Domestic Resource Mobilization and the Challenge of Governance

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

Summary features of ESCWA Countries 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

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

Corruption and Growth

Rule of Law and Growth

Voice and Accountability and Growth

Political Instability and Growth

State Capabilities and Reform Priorities

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

Domestic Resource Mobilization and the Challenge of Governance