Myths and realities about Governance and Corruption: Global evidence and lessons for Ukraine

1. Myths and realities about Governance and Corruption: Global evidence and lessons for Ukraine Daniel Kaufmann, The World Bank Institute www.worldbank.org/wbi/governance Special Seminar Presentation at ICPS, Kyiv, Ukraine, June 15th, 2005

2. Some ‘Popular Notions’ (& Myths) to be Challenged • Consensus on good governance for development and growth since the 1990s – ‘Washington Consensus’ • Fix the ‘Macro’, and Growth + other reforms will follow • Low Corruption & Good Governance: a result of development & growth’…[emerging economies corrupt; rich world a ‘model’]? • Governance has also improved worldwide in past decade • But Governance is ‘Unmeasurable’, thus no monitoring • And Cultural & Historical Determinism: ‘Patience’ • Best Governance Reforms practices?: More Laws, ‘Codes’, and Regulations, New ‘Agencies’, or more ‘Campaigns’ -- Challenging these ‘myths’ have major implications

3. Salient Points for Presentation • The ‘Power of Data’ [on Governance & Institutions] – while ‘sensitive’, & margins of error (not uniquely), data informs and empowers • From Attaining Macro-Stability to Sustaining it: complementary governance reforms–key to growth • World Average shows disappointing progress on Governance: It is a binding constraint nowadays • Significant variance: some countries show that it is feasible to improve governance in the short term • Some strategies and interventions have not worked – vs. what may work better in future? • Implications for the next stage: re-focus, frankly

4. The ‘Power of Data’: 3 Levels of Measurement • ‘Macro’: Worldwide Aggregate Governance Indicators: 200 countries, 6 components, periodic. • ‘Mezzo’: Cross-Country Surveys of Enterprises • ‘Micro’: Specialized, in-depth, in-country Governance and Institutional Capacity Diagnostics: Includes surveys of: i) user of public services (citizens); ii) firms, and, iii) public officials

5. Six Dimensions of Governance Governance as the set of traditions and institutions by which authority in a country is exercised – specifically: • The process by which those in authority are selected and replaced • VOICE AND ACCOUNTABILITY • POLITICAL STABILITY & ABSENCE OF VIOLENCE/TERRORISM • The capacity of government to formulate and implement policies • GOVERNMENT EFFECTIVENESS • REGULATORY QUALITY • The respect of citizens and state for institutions that govern interactions among them • RULE OF LAW • CONTROL OF CORRUPTION

6. Governance Data • “Perceptions” data on governance from 37 different sources constructed by 31 different organizations • 12 new data sources for 2004 • Use new data for minor backwards revisions for 1996-2002 • Data sources include cross-country surveys of firms, commercial risk-rating agencies, think-tanks, government agencies, international organizations, etc. • 352 proxies for various dimensions of governance • Organize these measures into six clusters corresponding to definition of governance, for five periods: 1996, 1998, 2000, 2002, 2004

7. Sources of Governance Data • Cross-Country Surveys of Firms: Global Competitiveness Survey, World Business Environment Survey, World Competitiveness Yearbook, BEEPS • Cross-Country Surveys of Individuals: Gallup International Voice of the People, Latinobarometro, Afrobarometer, Vanderbilt University/USAID • Expert Assessments from Commercial Risk Rating Agencies: DRI, PRS, EIU, World Markets Online, Merchant International Group, IJET Travel Consultancy, PERC • Expert Assessments from NGOs, Think Tanks: Reporters Without Borders, Heritage Foundation, Freedom House, Amnesty International, Bertelsmann Foundation, Fundar, International Research and Exchanges Board, Brown University, Columbia University, Binghamton University • Expert Assessments from Governments, Multilaterals: World Bank CPIA, EBRD, AFDB, ADB, UNECA, State Dept. Human Rights Report

8. Why Aggregate Indicators? Basic Premise:individual data sources provide a noisy “signal” of broader concept of governance, e.g.: • trust in police  RULE OF LAW • freedom of press  VOICE & ACC’TBILITY • policy consistency  GOV’T EFFECTIVENESS Benefits of Aggregation -- through the U.C. Method • aggregate indicators are more informative and precise about broad concepts of governance • broader country coverage than individual indicator • generate explicit margins of error for country scores

9. Building Aggregate Governance Indicators • Use Unobserved Components Model (UCM) to construct composite governance indicators, and margins of error for each country • Estimate of governance: weighted average of observed scores for each country, re-scaled to common units • Weights are proportional to precision of underlying data sources • Precision depends on how strongly individual sources are correlated with each other • Margins of error reflect (a) number of sources in which a country appears, and (b) the precision of those sources

10. Control of Corruption: one Aggregate Indicator (selected countries from 204 worldwide, for illustration, based on 2004 research data) Margins of Error Good Governance Governance Level Poor Governance Source for data: : 'Governance Matters IV: Governance Indicators for 1996-2004’, D. Kaufmann, A. Kraay and M. Mastruzzi, (http://www.worldbank.org/wbi/governance/govdata/); Colors are assigned according to the following criteria: Dark Red, bottom 10th percentile rank; Light Red between 10th and 25th ; Orange, between 25th and 50th ; Yellow, between 50th and 75th ; Light Green between 75th and 90th ; Dark Green above 90th.

11. Governance Indicators for Croatia, 1996 & 2004 Source: 'Governance Matters IV: Governance Indicators for 1996-2004’, D. Kaufmann, A. Kraay and M. Mastruzzi (May 2005). Report and data at: http://www.worldbank.org/wbi/governance/govdata/. Thin line reflects confidence range interval ( margin of error), at 90% confidence. In any comparison, overlapping ranges imply that no inference about significance in observed difference is warranted.

12. Governance Indicators for Ukraine, 1996 & 2004 Source for data: : 'Governance Matters IV: Governance Indicators for 1996-2004’, D. Kaufmann, A. Kraay and M. Mastruzzi, (http://www.worldbank.org/wbi/governance/govdata/); Colors are assigned according to the following criteria: Dark Red, bottom 10th percentile rank; Light Red between 10th and 25th ; Orange, between 25th and 50th ; Yellow, between 50th and 75th ; Light Green between 75th and 90th ; Dark Green above 90th.

13. Government Effectiveness, 2004: World Map Source for data: : 'Governance Matters IV: Governance Indicators for 1996-2004’, D. Kaufmann, A. Kraay and M. Mastruzzi, (http://www.worldbank.org/wbi/governance/govdata/); Colors are assigned according to the following criteria: Dark Red, bottom 10th percentile rank; Light Red between 10th and 25th ; Orange, between 25th and 50th ; Yellow, between 50th and 75th ; Light Green between 75th and 90th ; Dark Green above 90th.

14. Governance Map: Control of Corruption, 2004 Source for data: : 'Governance Matters IV: Governance Indicators for 1996-2004’, D. Kaufmann, A. Kraay and M. Mastruzzi, (http://www.worldbank.org/wbi/governance/govdata/); Colors are assigned according to the following criteria: Dark Red, bottom 10th percentile rank; Light Red between 10th and 25th ; Orange, between 25th and 50th ; Yellow, between 50th and 75th ; Light Green between 75th and 90th ; Dark Green above 90th.

15. Changes in Rule of Law, 1996-2004 Major Deterioration (selected countries) Insignificant Change Major Improvement (selected countries) Changes were calculated on the basis of the differences in country estimates from 1996 and 2004. Classification for major deteriorations and improvements were based on 75% confidence interval. Source for data: http://www.worldbank.org/wbi/governance/govdata/.

16. Measurable Worldwide Trends in Governance? • Through new method, it was possible to determine that changes can take place in the short-term: in 6-to-8 years, not only deteriorations but some significant improvements as well • Yet has the world on average improve on governance over the period? • We look at this question next, which matters for interpretation of our governance indicators ratings -- since our aggregate indicators are in relative units

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

18. And Quality of Infrastructure is Improving… Source: EOS 1997-2003 (Quasi-balanced panel). Question 6.01: General infrastructure in your country is among the best in the world?

19. Stagnating Trend in Control of Corruption Worldwide Good Poor PRS country coverage in 1996: 129, all other periods 140; QLM and EIU country coverage: 115 for all periods.

20. Governance Matters: The 300% ‘Dividend’ • Large Development Dividend of Good Governance: a one-standard-deviation (S.D.) improvement in governance raise incomes per capita in a country by about 300% in long-run • Is such a decline in corruption unrealistically large?: No -- one S.D. is the difference in Rule of Law from: Somalia, Iraq Nigeria, Cuba, Belarus, Uzbekistan  Moldova, Armenia or Macedonia  Botswana, Czeck R., Lithuania, Israel, Italy  Canada, Netherlands • The impact is from governance to incomes, and not viceversa -- higher incomes alone will not result in improved governance and corruption control • Importance of interventions to improve governance

21. Development Dividend From Good Governance $30,000 $3,000 $300 Data Source for calculations: KK 2004. Y-axis measures predicted GDP per capita on the basis of Instrumental Variable (IV) results for each of the 3 categories. Estimations based on various authors’ studies, including Kaufmann and Kraay.

22. Some Key Constraints to Business–View of the Firm, 2004 % firms reporting constraints among top 3: Source: EOS 2004. Question: Select among the the following list of constraints the most problematic factors for doing business in your country… (only selected constraints (and countries) are shown, due to space limitations, illustrative)

23. Impact on Global Competitiveness Index (GCI) Rank -- of Relaxation of specific Constraint to the Firm Source: Constraints to Business data based on EOS 2004 (Question: “From the following list, please select the five most problematic factors for doing business in your country, and rank them from 1 to 5.”); GCI based on GCR team calculations for 2004/2005 Report; GDP per capita from World Bank. Calculations based on regression estimates of the impact on the GCI of an improvement in the constraint by one standard deviation.

24. % firms report high leakage of public funds Leakage of Public Funds, Responses by Firms, 2004 Source: EOS firm survey, WEF2002-04. Question: In your country, diversion of public funds to companies, individuals or groups due to corruption is common / never occurs.

25. High Independence of Judiciary, Responses by Firms, 2004 Low Source: EOS firm survey, WEF2002-05. Question: Is the judiciary in your country independent from political influences of members of government, citizens and firms?

26. High Transparency of Government Policies(Views of Firms, 2004) Low Source: EOS firm survey, WEF2002-04. Question: Are firms in your country usually informed clearly by the government on changes in policies and regulations affecting your industry?

27. ‘Grand Corruption’: Bribery to ‘Purchase’ Laws, Policies, Regulations (Responses by Firms, 2004) High Bribe Frequency Low Source: EOS firm survey, WEF2002-04. Question: In your industry, how commonly firms make undocumented extra payments or bribes connected with influencing laws, policies, regulations or decrees to favor selected business interests?

28. Control of ‘Grand Corruption’ (Capture) vs. Government Transparency (EOS 2004) High r = 0.81 Low Low High Sources: EOS firm survey,WEF2004. Question: In your industry, how commonly firms make undocumented extra payments or bribes connected with influencing laws, policies, regulations or decrees to favor selected business interests? Question: Are firms in your country usually informed clearly by the government on changes in policies and regulations affecting your industry?

29. Citizen Voice Improves Accessibility of Public Services to the Poor Based on Public Officials Survey. The sample of institutions includes 44 national, departmental, and municipal agencies which are a prior anticipated to be accessible to the poor

30. Within-Country Illustration:Effective Transparency within Government Agencies Prevents Purchase of Public Positions (from Bolivia Diagnostic) Based on 90 national, departmental, and municipal agencies covered in the Public Officials Survey.

31. Main Findings and Implications Some Key Findings: • Measuring Governance: Important & Feasible –with caution • Governance matters: large “development dividend” strong causal impact of governance on incomes, not vv. • But the world on average is ‘stagnant’– with high variance • From focus on the ‘Macro’ to Institutions/Governance as the binding constraint Implication: Need to refocus efforts to improve governance • Frank questioning of what has not worked: e.g. anti-corruption agencies, more traditional T.A, ‘codes’ & laws • The danger of over-regulating (vs. incentives & transparency) • Focusing on what may work in moving forward… (cont.)

32. Some Lessons from Empirical Research Consequences and Costs of Corruption: • Lower Incomes, Investment; Poverty & Inequality • But no automatic virtuous circle (from higher income to improved governance) Determinants of Corruption: • Capture and Undue Influence by Vested Interests • No Voice, Press Freedoms, Devolution, Transparency • Low Professionalism of Public Service • No Example from the Top / Lack of Leadership • Easy and Gradualist Panaceas

33. No Evidence to support some ‘popular’ notions on Anti-Corruption (A-C) – challenging the following: • Constant drafting of new A-C laws/regulations • Creating many new Commissions & Agencies • Blaming Globalization or Privatization • Cultural Relativism (or Regional Characteristics) • Historical Determinism/Legal Origins …by contrast, what may be particularly important…

34. Synthesis: 7 Points of Reform Emphasis • Major Reduction in Regulations (and in Administrative Obstacles to Business) • Major Transparency Reforms: Political, Financial, Fiscal, Economic, & Internet Transparency – with Data, & monitoring • ‘Voice’: bottom-up participation and oversight from citizens, youth, NGOs – with Data, surveys • Depoliticization and Reform of Civil Service • Reform of the Judiciary • Accountability by Large Conglomerates/Firms (and Multinationals) • Role of the Rich Countries and International Financial Institutions: Collective Responsibility

35. Governance Has Improved in Some Groups:e.g. “Pull Effect” of EU Accession High Low Source for data: http://www.worldbank.org/wbi/governance/govdata/. EU EE Accessed Countries: Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovak Republic, and Slovenia.

36. Data for Analysis and Informing Policy Advice, Not for Precise Rankings Any data on Governance, Institutions, and Investment Climate is subject to a margin of error. It is not intended for precise country rankings, but to highlight relative strengths and weaknesses and draw analytical and policy lessons. The data presented here and in the Report do not necessarily reflect official views on rankings by the World Bank or its Board of Directors. Errors are responsibility of the authors. Further materials & access to interactive data: General: www.worldbank.org/wbi/governance Data: www.worldbank.org/wbi/governance/govdata/ Report: www.worldbank.org/wbi/governance/pubs/govmatters4.html

37. Basic Scorecard on 10 Transparency Reform Components: How does the country rate? • Public Disclosure of Assets and Incomes of Candidates, Public Officials, Politicians and Legislators - & dependents • Public Disclosure of Political Campaign contributions by individuals, and of campaign expenditures • Public Disclosure of Parliamentary Votes • Effective Implementation of Conflict of Interest Laws, separating business, politics, legislation, and government • Publicly blacklisting firms bribing in public procurement • Effective Implementation of Freedom of Information Law, with easy access to all to government information • Fiscal transparency in central and local budgets (web) • E*procurement: transparency (web) and competition • Adoption and implementation of ‘Lobby Law’ • Judiciary transparency and disclosure on funding, assets of judges, and on full disclosure of judicial decisions • What is Ukraine’s scorecard rating on these 10 points today-2005? • What will Ukraine’s scorecard rating be within one year -- 2006 ?