37197 308 privatesector P U B L I C P O L I C Y F O R T H E NUMBER NOTE 2006 Reforming Inspections JUNE Jacqueline Coolidge Jacqueline Coolidge Countering Corruption and Waste (jcoolidge@ifc.org) is a lead investment policy Government inspections of firms are important for enforcing officer at FIAS World regulations to protect public health, safety, and the environment and Bank-IFC. to carry out economic functions such as tax collection and banking regulation. But most inspection regimes in developing countries impose excessive costs on firms while failing dismally to prevent accidents or PRESIDENCY mitigate losses from disasters. There is a strong interest in models of reform that will reduce the burden of government inspections while VICE improving standards. This Note offers solutions that do both. Firms in many countries complain about tax very burdensome procedures for licensing and inspectors who harass businesses and threaten to inspections. Obtaining the permits and inspec- DEVELOPMENT freeze their accounts, building inspectors who tions for constructing a simple warehouse takes demand compliance with meaningless regula- more than a year in Bosnia and Herzegovina, SECTOR tions and cause delays in business start-up, sani- Brazil, Cameroon, the Islamic Republic of Iran, tary inspectors who interpret requirements Nigeria, the Russian Federation, and Zim- inconsistently and favor cronies and bribers over babwe--but only two to three months in many PRIVATE their competitors, and environmental inspectors industrial countries and about four to five who extort bribes rather than enforce needed months in Jordan, Mauritius, Panama, and the controls (box 1). Baltic countries (World Bank 2005, pp. 95­97). Many governments too see a need for Why a year when two to three months will do? GROUP reform. Tragic and avoidable losses resulting from workplace fires, industrial accidents, and What are the keys to successful reform? BANK the collapse of buildings during earthquakes or Experience in reform of government inspection other disasters have led them to conclude that regimes suggests six key lessons. their inspection regimes are not living up to their mandates. Be comprehensive rather than piecemeal WORLD The World Bank's annual Doing Business Most inspections reforms achieving sustained reports have shown that businesses in many success have been broad programs covering THE developing and transition economies still face most inspectorates dealing with businesses. R E F O R M I N G I N S P E C T I O N S C O U N T E R I N G C O R R U P T I O N A N D W A S T E put into place broader reforms to ensure Box The burden of inspections accountability for achieving objective perform- 1 ance measures (such as higher revenue and Where inspections seem arbitrary or unfair, they can lower costs). A lack of political will to ensure appear particularly burdensome. In the 1990s businesses in accountability at the highest levels of the the Russian Federation sometimes faced conflicting demands Customs Administration led to backtracking as from fire inspectors, with federal inspectors requiring that early improvements (including a smaller share fire extinguishers be placed 1.45 meters from the floor and of shipments subject to full inspection) evapo- municipal inspectors demanding that they be hung at 1.35 rated over time. 2 meters. Businesses learned to keep two hooks on the wall, Contrast these results with those of inspec- switching their extinguisher from one to the other depend- ing on which inspector showed up. In 2000 an entrepre- tions reforms linked to broader programs of reg- neur in Lithuania complained that she had been heavily ulatory reform. In the Netherlands a new fined by tax inspectors for moving her cash register from approach to regulatory compliance was aimed one room to another without obtaining prior permission. at improving outcomes while simultaneously And in Azerbaijan sanitary inspectors have been known to reducing costs for both government and accept a bribe from an established company to find a pre- business. To maximize effectiveness, the gov- text for shutting down a new competitor. ernment uses a list of "compliance indicators" to tailor the compliance strategy to each area of business regulation. Those likely to involve a These comprehensive reforms often include high degree of self-enforcement (such as work- governmentwide programs to improve the draft- place fire safety) usually require fewer mecha- ing of regulations, better assess their impact, nisms of control or sanctions. Conversely, where and enhance monitoring and accountability. self-enforcement is not realistic (as in tax com- Piecemeal reforms in one or a few inspec- pliance), a targeted inspection strategy and the torates can be useful, short-term palliatives, but possibility of sanctions may be required to they tend to be vulnerable to backtracking and ensure adequate compliance. reversals, such as when there is a change of gov- The government also introduced self- ernment. Worse, where governments suffer inspection in place of many government inspec- from entrenched, systemic corruption, high- tions. That enabled the ministry responsible for level officials cut off from one source of rev- maritime safety, for example, to greatly reduce enue will quickly turn to another--such as by the administrative burden on shipowners. The switching from worker safety inspectors to fire ministry simplified detailed reporting and inspectors. inspection requirements and made the For example, inspections reforms in Russia shipowner, not the inspector, responsible for merely limiting an inspectorate's planned safety. These reforms reduced the number of inspections of a business to one every two years ships needing inspection and the number of did nothing to halt unplanned inspections, follow-up investigations required--without demands for bribes, or illegal "fines." The affecting such outcomes as the incidence of reforms could have been strengthened by shipping accidents. And they reduced adminis- adding outcome-based performance indicators trative costs for shipowners by about 80 million for inspectorates (such as reductions in the inci- euros a year. Most other inspectorates saw simi- dence of workplace fires), risk-based selection lar improvements. of firms for inspection, and greater accounta- Mexico's inspections reforms were also sup- bility for inspectors. ported by broader legal and institutional In the Philippines attempted reforms of cus- reforms--to clarify objectives, train inspectors, toms inspections aimed at improving collections develop a compliance policy, introduce risk- (by introducing third-party certification and based selection of inspection targets, and the risk-based selection of inspection targets) fell like. The inspections reforms have largely short of even the primary goal of increasing net achieved their goals, and the success has been revenue. The reason? The government failed to sustained for several years. The course of reform can vary, however, with safety inspections into a single program, elimi- a relatively modest inspections reform some- nating redundant inspections and clearing up times serving as the starting point for broader confusion about priorities and strategies for regulatory reform. In Latvia an initial cabinet ensuring compliance. That in turn helped to sig- instruction to improve transparency and nificantly reduce costs while avoiding any dete- accountability in inspections in 1999 led to a rioration in outcomes. much broader law on administrative procedures in 2001, which in turn strengthened and deep- Use risk-based analysis ened the inspections reforms. These reforms Risk assessment techniques can increase the effi- 3 shortened the average duration of key inspec- ciency of inspection programs by helping to tions from 6­12 hours to 2­5 hours by 2003, identify high-priority problems (such as indus- reduced the frequency of inspections, and tries vulnerable to toxic waste spills), determine improved their quality as perceived by the probability that a business may be out of businesses--all with no deterioration in out- compliance (such as one that might be tempted comes. While the inspections reforms hap- to underreport revenue for tax purposes), and pened to be a starting point, the principles were estimate the probability that an offense will be seen as applicable to business regulation across detected during an inspection (such as in indus- the board, and supportive of the government's tries prone to hiring illegal aliens). Variables efforts to improve governance and accede to the like these can be used to target inspections European Union. where they are most likely to find serious infrac- tions, helping to reduce costs and improve over- Focus on ends, not means all compliance. Most inspectorates cling to an outmoded and Among developing countries, Mexico is one inefficient reliance on punishment as a deter- that has successfully introduced risk-based rent for noncompliance: Tell the business what inspection as part of a broader program of reg- to do and fine it if it fails to comply. Moreover, ulatory reform. Its customs service supplements many governments are too "loose" on the objec- a small number of random inspections of ship- tives of their regulatory and inspection regime ments with risk-based inspections triggered by and too "tight" on the regulations, failing to such factors as the type of goods declared (those allow for new materials, processes, or technolo- that can be easily smuggled or have been smug- gies that may be more efficient than old ones. gled in the past), new importers without previ- That results in regulations that are overly ous records, customs brokers with dubious detailed, rigid, and prescriptive (such as requir- records, and strategic sectors. The time to clear ing that buildings' walls be at least 20 centime- a shipment at the Mexico City airport has fallen ters thick or that packaged food contain a from up to three days to an average of only 20 specific amount of a specific preservative)-- minutes even as the volume of trade has grown encouraging a myopic focus on the means rather enormously. than the far more critical objectives (ensuring that buildings can withstand earthquakes of a Rely on alternative inspection mechanisms certain magnitude or reducing outbreaks of Relying on alternatives to government inspec- food poisoning to below a realistic threshold). tions can yield big savings for the government Consider the example of Canada. In the early and lighten the burden on businesses. 1980s many government agencies justified their Alternatives can include mandatory self- regulations and related inspections by reference inspection (as with maritime safety in the to a law that was itself often vague or flawed. As Netherlands), outsourcing (such as the use of part of the regulatory reform program, the gov- licensed customs brokers in Mexico), and third- ernment required all ministries and agencies to party certification (as with forestry certification clarify and publicize the objectives of their reg- in Canada). In all these cases some government ulations. That led, for example, to a decision to inspections still take place as a backup to and a consolidate several agencies involved in food check on the alternative inspections. R E F O R M I N G I N S P E C T I O N S C O U N T E R I N G C O R R U P T I O N A N D W A S T E Make inspectors accountable tions as well as the results, and most are develop- Holding inspectorates, and inspectors, account- ing outcome-based performance measures. able helps improve efficiency and deter abuse. Most important is to hold inspectorates account- Conclusion ableforimprovementsinoutcomes,suchasreduc- Reforms of inspection regimes have relatively viewpoint tions in workplace accidents and fires. low budgetary costs and benefits that accrue rel- To deter abuse in Latvia, each inspector is atively quickly. The costs of reform can be fur- required to have a clear program of inspections ther reduced, and compliance increased, by is an open forum to and provide a written report for each one, simplifying the regulatory requirements on busi- encourage dissemination of describing what was inspected and what the nesses. Many developing countries, especially public policy innovations for findings were. In addition, inspectorates are low-income ones, impose unrealistic require- private sector­led and required to publicize the rights and responsibil- ments given their level of development and their market-based solutions for ities of businesses being inspected, including enforcement capacity. Moreover, burdensome development. The views their right to appeal. These changes have inspections contribute to the decision of many published are those of the empowered businesses to fight corruption by small businesses to operate informally, allowing authors and should not be improving their access to information about them to escape all standards--from relatively attributed to the World regulatory requirements and ensuring that they unimportant ones to those that are critical. Bank or any other affiliated have effective recourse in case of problems. The Major reforms naturally are likely to face organizations. Nor do any of business community reports that petty corrup- resistance from entrenched interests, particu- the conclusions represent tion is much less a problem than it was in the larly from inspectors who do not want to lose official policy of the World 1990s, and the country's score on Transparency their jobs (or opportunities to collect bribes) Bank or of its Executive International's Corruption Perception Index and from higher officials in inspectorates who do Directors or the countries has improved significantly.1 not want to lose their power. That makes it criti- they represent. Latvia's government also improved the effec- cal to get high-level political support from the tiveness of its inspection regime by training its outset, especially where coordination across To order additional copies inspectors in client orientation. Inspectors are ministries is required. Resistance sometimes also contact Suzanne Smith, encouraged to become "consultants" to comes from entrenched businesses that have managing editor, businesses--advising them, for example, on established relations with "their" inspectors and Room F 4K-206, how best to guard against workplace accidents-- prefer to avoid competition from new entrants. The World Bank, 1818 H Street, NW, on the assumption that the businesses too want Nevertheless, resistance to inspections Washington, DC 20433. to avoid problems in the workplace. reform is usually limited. Much of it can be over- come by providing clear objectives and per- Telephone: Monitor progress formance indicators, accountability, training, 001 202 458 7281 Monitoring outcomes--such as maritime acci- and a "living wage" for inspectors. These costs Fax: dents, emissions of pollutants, and the inci- (both financial and political) are low compared 001 202 522 3480 dence of workplace fires--can help show with the benefits--lower costs for businesses Email: whether a government's objectives are being and greater ability to compete in global markets. ssmith7@worldbank.org met. For an inspectorate, monitoring can help assess the cost-effectiveness of its compliance Produced by Grammarians, strategy and measure the performance of Inc. inspectors. Business surveys can show how bur- Note densome inspections are for businesses and how 1.http://www.transparency.org/policy_research/surveys Printed on recycled paper this changes with reforms. _indices/cpi/2005. Latvia has conducted biannual business sur- veys since 2001 to assess such outcomes as the fre- Reference quency and duration of inspections, the business World Bank. 2005. Doing Business in 2006: Creating Jobs. community's perception of the quality of inspec- Washington, D.C. tions, and the incidence of both sanctions and bribes. Inspectorates are required to keep records on the number and location of all inspec- T h i s N o t e i s a v a i l a b l e o n l i n e : h t t p : / / r r u . w o r l d b a n k . o r g / P u b l i c P o l i c y J o u r n a l