Domestic Resource Mobilization and the Challenge of Governance

Prof. Mushtaq Husain Khan

Department of Economics

SOAS, University of London

ESCWA-Ministry of Foreign Affairs Qatar-DESA Preparatory Meeting Doha 29-30th April 2008

Resource Mobilization and Governance

Domestic resource mobilization through savings, taxation and financial markets is closely connected to the productivity of investment and both depend on the effectiveness of institutions

Governance has therefore rightly been identified as an important constraint on resource mobilization in developing countries

However the response to these challenges is often posed as one of improving broadly defined conditions described by ‘good governance’ and the ‘investment climate’

Problematic confusion between the broad good governance agenda and the specific governance, institutional and political tasks that different developing countries have to address

Diverse resource mobilization issues in ESCWA countries

Importance of specific responses particularly important given diversity of countries in this region

i) Some countries like Egypt and Yemen are typical developing countries

ii) Many are oil (and gas) economies like Saudi Arabia, Qatar, Bahrain, UAE but some are also making transitions out of oil dependence

iii) Some are significantly dependent on foreign aid/capital/remittance inflows like Jordan, Lebanon and the Occupied Palestinian Territories

iv) Region includes war ravaged and occupied economies like Iraq and the Occupied Palestinian Territories

Clearly there should be differences in the priority accorded to resource mobilization and investment as well as reform priorities in different areas

Developing countries need to insist on the space to devise their own governance reform priorities without getting trapped in the conventional good governance debate

Summary features of ESCWA Countries

Oil and hydrocarbon-rich economies display high but very variable savings rates as we would expect, and they suffer from a domestic resource absorption problem, with relatively low investment rates

Qatar and the UAE (particularly Dubai) are emerging as new models of increasing domestic investment through strategies of becoming global service and financial hubs

Institutional and governance reforms in these countries need to focus on how to sustain this transition and make these investments productive

Bahrain Kuwait Oman

Growth Rate

Savings Rate (%

GDP)

Investment Rate (% GDP)

Growth Rate

Savings Rate (%

GDP)

Investment Rate (% GDP)

Growth Rate

Savings Rate (%

GDP)

Investment Rate (% GDP)

1990 4.4 37.4 16.4 1990 na 4.5 17.6 1990 -0.1 32.0 12.31995 3.9 26.1 14.6 1995 4.9 25.1 14.8 1995 5.0 23.5 15.02000 5.3 35.3 10.3 2000 4.7 37.0 10.7 2000 5.4 39.8 11.92005 6.9 na na 2005 8.5 57.0 19.7 2005 na na na

Qatar Saudi Arabia UAE

Growth Rate

Savings Rate (%

GDP)

Investment Rate (% GDP)

Growth Rate

Savings Rate (%

GDP)

Investment Rate (% GDP)

Growth Rate

Savings Rate (%

GDP)

Investment Rate (% GDP)

1990 na na na 1990 8.3 24.1 15.1 1990 17.5 45.6 20.51995 na 36.1 35.1 1995 0.2 29.5 19.8 1995 7.9 35.6 29.72000 na 65.1 20.2 2000 4.9 37.5 18.7 2000 5.0 41.2 23.22005 6.1 70.3 35.5 2005 6.6 50.5 16.2 2005 8.5 42.4 24.4

Summary features of ESCWA Countries Egypt Syria Yemen

Growth Rate

Savings Rate (%

GDP)

Investment Rate (% GDP)

Growth Rate

Savings Rate (%

GDP)

Investment Rate (% GDP)

Growth Rate

Savings Rate (%

GDP)

Investment Rate (% GDP)

1990 5.7 16.1 28.8 1990 7.6 16.9 16.5 1990 na 8.8 14.61995 4.5 15.0 20.1 1995 5.8 20.3 27.2 1995 11.6 14.6 21.92000 5.4 12.9 19.6 2000 2.7 24.1 17.3 2000 4.4 25.2 19.52005 4.5 15.7 18.0 2005 4.7 na na 2005 4.6 na

Jordan Lebanon Iraq

Growth Rate

Savings Rate (%

GDP)

Investment Rate (% GDP)

Growth Rate

Savings Rate (%

GDP)

Investment Rate (% GDP)

Growth Rate

Savings Rate (%

GDP)

Investment Rate (% GDP)

1990 1.0 1.0 31.9 1990 26.5 -64.1 17.8 1990 na na na1995 6.2 8.4 29.6 1995 6.5 -15.1 36.5 1995 na na na2000 4.2 -5.6 21.1 2000 1.7 -2.8 20.1 2000 -4.3 na na2005 7.2 -17.9 23.7 2005 1.0 -4.8 20.7 2005 na na na

Egypt, Syria and Yemen are more like typical developing countries, finding it difficult to raise savings and investment rates consistently above 20%. Priorities here are similar to typical developing countries

Jordan and Lebanon are more dependent on foreign inflows (aid, FDI, remittances) for financing both domestic consumption and investment. Priorities here are to improve the productivity of investment

Iraq and the Palestinian Occupied Territories are war ravaged and occupied territories, with internal economies seriously disrupted by occupation and conflict

Why good governance dominates the reform agenda

Good governance is a set of desirable institutional conditions that are found in more advanced countries Stable property rights Relatively low corruption (but high legal rent seeking) Governments accountable to voters Rule of law

These are desirable goals in their own right, but in theory the achievement of these conditions would also help resource mobilization and investment efficiency

In theory good governance works by improving overall market and political ‘transaction efficiency’

If good governance conditions can be achieved savers will feel confident to save, investors to invest, and resources will be directed to areas with the highest returns

The good governance agenda

E conom ic P rospe rity

E ffic ien t M arke ts and pove rty reduc tion

S tab le P rope rty R igh tsA nd E ffic ien t D e livery

o f pub lic goods

L im ited R ent-S eeking

A nd C orrup tion

A ccountab ility and E ffec tive D em ocracy

Problem Areas not in question Surveys of business opinion confirm these areas

as important constraints to investment and domestic resource mobilization in developing countries

Civil society in developing countries often supports the enforcement of these rules on the grounds that many are highly desirable goals in themselves

Fiduciary responsibility of donor agencies and foreign investors has driven concerns about corruption and the diversion of resources: focus on PFM, anti-corruption strategies, and transparency and accountability reforms

The market-enhancing governance agenda

In theory, these governance reforms could assist resource mobilization and investment efficiency:

Low transaction cost markets, would allow scarce investible resources to be raised as savings and efficiently allocated as investment

Security of savers and investors from expropriation risk and a good rule of law would enable contracts for long term investment and risk-sharing which are essential for financing technology acquisition and learning

Accountable and non-corrupt governments could provide political stability and predictability of policy

But good governance is not easy to achieve

Stabilizing property rights requires not just a commitment from government but the emergence of highly productive owners and sectors who can pay for their own protection.

Fighting corruption involves having significant legal sources of finance for running politics, a budget large enough that all or most of the redistributive demands in

society can be met through the budget, and regulatory and enforcement structures for converting illegal rent seeking

into legal rent seeking

The political accountability of parties to a broad electorate and not just to powerful clients requires (amongst many other things) the feasibility of maintaining political stability through budgetary redistribution

Good governance is desirable but…..

This does not mean that improvements in good governance are not achievable at all in developing countries

Improvements are both possible and desirable

The question is whether the feasible improvement along this path can be significant enough to make a significant impact on transaction efficiency within a policy period

If the feasible improvement in ‘good governance’ is small, then we have to look for other governance reforms to achieve improvements in resource mobilization and the efficiency of investment allocation

The historical evidence from case studies shows that this is exactly what successful developers did

Governance and Growth

Market-Enhancing Governance: Composite Property Rights Index and Growth(using Knack- IRIS data) 1990-2003

-8

-6

-4

-2

0

2

4

6

8

10

0 10 20 30 40 50IRIS 'Property Rights' Index 1990

(ranges from 0 to 50)

Gro

wth

Rat

e of

Per

Cap

ita G

DP

199

0-20

03

Diverging Developing Countries

Governance and Growth

Market-Enhancing Governance: Composite Property Rights Index and Growth(using Knack- IRIS data) 1990-2003

-8

-6

-4

-2

0

2

4

6

8

10

0 10 20 30 40 50IRIS 'Property Rights' Index 1990

(ranges from 0 to 50)

Gro

wth

Rat

e of

Per

Cap

ita G

DP

199

0-20

03

Advanced Countries Diverging Developing Countries

Governance and Growth

Market-Enhancing Governance: Composite Property Rights Index and Growth(using Knack- IRIS data) 1990-2003

-8

-6

-4

-2

0

2

4

6

8

10

0 10 20 30 40 50IRIS 'Property Rights' Index 1990

(ranges from 0 to 50)

Gro

wth

Rat

e of

Per

Cap

ita G

DP

199

0-20

03

Advanced Countries Converging Developing Countries Diverging Developing Countries

Governance and Growth

Market-Enhancing Governance: Composite Property Rights Index and Growth(using Knack- IRIS data) 1990-2003

-8

-6

-4

-2

0

2

4

6

8

10

0 10 20 30 40 50IRIS 'Property Rights' Index 1990

(ranges from 0 to 50)

Gro

wth

Rat

e of

Per

Cap

ita G

DP

199

0-20

03

Advanced Countries Converging Developing Countries Diverging Developing Countries

Corruption and Growth

Corruption and Growth 1990-2003(using Knack's IRIS data)

-8

-6

-4

-2

0

2

4

6

8

10

-1 0 1 2 3 4 5 6 7

IRIS Corruption Index 1990(ranges from 0 to 6)

Gro

wth

Rat

e of

Per

Cap

ita G

DP

199

0-20

03

Advanced Countries Converging Developing Countries Other Developing Countries

Rule of Law and Growth

Governance and Growth 1990-2003 using World Bank Rule of Law Index(World Bank/Kaufmann et. al. data)

-8

-6

-4

-2

0

2

4

6

8

10

-2.5 -2 -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5

Rule of Law Index 1996

Gro

wth

Rat

e o

f P

er C

apit

a G

DP

199

0-20

03

Advanced Countries Diverging Developing Countries Converging Developing Countries

Voice and Accountability and Growth

Governance and Growth 1990-2003 using World Bank Voice and Accountability Index(World Bank/Kaufmann data)

-8

-6

-4

-2

0

2

4

6

8

10

-2 -1.5 -1 -0.5 0 0.5 1 1.5 2

Voice and Accountability Index 1996

Gro

wth

Rat

e o

f P

er C

apit

a G

DP

199

0-20

03

Advanced Countries Diverging Developing Countries Converging Developing Countries

Political Instability and Growth

Governance and Growth 1990-2003 using World Bank Political Instability and Violence Index(World Bank/Kaufmann et. al. data)

-8

-6

-4

-2

0

2

4

6

8

10

-3 -2.5 -2 -1.5 -1 -0.5 0 0.5 1 1.5 2

Political Instability and Violence Index 1996

Gro

wth

Rat

e o

f P

er C

apit

a G

DP

199

0-20

03

Advanced Countries Diverging Developing Countries Converging Developing Countries

State Capabilities and Reform PrioritiesG

row

th R

ate

s

Governance Characteristics(Democracy, Corruption,

Stability of Property Rights)Source: Khan (2004)

1. Diverging Developing Countries

2. Converging Developing Countries

3. Advanced CapitalistCountries

Regression LineReforms that transform Poorly

Performing States into Developmental States

Reforms that improve

governance in

successfultransformation

economies

What are the critical governance goals?

Successful resource mobilization and sustained growth in developing countries depends on identifying specific market and government failures that are immediate constraints

A viable strategy should identify governance reforms that are targeted, narrowly defined, and plausibly achievable in a policy cycle

These will differ from country to country because their initial conditions and dominant market failures are different, as are their institutional and political capacities to address these

Narrowly defined governance goals that address specific market failures should be identified in national development strategies

Examples of market failures affecting resource mobilization

The absence of risk-sharing institutions prevents investment in many potentially profitable sectors in developing countries

In theory good governance would solve the problem by allowing efficient stock markets to mobilize resources from venture capitalists for investment in risky sectors

In reality if we rely on this route we will have to wait for a long time to see any significant effects, and in fact stock markets play a limited role even in advanced countries

The alternative is to explore arrangements where government, banks and business associations work to set up a small number of financial instruments to address resource mobilization and investment in risky sectors, with a focus on developing specific governance capabilities for monitoring and regulating specific instruments

Pragmatic governance strategies

General lip service to unachievable good governance reforms can dissipate effort and can amount to lost opportunities for effective reform

Governance priorities should be narrowly defined and feasible

They should be linked to specific targets and priorities identified in national development strategies

It is better to be too conservative and start with very modest programmes

a commitment to ambitious good governance programmes are unlikely to make an impact on resource mobilization