emphasized the following messages of the paper: - Problems of governance are universal and are not particular to one Region, or only to the developing world. Each country is different, and a thorough understanding of the historical, social and cultural traditions of each country should underpin the Bank's response to such problems. - There is a need to take a long-term approach to issues of governance. - The Bank should be selective in its work on governance, recognizing the efforts of Bank and external donors cannot substitute for the domestic political commitment needed to undertake successful reforms. There remains some apprehension among our borrowing members that our staff might exceed the Bank's mandate in ways which could be interpreted as interfering in the political affairs of our borrowers. This concern, given the difficulty of drawing neat lines in this area, is understandable. I am confident that you will respect the sensitivities and concerns of borrowers while not shying away from issues relevant to development performance when these need to be raised. Until our borrowing members achieve a greater level of comfort with dialogue on governance matters and our own experience with it matures further, it is advisable that delicate policy issues are discussed only by senior managers (Directors and above). Technical issues, of course, can continue to be handled at staff level. I want to thank the Task Force on Governance chaired by Sarwar Lateef for doing a good job on a difficult, nebulous subject. This group, now chaired by Mary Shirley, could assist you in the dissemination of this paper. (?%L O . Barber B. Gonable ALANAGING DEVELOPMENT: THE GOVERNANCE DIEENSION* Contents EXECUTIVE SUMMARY ......... ............................ i I. INTRODUCTION ........... ............................. 1 Definition and Purpose ................................... 1 Relevance for the Bank ................................... 1 II. THE NATURE OF THE PROBLEM ............................ 3 The Role of Governments ................................. 3 When Governance Fails .................................. 5 III. DIMENSIONS OF GOVERNANCE ............................ 7 (a) Improving Public Sector Management ....................... 8 (b) Accountability ......... ............................ 8 (c) Predictability and the Legal Framework for Development .... ...... 10 (d) Information and Transparency ........................... 11 IV. THE ROLE OF THE BANK ................................ 13 Key Elements of an Approach ....... ...................... 13 Limitations of the Bank's Role ....... ...................... 15 V. IMPLICATIONS FOR BANK PRACTICE ........................ 17 Country Strategy and Implementation Issues ..................... 18 Implications for Research ......... ....................... 20 VI. CONCLUSION ........................................ 21 ENDNOTES .............................................. 23 ANNEX I: KEY DIMENSIONS OF GOVERNANCE ................... 27 ANNEX II: LIST OF MEMBERS OF THE GOVERNANCE TASK FORCE .... 57 REFERENCES ............................................ 59 * This paper was prepared by a Task Force with participawion from the Operations; Policy, Research and External Affairs; Legal; Corporate Planning and Budget; and Finance Complexes (see Annex II). MANAGING DEVELOPMENT: THE GOVERNANCE DIMENSION A DISCUSSION PAPER EXECUTIVE SUMMARY (i) This discussion paper is a review of efficient modern economy, and must continue issues of governance that lie within the Bank's to set high standards for itself and its mandate. Such an analysis was anticipated in borrowers. Its experience provides a number Mr. Shihata's Legal Memorandum of of examples of best practice (some of which December 21, 1990, discussed at a Board are described in this paper, and some in the Seminar on April 11, 1991, which set out "a accompanying review of work on public sector legal framework for the Bank's dealing with management) that have been seen to have a this issue". For purposes of this paper, demonstrable positive impact on development governance is defined as the manner in which management in its borrowers. power is exercised in the management of a country's economic and social resources for (iii) The Bank's experience has also shown development. The Bank's concern with sound that when programs and projects appear development management extends beyond the technically sound but fail to deliver results, the capacity of public sector management to the reasons are sometimes attributable to weak rules and institutions which create a institutions, lack of an adequate legal predictable and transparent framework for the framework, damaging discretionary conduct of public and private business, and interventions, uncertain and variable policy also to accountability for economic and frameworks and a closed decision-making financial performance. Given the limited process which increases risks of corruption nature of the Bank's direct operational and waste. Much needed legal reforms may experience in this area other than that covered come to naught, if laws are not enforced or under public sector management, this paper there are severe delays in the settlement of defines major concepts, and surveys Bank cases. Privatization efforts may not succeed experience to date. It also highlights some of or be politically sustainable and the supply the issues that have emerged as the Bank response to improved pricing policies may not addresses a wider range of concerns in this occur unless clear rules and institutions contain area. transaction costs (i.e. the cost of arranging, monitoring and enforcing contracts). (ii) The Bank's interest in governance Sophisticated public expenditure reforms may arises from its concern for the effectiveness of founder if accounting systems are so weak that the development efforts it supports. From this budgetary policies cannot be implemented or perspective, sound development management, monitored, or when lax procurement in the broadest sense of the word, is critical to encourages corruption which distorts public ensuring adequate returns and the efficacy of investment priorities. Public investments may programs and projects that the Bank finances, waste resources unless those who will use, and and so to the underlying Bank objectives of often pay for, the resulting services are helping countries reduce poverty and increase involved in their design and operations. sustainable growth. The Bank has a long record of helping countries build the (iv) These examples illustrate a broader institutions and practices essential to an point: good governance is central to creating Executive Swnmary and sustaining an environment which fosters focus is now taking place in such "areas" as strong and equitable development, and is an accountability and the legal framework. essential complement to sound economic policies. Governments play a key role in (vii) Public sector management (PSM) providing two sets of public goods: the rules issues are addressed in an accompanying paper to make markets work efficiently, and, more which reviews experience in selected areas. problematically, correcting for market failure. The primary focus of the Bank's work has In order to play this role, they need revenues, been in public expenditure management, civil and "agents" to collect revenues and produce service reform and parastatal reform. The the public goods. This in turn requires initial results have been positive, but often in systems of accountability, adequate and trying circumstances. The effort has been long reliable information, and efficiency in resource and arduous, reflecting obstacles of a socio- management. political nature. (v) Productive institutional arrangements (viii) This paper focusses on three other key will vary between countries based on their dimensions: accountability, the legal cultural traditions and historic relationships. framework for development, and information And they will continue to evolve as the and transparency: economy grows, becomes more complex and more integrated with international markets. (ix) Accountability at its simplest means Mature institutional frameworks take a great holding public officials responsible for their deal of time, but there is no guarantee that actions. Economic objectives of public arrangements which are supportive of accountability include congruence between economic growth and poverty alleviation will, public policy and actual implementation, and in fact, emerge. The state may behave in a the efficient allocation and use of resources. predatory manner or pursue strategies that This not only requires systems of financial hinder the development of efficient property accountability but also the capacity and rights. Or its agents may behave in an willingness to monitor the overall economic opportunistic manner and indulge in rent- performance of the government. At the micro seeking. Good governance is a continuum, level, the primary concern is with efficiency in and not necessarily unidirectional: it does not the production and delivery of goods and automatically improve over time. It is a plant services in the public sector. The Bank has that needs constant tending. addressed issues of both economic and financial accountability. Its public expenditure (vi) Recognizing the importance of sound work has assisted governments address a range development management, the Bank's of public resource management issues, and has emphasis in recent years has shifted rapidly supported reforms of sector-wide institutions from its own interventions to the overall to improve accountability in service delivery. country context within which those In terms of financial accountability, to interventions are taking place. In the area of improve compliance with accounting and audit public sector management, attention has covenants, the Bank is assisting some shifted from improving management of borrowers address country-wide constraints to project-related agencies to more general accounting and auditing through assessments reform of the civil service and public and technical assistance projects. The Bank is enterprises, and to the central economic also assisting governments establish adequate agencies that are responsible for macro- oversight and administrative capacity at central economic policy. A similar broadening of and provincial/local levels as they move to ii Managing Development: The Governance Dimension decentralize key economic functions of (xii) The Bank has, in recent years, assisted government. borrowers in ensuring coherence of rules and improved communication; in helping to (x) Macro-level accountability can be improve the efficiency of institutions which reinforced at the micro-level both through administer laws of significance to the competition and by enhancing opportunities for economy; in the training of judges in participation or other means of articulating the commercial law; in encouraging extra-judicial interests of the affected public. The Bank means of settling disputes (e.g. commercial does a great deal to encourage competition arbitration); and in developing capacity to put through deregulation and contracting out of in place appropriate procedural rules for services, and generally by assisting enacting and repealing laws. Effective legal governments to break up monopolies and reforms require careful preparation, and a barriers to entry. Participation can be thorough understanding of local conditions and encouraged through dissemination of the cultural and historical context. With this information on services, complaints in view, the Bank has, in a few cases, been procedures, and public hearings. The use of carrying out comprehensive reviews of legal local NGOs and the encouragement of systems as they relate to development activity. beneficiary participation in project design and implementation is encouraged in Bank (xiii) Adequate and reliable information is a projects, where appropriate. precondition for both accountability and the rule of law, and refers to the availability of (xi) Predictability and the legalframework and access to information from public and for development: Predictability implies that private sources, and transparency of decision- rules and regulations are clear and applied making processes. The availability of accurate even-handedly, and that lines of authority are information about the economy, in general, clear. An efficient civil service helps provide about market conditions and about the continuity and predictability; Bank PSM work intentions of government critically affects the is intended to support these goals. The rule of efficiency and competitiveness of the private law is a key element of predictability and sector. Yet, information flows are grossly stability where business risks may be rationally inadequate in many countries and transparency assessed, transaction costs lowered, and of decision making low. The Bank has been governmental arbitrariness reduced. It is this assisting borrowers improve economic connection of the rule of law with the more information flows, transparency in budgetary efficient use of resources that justifies its and monetary accounts, and procurement consideration by the Bank. Five basic procedures. These measures help to increase elements of the rule of law have been the effectiveness of resource use and to reduce identified as relevant to sound economic corruption and waste. development and, therefore, to the Bank: (a) there must be a set of rules known in advance; (xiv) Much of the work described under (b) these rules must be actually in force; (c) accountability, the legal framework for there must be mechanisms to ensure development, and information and application of the rules; (d) conflicts must be transparency represents a natural extension of resolved through binding decisions of an the Bank's work on public sector management. independent judicial body or through It is technical in nature and complements other arbitration, and (e) there are known efforts undertaken in economic reforms, such procedures for amending the rules when they as the elimination of monopolies or removal of no longer serve their purpose. controls which help reduce rent-seeking. iii Executive Summary Indeed, there is much that the Bank routinely (xvii) Second, selectivity is called for in does which indirectly contributes to improving allocating resources and developing work development management. programs. The selectivity needs to be in terms of the choice of countries for specific (xv) However, in undertaking this work, work on the dimensions of development the Bank's role itself is subject to a number of management outlined above, and in terms of limitations. As an external agency, it cannot the range of activities the Bank can take on substitute for the political commitment that and support at any given time. Such work governments must bring to reforms in should only be embarked upon in countries governance. Full ownership is as important in where there is a clear commitment to and need this area as it is in economic policy reforms. for improving development management along The Bank's legal mandate provides clear limits these dimensions. Many of the Bank's to its role, although the legal restrictions help borrowers may neither want the Bank to be so to protect the Bank's reputation for objectivity involved nor require such assistance. Where and technical excellence and its status as an there is need but no commitment, such work international institution guided solely by would waste resources. Similarly, the concern for economic development and not by dimensions of development management the any political agenda. The Bank's past Bank chooses to assist should reflect both the experience with complex institution building chances of success as well as the Bank's own efforts has been mixed, and suggests that it ability in terms of skills and resources to assist move with caution and absorb the lessons from effectively. those experiences. A further limitation arises from resource constraints. Work on (xviii) Third, in countries where the Bank is governance is expensive and time consuming, active in improving development management, and is limited by skill availability. However, it needs to assist in the design of highly such work will be handled like all other claims differentiated responses, taking account of the on resources through a determination of country's institutional needs, its political priorities within country programs based on economy, its society, and history. The need, borrower receptivity, cost, etc. The objective in each case must continue to be to Bank should, of course, not attempt to take help strengthen the enabling environment for too much on itself, and needs to collaborate sustainable and equitable development. This with other UN agencies and donors, where requires high quality Economic and Sector possible. Work. (xvi) Given these constraints, a measured (xix) The emphasis above is on the technical and selective approach is called for. The main issues of development management. It is elements of this approach are: First, the important to be aware, however, that a strong Bank, through its interventions, needs to emphasis by the Bank on prudent financial continue to exploit opportunities for improving management and attention to auditing and development management, whenever accounting or a legal framework suitable for appropriate, through a variety of means development will tend to bring deeper and including assisting borrowers break up more general problems of governance into monopolies, removal of controls and other sharper relief. Thus, for example, avenues for corruption, beneficiary sophisticated systems of financial accounting participation in projects, etc. and auditing may be established but the government may not absorb or use the results to good effect. A legal framework could be iv Managing Development. The Governance Dimension created, but arbitrariness or corruption in its need for additional criteria to reflect concerns implementation could undermine its value. with governance: merely the effective and This has already been the experience with consistent application of existing criteria based sensitive issues of PSM such as civil service on a greater awareness of the importance of reform where political constraints to the issues of governance for development success of such work have emerged. Where performance. lack of progress is due not to weaknesses in capacity but to lack of government (xxii) Given absorptive capacity constraints, commitment, the Bank then faces a problem and the long-term nature of the development which needs to be reflected in its country of appropriate institutions and economic strategy and dialogue. decision-making processes, development management concerns need to be integrated (xx) When political commitment to sound into a long-term perspective of a country's development management is weak, the Bank development strategy and prospects. As a normally takes up these issues in its dialogue follow-up to the Long-Term Perspective Study with borrowers while remaining proactive in on Sub-Saharan Africa, and the Maastricht seeking ways to help the country improve conference at which it was discussed, the performance in the key areas of concern. This UNDP and the Bank are assisting interested dialogue is supported by economic and sector African countries develop such perspectives. work, where appropriate. In such a dialogue, This also implies that some aspects of this governance issues are not discussed in work should be supported by investment isolation but as an integral part of a operations rather than adjustment lending and government's overall development program. that long-term capacity building technical In conducting this dialogue, the level at which assistance is called for. issues are discussed is a function of their sensitivity and requires the judgements of (xxiii) Such a long-term approach needs to be senior managers. Technical issues are handled supplemented by other measures to strengthen at staff levels, but highly sensitive issues are implementation capacity. This implies greater handled at an appropriately high level efforts at helping build ownership of (Country Director and above). Donor adjustment programs, a more conscious effort concerns regarding such lack of political to understand the political and social structure commitment to sound development and the customs and laws of its borrowers, the management are also surfacing increasingly at need to foster an "implementation culture" consultative group meetings. As Chair of within the Bank and to sensitize staff to the these meetings, the Bank would normally need to handle issues in this area with inform the country of widely-held donor humility, sensitivity and caution, and the need concerns, particularly when these are likely to to encourage participation by beneficiaries, affect Bank-assisted programs. where appropriate, in Bank projects. (xxi) When dialogue fails, the Bank's own (xxiv) Management proposes to disseminate lending to the country is likely to be affected. to staff the key messages for the Bank in this Lending levels have long been responsive to paper together with the Board's guidance. A issues of development management and broad-based dialogue with borrowers, performance, and will continue to be so. interested academics and others has been Judgements of performance are already initiated in the Africa Region and depending routinely made for purposes of IDA allocation upon this experience, could be extended and in assessing creditworthiness: there is no elsewhere. The Bank's research program in v Executive Summary this area needs to develop fiurther. A progress governance would be appropriate in two years' report on the Bank's unfolding experience with time. -o00- vi MANAGING DEVELOPMENT: TIIE GOVERNANCE DIMENSION A DISCUSSION PAPER I. INTRODUCTION 1991). Given the limited nature of the Bank's direct operational experience outside the public sector management area, this initial review Definition and Purpose defines major concepts and surveys Bank experience to date. The paper also cites best 1. The Bank's interest in governance practice and highlights issues that have arises from its concern for the effectiveness of emerged as the Bank addresses a wider range the development efforts it supports. A general of concerns in this area. definition of governance is the "exercise of authority, control, management, power of Relevance for the Bank government."'" A more relevant definition for Bank purposes is "the manner in which power 4. Governance issues are not new to the is exercised in the management of a country's Bank. As a development institution, the Bank economic and social resources for has grappled with these issues from its development."2 The Bank's concern with inception. However, the relatively good sound development management thus extends growth performance of developing countries beyond the capacity of public sector between 1965 and 1980 helped conceal the management to the rules and institutions which deep-seated problems of governance which create a predictable and transparent framework affected the efficient use of resources and for the conduct of public and private business retarded adjustment efforts to respond to a and to accountability for economic and changing external environment. By the financial performance. beginning of the 1980s, as growth decelerated sharply and the developing world was 2. Public sector capacity issues are adversely affected by a severe worsening in discussed in detail in the accompanying paper, the terms of trade, the emergence of a climate The Reform of Public Sector Management: of relative scarcity began to expose Lessons of Experience (PSM paper) (World governance issues in many countries. At the Bank, 1991b), and will be referred to only same time, it was becoming increasingly clear briefly in this paper. The major focus here is that investment lending could not achieve its on the overall management of resources for objectives in the absence of an appropriate development -- with a special emphasis on policy environment. accountability, the legal framework for development, and information and 5. Structural adjustment lending and transparency. related public sector management (PSM) reforms aimed at creating an enabling 3. In his legal memorandum of environment for growth. Their focus was on December 21, 1990, discussed in a Board reducing the area of government intervention seminar on April 11, 1991, the General in incentive policies, on the more efficient use Counsel set out "a legal framework for the of public resources and on reducing fiscal Bank's dealing with this issue as a prelude to deficits, thereby indirectly addressing those any future analysis of the manner in which the governance issues which affected the Bank may take it on operationally" (Shihata, management of resources. Despite some I | . . . . . . . . . . . . . . .~~~~~~~~~~~~~~~~~~~~~ Discussion Paper encouraging success with adjustment lending provincial and local government level, fuelling and public sector reforms, the enabling already unsustainable fiscal deficits. environment is still deficient in many cases. Improvement in the efficacy of Bank-supported 7. The Africa Region was the first to investments and policy reforms thus depends articulate the Bank's concerns in its Long- in such cases, on further improvements in the Term Perspective Study on Sub-Saharan institutional framework for development Africa (LTPS) (World Bank, 1989) in a frank management. discussion of the "crisis of governance".3 The LTPS proved a stimulus to the debate 6. For some of the Bank's borrowers, the now underway in both developing and effectiveness of both adjustment and developed countries on issues of governance in investment operations is impeded by factors general, and in the Bank, as it relates to which contribute to poor development economic development. Another stimulus has management. These include weak institutions, been the rapid political changes in Eastern lack of an adequate legal framework, weak Europe, Latin America and parts of Asia and financial accounting and auditing systems, Africa. These changes have been damaging discretionary interventions, accompanied by changes in the role of the uncertain and variable policy frameworks and state to reflect a greater preoccupation with the closed decision- making which increases risks creation of an enabling environment for of corruption and waste. There are examples development, larger responsibilities for the of countries where corruption has adversely private sector, a reduction in direct affected development. In those countries, government involvement in production and pervasive patronage in government has commercial activity and the devolution of perverted public investment choices to finance power from the center to lower levels of white elephants, usually by contracting government. These changes have usually been excessive foreign debt. Monopolies were associated with difficult economic reforms and sanctioned and allocated to friends of those in macro-economic adjustment requiring power, at great economic cost to the nation. considerable skill on the part of governments There are also examples where good progress in developing a political consensus around in policy reforms has been offset by these reforms. By its function, the Bank is uncertainties in the investment climate. In intimately involved in this broad reform some countries which have made good process and governments are increasingly progress in establishing realistic relative turning to it to address a much broader range prices, the expected private sector response of economic management issues, including the has been inhibited by inconsistent behavior legal framework and systems of procurement towards business by some government and financial accountability. agencies, by inconsistencies between new government policies and the existing legal 8. Bilateral donors have been increasingly framework, or by discrimination against sensitive to public criticism of concessional aid certain ethnic groups with strong business flows to governments which lack democracy, communities. In Eastern Europe, the lack of have a poor human rights record, or are seen a legal framework conducive to private sector to be corrupt, and have been pursuing a development is a severe impediment to broader governance agenda through political privatization and new investment. In some channels. Latin American countries, rapid decentralization has outstripped systems of 9. The Bank's mandate, as laid down in accountability and civil service institutions at its Articles of Agreement as applied in 2 Managing Development: The Governance Dimension practice, is the promotion of sustainable II. THBE NATURE OF THE economic and social development. Its concern PROBLEM for governance must be driven by that mandate. The General Counsel's memorandum identified five aspects of The Role of Governments governance that are beyond the Bank's mandate: the Bank cannot be influenced by the 11. Even in societies that are highly political character of a member; it cannot market-oriented, only governments can interfere in the partisan politics of the provide two sorts of public goods: rules to member; it must not act on behalf of donor make markets work efficiently, and in some countries in influencing the member's political cases, corrective interventions where there are orientation or behavior; it cannot be influenced market failures (McLean, 1987: 19-21). With in its decisions by political factors that do not respect to rules, without the institutions and have a preponderant economic effect; and its supportive framework of the State to create staff should not build their judgments on the and enforce the rules, to establish law and possible reactions of a particular Bank member order, and to ensure property rights, or members. This memorandum then production and investment will be deterred and suggested that governance may be relevant to development hindered (Eggertson, 1990). the Bank's work if it is addressed in terms of This is because high "transaction costs" (i.e., having good order and discipline in the the cost of arranging, monitoring and management of a country's resources. In this enforcing contracts) would inhibit such respect, the General Counsel considered the activities. Compensation for market failure is need for rules and institutions and mentioned, more problematic. Governments in the 1970s by way of illustration, a number of areas that relied on this rationale to rush into unwise may fall within the Bank's mandate such as policies and investments, although often their civil service reform, legal reform, own policy interventions were responsible for accountability for public funds and budget market failures and the investments did not discipline (Shihata, 1991: 47-54). yield adequate returns. Governments now increasingly recognize the need for more 10. Section II of this paper describes the restraint and for taking "market-friendly" nature of the governance problem from the steps to deal with problems. In addition, the Bank's perspective. Section III summarizes State must play a key role in ensuring the key dimensions of governance and the Bank's provision of services such as education, experience with each dimension. (Three of health, and essential infrastructure, particularly these dimensions -- accountability, the legal when such services are directed at the poor framework for development, and information and are not forthcoming from the private and transparency -- are discussed in greater sector. A well-educated labor force and detail in Annex I.) Section IV discusses the adequate infrastructure are fundamental to the role of the Bank. Section V discusses quality of private investment. implications for Bank practice; and Section VI outlines next steps. 12. However, to finance such expenditures, the state needs revenues. The state also needs "agents" who will collect taxes from the public and produce and deliver essential services (such as education and health, and a legal framework).' This, in turn, requires systems of accountability -- 3 Discussion Paper accountability within government and from the "In England, Parliament created the government to those to whom it delivers Bank of England and a fiscal system services. For the system to work, adequate in which expenditures were tied to tax and reliable information flows are essential. revenues. The consequent financial Without it, the rules are not known, revolution not only finally put the accountability is low, and uncertainties government on a sound financial basis, excessive. Thus, accountability, publicly but laid the ground for the known rules, information and transparency are development of the private capital all key elements of sound development market. More secure property rights, management. Moreover, the institutional the decline of mercantilist restrictions, framework needed to provide these public and the escape of textile firms from goods must be managed efficiently. urban guild restrictions combined to provide expanding opportunities for 13. Productive institutional arrangements firms in domestic and international will vary between countries, based on their markets. Both the growing markets cultural traditions and historic relationships. and the patent law encouraged the And they will continue to evolve as the growth of innovative activity.... economy grows and becomes more complex and more integrated with international In Spain, repeated bankruptcies markets. Mature institutional frameworks take between 1557 and 1647 were coupled a great deal of time to develop, but there is no with desperate measures to stave off guarantee that arrangements which are disaster. War, the church, and supportive of economic growth and poverty administering the complex alleviation will, in fact, emerge. The state bureaucratic system provided the may behave in a predatory manner or pursue major organizational opportunities in strategies that hinder property rights. Its Spain and in consequence the military, agents may behave in an opportunistic manner priesthood, and the judiciary were and indulge in "rent-seeking". Why do some rewarding occupations. The expulsion states behave differently from others? What of the Moors and Jews, rent ceilings are the conditions that permit success? The on land and price ceilings on wheat, historical evidence is far from clear. confiscations of silver remittances to However, institutional economists, like merchants in Seville (who were Douglass North, argue that institutions, compensated with relatively worthless defined as "the rules of the game in a society" bonds called juros) were symptomatic (North, 1990: 3),5 determine the performance of the disincentives to productive of economies. Efficient institutions emerge activity" (North, 1990: 114-115). when there are built-in incentives to create and enforce property rights, defined in the 14. Such historical contrasts illustrate the broadest sense. The example most often cited importance to development of the "underlying is that of the contrasting paths pursued by institutional characteristics" of societies. England and Spain in the seventeenth century, Institutional economists point out that in order when both countries faced severe fiscal crises. to understand better why these characteristics The path pursued by England led to a burst of are different in different societies, we need to innovative activity; that of Spain led to a know more about the interaction between decline of such activity. Thus, to quote culture and formal rules and institutions. North: 4 Managing Development: The Governance Dimension 15. The role of culture in shaping functioning of modern economic institutions, institutions and rules is an area of some such as the market, it is important to be aware contention in academic circles. Some argue of them when pursuing policy reforms and that the importance of cultural divergences institution building. diminishes as the market economy progressively transforms society. Others, When Governance Fails citing Japan, stress that norms and values of consensus and reciprocity may soften the 18. The institutional characteristics for impersonal nature of the market, and that managing development, thus, vary widely national cultures impart a long-term, culturally among countries and do not permit easy specific shape to the legal and other generalization. Nor is it practical to attempt a institutions that support the functioning of the taxonomy, classifying states, say, by different market. These two views are not necessarily governance characteristics. This complexity inconsistent; the issue is one of degree. arises from the unique imprint of history, geography and culture on each country's 16. The current debate on governance, institutions and rules, and the multidimensional therefore, needs to take account of cultural nature of governance as a concept. Thus, differences.6 The concepts that are discussed each country is at a different level of political, in this paper mean different things to different economic and social development reflecting a cultures. The concept of "contract", which is wide array of historical, geographic and at the heart of accountability and the rule of cultural factors. A number of the Bank's law, carries implicit the notion that rights and borrowers have been relatively successful in obligations incurred at a given point of time creating the institutions and rules that promote through an abstract legal device -the contract - broad-based economic development. Some will be honored at a later point of time by all others are on their way to doing so, while yet parties concerned. Some cultures may have others still labor under severe political, different conceptions of the relative importance institutional and economic constraints on better of contractual agreements in relation to other government performance. What is said in this rights and obligations. These may include, for paper about government performance must be example, strong and binding ethnic or kinship applied to individual countries in their context. ties. Social norms may affect, for example, attitudes towards evading taxes or what 19. But poor governance is readily constitutes conflict of interest. recognizable. The key symptoms are, inter alia: 17. The spread of political and legal systems modelled on Western traditions may * failure to make a clear separation lead to the simultaneous existence of two sets between what is public and what is of norms and institutions for dealing with private, hence, a tendency to direct broadly defined rights and obligations, with public resources for private gain; Western notions of the rule of law, private property rights and contracts superimposed on * failure to establish a predictable ideas such as "consensus", "communal framework of law and government property" and "reciprocity", which have behavior conducive to development, or evolved over long periods of time in many arbitrariness in the application of rules non-Western cultural settings. While these and laws; different ways of anchoring social rights and obligations may or may not hamper the 5 Discussion Paper * the existence of excessive rules, industrial and commercial groups, can be regulations, licensing requirements, emasculated by poor governance. Industrial etc., which impede the functioning of emissions standards, forest protection policies markets and encourage rent-seeking; and guidelines for the incorporation of environmental concerns into public * priorities inconsistent with expenditure decisions may be worth little more development, resulting in a than the paper they are written on unless rules misallocation of resources; are clear, information is available to the public, and government officials are * excessively narrowly-based or non- accountable. In the case of the environment, transparent decision making. problems are magnified by difficulties of monitoring and enforcement, which enable 20. Such "problems" may be due to lack official government policies to be ignored. of capacity or to volition, or both, and may be of varying severity. However, it is when they 22. Among the underlying causes of poor are sufficiently severe and act in tandem that development management is the level of they create an environment that is hostile to economic, human and institutional development. In such circumstances, the development. Lack of an educated and trained authority of governments over their peoples manpower and weak institutions can tends to be progressively eroded. This substantially reduce the capacity of countries reduces compliance with decisions and to provide sound development management. regulations. Governments then tend to Poverty and illiteracy make poor governance respond through populist measures or, as in more possible. This is not, though, to suggest some authoritarian regimes, they resort to that development automatically brings good coercion. Either way, the economic cost can governance; nor to imply that sound economic be high, including a diversion of resources to management is not possible in poor countries. internal security, and escalating corruption. There are a number of Asian counter- Poor development performance can in turn examples, both authoritarian and democratic. contribute to poor governance by further It is simply that poverty, illiteracy and weak eroding the confidence of citizens in their institutions make the task of good development governments, and causing governments to management much more complicated and behave insecurely. problematic. 21. The absence of good governance has 23. Pervasive corruption is particularly proved to be particularly damaging to the damaging to development. Corruption occurs "corrective intervention" role of government. in all countries and in many different forms. Programs for poverty alleviation and It tends to thrive when resources are scarce, environmental protection, for example, can be and governments, rather than markets, allocate totally undermined by a lack of public them; when civil servants are underpaid; when accountability, corruption and the "capture" of rules are unreasonable or unclear; when public services by elites. Funds intended for controls are pervasive and regulations the poor may be directed to the benefit of excessive; and when disclosure and special interest groups, and the poor may have punishment are unlikely. Although there have inadequate access to legal remedies. been isolated instances of governments being Similarly, the enforcement of environmental both corrupt and successful at promoting standards, which benefit the population as a development, in general, corruption weakens whole but which may be costly to powerful the ability of governments to carry out their 6 Managing Development: The Governance Dimension functions efficiently. "Bribery, nepotism, to explain whether or not countries initiate venality and lack of dedication to duty," notes reform, implement it effectively, or survive its the 1991 WDR, "can cripple administration political fall-out" (World Bank, 1991a: 7.11). and dilute equity from the provision of Authoritarian regimes were just as likely to government services, and thus also undermine yield to the interests of narrow constituencies. social cohesiveness" (World Bank, 1991a). The report concluded that "there was no Graft on a large scale is not possible without evidence to support the view that authoritarian collusion with private companies or foreign governments, on average, show greater suppliers, with officials of foreign promise for achieving rapid growth" (p.16). governments sometimes turning a blind eye, - Moving beyond growth to social development, a problem of international governance. the report notes that some studies suggest that for a given level of income, "improvements in 24. Other causes of poor development social indicators are associated with freedom management are a high degree of and liberty" (7.11). concentration of political power and the colonial inheritance. On the positive side, 27. In sum, governance is a continuum, many former colonies inherited systems of and not necessarily unidirectional: it does not financial accountability, an independent civil automatically improve over time. It is a plant service, and a legal framework. However, that needs constant tending. Citizens need to since these were imported from outside, they demand good governance. Their ability to do have not always taken root. Colonial rule so is enhanced by literacy, education and implied accountability to the colonial power, employment opportunities. Governments need rather than to citizens; it thus sometimes to prove responsive to those demands. destroyed indigenous systems of Neither of these can be taken for granted. accountability. Change occurs sometimes in response to external or internal threats. It also occurs 25. Colonial rule has sometimes through pressures from different interest bequeathed standing armies, thus, diverting groups, some of which may be in the form of resources away from development and making populist demands. While donors and outsiders fragile civilian governments prone to military can contribute resources and ideas to improve coups and related political instability. The governance, for change to be effective, it must 1991 WDR estimates that since 1948, there be rooted firmly in the societies concerned, has, on average, been one coup attempt per and cannot be imposed from outside. developing country every five years (World Bank, 1991a: 7.2). Colonially imposed frontiers have sometimes led to border III. DIMENSIONS OF GOVERNANCE disputes and ethnic strife. During the Cold War, such strife has, on occasion, been fuelled by arms exports to the rival factions/states. 28. As indicated in the foregoing discussion, there are four key dimensions of 26. These symptoms and causes of poor governance that are of relevance to the Bank's governance are not unique to any particular work: capacity and efficiency issues in public form of government. The 1991 WDR sector management, accountability, examined the evidence on the relative predictability and the legal framework for performance records of democracies and development, and information. These are now authoritarian regimes and noted that the discussed in turn (See Annex I for a more democratic-authoritarian distinction itself "fails detailed discussion of accountability, the legal 7 Discussion Paper framework for development, and information has been assisting borrowers rationalize the and transparency). size of the public enterprise sector, privatize, restructure, or liquidate public companies, as (a) Improving Public Sector Management appropriate, improve the competitiveness of the policy environment, and clarify the 29. When the capacity of the public sector relationship between the central government to manage the economy and deliver public and public enterprises with a view to services is weak, the prospects for increasing the returns on the government's development are poor. The public sector in investment in the sector. The core agencies many developing countries has been for key sectors and for national economic characterized by uneven revenue collection, management have been assisted to strengthen poor expenditure control and management, a management of these reform programs and to bloated and underpaid civil service, a large give greater priority to and to increase parastatal sector that provides poor returns on efficiency in the delivery of social services. the scarce public funds invested in it and Decentralization and tax reform are other weaknesses in the capacity of core economic areas where the Bank has supported agencies to design and implement policies that government efforts to improve public sector would address these problems. Not only does efficiency (as noted in the Tax Reform Policy this state of affairs contribute to large fiscal Paper). deficits requiring adjustment measures, but it also progressively erodes the capacity of the 31. The accompanying PSM paper state to provide economic and social services. provides a review of selected issues and concludes that initial results have been 30. The Bank's involvement in this area, positive, often in trying circumstances. The till the 1980s, was overwhelmingly in the effort has been long and arduous, reflecting institutional development of the agencies obstacles of a socio-political nature. In public implementing Bank-financed projects. With expenditure management, imperfect the introduction of adjustment lending, the accountability has gone hand in hand with Bank began to focus on improvements in weak institutional capacity. In civil service overall public sector management, and the reform, there is a shift in emphasis to improvement of sector-wide institutions and improved personnel management. In all cases, service delivery. Within this dimension, three the need for strong political commitment is areas have received primary attention in the noted. It is particularly difficult to ensure 1980s: public expenditure management, civil commitment to reforms over time. Tensions service reform, and parastatal reform. Within between economic benefits and political costs public expenditure management, the emphasis are typical of reforms in this area. has been on assisting borrowers improve public investment programming and the budget (b) Accountability process. Less advanced have been efforts to improve the execution and monitoring of 32. Accountability, at its simplest, means public expenditure programs. Under civil holding public officials responsible for their service reform, in the short term, the emphasis actions. How this happens varies widely from has been on cost-containment measures; in the country to country, depending upon cultural medium term, on strengthening personnel traditions, history, political institutions, management and the effectiveness and administrative capacities and the public's efficiency of public agencies. In the access to and use of information. For the management of public enterprises, the Bank Bank, accountability must be seen from the 8 Managing Development. The Governance Dimension viewpoint of development management. At a reflecting weaknesses in country-wide broad level, economic objectives of public accountability mechanisms. To address this accountability include congruence between problem, the Bank has been pursuing a three- public policy and actual implementation, and pronged strategy: (i) improving borrower the efficient allocation and use of public incentives to comply with accounting and audit resources. This not only requires systems of covenants; (ii) encouraging a more systematic financial accountability, but also the capacity review of auditing and accounting issues and willingness to monitor the overall during project preparation; and economic performance of the government. At (iii) strengthening borrower capacity through the micro level, the primary concern is country-wide reviews of accounting and comparable efficiency in investment and in the auditing. For example, accounting and production and delivery of goods and services auditing functions are being strengthened in in the public sector. Ghana, Madagascar, Mauritania and Indonesia. The LAC Region has been actively 33. The Bank has addressed issues of both helping governments strengthen agencies economic and financial accountability. As critical to accountability and transparency, noted above, public expenditure reviews have such as tax and customs officers, Central focussed on the efficiency of resource use in Banks and the offices of Controller-Generals. public investment programs, in the parastatals Accountability assessments are also underway sector, in the social sectors, and more in some countries. To be effective, such recently, in employment and wage issues in reviews need to focus on the processes by civil services. This has led frequently to the which audited reports are reviewed and action identification of reforms including the removal taken to deal with the corruption and waste of white elephants from public investment identified. programs, privatization, restructuring and closure of state enterprises, reallocation of 35. Decentralization is sometimes seen as resources in favor of primary health and the means of reducing an overload of central primary education, and the removal of "ghost government responsibilities by relying on local workers" and rationalization of employment decision making, micro-level accountability levels in the public sector. Through sector and through participation of beneficiaries in adjustment or investment loans, the Bank also the design and monitoring of service assists reforms of sector-wide institutions, with deliveries. However, decentralization must be a view to improving the efficiency and managed with care if it is not to result in fiscal accountability of institutions responsible for imbalances, wastage and corruption due to a service delivery. In the area of overall lack of adequate oversight from national economic performance monitoring, the Bank's authorities, weak administrative capacity at Operations Evaluation Department (OED) has local levels and the risk of capture of for long advised planning and performance institutions by local elites. Both in Latin ministries on monitoring and evaluation America and Eastern Europe, the Bank has functions. Greater attention to this issue is been active in assisting with the rapid also being paid under PSM projects. decentralization proceeding in those regions, mainly through technical assistance for the 34. In the area of financial accountability, strengthening of local governments and for the Bank has tended to focus on project ensuring fiscal and financial accountability. In implementation agencies. However, Mauritania, an institutional framework for the compliance with accounting and audit creation of municipalities is being established. covenants has often been disappointing, 9 Discussion Paper 36. Micro-level accountability can (c) Predictability and the sometimes reinforce macro-level accountability Legal Framework for Development through competition or the provision of alternatives, that is, opportunities for "exit", 37. Predictability implies "standard or by enhancing opportunities for operating procedures, institutionalized rules, participation, public comment or complaint, or non-personalized decision making and modest other forms of "voice".7 Exit mechanisms levels of discretion and regularized procedures include deregulation, contracting out, public- for establishing and implementing policies" public and public-private competition. The (Brautigam, 1991). In systems with high Bank has encouraged exit through deregulation predictability, rules and regulations are clearly and contracting out of services in various promulgated and generally and consistently projects and generally by encouraging break- applied, and lines of authority are clear. The up of local or national monopolies. Voice can civil service provides a measure of continuity. be encouraged through dissemination of In most countries, predictability is imperfect. information on services, complaint procedures, The Bank's concern is to support the public hearings, public feedback on continued evolution towards ensuring at least development activities and services, a minimum level of predictability. The Bank representation on boards, participation by is increasingly involved in assisting its beneficiaries in the design of projects, and the borrowers to improve the quality and encouragement of local NGOs which are able efficiency of the civil service which, when to reach poor or marginal groups who would successful, will help enhance predictability otherwise be voiceless. Popular participation (see the PSM paper). in project design and implementation has been shown to have a significant positive effect on 38. A sound legal framework for the efficacy of projects. Inevitably, however, development, a further key element of there are some attendant risks that need to be predictability, is an area of focus in this paper. factored in when pursuing these means (see The General Counsel defined the rule of law paras. 19, 25 and 26 in Annex I). NGOs in terms of a "system based on objective rules, were involved in 50 Bank-financed projects in which are actually applied, and on functioning each of the past two fiscal years, compared to institutions, which ensure the appropriate 15 projects in FY88. Some 20 projects, with application of such rules." Reforms proposed exceptionally participatory approaches, are by the Bank, he argued, "cannot be effective being studied by an Operations-PRE learning in the absence of a system which translates group in an exercise designed to draw lessons them into workable rules and makes sure they from Bank experience with popular are complied with" (Shihata, 1991: 42-43). participation. The Philippines Communal Such a system is needed to create a climate of Irrigation Project remains a particularly good stability and predictability, where business example of successful beneficiary participation risks may be rationally assessed, transaction on a large scale producing consistently good costs lowered, and governmental arbitrariness results. Best practice consists of a systematic reduced. It is this connection of the rule of effort during project preparation to explore, law with the more efficient use of resources where appropriate, opportunities to enhance that justifies its consideration by the Bank as competition and participation. a factor in economic development. From the Bank's point of view, the rule of law is not an end in itself; it is only to the extent that it establishes a set of preconditions for development that it comes within the purview 10 Managing Development: The Governance Dimension of the Bank. The elements of the rule of law functioning of an economy. The Bank is are varied. Not all have the same bearing on beginning to be active in this area with several the purposes of the Bank. The following basic operations under preparation that will assist elements have been identified by the General borrowers train judges in economic and Counsel: business fields and handle commercial matters in specialized courts. Other dispute settlement 39. There must be a set of consistent measures such as commercial arbitration can rules known in advance. The Bank is also be useful. assisting former socialist economies and others to ensure that new economic measures are not 43. Finally, there should exist known in conflict with existing laws or constitutional procedures for amending the rules when they provisions. More can be done by most no longer serve their purpose. When laws are governments to communicate laws effectively changed arbitrarily and subjectively without and to explain to citizens the content of recourse to established procedures, they lack legislation. The Bank is assisting some acceptance and invite evasion. While it is borrowers in this area. outside the Bank's mandate to determine what legislative process should be in place to amend 40. These rules must actually be in force. laws, the Bank is assisting in a modest way in Laws are frequently ineffective or are not training and technical assistance for the offices applied because they are perceived as obsolete of the Attorney General, Ministry of Justice, or irrelevant, or because enforcement capacity etc. in areas relating to development is inadequate. The underlying reasons for management. non-compliance with the rules are manifold; some borrowers (with Bank assistance) are 44. The Bank's experience shows that analyzing the causes and improving the effective legal reforms require careful efficiency and competence of the institutions preparation and a thorough knowledge of local which administer the laws. conditions, and the cultural and historical context. Legal sectoral reviews in Indonesia 41. The application of the rules requires and Cote d'Ivoire, and reviews of the legal flexibility and executive branch discretion to frameworks for financial operations in the deal with diverse situations. To avoid abuse Philippines, Guinea and Senegal have enabled of that discretion requires systems of review. the Bank to assist borrowers tailor rules and Some countries have independent or the strengthening of institutions to country specialized courts or ombudsmen; civil service circumstances. It is also important to reform will also address the underlying causes recognize, as noted in para. 16, that attention of abuse. Rationalization of obsolete rules and must be paid to local circumstances and regulations, by updating and simplifying legal traditions.8 systems, is being attempted with Bank assistance. (d) Information and Transparency 42. To assure a business environment 45. Adequate and reliable information conducive to investment and commercial refers to the availability of and access to activity, conflicts must be resolved through information from public and private sources, binding decisions of an independent judicial and the transparency of decision-making body or through arbitration. Confidence in processes. These are vital to both the enforceability of agreements and accountability and the rule of law. Their commitments is critical to the proper absence provides opportunities for deception, 11 Discussion Paper unfair or inequitable treatment and corruption. Indonesia's use of the SGS to manage its The Bank's interest in information is once customs services. again derived from and limited to their impact on development management. 48. Corruption is a two-way street. Donors have an important responsibility to 46. The availability of accurate ensure that their national commercial information critically affects the efficiency and considerations do not undermine good competitiveness of the private sector: economic management in the developing information about the economy, in general, world. Encouraging governments to develop about conditions in particular markets, and sound public investment programs and about the intentions and actions of government respecting the priorities established is an itself are crucial to private sector's calculation important contribution that donors can make. of risk and potential reward. Governments A document entitled "Good Procurement need to raise the quality of the information Practices for Official Development Assistance" they themselves provide and to ensure that the was prepared by the OECD's Development private sector also discloses essential Assistance Committee (DAC) in consultation information. Capital market development, for with the Bank. More recently, through a example, is hindered when public and private DAC Working Party on Financial Aspects of enterprises are not compelled to publish Development Assistance, a greater effort is audited accounts; likewise without being made to ensure that competition for transparency in the financial systems, capital contracts under donor-financed projects is not and financial markets remain circumscribed to a source of corruption and does not contribute a narrow range of firms and instruments, and to distorted investment priorities. The the soundness of the banking system remains intention is to ensure greater transparency and at risk. An efficient market economy needs fair trade practices through a common band of openness in this sense: openness is also concessionality levels, more open procurement strengthened, conversely, by a competitive procedures for large projects, an upper income economy, where there are many sources of limit for tied aid, ICB procedures, etc. information and where economic signals (such Project preparation through joint appraisals as prices) carry rich and relatively undistorted and cofinancing with multilateral development information. banks, including the World Bank, is seen as one way to ensure sound investments and 47. Transparency of decision making is a consistency with country priorities. When safeguard against corruption, wastage and the such cofinancing is not possible, the DAC has abuse of executive authority. Competition and proposed that donors look to the Bank for deregulation, the removal of unnecessary advice on the appropriateness of proposed controls, clear rules and disclosure are bilaterally financed large projects in the important first steps. Many countries have particular country economic situation. A sophisticated and strict laws against consensus has yet to be reached on these corruption, but these are not always enforced. proposals. The Bank has been assisting borrowers remove unnecessary controls and to reduce 49. Budgets in developing countries often regulations, improve domestic and external lack transparency. Revenues are sometimes procurement procedures and make budgets and diverted to special accounts outside the Central Bank accounts more transparent. budgetary framework. Transactions with Where corruption has been pervasive, more parastatals are obscured. A number of drastic measures may be called for, such as expenditure items are off-budget. Military 12 Managing Development: 7he Governance Dimension expenditures often escape scrutiny, avoid economic establishments in certain developing accountability expenditure control and countries -- can play a key role. auditing, in part because of the reluctance of civilian financial managers to question military procurement. High pressure salesmanship IV. THE ROLE OF THE BANK reinforced by generous trade credits in this area, as in others, can contribute to waste and corruption. Key Elements of an Approach 50. The Bank has been active in assisting 52. Governance is a concern for the Bank governments to improve the transparency of for two sets of reasons. First, from a broader budgets mainly through its public expenditure perspective, both history (see Section II) and work. In undertaking such work, its main the Bank's own experience show that good concern is that the country has systems of governance, in the sense that it has been used expenditure decision making and financial above, is central to creating and sustaining an accountability that ensures that all enabling environment for development. expenditures, including military expenditures, are properly assessed and prioritized, that they 53. Second, from the Bank's perspective, are transparent, and that they are subject to as noted in Section I, sound development expenditure controls and auditing. The Bank's management is inextricably linked with the focus is to assist borrowers to ensure that the returns to and the efficacy of investments that overall size of public expenditures is not the Bank helps finance and so to the Bank's excessive in relation to resource availability underlying objectives of helping countries and that adequate resources are allocated to reduce poverty and increase sustainable economic and social sectors, and within these growth. to programs that direct key services to the poor in a cost-effective manner. Its interest in 54. The Bank has a long record of helping military expenditures is because of its countries build the institutions and practices crowding-out effect on development spending. essential to an efficient and modern economy and must continue to set high standards for 51. Availability of information and itself and its borrowers. Section III in this transparency may lower uncertainty and paper and Annex I cite the many ways in transaction costs, but will not, by itself, bring which borrowers are being assisted in about greater accountability in the absence of improving development management. The organizations and mechanisms that analyze and Bank's concern here arises not merely from disseminate information. The mass media, in the impact of such assistance on country particular, play a key role here. The African performance but also, as a financial institution, Capacity Building Initiative is an example of such assistance is part of sound portfolio the potential role of donors in strengthening management. the analytical and research capacities of institutions in developing countries. Long- 55. Until recently, in such areas as term training/twinning arrangements -- accountability and the legal framework, the whether these are formal institutional Bank has tended to focus its attention narrowly connections or the informal evolution of on its own intervention rather than on the relations, like those of certain universities in country context within which those the developed world with close links to the interventions were taking place. Thus, the Bank insists, in all cases, on proper systems of 13 Discussion Paper audited accounts for its project entities but has * Country-wide accountability not often focussed on the constraints within assessments and projects have been which the overall system of financial undertaken in Madagascar, Indonesia accountability was operating. It has often and Bolivia along the above lines. encouraged borrowers to introduce new laws (para. 11 in Annex I) and regulations (e.g. trade and investment legislation) without always examining whether * Decentralization: Assisting the legal system as a whole is operational and governments to establish or strengthen whether laws will be implemented effectively. systems of financial accountability as This has changed rapidly in recent years. Just they devolve financial power to local as Bank public sector management work has authorities. (paras. 16-19 in Annex I) broadened from strengthening project-related agencies to a broader concern with overall (b) At the sector level: civil service and parastatal reforms, similar shifts are now taking place in these other areas Strengthening the capacity and in a few countries. This is evident from the accountability of ministries and following illustrative list of activities being institutions that develop policies, pursued in different Regions of the Bank. establish expenditure priorities and oversee the delivery of essential Accountability services. (a) At the macro level: (c) At the micro level: Strengthening accounting in the public * Assessment of choice and sector, focussing on a range of participation options in the design and actions, depending on country preparation of projects producing and situation and need such as the delivering services. (paras. 20-24 and availability of comprehensive and 28-31 in Annex I) timely information, classification of expenditures in a manner consistent * Encouraging beneficiary participation with budget and programs, appropriate where appropriate, in the design and analysis for decision making, implementation of Bank projects, comparison of budget and actual based on lessons drawn from the results, improving the organization ongoing Operations-PRE study of and responsibility for accounting in Bank experience with popular the finance ministry, and legal participation. (Box 5 in Annex I) requirements for financial reporting. (paras. 6-11 in Annex I) * Selective and focussed use of local NGOs to enhance service delivery and * Auditing reforms to enable appropriate ensure that the voice of the poor is independence of the audit organization heard in project design. (paras. 25-27 specified in the legal structure, greater in Annex I) attention to "value for money" auditing, and improvements in the educational system and professional training. (paras. 13-14 in Annex I) 14 Managing Development: The Governance Dimension Legal Framework for Development information. The Africa Capacity Building Initiative will contribute to Legal reforms, including better this process as well as long-term communication of laws, ensuring twinning/training arrangements. The consistency of laws, addressing training of economic journalists to constraints to implementation of laws, raise the level of public awareness and updating legal systems, training of the policy debate may also yield returns. judiciary in business and economic (para.76-77, Annex I) laws, and encouraging extra-judicial alternatives when legal systems are 56. Much of the above work represents a overburdened, such as commercial natural extension of the Bank's work on public arbitration and other dispute sector management. It is, like the PSM work, settlements mechanisms. (paras. 32-60 technical in nature and complements other in Annex I) efforts undertaken in economic reforms, such as elimination of monopolies, deregulation or * Legal Sector Reviews, undertaken at removal of controls to contribute to good the request of borrowers, with a view economic management and reduce to removing impediments to private opportunities for rent-seeking. Indeed, there sector activity. is much that the Bank has been doing routinely which indirectly contributes to good Information and Transparency governance. * Transparency: Assisting governments Limitations of the Bank's Role improve the transparency of budgets and public expenditure programs; 57. In undertaking such work, the Bank assisting with the preparation of faces some inherent limitations: those of any environmental assessments and external agency, of its legal mandate, of its encouraging borrowers to share these comparative advantage, and of the skills and with those affected by projects; resources available to it. First, as an external assisting improve domestic and agency, the Bank cannot substitute for the external procurement (Box 13 in political commitment that governments must Annex I and paras. 71-75) bring to reforms in this area. Outsiders can mechanisms and institutions to ensure assist and advise, but unless governments are competition, transparency (including committed to reform, changes that are brought disclosure of selection criteria), and about will not be sustainable. Full ownership fair contract conditions in public of reforms is as important in this area as it is procurement etc. with economic policy reforms. * Economic and social information: 58. Second, the Bank's legal mandate Assisting governments improve the clearly delimits its areas of concern. By way collection and dissemination of of illustration, the Bank may support econormiic and social data. (paras. 76, government efforts at decentralization. It Annex I) may, through its economic and sector work make a persuasive case for or against * Analysis and dissemination capacity: decentralization of particular functions. But Strengthening the capacity to the decision to decentralize is one that only understand, process and use governments can take. Similarly, the Bank is 15 Discussion Paper rightly concerned with financial and economic developing human capital rather than quick accountability, but political accountability is physical implementation: the realization that outside its mandate. Similarly, the Bank may expatriate technical assistance is a poor assist in strengthening local governments; it substitute for developing local capability. may not, however, have conditionality There were also other important lessons not requiring local government elections. With directly related to governance involving the regard to the legal framework for incentive frameworks, the role of the private development, the Bank's concern is with its sector and over-optimism on the availability of procedural and institutional aspects. The profitable technical packages. substantive elements of such a framework have political connotations that may sometimes lie 60. Finally, work on development outside the Bank's mandate. Here the General management and institution building is Counsel's memorandum provides clear general expensive and time consuming. However, guidance, although such distinctions can, such work will be handled like all other claims sometimes, be difficult to make in practice. It on budget resources, through a determination is important to note the underlying motivations of priorities within existing country programs, behind the restrictions in the Articles of based on need, borrower receptivity, etc. As Agreement. These restrictions help to protect noted below (para. 64), selectivity would be the Bank's reputation for technical excellence important in terms of countries and the range and objectivity and its status as an of activities to be pursued. The Bank should, international institution that is guided solely by of course, not attempt to take too much on its concern for economic development and not itself. There are UN and other agencies who by any political agenda of its own. have experience in some relevant areas, which the Bank can tap through collaboration and its 59. Third, the Bank's past experience aid coordination function. Given that the provides a counsel of caution. The rationale for the Bank's involvement in accompanying PSM paper is evidence that governance is that it helps improve the work in this area is likely to prove difficult effectiveness of its programs and projects, and and not yield quick results. The Bank's early not as a new line of business, high quality experience with integrated rural development work and improved Bank practices in this projects in the 1970s taught many valuable broad area should help the Bank to move lessons. These projects were ambitious further towards an 'implementation culture", ventures into the public sector and social leading over the longer run, to increased cost engineering. Of the many lessons learned efficiencies for the Bank itself and greater from that experience, some reinforce the need effectiveness of Bank interventions. for the exercise of care and humility in tackling problems of governance. The lessons 61. The skill-mix problem also raises include the need for a more differentiated difficulties. Many governance concerns can approach between regions, countries and and are being addressed by various specialists project type; the need for strong government in the broad PSM field, although experienced commitment at an early stage; the need for auditors, accountants, lawyers, tax specialists, training and retraining Bank staff to meet the management specialists and the like, are complex needs of these projects; the need for generally in short supply in the Bank. The long-term institution building and for avoiding LAC region has gradually built up a range of project institutional arrangements that lead to new skills through judicious hiring and use of frequent conflict with other parts of national consultants. Consultants can play an and local governments; emphasis on important role; Bank staff need to ensure 16 Managing Development: The Governance Dimension though that consultants are sensitive to the * Helping countries deal with the Bank's institutional concerns. Here again, the especially complex issues of poverty Bank needs to assist borrowers to draw on and the environment (see para. 21 skills in other agencies, but recognize that above), where the quality of there will nevertheless be significant trade- governmental performance is offs. particularly important. * Projecting a long-term vision of an V. IMPLICATIONS FOR enabling environment, as in the 1991 BANK PRACTICE WDR but at country level, and supporting such fundamental ingredients as universal literacy, 62. Bank actions relating to the expanded primary education, better governance dimension of development would information on development issues and be chosen selectively from the following range a supportive environment for a of options depending upon country growing private sector. circumstances and needs, the state of the dialogue with the borrower, and budgetary * Improving implementation constraints: performance through greater efforts at assisting borrowers build ownership * Assisting governments in reforms that of adjustment programs, understanding they have identified or assisting them the political and social structure of the to identify reforms when they have country as well as its laws and asked for such assistance. The Bank customs, and increasing attention to is already experiencing a growing fostering an "implementation culture" demand for technical assistance in in the Bank, including greater support of a legal and procurement emphasis on beneficiary participation framework in Africa and Eastern in project design. Europe and strengthening decentralization in Latin America. As a practical matter, given differing country circumstances as well as budgetary and staff * Persuading governments through constraints, a measured and selective dialogue and economic and sector approach must be pursued. The main work of the need for reforms. elements of this approach are set out and some Institutional and public sector of the actions outlined above are elaborated, in management assessments and public the paragraphs that follow. expenditure reviews and financial accountability and legal sector reviews 63. First, the Bank, through its in Africa and Asia are examples of interventions, should continue to exploit how this has begun to happen. opportunities for improving development management, whenever appropriate, through a * Crafting country lending strategies and variety of means including assisting borrowers levels to take account of the impact of break up monopolies, removal of controls and governance issues on development other avenues for corruption, beneficiary performance. participation in projects, etc. 17 Discussion Paper 64. Second, selectivity is necessary in or use the results to good effect. A legal allocating budgetary resources and developing framework could be created, but arbitrariness work programs. The selectivity needs to be in or corruption in its implementation could terms of the choice of countries for specific undermine its value. This has already been work on the key dimensions of development the experience with sensitive issues of PSM management outlined above, and in terms of such as civil service reform where political the range of activities the Bank can take on constraints to the success of such work have and support at any given time. Such work can emerged. Where lack of progress is due not only be embarked upon in countries where to weaknesses in capacity but to lack of there is a clear commitment to and need for government commitment, the Bank then faces improving development management along a problem which needs to be reflected in its these dimensions. Many of the Bank's country strategy and dialogue. borrowers may neither want the Bank to be so involved nor require such assistance. Where 67. When political commitment to sound there is need but no commitment, such work development management is weak, the Bank would waste resources. Similarly, the normally takes up these issues in its dialogue dimensions of development management the with borrowers while remaining proactive in Bank chooses to assist should reflect both the seeking ways to help the country improve chances of success from such an involvement performance in some of the key areas. This as well as the Bank's own ability in terms of dialogue is supported by economic and sector skills and resources to assist effectively. work, where appropriate. In such a dialogue, governance issues are not discussed in 65. Third, in countries where the Bank is isolation but as an integral part of a active in improving the governance dimension government's overall development program. of development management, it needs to assist In conducting this dialogue, the level at which in the design of highly differentiated issues are discussed is a function of their responses, taking account of the country's sensitivity and requires the judgements of institutional needs, its political economy, its senior managers. Technical issues are handled society, and history. The objective in each at staff levels, but sensitive issues are handled case must continue to be to help strengthen the at an appropriately high level (Country enabling environment for sustainable and Director and above). equitable development. This requires high quality analysis, usually as part of appropriate 68. The issue of political commitment to Economic and Sector Work. sound development management is also surfacing increasingly at consultative group Country Strategy meetings. The General Counsel's legal and Implementation Issues memorandum noted that the Bank should not act as the agent of donor countries at these 66. It is important to note in this context meetings. As Chair of these meetings, it is that a strong emphasis by the Bank on prudent normal for the Bank to inform the country of financial management and attention to auditing widely-held donor concerns, particularly when and accounting or a legal framework suitable these would affect Bank-assisted programs. for development will tend to surface deeper and more general problems of governance. 69. When dialogue fails, the Bank's own Thus, for example, sophisticated systems of lending to the country is likely to be affected. financial accounting and auditing may be Lending levels have long been responsive to established but the government may not absorb issues of development management and 18 Managing Development: The Governance Dimension development performance, and will continue to strengthening of budgetary decision making be so. Judgments of performance are already and accountability, development management routinely made for purposes of IDA allocation concerns must be integrated, where and in assessing creditworthiness. This appropriate and relevant, into a long-term involves judgments about the quality of perspective of a country's development development management as it relates to strategy and prospects. In the Africa Region, growth and to poverty reduction, consistent as a follow-up to the Long-Term Perspective with the policy paper on poverty (World Bank, Study on Sub-Saharan Africa and the 1990e). There is no need for additional Maastricht conference which discussed it, the criteria to reflect concerns with governance: UNDP and the Bank, with assistance from the merely the effective and consistent application Netherlands Government, are assisting of existing criteria based on a greater interested African countries to develop such awareness of the importance of issues of perspectives. The objective, in this case, is to governance for development performance. use the exercise to help develop a national consensus on development objectives and 70. Poverty and the environment are two instruments, and to put government adjustment critical areas of country strategy which present programs within the framework of a long-term particular challenges of governance. The development strategy aimed at poverty Bank needs to pay attention to the equity as reduction and consistent with environmental well as cost-effectiveness of social concerns. Countries elsewhere may wish to expenditures in its poverty assessments and consider a similar approach. For the Bank, public expenditure reviews, including this means taking a longer-term view of its addressing questions of the adequacy of social own interventions to assist borrowers improve safety nets (especially important in middle- economic management, recognizing that quick income countries). The legal framework can results may be unrealistic, and focussing on also greatly influence the access of human and institutional capacity development. disadvantaged groups, such as women or This also implies that some aspects of this landless people, to public services and work should be supported by investment economic opportunities. On environmental operations rather than with adjustment lending. matters, even non-interventionist governments Carefully designed long-term technical face relatively extensive requirements for assistance is also appropriate. administrative and regulatory decision making, much of it discretionary, in areas -- like forest 72. This long-term approach would policy or pollution control -- where property reinforce efforts underway to strengthen rights are uncertain and market processes, ownership of adjustment programs. The therefore, cannot easily produce a socially technical complexity of the preparatory work desirable outcome. The Bank is considering on adjustment operations and the speed with how these inherent difficulties can be which borrowers require resource transfers, overcome and potentially abusive discretionary sometimes leave insufficient time for adequate powers curbed for example, by separating dialogue and can cause the Bank to contribute surveillance from administrative responsibility. to programs whose ownership is weak and that WDR 1992 will discuss some of these issues are then seen to be externally imposed. In an of environmental policy and governance. ideal world, sufficient preparation time would permit a better understanding of the political 71. Given absorptive capacity constraints, economy of the country, and through a more and the long-term nature of the task of intensive and extensive dialogue, greater developing appropriate institutions and the ownership and understanding of the program 19 Discussion Paper by the borrower is assured. However, organizing participatory processes, mediating governments and Bank staff frequently do not conflicting points of view while achieving have that luxury. Governments often delay results in a timely manner. In some cases, it adjustment and come to the Bank for means identifying intermediaries through assistance on adjustment when they are facing which the Bank can work. It may also mean a serious crisis. There is, then, an inherent working with local NGOs; in other instances, conflict between the need for quick support of this may mean searching for special skills in sensitive policy reforms and the need to build local sociologists, development managers, ownership and understanding of the program. anthropologists or consultants who can be Moreover, greater ownership comes after a brought into projects for particular aspects of program begins to show results. It, project work. Timetables may sometimes nevertheless, remains important to ensure that need to be adjusted in order to accomodate operations are designed, taking into account, this labor intensive work -- often at the the political economy of the country. It is also beginning of the project cycle. The Bank's important to ensure that ownership of the learning process on popular participation is program, however narrow at the start, is addressing these issues (Box 5, Annex I). genuine, and is broadened over time. At the same time, the strength and integrity of Implications for Research adjustment programs must be protected. 75. Much of the Bank's current policy and 73. Beyond adjustment lending, fostering research work in public sector management an "implementation culture" requires attention bears on "governance" issues. For example, to good governance in the design of projects, studies underway examine ways to introduce as well as a deliberate focus on greater public accountability in public finance implementation. Best practice includes simple and in civil service management, while work project design, discourages creation of on regulatory institutions and on the political autonomous project implementation units, economy of adjustment also addresses some of encourages use of existing structures to the questions discussed in this paper. Much implement projects, increases supervision, uncharted territory remains, and current work suggests prior action and conditionality rather could be extended in several directions. than delayed dated covenants, recommends recruitment of key staff well before 76. One such is further research on the effectiveness and pays special attention to the rule of law, to explore the minimal juridical fiscal effects of projects. All of these conditions for broad-based development. For recommendations, coming more and more example, in areas such as contract sharply into focus in Bank operations, are enforcement, employment and tenancy instances of the approaches to good transactions, recourse against public agencies development management discussed in this and judicial independence, is there relatively paper. consistent and culture-neutral experience on which countries can base their own efforts? 74. Beneficiary participation is, in many Another important area is the accountability of instances, an important component of public agencies, where it would be useful to institutionalizing an implementation-oriented evaluate the wide variety of mechanisms and approach as well as a means of improving the models available. These include contracting effectiveness of particular projects. The Bank, out of services to private providers (on which as noted, is attempting to spread best practice some work is in progress), decentralization of in this area. This will require skills in provision and/or finance, ombudsman 20 Managing Development: The Governance Dimension mechanisms, "customer-driven" service systems and others. Further research could follow up some of the findings of WDR 1991 to explore the two-way relationship over time between economic growth and changes in governance. VI. CONCLUSION 77. Management proposes to proceed with the following: (i) Dissemination to the staff of the key messages for the Bank in this paper together with the Board's guidance. (ii) A broad-based dialogue with borrowers, interested academics and others in all Regions. This has already begun in the Africa Region. (iii) A research program along the lines discussed in paras. 75-76. (iv) A progress report to the Board on the Bank's ongoing experience with governance issues in about two years' time. 21 I Managing Development: The Governance Dimension ENDNOTES 1. Webster's Unabridged Dictionary 2. Governance, in general, has three distinct aspects: (i) the form of political regime (parliamentary/presidential, military/civilian, authoritarian/democratic); (ii) the processes by which authority is exercised in the management of a country's economic and social resources; and (iii) the capacity of governments to design, formulate, and implement policies, and, in general, to discharge government functions. The first aspect clearly falls outside the Bank's mandate. The Bank's focus is, therefore, on the second and third aspects. 3. This discussion was itself partly prompted by criticisms of early drafts of the LTPS from African reviewers who felt this issue needed to be aired. 4. This gives rise to the so-called "Principal-Agent" problem which relates to how the Principal can most effectively induce the Agent to act the way the Principal would like. There is a growing body of literature on "Agency theory." See Eisenhardt, 1989. 5. North draws an important distinction between institutions and organizations. "Institutions, together with the standard constraints of economic theory, determine the opportunities in a society. Organizations are created to take advantage of those opportunities; as the organizations evolve, they alter the institutions" (North, 1990: 7). 6. Lucien Pye argues persuasively that "culture is not a matter of the rule of the irrational as opposed to objective rational behavior, for the very character of rational judgements varies with time and place. Common sense exists in all cultures, but it is not the same from culture to culture. Sentiments about change, judgements about utility, expectations as to what different forms of power can and cannot accomplish are all influenced by cultural dispositions... .People cling to their cultural ways not because of some vague feeling for their historical legacies and traditions, but because their culture is part and parcel of their personalities" (Pye, 1985). 7. The concepts of "exit" and "voice", which originated in Albert Hirschman's classic work, Exit, Voice and Loyalty (Hirschnan, 1970), have been adapted by Samuel Paul to the issue of accountability (Paul, 1991). 8. For example, under a Bank-supported Madagascar Environment Program - The Land and Rural Resources Directorate (DPRA), a public titling agency, for which the Bank has been a lead donor, has been struggling unsuccessfully for some time with formal legal arrangements which would ensure that disadvantaged people who invest in land, will have access to future benefits from their investments. Having failed the formal legal way to do this, they pursued a different course. A survey of the current, traditional land tenure system is under way to understand traditional rights and control mechanisms, and to understand how investment decisions are made and benefits derived. This survey, which is highly participatory, builds on people's knowledge of the land around their communities and of the rights and obligations traditionally allocated to groups and individuals. Once this survey is completed, it is planned that the DPRA will set up village discussions in which individual rights will be agreed upon for a specified period and verbal community consensus will sanctify these rights. This community agreement will be updated on a regular basis every few years. The results of the village discussions, and the community agreements about individual rights that follow, will be included in reports to be given the status of official (legal) documents. 23 Managing Development: The Governance Dimension ANNEX I KEY DIMENSIONS OF GOVERNANCE Contents A. ACCOUNTABILITY . .................................... 27 The Nature and Scope of Accountability ...... ................. 27 Macro-Level Accountability ......... ...................... 28 Decentralization: The Macro-Micro Linkage ..... ............... 32 Micro-level Accountability ......... ...................... 34 Governments and NGOs ........... ...................... 36 The Bank's Role in Promoting Exit and Voice ..... .............. 36 B. THE LEGAL FRAMEWORK FOR DEVELOPMENT .... ............ 38 A Set of Rules Known in Advance ....... ................... 40 Rules to be Actually in Force ......... ..................... 41 Mechanisms to Ensure Application of the Rules ..... ............. 43 Conflict Resolution . ................................... 45 Amendment Procedures ........... ...................... 45 C. INFORMATION AND TRANSPARENCY ...... ................. 48 Information, Transparency and Economic Efficiency .... ........... 48 Prevention of Corruption .......... ...................... 49 Analysis and Dissemination Capacity ...... ................... 52 ENDNOTES ........................................... 53 List of Boxes 1 - Reflections on Corruption ............ ..................... 29 2 - Indonesia-Accountancy Development Project ...... ............... 31 3 - Decentralization in Poland and Romania ...... .................. 33 4 - The Philippine Communal Irrigation Program ...... ............... 35 5 - Popular Participation and the Bank ....... .................... 37 6 - Improving Accountability and the Environment ..... ............... 39 7 - Communication of the Law .......... ...................... 41 8 - Legal Inconsistencies in Eastern Europe and Africa ............. I ... 42 9 - Enforcement ......................................... 44 10- - Reform of the Regulatory Framework ....... .................. 46 11 - Improving the Judiciary . ................................. 47 12 - Transparency in Government: "The Ten Commandments" in Madagascar ....... ............... 50 13 - Changing Procurement Policies and Practices in Eastern Europe .................................... 53 25 Managing Development: Te Governance Dimension ANNEX I KEY DIMENSIONS OF GOVERNANCE A. ACCOUNTABILITY 2. Accountability is important throughout the economic system, not just within government. Governments also have an "[Accountability] is found important role to play in ensuring where rulers readily delegate accountability in the private sector, through authority, where subordinates company and securities legislation, competitive confidently exercise their policy, and regulatory oversight. As the state discretion, where the abuse of sheds many productive investments in power is given its proper developing countries, this function becomes name, and is properly particularly important. punished under a rule of law which stands above political 3. Public accountability involves three faction." inter-related groups: (i) the general public and John Lonsdale (1986) particularly recipients of public services, who are interested in service providers being accountable to them; (ii) political leaders and The Nature and Scope of Accountability supervisors of service providers, who would like the service providers to be accountable to 1. Accountability, at its simplest, means them for a mixture of public policy and holding public officials responsible for their private/parochial interests; and (iii) the service actions. Political leaders are ultimately providers themselves, with objectives and responsible to their populations for interests often different from the first two. government actions and this means that there has to be accountability within government. 4. The phenomenon of "capture" of How this happens varies widely in different public services and resources by relatively countries, depending upon cultural narrow special interests is an ever-present characteristics, history, political institutions, problem in all countries. It is made worse by administrative capacities and the public's monopoly, and also by limited capacity of the access to and use of information. At a broad public to demand and monitor good level, economic objectives of public performance, especially since it is often hard accountability include ensuring congruence to measure the benefits of public services. between public policy and actual These factors make improvements in public implementation, and the efficient allocation accountability an especially complex and and use of public resources. This not only difficult undertaking. requires systems of financial accountability, but also the capacity and willingness of 5. The historical evolution of governments to monitor their overall economic accountability reveals three features. First, performance. At the micro level, the primary micro-level accountability has become more concern is similar efficiency in investment and important as the role of the state has expanded in the production and delivery of goods and and made it impossible to apply broad political services in the public sector. accountability to all the myriad actions of modem government. Second, the focus in public accountability tends to be on inputs, 27 Annex I especially public expenditure, rather than on Bank's) but also because it generally reduces outputs or impacts, which are often diverse the efficiency of resource use (Box 1). and complex to measure. Third, except for legal accountability for government action in 8. The Bank has historically focussed on some countries, accountability has mostly been financial accountability, especially in the by internal administrative controls by political context of investment projects. As is the leaders, government agencies and bureaucrats experience of other donors, compliance with acting as proxies for the public. But accounting and auditing covenants has been hierarchical control is often ineffective, uneven. The problems encountered in these especially when collusion between supervisory areas are not project specific but are and subordinate personnel is likely. Micro- symptomatic of weaknesses in country-wide level accountability, remains critical, financial accountability. The need for especially in ensuring government improved financial accountability at the responsiveness to the views and needs of the national level is of particular relevance in "publics" for which services are intended. countries where the Bank is undertaking adjustment lending and is, in effect, providing Macro-Level Accountability substantial resources directly to government budgets. 6. There are two key aspects of macro- level accountability that are particularly 9. To address this issue, the Bank is relevant: financial accountability, and pursuing in selected countries a three-pronged accountability for overall economic strategy. First, it is trying to improve performance. borrower performance through stricter enforcement and the introduction of penalties Financial accountability involves: for non-compliance. The penalties include not extending closing dates, conditioning further (i) A properly functioning government processing of loans to compliance with accounting system for effective requirements on past loans and suspending expenditure control and cash disbursements. management; 10. Second, it is trying to encourage more (ii) An external audit system which systematic review of auditing and accounting reinforces expenditure control by capacities and needs during project exposure and sanctions against preparation, and encouraging greater misspending and corruption; contracting out for project accounting and audit services. (iii) Mechanisms in place to review and act on the results of audits and to ensure 11. Third, it is helping to strengthen that follow-up action is taken to borrower capacity through country-wide remedy problems identified. reviews of auditing and accounting systems, and following up with assistance. In Ghana 7. Without a well-functioning system of and Madagascar, Economic Management financial accountability, government efficiency Support Projects aim to remedy deficiencies in is poor, and the probability of corruption public financial management in those increases greatly. Corruption is clearly an countries. The projects would clear the issue of concern not only because of potential backlog of government accounts and introduce misuse of external resources (including the new accounting methods and software to 28 Managing Development: The Governance Dimension BOX 1 Reflections on Corruption Corruption is the misuse of power for enforcement. Simultaneously with enacting personal gain. Many people, anywhere, can be legislation, the strength and independence of the tempted to misuse power for personal gain, if judiciary has to be secured (see para. 51). permitted to do so at no cost or risk to themselves. Thus, corruption occurs in all countries in many Many political leaders in countries with different forms. It tends to emerge and increase in serious poverty have amassed extraordinary fortunes. any country when inequalities are acute, resources Foreign exchange reserves were transferred to scarce, rules unclear, disclosure and punishment foreign bank accounts. Such abuse, needless to say, unlikely, and upward mobility is restricted. Efforts adversely effects economic development. It to reduce its incidence need first to identify the kind unleashes cynicism which corrodes public trust - and of corruption (graft, bribery, theft, conflict of signals to others to do likewise. Private wealth interest, nepotism, bias, or favoritism), itsfrequency accumulated through abuse of power amidst public (pervasive, occasional, or intermittent), and its squalor undermines legitimacy. Yet, graft on this perpetrators (contractors, public officials, political large scale is not possible without collusion between elite, businessmen, foreign suppliers). major private corporations and public agencies. Often the "commissions" are paid by foreigners - The causes of corruption relate to political foreign contractors, companies, or consultants. and economic conditions within the society and their Sometimes such activity is associated with foreign linkages to problems in the world economy aid. Foreign companies argue that bribery is but one (Theobald, 1990: 10-11; 161-169). As such, causes of the costs of doing business in a country. are as complex as types of corruption are varied. Financing necessarily flows through different While distinguishing between symptoms and causes agencies; a percentage "take" off the top is is important, sometimes symptomatic relief provides considered a fee by some, a kickback by others. opportunities for needed social and economic change leading to more lasting "cures". For example, What, if anything, can donors do in these bribery of public officials allocating essential licenses circumstances? In part, the recommendation for can be mitigated by clear rules, disclosure, and countries is also true for donors - reduce the nwnber effective enforcement. Further, the amount of of unnecessary regulations, and rely more on market licensing can be reduced with clear rules. The forces; ensure that the laws of the country are longer-term measure of civil service reform adds observed; insist upon meeting procurement and more long lasting relief. Only over time, and with contracting standards; upon meeting audit major policy reform, can improved economic requirements, study audit reports, pay attention to the performance increase economic opportunities and manner in which disbursements are handled. Even thereby provide the environment and context for with these safeguards, the problems are daunting. diminished corruption. Yet, every generation has to Aid coordination provides another venue for flagging make its own struggle against its resurgence. the importance of supervision, audits, and attention to disbursement processes. Audits may be required, Competition, clear rules, and disclosure are and not always performed, or where performed, they important first steps. Many countries have may not be read. Project supervision is difficult to sophisticated and strict laws addressing corruption. maintain in the best of circumstances; when donor Yet the existence of legislation alone is insufficient. agencies are pressed to do more with fewer people, The problem may lie with a lack of dependable supervision suffers. (continued on next page) improve the accuracy and timeliness of establish the Office of Auditor-General. Audit financial data. Similarly, the Development systems in the banking sector are being Management Project in Mauritania helped to reformed in Poland and Algeria, while Poland 29 Annex I BOX I Reflections on Corruption (continued) Corruption is a two-way street. Donors tied aid, more transparency in large projects, e.g. have a responsibility to ensure that commercial through ICB procedures and mandatory consultation, considerations do not undermine good economic etc. Project preparation through joint appraisals and management in developing countries. Encouraging cofmancing with multilateral development banks govemments to develop sound public investment including the World Bank is seen as one way to programs and respecting the priorities established is ensure sound investments. When such cofinancing is an important contribution donors can make. In this not possible, the DAC has proposed that donors look regard, the Development Assistance Committee to the Bank for advice on the appropriateness of (DAC) of the OECD, in consultation with the Bank, proposed bilaterally financed large projects in the has prepared a document entitled "Good Procurement particular country situation. A consensus has yet to Practice for Official Development Assistance". More be reached on these proposals. recently through an OECD/DAC Working Party on Financial Aspects of Development Assistance a Some observers have also suggested that one of the greater effort is also being made to ensure that next steps may be to have donors more fully competition for contracts under donor-financed exchange information with one another about projects is not a souree of corruption and does not companies, contractors, or consulting groups which contribute to distorted investment priorities. The have been identified as having participated in graft, intention is to ensure greater transparency and fair bribery, or other corrupt behavior. This trade practices through a common band of 'blacklisting' of corrupt companies or contractors by concessionality levels, more open procurement donors would provide a useful disincentive for these procedures for large projects, upper income limit for practices. has also requested technical advice on audits described in the Public Sector Management and evaluations of government programs and (PSM) paper, public expenditure reviews have accounts. In January 1990, the Africa Region focussed on the efficiency of resource use in set itself a target of 12 projects or project public investment programs, in the parastatals components aimed at strengthening financial sector, in the social sectors, and more management capabilities of borrowers through recently, in employment and wage issues in FY92. The Asia Region established a Task civil services. This has led frequently to the Force on Auditing which also suggested the identification of reforms including the removal need for a more comprehensive approach to of white elephants from public investment the problem. In Indonesia, the Bank is programs, privatization, restructuring and supporting a comprehensive Accountancy closure of state enterprises where appropriate, Development Project (Box 2). These country- reallocation of resources in favor of primary level reviews need to focus on coverage, health and primary education, and the removal timeliness and quality of financial control of of "ghost workers" and rationalization of projects and public expenditures, but also take employment levels in the public sector. account of legislative or other review of Increasing attention is being paid to strengthen government policies and programs and of the capacity of governments to monitor and public access to information. evaluate their own economic performance, including issues of resource use. 12. Accountability for Economic Performance: The Bank has also addressed 13. Governments could do more to issues of economic accountability. As strengthen the overall monitoring and 30 Managing Development: The Governance Dimension BOX 2 Indonesia-Accountancy Development Project Indonesia's government accounting practice to prepare for future expansion of had changed little since the 1864 Dutch Financial accountancy education and training; and, Administration Act. Finding that they could not cope with the increasing complexity of government - improving the legislation on accounting, financial transactions, the government requested Bank auditing and disclosure requirements. support for an accountancy project. Budget reports and fnancial statements did not provide a The modernization of government comprehensive view of the financial sktuation and accounting is being carried out with the use of local were often delayed. It took three years before and foreign specialists who are assisting in the design government expenditures for a given period were of a uniform chart of accounts and a clear and reported to Parliament. specific classification of expenditures. Similar changes in accounting practices will be adopted by In the private sector, the accounting system public enterprises and by lower levels of government. had fallen behind other skills required in industry and commerce. The shortage of trained accountants and With regard to private sector accounting, managers who could produce and use accounting the World Bank will support the Indonesian Institute information was severe. The professional body of of Accountants to continue the Certified Accountant's accountants - the Indonesian Institute of Accountants professional education. Accounting principles and - was relatively young and lacked detailed auditing standards will be formulated for more accounting and auditing standards to guide the consistent financial reporting by commercial and profession, a code of ethics and disciplinary processes industrial businesses and a code of ethics will be to regulate it. developed. The Bank-financed accountancy In accounting education, the Bank will development project will address all these areas by: finance programs for personnel development, procurement of teaching equipment and materials, ! - improving accounting practices in the research, fellowships to train accounting teachers, public sector by supporting the introduction and loan programs for institutions and students. The of modernized government accounting; improved quality of accounting programs in universities and institutions will permit expansion of - improving accounting practices in the accountancy enrollments and increase the supply of private sector by supporting the accounting professionals. development of technical standards and a code of ethics for the accountancy The proposed project will be implemented profession; over five and half years. Its total cost is US$162.5 million, of which the Bank loan will finance - supporting the govemment's program to US$112.0 million. raise the quality of accounting faculties and evaluation function, currently largely donor under PSM projects is under way. This will driven and project specific. Yet in many need to be a gradual process, given the countries, departments are required by competing claims on resources. legislation to prepare annual reports on their activities. Some countries have performance 14. In some industrial countries (and a few monitoring ministries. OED has tried to developing countries), a current wave of PSM encourage these activities, and more work reforms seeks to raise the efficiency with 31 Annex I which public resources are used by giving Decentralization: The Macro-Micro public managers greater freedom to run their Linkage operations but substantially increasing their accountability through objectives, specific 16. Decentralization is an increasingly targets and performance monitoring. There common phenomenon in Latin America, Asia has also been an attempt to link such and Eastern Europe. In theory, it can lead to efficiency concerns to broader notions of significant improvements in efficiency and performance in implementing government effectiveness by reducing overloading of policy objectives. This accountability is central government functions and improving sometimes reflected in contracts, programs or access to decision making and participation at memoranda of understanding. A number of lower levels of government, for example, by developing countries have adopted the use of improved service design, user financing such memoranda in the context of parastatal targeting and delivery (See Box 3). reforms, which are then negotiated by heads of government departments and chief 17. However, if not carefully managed, executives of public enterprises. These have decentralization can lead to a deterioration in had mixed results, particularly when the use and control of resources, especially in undertaken with inadequate preparation or the short term. National goals can be discussion. This is accompanied by a seriously distorted by local governments and movement away from a single year to a scarce resources diverted to misuse. medium-term budgetary framework that Moreover, radical decentralization can provides managers with a stable resource seriously weaken the capacity of the central stream. Alongside this, accounting systems government to manage the economy through and internal auditing are being strengthened, fiscal and monetary means. In the late 1980s, with increased emphasis on cash management Argentina's provincial governments were and, in some cases, accrual accounting. The responsible for the largest and fastest-growing audit function is now being widened to include portion of the public sector deficit. Apart not only financial probity but also "Value-For- from the potential damage done to Money" (VFM) audits. macroeconomic stability and expenditure efficiency, resources are arguably more open 15. The applicability of these innovations to capture by elite groups at the local level to developing countries will vary. Some of than at national levels. the Bank's borrowers are probably ready for reforms along the lines described above. 18. Perhaps, the most serious problem is However, in most countries, the basic weak administrative capacity at local levels, accounting and auditing systems are not in leading to waste and corruption. The poorest place. Greater autonomy to managers must be local authorities, whose constituents stand to linked to improvements in financial gain the most from improved delivery and information systems. Similarly, only when targeting of social services, are precisely those financial audit systems are functioning well least able to manage increased responsibilities. can "Value For Money" auditing be considered. 19. The Bank's present approach to decentralization and local government development relies heavily on financial tools to ensure efficiency, including cost recovery for municipal services. An upcoming study on decentralization in LAC countries suggests the 32 Managing Development: The Governance Dimension BOX 3 Decentralization in Poland and Romania As Poland and Romania pursue political Local governments will be key liberalization and macroeconomic adjustment, they implementing institutions for the Bank's pipeline of are also embarked on a significant decentralization of proposed projects in both countries, primarily in the the public sector. The three issues are closely areas of infrastructure, the social sectors, linked. environment, rural development and poverty alleviation. However, before these decentralizing Strengthening local government is widely countries may absorb effectively lending operations, viewed as essential to ensuring greater responsiveness local govemments must be strengthened to discharge and accountability in many infrastructure and service effectively their new and growing responsibilities. areas that have been dominated from the center in Key areas for institutional strengthening include: both delivery and financing aspects. Development of local taxation policy and administration (and political and institutional means to hold local consistency with national taxation policies); government authorities accountable to their management of local enterprises (e.g. privatization constituents is important because much of the and/or regulation in areas such as water supply and justification for public sector decentralization is based sanitation, transport, solid waste and housing); on the premise that many areas of infrastructure and budgeting, accounting and audits; maintenance services are provided more efficiently at the local programming and implementation; investment level since beneficiaries can better express their planning and evaluation; and procurement practices. demand for these services, control costs and hold local authorities accountable for their actions. Because decentralization in these countries comes after decades of tight, central control, the pace Decentralization of the public sector and scope of the decentralization process are issues requires fundamental reforms in the expenditure and of concem for the countries and for the Bank, and all financing responsibilities of local govemments in recognize that there is no- broadly recognized "road Poland and Romania. Fiscal chaos could ensue if map" for public sector decentralization. local revenue capacity is not enhanced and intergovernmental fiscal transfers are not controlled. Therefore, the Bank's strategy for A collapse of local infrastructure and services is assistance to the decentralization process is broad and likely if local expenditure assignment is not matched country-specific, but the short-term strategy is with revenue authority and local institutional evolving in four key areas: (a) policy dialogue and capacity. Local govemment reforms must include, possible inclusion of local government strengthening therefore, fiscal reforms at the national and local measures as part of the program to be supported by levels and local government institutional adjustment lending; (b) country and regional sector strengthening. These reforms also will be crucial to work on local govemment reform (e.g. regional work stimulating increased private sector productivity, not in FY91 and local government reform in Poland for only through improved delivery of public FY92); (c) targeting technical assistance on local infrastructure and services, and a prudent regulatory govemment reform (e.g. local govemment framework, but also because local governments will component of Infrastructure Technical Assistance be key to implementing an effective policy of Loan to Romania); and (d) highly selective project property rights through legal cadastre that provide support thomugh lending operations in areas critical to security for the transfer of property. overall adjustment and reform (e.g. proposed housing project loan to Poland). need for a more comprehensive strategy, with a project helped to establish the institutional greater attention to mechanisms such as framework for the creation of municipalities. hearings or surveys, which allow local In this instance, local elections followed, preferences to be ascertained. In Mauritania, providing the public with one accountability 33 Annex I mechanism. In Indonesia, an upcoming 21. There are invariably numerous barriers project provides assistance for (i) to exit and voice. Legal and policy-induced strengthening the institutional and human barriers are more easily dealt with; natural resource capabilities of local governments by barriers, such as spatial barriers (e.g. an increasing the efficiency and effectiveness of isolated village can afford only one school) are previously fragmented training programs, and more difficult to remove. Services that the (ii) strengthening the institutions and poor (weak voice) require and for which coordinating capacities of local government alternative sources of supply are difficult to and administration. Other initiatives could find (low exit) will be the most difficult to focus on strengthening the oversight function deal with. of national government. Venezuela has successfully used an executive council 22. Exit mechanisms: There are several (COPRE) to marshal ideas, try out policies possible exit mechanisms, notably and legislation, and develop guidelines and deregulation, contracting out of services to administrative models. Future Bank efforts multiple private providers, public-private, and such as the Africa Municipal Development public-public competition. The key element is Program could build on these experiences. contestability: when incumbents are made to bid for contracts along with outside Micro-level Accountability competitors, they will be more careful about their performance and their terms. Similarly, 20. Micro-level accountability can when regulations favor new entrants, the reinforce macro-level accountability when: (i) knowledge of potential entry can mitigate there is competition, or scope for the public to monopolistic behavior on the part of "exit" when dissatisfied with a service. This incumbents (Baumol and Lee, 1991). New can have a salutary effect on the agency technologies can be used, where cost effective, concerned, through a reduction in its revenues to broaden choice and access (e.g. mobile and a related threat to the careers or pay of its courts, mobile schools and health clinics or the staff; (ii) there is participation, so that the use of VCRs or television for education). public can influence the quality or volume of a service through some form of articulation of 23. Voice mechanisms: Dissemination of preferences or demand. If such "voice" makes information about services can aid the public the public agency more responsive, in demanding greater accountability from accountability is enhanced.' In the National service providers. Periodic evaluation of Irrigation Administration in the Philippines, services can exert pressure. For example, a the exercise of voice resulted in a greatly poll of beneficiaries' views on the service or improved irrigation system (Box 4). Often the gathering of data from both beneficiaries however, competitive provision is more and service providers can sometimes be an efficient except where national monopolies or effective alternative to elaborate participation market failure are predominant -- and it is arrangements. Complaints procedures and undesirable to regard participation mechanisms institutional mechanisms such as ombudsman as a substitute for (rather than an adjunct to) are ways of providing voice when there is no the availability of alternative providers. In need or incentive for collective action. any case, there are inherent problems (free "Hotlines" can be established to help prod riding, elite dominance, resource diversion) in response to unsatisfactory services. These collective action: the costs and benefits of mechanisms are in place in some countries, "voice" options need to be evaluated case by and their effectiveness varies widely: in case (Olson, 1965; 1982). particular, elites tend to make the most use of 34 Managing Development: The Governance Dimension BOX 4 The Philippine Communal Irrigation Program In May 1982, the World Bank approved a 295 worked on communal projects and 106 on US$72 million loan to the Philippines for a national projects. The gradual approach to expanding communal irrigation program that would involve the the program allowed the community organizers to participation of farmer beneficiaries in all phases of accumulate learning. Organizers who worked on the project planning, design, and construction of the initial projects became the trainers and supervisors system. The project would involve construction or for later arrivals. rehabilitation of 144 communal irrigation projects covering about 33,500 hectares in 35 provinces of 11 Evaluations in 1989 concluded that: regions. After completion of a system, the farmers participation produced consistently positive results. would assume full control of its operation and The canals and structures were viewed by the maintenance. farmers as more functional and the system was more productive, with greater increases in rice yields and The project was remarkable in two ways: in irrigated area in the dry season. The irrigation first, it was one of the most participatory projects associations were more likely to use water ever to involve the Bank. Second, the initiative for distribution methods that assured greater equity of the participatory approach came from a government water access to the members and were more likely to agency, the National Irrigation Administration (NIA), use sound financial management practices. They which had been developing and testing the contributed more to construction costs at the time of participatory approach for five years. construction and subsequently paid a greater percentage of their loans due. The costs of achieving Before the participatory approach was the wide range of benefits demonstrated for the introduced, nearly all of NIA's professional field participatory projects was only 3% of the total cost staff in charge of communal projects were trained of construction." exclusively in technical subjects such as construction, design, and survey. The participatory approach, This program, widely studied around the however, required the addition of staff oriented world as a model of the possibilities of increasing toward people and trained in building the problem- effectiveness and sustainability, is still under way. A solving capacities of local people. Consequently, new Bank loan in 1988 for the operation and NIA hired community organizers who could work maintenance of the national system (which is distinct with the farmers to develop irrigation associations. from the communal system) provided funds for community organizers and farner training. Work NIA hired six community organizers for its has begun on a follow-up loan for the communal first participatory project in 1976. By early 1983, program. the number had expanded to 401. Of that number, these services. Consequently, they are most participation of users in decision making is useful to the poor when the service is "non- difficult or inappropriate, a consultation excludable," like drinking water, roads, or process can be instituted through public public facilities. hearing, advisory panels, etc. Legal action by consumer action groups is also a possibility, 24. Participation of public representatives though not common in developing countries. in decision-making or regulatory bodies is one way of enhancing "voice." Users' representatives, for example, can be appointed to the board of directors of these organizations or hold equity shares of utilities. Where direct 35 Annex I Governments and NGOs from governments who must approve direct funding of NGOs (Fowler, 1991). The 25. Some developing countries have existing literature (mostly sponsored by witnessed a mushrooming of private voluntary bilateral donors) shows that NGOs tend to be organizations (e.g. India, the Philippines, effective at reaching low-income groups, Bangladesh, Kenya, Zimbabwe, Senegal, especially in remote areas, and at working in Colombia, Mexico, and Chile to name a few), a relatively participatory way. They tend to while some other countries clearly have not be weak in planning and administration. (e.g. C.A.R. or Malaysia) and depend much NGOs' most important contribution may not more heavily on governmental organizations be service delivery but a pilot role for social and initiatives. Various factors contribute to initiatives urging and developing new the emergence of a strong voluntary sector, approaches which are sometimes replicated on among them culture, level of development, a larger scale. There can be, as a result, and the stimulus provided by the influx of synergies between governments and NGOs; external NGOs after a natural disaster. A governments learn more about the needs of powerful factor clearly is government hostility widely dispersed publics while NGOs acquire or encouragement. more effective management skills. The rapidly changing relationship between the State 26. Government policies determine the and NGOs needs further research and enabling environment for NGOs and the roles reflection. that they assume. Governments determine in the first instance through rights such as The Bank's Role freedom of association, or of speech whether in Promoting Exit and Voice NGOs can function effectively. Regulatory policies -- and fiscal policy -- also affect the 28. The Bank is active in promoting environment within which NGOs operate. deregulation and improving the working of Precisely because NGOs may be a channel to markets in structural adjustment loans, in the poor, or may be advocates on behalf of the parastatal reforms and in much of its sector poor, NGOs can be used by governments and lending. The Bank has, in recent years, also donors to reach beneficiaries that are worked to expand participation and the otherwise difficult to involve in the flow of involvement of NGOs in Bank-financed project benefits. They can also be called upon projects. In FY89 and FY90, NGOs were to assume roles in the provision of benefits or significantly involved in 50 of the projects the in communicating between different Board approved. In some sectors, most constituencies. But it is also the case that notably agriculture and population, NGOs are some governments are suspicious of NGOs contributing significantly to effective project precisely because of their advocacy on behalf implementation. NGO criticism, although of the poor. There are, thus, pressures to sometime unduly harsh, has nevertheless coopt NGOs and make them extensions of the contributed to the redesign or improved state. implementation of a number of Bank-financed projects. 27. Direct donor funding can be an important means of supporting NGO activities. 29. Voice can also be enhanced through But it carries with it a number of attendant popular participation in the design and risks including shifting NGO accountability implementation of Bank-financed projects. from their natural constituents to donors, and Bank experience suggests that participation can making them vulnerable to subtle pressures be important to project success and 36 Managing Development: The Governance Dimension BOX S Popular Participation and the Bank "We affirm ... that the economic crisis cannot be resolved ... without the full and effective contribution, creativity and popular enthusiasm of the vast majority of the people." ARUSH4, 1990 Popular participation is the process by which But popular participation is also valuable for people, especially disadvantaged people, influence bigger projects. The Bank's experience with decisions which affect them. The term "popular" environme issues and adjustment loans indicates that refers not only to the absolute poor, but also to a public consultation and information sharing can broader range of people who are disadvantaged in improve the design and build public support for large- terms of wealth, education, ethnicity, or gender. scale investments and policy decisions. This approach "Participation" means influence on development is working, for instance, in Mexico's Hydroelectric decisions, not simply involvement in the project, India's Upper Krishna Dam project, and implementation or benefits of a development activity, Ghana's Private Investment and Sustained Development although those types of involvement are important and Promotion Credit. are often encouraged by opportunities for influence. Operations and PRE are pursuing a modest The World Bank has learned from its program of action and learning, supported by SIDA experience that popular participation is important for trust-fund resources, designed to strengthen the Bank's the success of projects economically, environmentally, support for popular participation where this would and socially. The most important lesson has been that contribute to the development effectiveness of Bank- popular participation is a question of efficiency, as well related operations. Learning is being stressed because as being desirable in its own right. In one study, the there are relatively few large-scale participatory Bank evaluated 25 projects five to ten years after development projects in the developing world. It is completion. Strong beneficiary organizations (an important to learn in what situations participation is instrument of facilitating participation) proved to be a worth the effort, and, in those cases, how the Bank and key factor in determining project sustainability (World borrowing governments can effectively promote Bank, 1985). Another study of 68 Bank-financed participation more widely. To date, Bank-supported projects found that the economic rate of return was participatory projects have been the exception rather twice as high for projects which had been sensitive to than the rule, sometimes stemming from the personal local social and cultural realities (Kottak, 1985). commitment of individual task managers. The Bank's experience with participatory In most situations, the constraints on popular projects is limited, but growing. Participatory participation are extemal to the Bank (the intrinsic approaches have most often been adopted in projects difficulties of engaging low-income people in project designed to help particular communities -- agriculture, decisions, for example, and reluctance on the part of especially irrigation, forestry, and livestock; urban some govemrnments). But improvements in income and development and rural water supply; population, education, together with increased interest among health, and nutrition. Social investment funds are a borrowing member governments, are relaxing extemal promising way for govemments to support community- constraints in some situations. While grappling with initiated micro-projects. A recent review reveals that the problems of making govemment implementing in virtually every participatory project the Bank has agencies more people-centered, the learning process is financed, participation has contributed to project focussing especially on ways the Bank's own effectiveness (World Bank, 1990b). Individuals, operational practices could be more supportive of households, grups, and communities are more likely participatory approaches. to have a stake in, contribute to, and maintain projects which respond to their needs, knowledge, and initiative. 37 Annex I sustainability. It is especially useful for B. THE LEGAL FRAMEWORK FOR activities focussed on particular communities DEVELOPMENT and dependent on their active cooperation, but it is also relevant to large scale infrastructure projects. Participatory approaches in Bank "The Rule of Law is not a projects have been tested successfully in Western idea, nor is it linked sectors (notably, irrigation, forestry, livestock up with any economic or and agricultural credit, urban development and social system ... As soon as rural water supply, health and nutrition, you accept that man is environment and social investment funds). governed by law, and not by The Bank has recently embarked on an effort whims of men, it is the Rule to learn better how to foster popular of Law."2 participation in Bank-supported activities (Box 5). 32. The literature on the rule of law is voluminous and the concept lends itself to 30. Attention to "exit" and "voice" options endless discussions at a jurisprudential level at the design stage of relevant Bank-financed with limited practical relevance. The service delivery projects will complement the emphasis here is on a pragmatic view of the strengthening of internal control systems. The rule of law in the context of economic use of such mechanisms, however, will cause development and Bank operations. accountability to improve only when this leads to a change in the behavior of the service 33. The General Counsel has defined the provider -- its efficiency, access, and quality rule of law as "a system based on objective of service, not just its compliance with internal rules which are actually applied and on rules. This must be reinforced with incentives functioning institutions which ensure the that reward responsiveness to users and the appropriate application of such rules" (Shihata, wider public. 1991: 42-43). There is empirical evidence that investment is adversely affected by 31. Accountability at the micro-level will, uncertainty. Investment will not take place in turn, be sustained only when the and will not succeed without a system which government and society at large are concerned provides a minimum of stability and and wish to improve it. Comparative predictability. information on how different countries perform in respect of key public services can 34. Stability and predictability create a be a powerful tool to generate national and climate in which business risk may be international interest in this area. Selected rationally assessed and the cost of transactions performance indicators based on good lowered. In turn, some elements of the rule of professional judgment can be assembled on law are a necessary condition for stability and these services from as many countries as predictability. It is primarily this connection possible for wide dissemination (including the of the rule of law with the level of investment WDR) (Box 6). It will provide the data for and the more efficient use of resources that governments, scholars, media and the public at explains its importance as a factor in economic large to see where they stand in respect to the development. From the Bank's point of view, level and quality of their services. the rule of law is not an end in itself. It is only to the extent that it establishes some of the pre-conditions for economic development that it is legitimate to bring it within the 38 Managing Development: The Governance Dimension BOX 6 Improving Accountability and the Environment The deteriorating quality of air, water and framework for govemment service and natural land resources in many developing countries is linked resource decisions based on the level of services they to problems of accountability and capacity. provide to users. SLIC indicators are currently being Govemment decision-makers in charge of natural formulated in a number of different Urban resource management often contribute to Development projects in Indonesia. environmental deterioration through poor management decisions. Poor decisions are a function Service indicators for water resources can both of inadequate incentives, and of an inability to be related to the specific uses described above for project the actual effects of well-meant decisions or water resources. Indicator sets for each purpose to evaluate altemative uses of scarce govemment would be specified by aggregating relevant measures. funds. Service levels for industrial or agricultural water supply users would be based on physical measures; Environmental resource management is for household water users or recreational users, further complicated by the multi-sectoral nature of service levels might be based on total health risk; for many decisions. Water resources, for example, are ecological habitat, service levels could be the number affected by solid waste systems, storm water of viable ecosystems exposed to risk in the river drainage, the demands of commercial, household and stretch or habitat area. recreational users, and the requirements of ecological habitats. By identifying and monitoring the specific environmental quality measures identified as Research currently underway in the Bank important by decision-makers and users, SLIC wiU addresses this problem. The "Service Level improve the effectiveness of infrastructure and Indicators for Capital" (SLIC) research sponsored by natural resource management decisions, and help the Intemational Economics Department is seeking establish operations and maintenance priorities for service level indicators for public facilities public infrastructure. In addition, by measuring (sewerage, water, etc.) and for natural resources, these indicators over time, SLIC should be able to based on measures of quantity, quality and reliability establish trends in environmental resource quality, for both users and decision-makers. Included in this improving natural resource accounting, and defining research effort is a framework for applying Service more precisely the relationship between natural Level Indicators through Benefit/Cost analysis. This resources and economic development. And as SLIC extends the usefulness of these measures into enables line managers to make better decisions, investment decisions. SLIC creates a bottom-up publicly available service level indicators can also measure of resource performance, provides an enable users to hold service providers accountable for information base which allows users and managers to the level and quality of the services they receive, view how decisions are made and the effects they both from govemment facilities, and from other have, and establishes a transparent accounting providers. purview of the Bank. The Bank's interest in a proper understanding of the historical and the rule of law is from the vantage point of cultural context. development management. As we will see below, the aspects of the rule of law are 35. From the great variety of definitions, varied and so are the views about them. Not two major aspects of the rule of law emerge. all have the same bearing on the purposes of The first is sometimes called the instrumental the Bank. Moreover, how the legal system notion of the rule of law. It concentrates on operates is highly culture specific and the the formal elements necessary for a system of Bank needs to approach work in this area with 39 Annex I law to exist without judging the content of the inherited formal rules for the communication laws or their purpose. of laws similar to those of the metropolis. Frequently, the obligation of governments to 36. The second aspect refers to the content disseminate new laws was and still is limited of the law and is linked to concepts such as to their publication in gazettes. The law is justice (e.g. the element of due process), available but the citizens have the burden of fairness (the principles of equality) and liberty acquainting themselves with the law. (civil and political rights). In the view of many, the formal aspect has to be 38. Publication of the official gazettes in complemented by substantive principles of the many countries has ceased. The Bank has rule of law to create a "fair" legal system. In assisted or is in the process of assisting several terms of the Bank's work, a "fair" legal countries to restart at least publication of the system would have to be conducive to gazette (Box 7). It is also assisting in making balanced development, e.g. a system which the law more accessible and better known facilitates growth and responds to the needs of within the government itself.3 However, in the poor. These would seem to represent many developing countries, large segments of issues the Bank is normally concerned with in the population are illiterate, the media are its project and policy lending. They are ineffective and languages are diverse. Under outside the scope of this analysis which these circumstances, there are obvious focusses on the basic "processes of the limitations as to how much the law can be formulation and application of rules," (Shihata known and understood by the average citizen 1991: 45) and analyzes each of the five and it is necessary that law be as clear and elements listed in "Issues of 'Governance'." explicit as it is technically feasible. In so doing, we incorporate the Bank experience so far, and draw conclusions for 39. To the extent that economic policies Bank operations and the relationship of the must be reflected in rules which are to be rule of law with the other elements of complied with, governments need to make governance considered in this paper. The five these rules known through all possible means elements are: (i) a set of rules known in of communication. Rules are understood here advance; (ii) rules to be actually in force; (iii) in a broad sense and include legislation, mechanisms to ensure application of the rules; courts' decisions, guidelines, etc. When land (iv) resolution of conflicts through binding is being expropriated, for instance, simple decisions of an independent judicial body; and, explanatory pamphlets outlining the rights of (v) procedures for amending rules when they those affected and explaining how they can no longer serve their purpose. exercise those rights should be made available to the population affected. Knowledge by A Set of Rules Known in Advance people of their own rights contributes to limiting the arbitrary behavior of govermnent 37. This comprises three elements: the officials and assist in creating the climate of existence of rules as a set (denoting predictability associated with the rule of law. coherence), their communication (with accuracy, clarity and effectiveness) and the 40. As regards the coherence of the rules, application of rules only known in advance when conditioning disbursements in specific (non-retroactivity of laws). Communication Bank operations on the enactment or and coherence are two elements with which modification of certain laws, it is essential for the Bank has been concerned. As regards the success of the operation that the country communication, many developing countries implements its own rules. A decree, for 40 Managing Development.- The Governance Dimension BOX 7 Communication of the Law MAURITANIA: Development Management Project printing company to ensure its regular publication. (Credit 1865 MAU) In addition, the contract provided that the backlog caused by the two-year delay in the publication of the The publication of the Mauritanian Official Gazette be gradually eliminated. Gazette was done under a contract between the Government of Mauritania and a French printing As of January 1989, the Official Gazette company located in Bordeaux. This arrangement was has been published fortnightly. Texts of a general however not effective and the Gazette was rarely nature and government decrees are published within published. Then the Government of Mauritania, with a month of their signature. The backlog of the assistance of IDA and the French Government, previously unpublished legislation is being cleared. decided to print and publish the Official Gazette domestically. To do so, a contract was awarded to The SGG is responsible for the distribution a private printer and the functioning of the of the Official Gazette within the Government and Department of the Legislation (Services of the the subscriptions and sales to public. It is expected Presidency) was improved within the framework of that, as revenues from legal notices increase, the the above-mentioned IDA Credit. The French Official Gazette will be able to fund itself. Government provided technical assistance in the preparation of the Official Gazette using the French LAO PDR Official Gazette as a model. In 1975 the National Congress of the The Official Gazette which had not been People's Representative in the Lao People's Republic published for over two years, has now been abolished the former constitution and all existing laws published in French and Arabic on a monthly basis and regulations. In 1989 the government endorsed for the last two and a half years. the establishment of a new economic mechanism, separating the state's administrative and regulatory GUINEA: Second Economic Management Support function from production activities and increasing the Project (Credit 1963 GUI) role of the private sector. Under a component of a UNDP-funded project supporting the New Economic The Guinean Official Gazette was Mechanism, the Bank will assist the government to experiencing delays of up to two years in the printing prepare and implement key economic and financial of its issues. In order to correct this situation, the legislation, to train lawyers in business law and to Secretariat General du Gouvernement (SGG) establish a center of economic law. As part of such obtained, as part of this project, US$80,000 from activities the project will make a proposal to the USAID to finance printing of the Official Gazette for government to establish an official gazette to publish two years, and signed a contract with a private and promulgate new laws and regulations. instance, should not derogate from legislation. picture together with any expertise from There should be no contradictory statutes. abroad as may be needed. There are, for instance, countries whose constitution forbids private ownership of the Rules to be Actually in Force means of production. In the context of private sector development operations, the Bank needs 41. It is not enough for a law to be on the to ensure that the operation is based on a books: it has to be applied, it has to be in sound legal premise (Box 8). In this respect, force in reality and not only in the formal it would be advisable that, whenever possible, sense, and most important, it has to be local legal expertise be brought into the complied with. When a law is left in 41 Annex I BOX 8 Legal Inconsistencies in Eastern Europe and Africa The centralized systems of state planned law on Small Privatization was introduced effective economies of Eastern European countries face a December 1, 1990, while a law on Privatization is number of legal problems in their efforts toward currently under consideration. economic reform and the development of market economies. Lately, these countries have been Another example which ilUustrates the effects introducing reform elements for private sector of inconsistencies and contradictions in a legal system development. However, contradictions and is the following: the socialist economic ystem has been inconsistencies are often encountered. For example, protected by the rules of constitutional law, labor law, several countries have started privatization efforts. In administrative law, as well as by the rules of criminal this process some have already amended their law. In the Soviet Union, "undesirable" economic constitution to make provision for private property behavior has been controlled through criminal or rights. Others have not yet changed their constitution administrative sanctions for behavior which violates to this effect, but, nevertheless, proceed with the accepted socialist norms and undermines the economic privatization effort. In the context of Bank operations system. There are several articles in the criminal and an effort should be made to address these issues which administrative codes of most republics which can hamper reform. Following are some examples. criminalize behavior that in a market system is rational and economically desirable. It seems that many of In Romania, there has been considerable these articles wiUl be eliminated in the next major legislative activity. With regard to private sector revision of the codes. In the meantime, however, the development, the law on Restructuring State Economic existing criminal codes continue to stand and to hamper Units as Autonomous Units and Commercial the economic reform effort. Prosecution under most of Companies was passed in September 1990; a draft law these articles continues, with thousands of convictions on Privatization (currently under consideration) wil per year. Even if it is not feasible to amend the codes govem this issue. Other laws under preparation will immediately, steps need to be taken to limit the effect cover bankruptcy, commercial and company law, of these provisions on those who wish to engage in foreign investment and smaUl and medium enterprise new forms of legitimate business. development (to supersede Law No. 54 defining and permitting smal enterprises, which was passed in early Although the Eastem European countries are 1990). These laws are reducing the role of the the most striking example, similar examples can be govemrnment in productive activities while retaining its found elsewhere. For instance, Guinea-Bissau is monitoring functions, introducing private ownership presently amending its Constitution, approved May 16, and encouraging foreign investment through joint 1984, as part of a general political transition from a ventures. The legal framework is, however, operating socialist state to a more "capitalist" state. An under the severe constraint of the clearly defined impediment to developing the private sector is Article property rights. The Parliament has been given two 12 of the Constitution, which provides for state years from the time of its inception to develop the ownership of all land (leases are gmnted to private relevant provisions. individuals), minerals, banks, insurance companies, etc. Article 13 also provides for state control of By contrast, in Czechoslovakia, amendments foreign trade and exchange transactions. One of the were introduced to the Constitution effective May 1, objectives of the legal technical assistance provided to 1990, recognizing aU forms of ownership rights, and Guinea under the Second Economic Management providing that they (whether state, cooperative or Support Project is to coordinate the various donor private) enjoy the same level of protection and that no financed pieces of legislation so that they dovetail as a form of property ownership has a privileged status. A whole. abeyance or is not respected, the answer does analysis of why the old law does not work will not necessarily need to be a new law. An avoid placing yet another law on the books. 42 Managing Development: The Governance Dimension. 42. The reasons why laws are ineffective costs of economic transactions. In advising vary greatly. In many developing countries, governments to adopt new laws, the Bank the fact that many laws are not applied is often should be fully aware of implementation related to their inadequacy to the local constraints. As regards enforcement of the situation. They had been transplanted from laws, some aspects of it have a clear bearing other countries and not adjusted to the local on economic development and have been the situation. Alternatively, they were not subject of Bank operations; for instance, updated to current developments in the improvement of tax collection, and changes in countries concerned. For a law to be security laws to permit financial institutions to effective, one has to consider many elements foreclose on debt and mortgages (Box 9). leading to its observance. Such diverse factors as custom, geography, technology, and history Mechanisms to Ensure Application of the play a role in inducing obedience to laws. Rules Because of these factors, the same law and its sanctions in different times and places within 46. Mechanisms must exist to ensure the different physical and institutional proper application of the rules and to allow for environments will not induce the same departure from them as needed according to behavior. Furthermore, societies evolve and established procedures. The concept of the laws may become obsolete. There is a certain rule of law requires furthermore that all inertia in legal systems and they simply may govermment officials act within the ambit of not have been updated to take into account the law. State power ought to be exercised social, business or technological changes. under the authority of law. The proper application of the rules by government 43. Another obvious reason why laws fail officials is the essential element of establishing to be applied is the absence of competent legality and -- in conjunction with the idea of administrators of the legal system. The law is justice -- legitimacy. To act within the law not only a set of rules but it encompasses means that the executive branch of the procedures and institutions for implementing government bases its actions on the statutory these rules. To the extent these are lacking, power from which government officials derive laws most likely will remain on paper. their authority and that the exercise of such authority is within the boundaries set by the 44. Donors must be sensitive to the law. variables which affect the success of the transfer of legal institutions and the application 47. Of course, the legislation authorizing of the laws. They must also be aware of the government actions cannot prescribe for all limitations of sanctions to induce behavioral circumstances precise and clearly-defined change. Punishment best enforces already standards. Thus, while the proper application institutionalized law, nudging the occasional of the rules should ensure predictability, it deviant into conformity. In many instances, it must always leave some room for flexibility. is more appropriate to use incentives and Further, market competition functions as a roundabout measures to achieve results, limit to public discretionary power. (Citizens normally, at lower costs than punishment and can choose private provision over public to the relief of over-burdened courts. provision services.) Yet, there are complex choices on how to delegate discretionary 45. As regards legal institutions, the Bank power to the bureaucracy. Traditionally, the may assist in improving the efficiency or rule of law called for narrow grants of competence of judicial systems to reduce the discretion. But the complexity and variety of 43 Annex I BOX 9 Enforcement In Guinea under the Private Sector institutions, who were forced in each case to go to Promotion Credit, the deficient functioning of the court to get a judgment before they could move judicial system and the legal void on bank sureties against the property. This protection for debtors has been identified as major constraints for banking stemmed from historical concerns about unscrupulous activity in the country. Banks are unable "to enforce money lenders but did not match the needs of a their rights as creditors through foreclosures or other modern economy. On the advice of the Association court-approved actions, due in particular to debtor- the law was changed to permit direct execution. The judge collusion and rampant corruption" (GUI result is a law which establishes a better balance Report; 5207-55). This operation is a modest start to between the rights and obligations of debtors and address these problems and it will be followed by creditors. training of the judiciary and legal professions in banking and commercial matters and by In the Philippines as part of the Financial improvements in material working conditions. Sector Adjustment Loan, the Bank not only advised that the lengthy holding period for repossession by In Sri Lanka, the Association has been debtors of pledged property be shortened to a more working in two operations in the financial sector to reasonable period, but also that the 1905 bankruptcy reform the laws allowing financial institutions to law be revised to make it less punitive on debtors and foreclose on collateral pledged under loans. Sri more rehabilitative, in the interests of both creditors Lankan law had prevented direct execution by and debtors. issues in modem times have led to increasing mechanisms to ensure the proper application delegation of authority to the executive branch of laws, and rules that regulate how to depart based on broad standards, discretion secures from them. Several different forms of flexibility and responsiveness to different checking administrative action and avoiding situations which could not have been predicted the abuse of discretionary power have been by the legislatures. (For example, adopted in various legal systems ranging from environmental legislation often must accord review by independent civil and criminal discretion to local public officials.) Discretion courts to specialized administrative courts and represents a counterweight to legal formalism. ombudsmen. 48. Discretionary power is not absolute 50. In addressing the issue of functioning power. Discretion in law is always limited. and effective institutions, the Bank has assisted The most basic guidelines for the exercise of borrowers to improve their civil service and to discretion require that any exercise of powers establish well-defined administrative be based on reasons, that these reasons be structures. Support of civil service reform has applied consistently, fairly, and impartially, concentrated on better training for civil and that they be intelligibly related to a servants, pay structures and the need to ensure framework of purposes, policies, principles that the financial remuneration of civil servants and rules. is adequate. The Bank is advising governments on how to improve their 49. As with all exercise of power, there is administrative decision-making processes and a need to ensure the respect for these to establish administrative structures which limitations to secure the correct exercise of clearly assign authority and responsibility. discretion. Thus, there is a need for 44 Managing Development: The Governance Dimension 51. At times, the proper application of the time. Often, the courts lack proper facilities rules is hampered by an overabundance of -- and there is an urgent need for improving the in some instances -- contradictory or obsolete training of the persons involved in the rules and regulations which overwhelm the administration of justice. Despite all this, bureaucracy. The Bank is assisting countries arbitration proceedings outside the court to review, update and simplify their legal system are not well-developed. systems.4 Such reforms of legal systems will improve the administrative capacity of the 54. There are several Bank operations government to regulate the economy and to under preparation that will assist member reach administrative decisions based on a clear governments in the training of judges in set of new and relevant laws (Box 10). economic and business law and may go as far as recommending certain division of labor in Conflict Resolution the court system so that commercial matters would be handled by specialized courts. 52. Conflicts in the application of the rules (Box 11). can be resolved through binding decisions of an independent judicial or arbitral body. The 55. In assisting to make the court system existence of an independent judicial or arbitral more efficient and competent the donors may body which can render binding decisions with wish to look beyond the basics of training and respect to conflicts in the application of the of providing adequate physical facilities. For rules is an essential element of the rule of law instance, many developed countries also have concept. The law loses its conflict-resolving in the past encountered the problem of a and confidence-inspiring function if there is no judiciary too unwieldy, expensive and slow to independent and credible judicial system which handle disputes. The answer has not assures that private contractual arrangements necessarily been to improve on the courts but are respected and that the law is applied to expand extra-judicial means of settlement by uniformly by the executive. With regard to permitting commercial arbitration.5 Another the first aspect, it is obvious that confidence in alternative is to search what caused the growth the enforceability of agreements and of disputes by updating or clarifying archaic or commitments is instrumental to the proper uncertain legal situations. The business world functioning of an economy and the conduct of has also responded by rationalizing business private economic activities. If there are practices through the development of standard unreasonable delays and high costs in forms and patterns of doing business. The enforcing laws and agreements between private courts themselves may help by mass handling parties, the efficient conduct of economic of certain commercial matters, e.g. activities is hampered. With regard to the garnishment and collection of debt. These are second aspect -- i.e. the check on government areas within the mandate of the Bank in as actions -- it is also evident that a strong much as functioning rules and institutions, judiciary can provide an effective shield including an effective dispute-settlement against the concentration of arbitrarily mechanism, are essential for economic exercised executive power. development. 53. The state of the judiciary in a number Amendment Procedures of developing countries is precarious. Even in those countries where there is a nominally 56. There are known procedures for independent judiciary, the courts are usually amending the rules when they no longer serve overworked and dispute resolution takes a long their purpose: As noted above, the rule of 45 Annex I BOX 10 Reform of the Regulatory Framework GHANA: Financial Sector Adjustment Credit losses. Monetary penalties for violations of laws and (Credit 1991 GH) regulations are strengthened and will be periodically revised to serve as a deterrent to illegal and Banking activities in Ghana have been imprudent acts. govemed by laws and regulations enacted in the 1960s and early 1970s with a number of amendments POLAND: Structural Adjustment Loan (Loan 3247 and decrees issued on an ad hoc basis since the POL) enactment of the original legislation. Several serious omissions in this body of legislation, together with In Poland, the Government's Economic weak bank supervision, led to the concentration of Transformation Program (ETP), pursues structural risk in the portfolios of banks, inadequate capital and reform towards the establishment of a market reserves, inflated profits and unrecognized loan economy. The SAL will support reform initiatives losses. mainly in the areas of: (i) enterprise restructuring, privatization, private sector development, with In connection with the IDA-financed emphasis on appropriate legislation to define the Financial Sector Adjustment Credit, the Government 'rules of the game" (including privatization, of Ghana established a committee of legal experts to demonopolization and competition), the establishment review the existing legislation, draft the changes of an adequate institutional framework for enterprise necessary to improve the regulatory framework and restructuring; (ii) financial sector reform, with introduce prudent standards to ensure the viability of emphasis on improved banking regulation and the banking system. Risk exposure limits as a supervision, introduction of adequate accounting and percentage of capital have been set on a bank's auditing standards, etc. and (iii) social safety. exposure to a single customer or related group. A minimum capital-adequacy ratio has been established, SRI LANKA: Economic Restructuring Credit taking into account the quality of the bank's assets as (Credit 2128 CE) well as its off-balance-sheet risks. Banking supervisors will have the ability to mandate even a The Economic Restructuring Credit (ERC) higher capital-adequacy ratio, when, in their opinion, supports the Government's efforts aimed at conditions warrant. Banks which do not meet the stabilizing the economy and implementing structural minimum guidelines are not allowed to pay reforms. In addition to addressing the country's dividends. New regulations specifying the format serious internal and external imbalances, the size of and content of audit reports and the minimum scope the public sector, its claim on resources and the of audit reviews have been introduced together with efficiency with which it uses its resources, the ERC uniform accounting and auditing standards and also focuses on the development of the private sector prudent reporting requirements. The accounting through improvements in the existing regulatory standards include guidelines for loan portfolio review framework and incentive system and through transfer and classification, the treatment of interest on non- to the private sector of activities and assets now performing loans, and provisioning for potential loan being managed by the public sector. law is instrumental in creating a climate of hoc decisions whereby the creation, predictability and stability -- as the antithesis amendment or invalidation of laws is to governmental arbitrariness. Rules that are undertaken without known and established constantly changing cannot fulfill this function. procedures. Laws created this way will be Neither can rules that are arbitrarily repealed, perceived by those affected as not being amended or waived. The perception of enacted through "the right process." arbitrariness and subjectivity is created by ad Furthermore, it will lead to a general lack of 46 Managing Development: The Governance Dimension Box 11 Improving the Judiciary BANGLADESH: Financial Sector Adjustment Courts Act in 1990 which established special Credit (Credit 2152 BD) commercial courts in the major economic centers of Bangladesh, whereby financial institutions could The court system in Bangladesh took an bring actions against defaulting borrowers and the average of 10-15 years to dispose of suits brought by loans could be adjudicated. Progress, which to date, financial institutions against defaulting borrowers. has been highly favorable, is being monitored under The result was that transaction costs were extremely the Financial Sector Adjustment Credit and involves high and collection rates were very low. With the the establishment of courts, appointment of judges assistance of the Association and the International and disposal of cases. Monetary Fund, Bangladewh enacted a Financial Loan obedience to the law beyond the particular 59. The foregoing analysis of the rules, and affect the credibility of the whole procedural and institutional elements of the legal system. rule of law has focussed on their contribution to establishing a "good order" understood as 57. The requirement of procedures in "a system in place, based on abstract rules place for amending or repealing laws is limited which are actually applied and on functioning to the existence of such procedures. It is the institutions which ensure the proper prerogative of the country concerned -- and application of such rules" (Shihata, 1991: 43). outside the mandate of the Bank as stated The existence of such a system is needed for earlier -- to decide how the legislative process economic development; in particular, the is organized, including whether a separate economic reform policies introduced by many legislative body should exist. What matters is of the Bank's members and supported through that the public is aware of the process through Bank operations cannot be implemented which laws can be amended, repealed or effectively if these reform measures are not waived. translated into workable rules and applied by functioning institutions in a proper and 58. In the context of attempts by appropriate manner. Thus, the elements of the borrowers to introduce legal reforms, the Bank rule of law discussed above address these has stressed the importance of having processes of the formulation and application of appropriate procedural rules in place for rules and constitute the procedural framework enacting and/or repealing laws. In order to and institutional system which -- if adhered to improve the technical capabilities of the by the governments concerned -- lead to countries concerned in drafting procedural stability and predictability and elicit rules and regulations, the assistance financed compliance with the rules. by the Bank has supported governments' legal offices, i.e. Attorney General, Ministry of 60. The rule of law and the various other Justice, etc., and consisted of training and elements of sound development management technical assistance (Laos, Guinea and, under are closely interrelated. By simplifying preparation, Angola and Mongolia). existing rules and limiting discretion in certain decisions the Bank has assisted in reducing the opportunities for corruption. The publicity 47 Annex I that the Bank has insisted on in the in the analysis, articulation and acceptance of administration of certain processes such as policy choices. procurement has increased transparency in decision-making. Also, the development of Information, Transparency and Economic communication systems for making the laws Efficiency known helps in making governmental bureaucracies more accountable. 63. Economic efficiency requires that information about government policies and actions be available, that major processes of C. INFORMATION AND economic decision-making (for example the TRANSPARENCY budget) are reasonably transparent, and that there is some opportunity for public comment or influence in the process of economic policy- "Information is now a crucial making. This last aspect is of course greatly determinant of the pace of influenced by a country's government and social and economic change." traditions about political participation and Report of the public debate -- questions beyond the Bank's South Commission (1990. 196) purview. With that limitation in mind, there are three important reasons for greater 61. A competitive market economy transparency in policy making as it impacts requires that economic actors have access to upon economic efficiency. relevant, timely, and reliable information. The less available or credible the information 64. First, where government economic the greater the uncertainty and risk, and decision-making is unexamined and therefore the cost, of committing capital or uncontestable the dangers of corruption and labor. In all countries government is a major diversion of public resources (including source of information, and sets many of the external assistance) increase. Transparency is requirements for other providers as well. not a sufficient condition to control corruption, Information about the economy, about but it is in most circumstances a necessary particular market conditions, and about one, as will be discussed below. government policies and intentions is all central to private sector calculations, and is 65. Second, closed decision-making either provided by government or greatly increases the risk of government error -- and influenced by what government requires other of negative reactions. Government's impact entities to make publicly available. on the private sector environment, through an array of influences from monetary and 62. Governments have legitimate reasons exchange rate policy through taxation and to withhold some types of information -- on expenditure policies to public procurement, is aspects of state security, for example, or pervasive and profound. Where decisions in where premature disclosure could invite these areas are taken in relative isolation from behavior undermining the policy (e.g. changes private-sector reactions, the likelihood of in exchange rates). Aside from these special costly mistakes increases -- fiscal policy is a cases, three areas are discussed where common example. In other instances, improved information and greater transparency governments may be surprised by angry public are beneficial: economic efficiency, reactions to the economic consequences of transparency as a means of preventing secretly made decisions -- for example, over corruption, and the importance of information pricing and subsidies -- when a more open 48 Managing Development: The Governance Dimension process of public education and debate might issued guidelines for openness which represent have both improved policy design and eased remarkable progress for a government that public acceptance. leaned towards secrecy not long ago (Box 12). 66. Third, the efficiency and effectiveness of economic actors, and the competitiveness of 68. The Bank is also active in several markets, requires broadly based access to specific areas where transparency is an relevant information. A common problem important issue: in public expenditure hindering the development of capital markets, decision-making (see PSM paper); in assisting for example, and of equity-based financing in governments to improve public procurement; particular, is the lack of clear disclosure rules and, increasingly, in the assessment of based on audited accounts of private and environmental impact. Public disclosure of public enterprises. Lack of transparency in environmental assessments is one instrument financial markets often leads to arbitrary and that the Bank is encouraging governments to capricious relations between commercial banks use as a way of ensuring greater accountability and their clients. Without proper accounts and and transparency. This is particularly critical disclosure, neither bank lending nor in ensuring that people involved in involuntary investment through the capital markets can be displacement by development projects (such as based on a firm assessment of credit the Narmada and Upper Krishna river) are worthiness. This assessment is necessary to kept fully informed of the results of such evaluate risk and adequately price the cost of assessments. Thus, under the Ecuador capital to the borrower. The capital market Municipal Development and Urban remains circumscribed to a narrow range of Infrastructure project (FY91) an attempt is firms and instruments protected by either made to ensure public review of environmental implicit governmental guarantees or by the impact studies of infrastructure projects. "reputation" of the most powerful economic groups. A lack of transparency may be Prevention of Corruption especially damaging for banking systems. It can lead to a large accumulation of non- 69. Clearly, the main weapon against performing assets which would cause bank corruption is to reduce the opportunities for it failure, except for the fact that throughout the to a minimum -- to eliminate economic developing world deposits are usually distortions and administrative controls, and explicitly or implicitly guaranteed by the state. therefore to reduce the scope for illicit Private losses are therefore socialized, as non- arbitrage and bribery, "dash," "speed money" competitive risk-taking siphons resources from and the like. Transparency in government productive uses to speculative activities. business has a vital ancillary role. The Bank's involvement in transparency is through its 67. The Bank has been primarily work on public expenditure (transparency of concerned to work with governments to ensure budgets, elimination of "caisse noires"), broad awareness and acceptance of economic through its assistance to governments in reform programs (e.g. in the context of establishing transparent procurement structural adjustment operations), and to focus procedures and conducting environmental government attention particularly on the assessments. impact of its actions on private sector confidence and the business environment. 70. Since central government ministries as Madagascar's government, on its own principals must -- and should -- delegate to a initiative, and without Bank involvement, has wide variety of agents the implementation of 49 Annex I BOX 12 Transparency in Government: The "Ten Commandments" in Madagascar The following are excerpts from an Official with power of decision. The former is free to issue Communication published in the December 18, 1990 a favorable or unfavorable opinion, but must issue of the Official Gazette of Madagascar. nonetheless pass the request on. If it believes that the dossier is incomplete, or deficient in some other FROM: The President of the Democratic Republic way, it should inform the applicant and ask him to of Madagascar put matters right; this is particularly important as TO: The Prime Minister and Head of regards our incentives for investors... Government and the Presidents of ... Institutions 2. The Administration should assist the public. The terms of annexed communication from 3. The Administration should facilitate the Prime Minister ... will serve as a rule of conduct inquiries by the public. and as general guidelines ... The Government and ... other institutions of the Republic are requested to Requests from the public sometimes relate ensure that this is given the widest possible to laws or regulations that contain all the relevant circulation and is applied in both the central and the information being sought. The Administration should local public services... therefore make leaflets, etc., available to the public.. .In brief, each agency should make available Communications to the public all the necessary information regarding My own observations and complaints the activity ... Within each agency, a public reaching my office lead me to submit the following information unit should be established... proposals with a view to establishing a proper code ... of conduct within the Administration as regards its 4. The Administration must establish and relations with the public. The principal aim is to observe set periods for handling requests. improve attitude and behavior in the Administration and to preserve trust between the Administration and Few laws or regulations stipulate that the the public. Administration must respond within a certain period. As a result, the public is at the mercy of officials and 1. The Administration must not be permitted is never certain as to when it will get a reply ... Some arbitrarily to block correspondence addressed to it. departments have made efforts to improve this ... situation by stipulating maximum periods ... This The principle must be that the authority that practice should be extended to all agencies... is addressed must forward the request to the authority (continued on next page) policy choices, there are inevitably public record is one of the mechanisms for asymmetries in who has access to quality doing so. Guidelines on public information information. Reporting and monitoring policy generally include criteria for users, systems can update the information base of rules about time lapses prior to disclosure, and principals but there are always opportunities clear rules for access. Precisely because for agents to engage in rent-seeking, or private information is scarce, and therefore valuable, appropriation of gains to be made from insider information policy needs careful attention. information. Monitoring and supervision of these agents is a perennial management 71. Few areas of government activity are concern; making most information a matter of more prone to problems of corruption than so Managing Development: The Governance Dimension BOX 12 Transparency in Government: The "Ten Commandments" in Madagascar (continued) 5. The Administration must have the courage people know who they are dealing with. The use of to question certain principles. badges could be courteous innovation.... (a) The principle that silence is equivalent to a 8. No official should have permanent tenure of refusal .. it is time to stipulate that a position requiring contact with the public. Periodic silence .. after a certain period has elapsed, rotation, even if only within the organization, is is equivalent to acceptance... strongly urged... The Head of State issued a directive on September 12, 1990 to the effect that enforcement (b) The legal principle of implicit rejection. agents should not remain in the same position for more than three years.. .This measure.. .should be It is high time the Administration extended to other officials in contact with the understood that time is money. public.... 6. The Administration must opt systematically 9. The Administration must know how to for the automaticity of decisions. punish and reward. The administration's discretionary power There are some good officials and they must be reduced to a strict minimum by the must be encouraged and rewarded ... Poor officials, on publication of clear and precise rules of the game, the other hand, should be punished and their which it must respect. Regulations and laws that promotion should be prohibited. have an impact on the public must move towards this objective, which is also stated as a The best way to assess an official that principle ... regarding the conceptual framework for works with the public is to listen to what the public the preparation of laws. thinks about him. An official, fully documented register could be provided for members of the public 7. The Administration must do away with to record their complaints or their satisfaction... anonymity. 10. The Administration must evaluate itself and The myth of the anonymous civil servant is be open to external audits. no longer appropriate in a modern administration. The names and positions of agents interacting with Self-evaluation is carried out by an internal the public should appear on nameplates on their audit unit which each agency must establish to doors or be posted on signs in their offices so that monitor its operations, verify how, and how fast, dossiers are handled and study users' complaints.... that of customs and procurement. Some Further, procurement is a critical aspect of countries have resorted to correcting the project and program implementation. mismanagement of customs by contracting out the customs service to a wholly independent 72. Procurement difficulties are private sector enterprise (Indonesia). Public symptomatic of problems of government procurement, on the other hand, is not a self- capacity, and of the inherent pressures when contained procedure which can be handled in large contracts are in play. Since 1983, the this manner -- though inspection and Bank has been systematically undertaking supervisory services can play a valuable role. country Procurement Assessment Reviews (CPAR) which review public procurement 51 Annex I laws, procedures, and institutions in borrowing 75. Several countries do not require public countries to identify any fundamental conflict bid opening, and permit bargaining even after with Bank procurement guidelines, and to bids have been opened. The Bank is decide on acceptability of local procedures for attempting, in such cases, to review the contracts which are appropriate for ICB. The rationale for existing local procurement procedures are assessed from the perspective regulations rather than simply requiring of competition, transparency, disclosure of conformance to Bank guidelines. It is selection criteria, award to lowest qualified attempting through local seminars and bidder, fair contract conditions, mechanisms discussions, to focus attention, for example, for dispute settlement, and an assessment of on the importance of procurement processes to institutional capability and efficiency in the development of local contracting capacity implementing Bank operations. and pointing to the value for a development perspective, of adopting revised national 73. With the advent of adjustment lending, systems to conform to international norms. In the CPAR has expanded to parastatal and almost all reforming Central and Eastern private sector procurement practices and their European countries, institutions were not compatibility with practices in market familiar with local or international competitive economies in developed countries. To date, bidding. However, these countries are now CPARs have been completed for 60 countries requesting and showing receptiveness to Bank with the remainder in the process of being technical assistance on procurement legislation completed; they are updated every four years. and procedures (Box 13). In 1990, the Africa region convened a conference on public 74. Where institutions are weak or procurement procedures at which African procedures inefficient, the loan includes public officials presented papers along with technical assistance components, or support to procurement experts from developed countries hi-re procurement agents. Thus, for example, on the merits of different approaches to technical assistance has been provided to improving the efficiency of public improve the institutional framework and procurement. introduce more efficient procedures in Uganda and Madagascar. In other cases, new Analysis and Dissemination Capacity procurement codes have been issued. In the Philippines, action was taken under a Debt 76. The collection and dissemination of Management Loan to streamline overall economic data has been a focus of Bank procurement rules and procedures so as to assistance and advice for a long time, and has permit greater delegation of authority to included, for example, support for statistical implementing agencies and to establish offices, technical assistance where appropriate, standards to shorten contract award and capacity building. Despite these efforts, procedures. Work initiated under this project and the importance of data collection and has been pursued under subsequent projects dissemination, however, adequate economic (the Fifth Highway project) and guidelines information has been a casualty of the acceptable to the Bank are now available for economic crisis and government stringency, local procurement of goods and consultants. especially in much of Africa. Central Banks This has facilitated an easing of regulations which once produced excellent reports on the relating to contractors thereby increasing their economy (as in Ghana) have ceased to do so, willingness once again to accept government and government statistical series in many contracts. countries have become less timely, reliable, and complete. Given the expanded and more 52 Managing Development: The Governance Dimension BOX 13 Changing Procurement Policies and Practices in Eastern Europe The countries of Eastern and Central national and local, and would ideally apply to all Europe (Albania, Bulgaria, Czechoslovakia, sectors. At the same time, training of procurement Hungary, Poland, Romania, and Yugoslavia) are personnel would need to be performed on an urgent rapidly accelerating their transition from centrally and massive basis, to implement the new planned to market-oriented economies, a process procurement practices. The delays in project involving profound changes, also in the field of implementation caused by inefficient procurement public procurement. They are increasing their practices may result in opportunity, interest, and externally supported investment project operations, in inflationary costs of considerable magnitude (10-20% cooperation with bilateral agencies and international of total project costs). financing institutions. During the past forty years, the countries have performed public procurement The World Bank has, at the invitation of through direct allocation of resources, or negotiated several of the countries, advised their senior officials contracts. They do not have a recent background in on the requirements for implementing the needed using open, competitive bidding procedures, and vary legal and policy changes, and to train involved in their abilities to applying international procurement personnel. Contacts have also been made with practices. mukilateral and bilateral agencies which have a direct interest in the issues, with the objective of their The countries lack the requisite public participating financially and technically with the Bank procurement laws and related legal systems, in country and regional projects which would address regulations and experienced procurement officers. the problems through technical assistance. Financing New and comprehensive legal systems for public of such projects could also come from Bank loans, procurement are required at all levels of government: should the countries so request. sophisticated requirements implied by the an enabling environment for growth. Bank's poverty and environment agenda, this Information must be understood, processed, is an area deserving more emphasis. China's and used effectively. Capacities need to be post-reform Statistical Yearbooks are an developed -- in the universities, in policy example of how substantial breakthroughs can research institutes, in economic committees of be made in the quality and availability of legislatures where appropriate, and in the economic information. media -- to understand information about development issues, and to contribute to 77. The capacity of NGOs and institutions broader public education in turn. The African (professional associations, trade unions, Capacity Building Initiative represents a business organizations, grass roots groups, potential instrument for strengthening the role research centers, universities and mass media) and capacities of a wide variety of non- to articulate the needs of important governmental institutions. The Bank's constituencies, analyze policy requirements External Affairs Department has also done and contribute to policy formulation is an much to improve access to economic important aspect of accountability. Building information for developing country journalists. this capacity is a central aspect of developing 53 Managing Development: The Governance Dimension ENDNOTES - Annex I 1. The concepts of "exit" and "voice" which originated in Albert Hirschman's classic work, Exit Voice and Loyaliy (Hirschman, 1970) have been adapted by Samuel Paul in his work for the PRE Working Paper No. 614 on accountability (Paul, 1990). 2. Sir Adetokunbo A. Ademola, Chief Justice of Nigeria, in his address to the Convention on the Rule of Law, organized by the International Commission of Jurists (Lagos, 1961). 3. This is the case of the legal information system included in the Social Sector Management Technical Assistance Project in Argentina (Loan 2984 AR). 4. A practical example is Ghana. The legal and regulatory framework governing private sector activities is being reviewed by the government in order to eliminate obsolete laws and revise other laws to reflect the policy change from a command economy to a free market system. This follows the changes of the regulatory framework for the financial sector which has already led to encouraging results. 5. For example, the Indonesia Report concluded that strengthening the arbitration system and arbitral bodies could improve contract enforcement and avoid some of the constraints in the judicial system. 55 Managing Development: The Governance Dimension ANNEX II TASK FORCE ON GOVERNANCE Adamolekun, Oladipupo 0. AFTPS Beckmann, David M. EXTIE Bryant, Coralie PRDPD Campbell, Tim LATIE Chaudry, Shahid A. LATPS Dia, Mamadou AFTIM Einhorn, Jessica P. FODDR Gruss, Hans Jurgen LEGAF Harris, Randolph L. P. CODOP Heyneman, Stephen Paul EMTPH Isenman, Paul PRDDR Jones-Carroll, Charlotte PBDCP Kohli, Harinder S. EMTDR Lacey, Robert Mark EDICD Lamb, Geoffrey B. PRDPD Landell-Mills, Pierre M. AFTDR Lateef, K. Sarwar * EXTIE Nankani, Gobind T. LAIIN Okonjo-Iweala, Ngozi N. OPNSV Pachter, Lisa EXTIE Paul, Samuel CECPS Pellegrini, Anthony J. EMTIN Rigo, Andres LEGAF Ritchie, Daniel ASTDR Sagasti, Francisco EXTDR Schiavo-Campo, Salvatore AF3CO Shakow, Alexander EXTDR Shirley, Mary M. CECPS Socknat, James A. ASTPH Wai, Dunstan M. AFREA Winkler, Donald R. LATPS * Task Manager Secretarial support to the Task Force was provided by Lynette Alemar (PRDPD), Sonia Benavides (EXTIE), Maria Estrella (EXTIE), Marjorie Pavia (EXTIE) and Amelito Velasco (PRDPD). 57 References Hirschman, Albert. 1970. Exit, Voice or Loyalty. Yale University Press. Haggard, Stephan. 1988. "The Politics of Industrialization in the Republic of Korea and Taiwan," in Helen Hughes (ed), Achieving Industrialization in East Asia, New York: Cambridge University Press. Hyden, Goran. 1983. 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Migdal, Joel S. 1988. Strong. Societies and Weak States: State-Society Relations and State Capabilities in the Third World. Princeton: Princeton University Press. Nelson, Joan. Economic Crisis and Policy Choice: The Politics of Adjustment. Princeton University Press, 1990. North, Douglass. 1990. Institutions, Institutional Change and Economic Performance. New York: Cambridge University Press. Olson, Mancur. 1965. The Logic of Collective Action. Cambridge University Press. Olson, Mancur. 1982. The Rise and Decline of Nations: Economic Growth, Stagflation and Social Rigidities. New Haven: Yale University Press. Organization of African Unity. 1981. African Charter on Human and People's Rights. Addis Ababa. 60 Managing Development: The Governance Dimension Paul, S. 1991. "Accountability in Public Services: Exit, Voice and Capture." The World Bank. PRE Working Paper No: 614. Polanyi, Karl. 1957. 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