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Governance and Economic Development

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This presentation is made by Alexander Plekhanov during the Development Day conference 2019.

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Governance and Economic Development

  1. 1. Alexander Plekhanov Office of the Chief Economist Governance and economic development
  2. 2. Governance concerns authority, decision-making and accountability in all domains 2 https://www.aeaweb.org/articles?id=10.1257/app.20130170 Governance is about the quality of institutions and the processes that they support Institutions = broad rules of the game in a society (North, 1990) • National-level governance • Governance in regions and municipalities • Governance in firms • Green governance of firms
  3. 3. Examining views of firms using Enterprise Surveys 3 Source: Enterprise Surveys and authors’ calculations. Enterprise surveys: Average percentage of sales diverted to informal payments Building on data on 18,000+ firms surveyed as part of Enterprise surveys 2018-19 in EBRD regions, previous rounds 2008-09 & 2011-14 Senior managers evaluate 15+ aspects of the business environment + questions about firms’ performance Special modules on the green economy, management practices and the use of CEO time
  4. 4. And looking at residents’ perceptions of governance and quality of public services using Gallup World Poll 4 Source: Gallup World Poll and authors’ calculations. Gallup World Poll: Global coverage since 2006, measures of life satisfaction How much life satisfactions do higher incomes buy? How much does the quality of governance matter?
  5. 5. Use Worldwide Governance Indicators to measure country-level governance 5Source: World Bank, IMF and authors’ calculations. Simple average of the Worldwide Governance Indicators of control of corruption, rule of law, regulatory quality and government effectiveness. Worldwide governance indicators at a glance, 2017 Control of corruption, rule of law, regulatory quality and government effectiveness scaled -2.5 to 2.5 [also voice and accountability and political stability and absence of violence] Results are similar for other measures as shown in TR 2013
  6. 6. The governance dividend
  7. 7. EBRD regions had weak governance in the mid-1990s relative to advanced economies and many EMs 7Source: World Bank, IMF and authors’ calculations. Simple average of the Worldwide Governance Indicators of control of corruption, rule of law, regulatory quality and government effectiveness. Economies in the EBRD regions had relatively weak governance in the mid-1990s In contrast with relatively strong skills
  8. 8. Countries’ progress was somewhat faster than in other EMs with comparable per capita income levels 8 Source: World Bank, IMF and authors’ calculations. Average of the Worldwide Governance Indicators of control of corruption, rule of law, regulatory quality and government effectiveness. Low-income = income below Tajikistan at market exchange rates in 2017, high-income = above Slovenia. Economies in the EBRD regions have strengthened the quality of institutions faster than other EMs with comparable income level Transition reforms, EU accession played an important role (see TR 2013); most progress in regulatory quality For emerging markets in general, governance gap with respect to advanced economies has been widening even as the income gap has (slightly) narrowed
  9. 9. In the end, the governance gap with respect to advanced economies remains large 9 Source: World Bank, IMF and authors’ calculations. Quality of economic institutions is captured by the average of the Worldwide Governance Indicators of control of corruption, rule of law, regulatory quality and government effectiveness. 2017 or latest available. Governance gap with respect to advanced economies remains large Most advanced economies are well above the linear trend line – governance becomes particularly important as growth models rely on innovation, entrepreneurship vs import of technology and economies of scale
  10. 10. Enterprise surveys also show that constraints on business have become less severe over time 10 Source: Enterprise surveys and authors’ calculations. Averages on a 0-4 scale (“no obstacle” to “severe”). Comparator economies are those with similar per capita incomes and where surveys were conducted both in 2006-10 (diamonds) and in 2016-19 (bars). Israel: 2013, Sweden: 2014. Constraints on business have become less severe over time Improvements in the EBRD regions are larger than among comparators with similar per capita income (mainly in Latin America – due to survey coverage) – but levels remain higher than in advanced economies
  11. 11. And corruption is no longer in top 3 constraints as seen by firms 11 Source: Enterprise surveys and authors’ calculations. Averages on a 0-4 scale (“no obstacle” to “severe”). Comparators are economies with similar per capita incomes and where surveys were conducted both in 2006-10 (diamonds) and in 2016-19 (bars). Sweden/Israel surveyed in 2013-14. Corruption no longer features among the top 3 constraints to doing business In contrast with 2008-09 when, with the exception of Central Europe, it consistently featured in the top 3 Among comparators, perception of corruption improved but it remains in top 3 – also in Russia and SE Europe
  12. 12. Improvements in regulations in Doing Business – firms’ experiences often differ significantly 12 Source: World Bank Doing Business, Enterprise Surveys and authors’ calculations. Values for Enterprise Surveys are estimated for a firm approximating Doing Business case studies based on a linear regression of firms’ answers (log number of days) on firm characteristics. Improvements in regulations in Doing Business surveys and based on firms’ experiences Doing Business measures days it takes to eg get a permit based on laws on the books and expert opinions; enterprise surveys provide a snapshot based on enterprises’ experiences – which take into account enforcement of rules and use of alternative channels so actual length of time tends to be shorter than in DB The number of days it takes to obtain construction permit, 2008 → 2019
  13. 13. Improvements in the quality of institutions relative to global average have slowed down 13 Source: World Bank, IMF and authors’ calculations. Quality of economic institutions is captured by the average of the Worldwide Governance Indicators of control of corruption, rule of law, regulatory quality and government effectiveness. Improvements in the quality of economic institutions in Central and SE Europe have slowed down In Central and SE Europe the Worldwide Governance Indicators peaked in 2014, as EU accession momentum subsided, populism gained momentum in a number of economies
  14. 14. And a widening governance gap as seen by residents in the Gallup World Polls 14 Source: Gallup World Poll and authors’ calculations. Index is based on 6 questions covering trust in corruption not being widespread throughout the government or business, confidence in the national government, the judicial system and courts, honesty of elections and freedom of media. A widening governance gap as perceived by residents
  15. 15. High growth dividend from improving institutions – mainly through building physical and human capital 15Source: IMF, World Bank, Penn World Table 9.0 and authors’ calculations. An “improved-governance” scenario assumes that countries close half of the gap between the levels of their economic and political institutions and those in the G-7 economies. https://www.aeaweb.org/articles?id=10.1257/app.20130170 Scenario: Closing half-gap in economic institutions between Ukraine and G7 (to today’s Croatia) over 10 years Calibrated based on past experiences of large improvements governance; conservative assumptions Similar conclusion when looking at the aftermaths of closely-fought elections In a scenario with improved governance, income per capita growth in Ukraine is at least 1.2% per annum higher
  16. 16. At firm level, less corruption is associated with higher growth of sales and productivity 16 Source: Enterprise surveys and authors’ calculations. Firm’s informal payments are instrumented using the average value for the region and sector where the firm operates. “Kvetch” = firm’s perception of transport, electricity access to land minus country average perception. 95% conf. intervals. A one standard deviation improvement in governance is associated with a 1.4% per annum faster sales growth Firms that grow faster may have to deal with a larger number of regulations such as getting new licenses -- firm’s exposure to corruption is instrumented with average answer for region-sector (excluding the firm) Control for a firm’s tendency to complain (“Kvetch factor”, Kaufmann and Wei, 2000)
  17. 17. The dividend adds up over time – difference of a generation in duration of income convergence 17Source: IMF and authors’ calculations. Based on income levels measured at PPP. Where data are missing, no convergence is expected on the basis of observed growth rates. Income convergence is now forecast to take longer – unless governance improves
  18. 18. Poor governance affects well-being directly, in addition to being a constraint on growth 18Source: Gallup World Poll and authors’ calculations. Perception of governance is instrumented using average of randomly selected subsample of observations in the same region (1/2 of total number), which are excluded from the main sample. Controlling for propensity to complain. In Ukraine, 1 sd improvement in governance has the same impact on life satisfaction as +US$270 per month; closing half-gap in governance to G7 is associated with closing 15% of happiness gap ( 8pp direct effect) People are likelier to state intention to emigrate if they are dissatisfied with governance Life satisfaction is significantly higher where governance is stronger
  19. 19. People are likelier to state intention to emigrate if they are dissatisfied with governance 19Source: Gallup World Poll and authors’ calculations. Calculated by regressing intentions to emigrate on each governance indicator in turn, using a linear probability model with survey-weighted observations. All regressions take account of demographic characteristics. 95% intervals In Albania, having confidence in government fighting corruption reduced intention to emigrate by as much as extra US$ 400 per month People with low levels of confidence in public institutions are more likely to report an intention to emigrate
  20. 20. Source: EBRD. Close to 200 reformers are supporting reform delivery Strengthening country-level institutions is difficult but possible: Evidence from Ukraine State capacity relies on developing local expertise, not simply importing foreign know-how Nurturing reform coalitions is key to effecting real change Built-in flexibility encourages local ownership and long-term sustainability 20
  21. 21. Advance of (uncensored) internet fosters transparency, especially in weak-governance countries 21Source: Guriev et al. (2019). The dots show the means of the outcome variable net of all controls by equal-size bins, with polynomial trend lines. The confidence intervals are constructed by performing a block bootstrap at the level of clusters. Look at rollout of 3G (data) internet across Europe post-2008 It strengthens link between perceptions of corruption in Gallup World Poll and corruption (as covered in EIU), as long as internet is not censored Government approval is lower where increases in 3G coverage were greatest – if internet is uncensored
  22. 22. National level: The governance gap remains large. It matters 22 EBRD regions entered the 1990s with stronger skills than comparators with similar per capita income but governance somewhat weaker than comparators, much weaker than advanced economies Considerable improvements in governance can be tracked in country indicators, Gallup Surveys and the latest enterprise surveys Yet evidence of slower progress (or even reversals) in the last decade – in a way that the “governance gap” with respect to advanced economies is almost as large as it was Yet this is more problematic than before: As economies develop, deficit of governance becomes more problematic Closing (half) the gap yields a sizable growth dividend for firms’ sales and economies, largely through greater investment in human and physical capital – and it makes residents happier and less likely to emigrate Strengthening country-level institutions is difficult but not impossible
  23. 23. Governance in regions and municipalities
  24. 24. Quality of governance varies significantly not just across countries, but also within them 24 Source: European Quality of Government Survey and authors’ calculations. Higher values of the index (on the 0-100 scale) correspond to better governance The quality of governance varies significantly within countries As countries become richer, public spending and decision making tends to become more decentralized
  25. 25. In Enterprise Surveys, much regional variation in terms of most binding constraint on growth of business 25 Source: EBRD-EIB-WB Enterprise Surveys and authors’ calculations. Within-country variation in most important obstacles to firms’ operations Reflects differences in implementation and enforcement of national-level regulations And also growing areas that are direct responsibilities of municipalities and regions
  26. 26. In EBRD regions, municipalities primarily responsible for waste, waste water, water, pre-school education 26Source: EBRD Capital Expenditure and Investment by Municipalities Survey and authors’ calculations. Tiers of government with legal responsibility for service delivery, by area Based on a survey of municipal governance arrangements conducted by the EBRD
  27. 27. Importance of regional factors in explaining perceptions of governance has been growing steadily 27 Source: Gallup World Poll and authors’ calculations. Gallup World Poll is a representative annual household survey , 140+ economies, 1,000+ respondents per economy in up to 50 locations % of variance in perception of governance explained by regional differences has been growing in the EBRD regions In part, reflects increased devolution of decision-making authority to lower levels of government As well as growing regional inequality that comes with technological change and urbanisation: weak governance, slow growth and outmigration of the skilled can reinforce each other in regions lagging behind
  28. 28. Quality of governance varies more within countries with weaker average governance 28 Source: European Quality of Government Survey and authors’ calculations. Logarithmic trend line. The quality of governance varies more within countries with worse governance And larger disparities in governance are associated with higher regional income inequality
  29. 29. Large effects on regional growth – using borders of former empires to establish causal links 29 Source: Diercke International Atlas World Political Map 1900 and Grosjean (2011). Based on the NUTS 2013 classification. Boundaries of former empires cut across today’s countries in several instances Former empires have significant impacts on institutions Imperial past is unlikely to have direct effects on growth / well-being today Nor would they be affected by economic activity today, making them plausible instruments in regressions.
  30. 30. Growth dividend of improvements in regional governance actually seen in EQI 2010-17 is 0.9% pa 30 Source: EBRD-EIB-WB Enterprise Surveys, Eurostat, EQI, OECD, World Bank and authors’ calculations. Based on regressions of regional growth on the quality of regional governance instrumented using dummy variables based on the boundaries of former empires in Europe. Regional governance has large effects on regional growth Improving governance from Romania’s worst-scoring region (the south-east), to best (Sud-Muntenia, surrounding Bucharest) is associated with 1.7% per annum in growth Over an individual’s working life, per capita income-wise this means Hungary → Spain or Serbia → Poland Also large impact on employment, life satisfaction (beyond the income effect)
  31. 31. Incentives to improve regional governance: Competition for capital and skilled labour 31 Source: FDi Intelligence, Financial Times Ltd 2019 and authors’ calculations. Based on the locations of the latest 500 projects in Croatia, Bulgaria, Greece, Hungary, Poland, Romania and the Slovak Republic. Locations of greenfield FDI projects Look at locations of greenfield foreign direct investment projects
  32. 32. Quality of regional governance matters for FDI, in particular with large capex (hard to relocate) 32 Source: Eurostat, fDi Intelligence, Financial Times Ltd 2019 and authors’ calculations. Regressions of log(number+1) of greenfield FDI projects per NUTS2 region on EQI institutional quality, controls and country fixed effects. Dark = significant at 5%. Regions with better governance attract more greenfield FDI projects People also report lower intention to emigrate if they reside in better-governed regions
  33. 33. Regional level: Benefits of improving subantional governance, with unchanged national governance 33 The quality of governance varies significantly not just across countries, but also within them Countries with lower levels of subnational spending and those with weaker governance on average tend to have larger within-country disparities in the quality of governance Within-country disparities in governance have been increasing; vicious circle of low quality of governance, weaker economic growth and outmigration of the skilled Improving regional or municipal governance could add ≈ 1pp per annum to per capita regional income growth via better firm performance + improve well-being of individuals In the interregional competition for resources, better-governed regions attract more greenfield FDI projects and individuals are less likely to emigrate Way forward: Benchmarking performance + disseminating best practices + stakeholder participation + coordination across municipalities + ensuring that municipal investment projects with high economic rate of return can secure financing.
  34. 34. Governance in firms
  35. 35. Governance in firm = rules/practices re relationship between shareholders, directors, managers, employees 35 Source: EBRD Corporate Governance Sector Assessment. conducted by EBRD Legal Transition Team. Range 1-5, average of 2.8. Corporate Governance Sector Assessment scores in the EBRD region Aims to minimise the conflict of interest between shareholders and managers – as managers have better information but not necessarily the same interests as shareholders Corporate Governance Assessment scores are higher where management practices are also stronger
  36. 36. Higher-income economies tend to have better management, yet much variation is within economies 36Source: Enterprise surveys and authors’ calculations. Explained share of variance refers to the share of variation in firm-level management scores explained by different combinations of country, sector, and size fixed effects. Management and senior manager time use scores vary greatly across firms within countries
  37. 37. Better managed firms are more productive 37 Source: Enterprise surveys and authors’ calculations. Regressions control for firm age, listed status, foreign ownership status, and include 2-digit ISIC industry and country fixed effects. Standardised beta-coefficients *, ** and *** denote values that are statistically significant at the 10, 5 and 1% level. Better management practices are associated with higher output per worker
  38. 38. Foreign firms tend to be better managed 38 Source: Enterprise surveys and authors’ calculations. Foreign-owned firms have best management practices Scoring is based in Enterprise Survey questions on management practices capture a firm’s core business practices relating to operations, monitoring, targets and incentives
  39. 39. Firms that face strong competition, those in regions with better business environment are better managed 39 Source: Enterprise surveys and authors’ calculations. Based on regressions, results are significant at 5%. Regions with high competition are those where % of firms reporting having 10+ competitors > median; similarly for regions where labour market regulations are less of an obstacle. Firms operating in regions with stronger competition and better business environment are better managed
  40. 40. Weak national-level governance impedes delegation to professional managers 40 Source: Enterprise surveys and authors’ calculations. Regressions control for logarithm employment, log-age, 2-digit industry and country effects. High-trust and low-trust subnational regions based on % of Gallup respondents who believe others can be trusted. Standard errors in parentheses. Family-owned companies are more likely to higher professional managers in regions with high levels of trust Firms run by professional managers score more highly in on management quality and use of CEO time But national-level governance / trust is weak delegation is risky; only 17% delegate to professionals
  41. 41. Weak contract enforcement results in suboptimal use of production inputs 41 Source: World Bank, Enterprise Surveys and authors’ calculations. Share of input materials in total costs on the vertical axis represents residuals after taking into account firm size, sector and other observable characteristics in the regression analysis. 95 per cent confidence intervals shown. Where contract enforcement is costly firms’ use of material inputs is lower
  42. 42. Firms: Strengthening corporate governance and management in firms 42 Various aspects of firm governance are closely related: For instance, businesses have better management practices, on average, in countries that score higher in terms of the EBRD’s Corporate Governance Sector Assessment Differences in firm performance are to a significant extent driven by differences in firm governance: Better corporate governance and management practices enable firms to combine human capital, physical capital and material inputs more efficiently Foreign firms, firms in markets with stronger competition (including those with international operations), firms operating in regions with less onerous labour regulations are better managed Firms with professional managers are better run but few family owners delegate – to a large extent due to weaknesses of national-level governance and deficit of trust Recent thinking around corporate governance emphasise that firms should explicitly elevate broader interests such as those of employees and customers, for instance emissions (see Chapter 4)
  43. 43. The green governance of firms
  44. 44. Quality of green management varies across economies: Based on Enterprise Surveys green economy module 44 Source: EBRD-EIB-WBG Enterprise Surveys and authors’ calculations. Green management practices vary considerably across economies Strategic objectives that mention environmental or climate change issues, manager responsible for environmental and climate change issues, monitoring and targets
  45. 45. Country factors matter yet 90%+ of variation in green management practices is within economies 45 Source: EBRD-EIB-WBG Enterprise Surveys and authors’ calculations. Cross-country differences in sectoral composition of the sample are controlled for. Density = the number of values that fall into each class divided by the number of observations in the set and the width of the class. Green and general management scores vary considerably across firms Country factors explain 10% of variation (1/3 of the explained total) – reflecting regulations and standards Large mass of firms with just-below-average green management scores (to the left of zero) and a long tail of firms with good green management scores; same pattern within countries
  46. 46. Firms in “dirty” sectors have greener management in response to regulatory, customer pressures 46 Source: EBRD-EIB-WBG Enterprise Surveys and authors’ calculations. Dirty sectors include paper products, printing and publishing, coke, petroleum, chemicals, rubber and plastics, non-metallic mineral products, basic metals and transport. Firms in “dirty” sectors have on average better green management practices
  47. 47. Older, larger firms; foreign firms, exporters also have better green management practices 47 Source: EBRD-EIB-WBG Enterprise Surveys and authors’ calculations. SMEs have fewer than 100 employees; young firms are less than five years old. Older, larger firms; foreign firms, exporters have better green management practices
  48. 48. Exposure to extreme weather, pollution by others prompt firms to step up green management 48 Source: EBRD-EIB-WBG Enterprise Surveys and authors’ calculations. Positive correlation between the average quality of green and general management practices Overall, 10% of firms in the EBRD regions reported experiencing monetary losses due to extreme weather events over the last three years
  49. 49. Firms that face customer pressure, higher energy costs are more likely to make green investments 49 Source: EBRD-EIB-WBG Enterprise Surveys and authors’ calculations. Customer pressure, energy taxes boost green investments Examples of pure green investments: Green energy generation on site, energy management, waste minimisation, recycling and waste management, pollution control measures, water
  50. 50. Firms that do not invest in energy efficiency say “not a priority”, only 13% cite non-profitability 50 Source: EBRD-EIB-WBG Enterprise Surveys and authors’ calculations. Reasons for not adopting energy efficiency measures vary SMEs are more likely not to invest due to credit constraints than large firms Need for awareness campaigns – and policies delivering “a nudge”
  51. 51. Where firms are credit-constrained they invest less in green measures 51 Source: EBRD-EIB-WBG Enterprise Surveys and authors’ calculations. The first-stage instruments are the branch-weighted average wholesale funding dependence in 5km radius and dummies for having experienced extreme weather or pollution caused by others Credit constraints, green management, and green investments But the quality of green management has a greater bearing on green investments Credit constraints are instrumented by the extent to which banks in a locality relied on wholesale funding before the 2008-09 crisis (and thus had to deleverage more in the aftermath)
  52. 52. And in credit-constrained localities pollution from industrial facilities declined more slowly 52 Source: European Pollutant Release and Transfer Register. Based on locations of 1,819 industrial facilities across Bulgaria, Czech R., Estonia, Hungary, Lithuania, Romania, Poland, Slovak R. and Slovenia during 2007-2017. Geographical distribution of industrial facilities across Emerging Europe Average industrial facility reduced its greenhouse gas emissions by 88% during 2008-2017 (in localities where banks had an average funding structure)
  53. 53. In credit-constrained localities annual emissions were around 4.6% higher than in other localities 53 Source: EBRD-EIB-WBG Enterprise Surveys and authors’ calculations. 95% confidence intervals shown. Impact of local credit supply shocks on facility-level GHG emissions, by year The delayed impact of the 2008-09 crisis reflects project implementation lags
  54. 54. Green firms: Emissions in the EBRD regions have fallen since 1990s yet more progress is needed 54 Evidence from Enterprise Surveys: there are firms with excellent green management practices in the region, yet the majority lag behind Credit constraints slow down firms’ investments, including those with environmental benefits. Yet whether firms undertake improved energy management, green-energy generation, air- pollution controls and other purely green investments depends primarily on green management practices Firms tend to prioritise green management and investments when faced with extreme weather / pollution or in response to customer pressure To give firms a “nudge”, governments may have to use environmental standards, other regulation, subsidies that are contingent on the use of specific green technologies, support targeted green credit lines An important precondition for success is effective enforcement in a corruption-free environment Voluntary environmental standards may help to leverage the power of peer pressure and consumer awareness to reduce firms’ environmental footprint further
  55. 55. Structural reform
  56. 56. Updated assessment of transition qualities 56 Source: EBRD. Sustainable market economy as Competitive, Well-governed, inclusive, green, integrated and resilient

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