Worldwide Governance Indicators and key Findings: Implications for Credit, Investment and Policies in Emerging Markets Daniel Kaufmann The World Bank Institute www.worldbank.org/wbi/governance or, www. govindicators.org Presentation at Conference on Political Risk Revisited, at Chatham House, London, February 5 th, 2007 1
Evidence-based Approach, through empirics 1. Data Matters--on Governance & Institutions: data can be gathered, analyzed, and used judiciously 2. Institutions, Governance and Corruption Matters 3. On average stagnation on Governance yet high variance --some countries improve in short term 4. Behavior of the Firm and Investor also Matters 5. Global collective responsibility 6. Governance matters for a country s: growth, competitiveness, investments & financial markets 7. Implications for Political Risk Analysis & Sectoral Policy 2
The Power of Data : progress in measurement 1. The Macro /Aggregate Level of Measurement: Worldwide Aggregate Governance Indicators: 200 countries, 6 components, periodic. 2. Mezzo : Cross-Country Surveys of Enterprises 3. 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 On Aggregate/Macro Level first 3
Six Dimensions of Governance Measured 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 [Political Governance]: 1. VOICE AND ACCOUNTABILITY 2. POLITICAL STABILITY & ABSENCE OF VIOLENCE/TERRORISM The capacity of government to formulate & implement policies, and deliver services [Economic Governance]: 3. GOVERNMENT EFFECTIVENESS 4. REGULATORY QUALITY Respect of citizens and state for institutions that govern interactions among them [Institutional Governance]: 5. RULE OF LAW 6. CONTROL OF CORRUPTION 4
2006 Worldwide Governance Indicators: Key Features after a decade of Governance Data Widely used by policymakers and researchers to study causes and consequences of good governance biannual data since 1996, now annual data Based on 31 data sources from 25 organizations, capturing views of thousands of informed stakeholders Covering over 213 countries & territories, estimate of 6 dimensions of governance and of margins of error Now also: access to individual data underlying the construction of the aggregate indicators hundreds of individual indicators over past decade very large on-line governance data resources, at www.govindicators.org 5
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 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, Columbia University, International Research and Exchanges Board Expert Assessments from Governments, Multilaterals: World Bank CPIA, EBRD, AFDB, ADB, State Dept. Human Rights 6 Report, Trafficking in Persons Report
Building Aggregate Governance Indicators Benefits from Aggregation Use Unobserved Components Model (UCM) to construct composite governance indicators, and margins of error for each country Estimate of governance: weighted average of individual scores for each country, re-scaled Weights are proportional to precision of underlying data sources, and precision based on extent of consensus among sources Margins of error reflect (a) number of sources in which a country appears, and (b) the 7 precision of those sources
Good Governance 2.5 Governance Level Control of Corruption Selected Countries, 2005 Margins of Error 0-2.5 EQ. GUINEA Poor Governance SOMALIA HAITI MYANMAR SUDAN PARAGUAY CAMEROON CAMBODIA KENYA CHINA MEXICO INDIA BRAZIL GREECE ITALY Source for data: 'Governance Matters V: Governance Indicators for 1996-2005, D. Kaufmann, A. Kraay and M. Mastruzzi, September 2006. Note: Colors are assigned according to the following criteria: Dark Red, below 10 8 th percentile rank among all countries in the world; Light Red between 10 th and 25 th ; Orange, between 25 th and 50 th ; Yellow, between 50 th and 75 th ; Light Green between 75 th and 90 th ; Dark Green above 90 th. SLOVAK REPUBLIC KOREA, SOUTH SOUTH AFRICA HUNGARY URUGUAY ESTONIA SLOVENIA BOTSWANA JAPAN CHILE UNITED STATES DENMARK NEW ZEALAND SINGAPORE FINLAND ICELAND
Are Countries Stagnating in Governance? The world on average has not improved on governance, though it has on the macro-economic policies, infrastructure, etc: there is a governance gap But large or small variation across countries? New method: for each country, we can identify whether there are significant changes over time It is found that changes can take place in the shortterm: in 6-to-8 years, some deteriorations as well as some significant improvements as well 9
3 High Inflation Significant Decline in Inflation Rates Worldwide TRANSITION 1.5 EMERGING (avg. in logs) Low OECD+NIC 0 1984-1988 1989-1993 1994-1998 1999-2001 10 Source: Rethinking Governance, based on calculations from WDI. Y-axis measures the log value of the average inflation for each region across each period
6.5 Quality of Infrastructure also improved High East Asia Industrialized OECD 4 Transition Low Emerging 1.5 1997 1998 1999 2000 2001 2002 2003 Source: EOS 1997-2003 (Quasi-balanced panel). Question 6.01: General infrastructure in your country is among the best in the world? 11
But by contrast, governance has stagnated Judiciary Independence (EOS survey resuls 1998-2004) High Independence 7 Independencia de la Judicatura 4 1 No 1998 1999 2000 2001 2002 2003 2004 Independence OECD East Asian NICs Latin America NON OECD 12
No Significant Trend in Control of Corruption Worldwide Averages Good 0.8 EIU PRS QLM 0.5 0.2 Poor 1996 1998 2000 2002 2004 PRS country coverage in 1996: 129, all other periods 140; QLM and EIU country coverage: 115 for all periods. 13
Press Freedom in the World, 1995 vs. 2004: Stagnant? 34 32 % countries in 1995 Not Free Part Free % countries in 2004 Free 34 38 36 Not Free Part Free Free 26 Source: Freedom House. Y axis measures percentage of countries in the region with free press (rating of 30 or below), 14 partly free (ratings between 30 and 60) and not free (rating above 60).
2 Changes in Control of Corruption, 1996-05 Major Deterioration (selected countries) Insignificant Change (selected countries) 0 Major Improvement (selected countries) -2 IVORY COAST ZIMBABWE ISRAEL NAMIBIA EGYPT CAMBODIA LAOS ROMANIA CAMEROON PAKISTAN RUSSIA GHANA BOLIVIA BOTSWANA SPAIN BULGARIA ESTONIA LATVIA Changes were calculated on the basis of the differences in country estimates from 1996 and 2005. Classification for major deteriorations and improvements were based on 75% confidence interval. Source for data: 'Governance Matters V: Governance Indicators for 1996-2005, by D. Kaufmann, A.Kraay and M. Mastruzzi, September 2006 - www.govindicators.org 15
Development Dividend From Good Governance $30,000 Control of Corruption $3,000 $300 Low Governance Medium Governance High Governance 16 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.
High Growth Competitiveness Index (EOS) 6 4 Good Governance associated Country s Competitiveness r = 0.90 CHN THA IND EGY POL MUS MEX SLV GHA COL BGR TTO KAZ HRV PERROM TURBRA NAM AZE JAM TZA IDN RUS ARG PAN PHL DZA MAR UKR PAK MDA VNM YUG NGA VEN GEO UGA MOZ MLI MKD KEN HNDGMBIH GTM MNG NIC LKA BOL ALB DOM TJK ETH MWI ECU MDG ZWE TMP BGD CMR PRY KHM GUY BEN KGZ TCD USA SWE TWN CHE NOR JPN AUS NLD GBR KOR DEUCAN NZL QAT ARE PRT AUT MYS CHL LUX ISR IRL FRA ESP HKG KWT SVN BEL CYP MLT BHR CZE HUN LVA TUN JOR LTU SVKZAF GRC ITA BWA URY CRI DNK SGP ISL FIN Low 2-1.5-1.0-0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 Low WGI Control of Corruption High Sources: GCI drawn from EOS firm survey, WEF 2005 117 countries; Control of Corruption from Kaufmann, Kraay 17 and Mastruzzi, Governance Matters IV: Governance Indicators for 1996-2004.
70 60 Constraints to Business vary across regions & countries (responses from the Firm in EOS 2005) % firms reporting constraint among top 3: Infrastructure Bureaucracy Corruption Tax Regulations Inflation 50 40 30 20 10 0 Chile East Asia NICs East Asia developing Sub-saharan Africa Latin America Source: EOS 2005. The question posed to the firm was: Select among the above 14 constraints the five most problematic factors for doing business in your country. Note that the overall EOS sample covers 120 [CHECK] countries, and in some regions particularly 18in the Middle East, Africa and the FSU, many countries are not surveyed. Thus, regional averages need to be interpreted with caution, since typically countries not surveyed tend to rate lower in governance than those surveyed.
Unbundling Corruption: Different types of Bribery (responses by firms 2005) % Firm Report High Bribery (1-3) Bribery in: 100 Connection to Utilities Taxation Procurement Judiciary State Capture Frequency of Bribery 80 60 40 20 0 OECD East Asia East Asia South Asia Sub-saharan Former Eastern Latin (NIC) dev. Africa Soviet Europe America Union Source: EOS firm survey, WEF2005 117 countries. Question: In your industry, how commonly firms make undocumented 19 extra payments or bribes connected with permits / utilities / taxation / awarding of public contracts / judiciary? (common never occurs).
Multinationals Bribe Abroad? % Firms Reporting Frequent Procurement Bribery, EOS 2005 % Firms Reporting Procurement Bribery is Prevalen 100 80 60 40 20 0 Domestic Firm in OECD Country OECD Multinational in another OECD country OECD Multinational in Non-OECD country Domestic Firm in Non-OECD Country Procurement Bribery is prevalent (% Firms Report) Source: EOS, preliminary. Question: In your industry, how commonly would you estimate that firms make undocumented extra payments or bribes connected with the following: permits, public utilities, tax payments, loan applications, awarding of public 20contracts, influencing of laws, policies, regulations and decrees to favor selected business interest, and judicial decisions. Any firms reporting answers 1 through 3 were considered to be reporting at least high frequency of bribery, while answers 4 through 7 were not.
Governance Matters for Assessing Emerging Financial Markets Prospects Indicators Matter, and Some Empirical Lessons 21
Stock Market Volatility vs. Control of Corruption High 30 RUS Stock Market Volatility 20 10 r = -0.56 NGA IDN VEN COL MEX ARG TUR BRA CHN THA PHL ZWE KOR PER LKA IND SVK EGY MAR JOR POL CZE ZAF SAU HUN MYS TWN GRC ITA CHL JPN ISR PRT ESP HKG FRA USA Low 0-1.5-1.0-0.5 0.0 0.5 1.0 1.5 2.0 Low Control of Corruption High Sources: KK 1998 and Morgan Stanley Capital International Dataset and Emerging Markets Database (1998). Stock volatility 22 defined as the standard deviation of monthly returns over December 1984 to December 1998, multiplied by 100.
Opacity (or misgovernance) affects Herding.15 (investors mimic each other s behavior) H e r d i n g.1.05 20 30 40 50 60 ofactor 23 Gelos and Wei, 2005 Opacity (Misgovernance)
Misgovernance Higher Fragility of Financial Sector Soundness of Banks vs. Control of Corruption (View of the firm, GCS 2001) 7 Soundness of Banks Average Uncontrolled Rating Predicted Controlled Value 5 Low 3 Poor Control of Corruption Average Control of Corruption Source: Global Competitiveness Survey, 2001, KK Governance Indicators Good Control of Corruption 24
Bond Spreads (log - BFS06) 2006 Bond Spreads vs. Corruption Control 4,000 1,250 400 125 40 Low Control Ivory Coast Nigeria Ecuador Pakistan Dominican Mexico Republic Russia Venezuela Brazil Thailand Philippines Lebanon Peru El Salvador Colombia China Argentina Egypt Poland Tunisia Morocco Malaysia r = - 0.57 Korea, south Hungary South Africa -2-1 0 1 2 Uruguay Control of Corruption (KK05) Chile High Control Sources: Bloomberg Financial Services & WBI. Bond spreads are drawn from the Global Emerging Market Bond Index (EMBIG) produced by JP Morgan on 33 emerging economies. 25
Summary and Implications 1. Governance measurement skepticism challenged 2. Misgovernance as one binding constraint nowadays 3. Beyond corruption: governance more broadly 4. Beyond administrative corruption -- influence peddling and state capture by firms is also key 5. Governance Matters for country growth prospects, for Investments, and for financial markets 6. Misgovernance affects: fragility of financial markets & banks, volatility of equity markets; investor herding behavior (& lower I); bond market spreads 7. Capital Market Development: Disciplining for GG 8. Assessing & Measuring Governance key for Political Risk assessment 9. Good Governance & Transparency at Sectoral Level 10. Global Challenges and Responsibility 26
Governance Has Improved in Some Groups: e.g. Pull Effect of EU Accession High 1 Rule of Law Low 0.5 0-0.5-1 EU Accessed ex-soviet Union (no access) -1.5 1996 1998 2000 2002 2004 27 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.
Governance Indicators: Chile, 2004 vs. 1996 Source for data: http://www.worldbank.org/wbi/governance/govdata2002 ; Colors are assigned according to the following criteria: Dark Red, bottom 10 28 th percentile rank; Light Red between 10 th and 25 th ; Orange, between 25 th and 50 th ; Yellow, between 50 th and 75 th ; Light Green between 75 th and 90 th ; Dark Green above 90 th.