How To Understand The World'S Governance

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1 Metrics Matters: Measures of Governance and Security and the Business Perspective An initial empirical exploration Daniel Kaufmann, World Bank Institute For presentation at the NATO Forum on Business and Security, February 10 th, 2004, at Berliner Congress Center 1

2 Governance: A working definition Governance is the process and institutions by which authority in a country is exercised: (1) S -- the process by which governments are selected, held accountable, monitored, and replaced; (2) E -- the capacity of gov t to manage resources and provide services efficiently, and to formulate and implement sound policies and regulations; and, (3) R -- the respect for the institutions that govern economic and social interactions among them 2

3 Operationalizing Governance: Unbundling its Definition into Components that can be measured, analyzed, and worked on Each of the 3 main components of Governance Definition is unbundled into 2 subcomponents: Democratic Voice and (External) Accountability Political Instability, Violence/Crime & Terror Regulatory Burden Government Effectiveness Corruption Rule of Law We measure these six governance components 3

4 Empirical Approach to Governance 1. Macro : 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 4

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, Latinobarometro, Afrobarometer Expert Assessments from Commercial Risk Rating Agencies: DRI, PRS, EIU, World Markets Online, Expert Assessments from NGOs, Think Tanks: Reporters Without Borders, Heritage Foundation, Freedom House, Amnesty International Expert Assessments from Governments, Multilaterals: World Bank CPIA, EBRD, State Dept. Human Rights Report 5

6 Control of Corruption -- Selected Countries, KK 2002 Good Bad -2.5 Source for data: Kaufmann D., Kraay A., Mastruzzi M., Governance Matters III: Governance Indicators for , WP #3106, August Units in vertical axis are expressed in terms of standard deviations around zero. Country estimates are subject to margins of error (illustrated by thin line 6atop each column), implying caution in interpretation of the estimates and that no precise country rating is warranted.

7 Governance World Map : Control of Corruption, 2002 Source for data: ; Map downloaded from : Colors are assigned according to the following criteria: Red, 25% or less rank worse ( bottom 10% in darker red); Orange, between 25% and 50%; Yellow, between 50% and 75%; Light Green between 75% and 90% ; Dark Green above 90% 7

8 Governance World Map : Political Stability/ Lack of Violence, 2002 Source for data: ; Map downloaded from : 8 Colors are assigned according to the following criteria: Red, 25% or less rank worse ( bottom 10% in darker red); Orange, between 25% and 50%; Yellow, between 50% and 75%; Light Green between 75% and 90% ; Dark Green above 90%

9 Governance Indicators: Yemen, 1996, 2000 & 2002 Source for data: ; Colors are assigned according to the following criteria: Dark Red, bottom 10 9 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.

10 Governance Indicators: Jordan, 1996, 2000 & 2002 Source for data: ; Colors are assigned according to the following criteria: Dark Red, bottom 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.

11 Firm s Cost of Terrorism threat and Organized Crime (% Firms Report High Cost, selected countries) Cost of Terror Threat Cost of Organized Crime Percentage firms (%) Algeria Belgium Canada Colombia France Germany Greece Israel Italy Kenya Latvia Netherlands Norway Philippines Portugal Russia Spain Sri Lanka 11 Source: EOS 2002/03. Question: The threat of terrorism in your country imposes significant cost on business Turkey United Kingdom Uruguay United States

12 % Firms Report High Cost of Terrorism, Crime, and State Capture (high level corruption) Regional Averages Percentage Firms Cost of Terrorism Common Crime Organized Crime State Capture 0 OECD East Asia (NIC) East Asia dev. Former Soviet Union Source: EOS 2003 (GCR), author s calculations Eastern Europe South Asia Subsaharan Africa Middle East/N. Afr Latin America 12

13 High 5 Cost of Terrorism Threat to Business and State Capture ( Grand Corruption ) Costs of Terrorism Threat Low 3 1 Low Medium High Source: EOS, 2003 State Capture ( Grand Corruption ) 13

14 % Firms Report High Extent of Money Laundering (Bank & Non-Bank; Regional Averages) Bank Money Laundering Percentage Firms Non-Bank Money Laundering 10 0 OECD East Asia (NIC) East Asia dev. Former Soviet Union Eastern Europe South Asia Subsaharan Africa Middle East/N. Afr Latin America 14 Source: EOS 2003

15 Far from a Simple Laudromat : AML within a Broader Perspective A Schematic Chart Misgovernance, Money Laundering and Terrorism Governance Setting: Good Governance Misgovernance and Corruption in Public Sector and Corporate/Financial Sector ML Process: Stage 1. Type of Business Activity and Source of Profit: Legal Business Concern Drug Trafficking/ Arms Trade/ Prostitution Corruption by Country Leadership/ Politicians Corrupt Public Officials/ Procurement Regulatory/ State Capture by Corporates/ Banks Insider Trading, Stock Market X-Rate & Trade Prices Manipulation Organized Crime/ Racketeering/ Extortion/ Gambling Transfer Pricing/ Tax Evasion Charities and Other Front Companies Stage 2. Type of Financial Transaction/ Intermediary: Legal Financial Transaction through Bona-fide Financial Institution Money Laundering; #1: a) Through Banks: i) Placement ii) Layering iii) Integration -- e*banking Money Laundering; #2: b) Through NBFIs: -- Real Estate -- Securities Brokers/Derivatives/X-Rate Market -- Leasing/Insurance Companies -- Others Informal Financial and other Institutions: -- Hawalas -- Exchange Rate Mkt. (Peso) -- Commodities (gems, etc.) -- Cash -- Others Source A Source(s) B (B1,B2) Source C Stage 3. Use of Funds/Profits: Legitimate Consumption/ Investment/ Developmental Use of Funds Illegal Political/ Campaign Funding Terrorist Activity Other Criminal Activities Luxury Consumption DK/EF/WBI Draft 11/01 Stage 4. Development? Pro- Development Anti-Development and Global Public Bad 15

16 High 6 Money Laundering through Banks and Diversion of Public Funds Money Laundering through Banks FIN ISR URY CHE HKG IRL ESP PRT DEU BEL NORAUT BWA NLD CHL SVN SWE CAN USA AUS SGP GBR NZL TUN DNK ISL r = 0.85 UKR ARG RUS COL IDN PRY PHL HTI NIC HND ROM BOLECU GTM MEX BGD BGR VENNGA LVA PERPAN TTO JAM CZE POL TUR IND DOM ZWE LTUTHA LKA SVK CRI BRA MAR GRC SLV MUS KOR HUN ITA MYS JOR HRV TWN ZAF VNM CHN EST JPN FRA NAM Low Diversion of Public Funds High 16

17 High 7 Non-Bank Money Laundering and Capture of the State r = 0.82 Non-Bank Money Laundering NOR GBR NZL FINDNK AUS BEL HKG PRT IRL NLD CHE SWE ISR DEU AUT USA SGP CAN ITA HUN ESP EST ZAF ROM JAM IND THA RUS BRA POL TTO CRI PER TUR PAN SVK LVA LTU HRV GRC MUS URY SVN KOR FRA TWN MYS NAM JOR CHL BWA CHN JPN TUN COL HTI ARG UKR PRY MEX BOL NIC BGR ZWE CZE ECU PHL NGA HND DOM LKA MARSLV VNM BGD GTM IDN VEN ISL Low State/Regulatory Capture ( grand corruption ) High 17

18 Cost of Terrorism vs. (Non-Bank) Money Laundering 7 High Cost of Terrorism 4 r = 0.28 ISL DEU AUS SGP TUN USA JPN FRA NLD AUT GMB CHL CHE EGY SLV CHN KOR MAR MLT ITA MUS TZA PAN POL BRA TCD IND SEN RUS TUR CRI DZA MEX PHL VEN ZWE BGRTTO AGO JAM ARG COL MOZ Low 1 SWE PRT FIN URY Money Laundering High Low Source: EOS

19 Governance, Security and the Perspective of the Firm 1. Metrics in Governance & Security: feasible, & it matters 2. The Firm: unit of empirical observation--obtaining data 3. Costs/Risks to the Firm of different forms of insecurity vary greatly from setting to setting country diagnostics 4. The perverse role of (few) firms in misgovernance: money laundering, state capture, and their corrupting influence 5. Money Laundering (ML): i) within a broader governance framework; ii) complex link between ML and terrorism; and, iii) Bank vs. Non-Bank Money Laundering -- data 6. Implications, 1: strengthening rule of law institutions, protection against organized/disorganized crime Implications, 2: a developmental perspective Implications, 3: a broad governance perspective (ML, 19etc.)

20 Data for Analysis and informing Policy Advise, not for Precise Rankings Data in this presentation is from aggregate governance indicators, surveys, and expert polls and is subject to a margin of error. It is not intended for precise comparative rankings across countries, but to illustrate performance measures to assist in drawing implications for strategy. It does not reflect official views on rankings by the World Bank or its Board of Directors. Errors are responsibility of the author(s), who benefited in this work from collaboration with many Bank staff and outside experts. 20

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