1ý7577 LATPS Oceasional Paper Series Number 13 - August 30, 1993 THE IMPACT OF SOCIO-CULTURAL AND GOVERNANCE FACTORS ON INSTITUTIONAL REFORM Thakoor Persaud and Waleed Haider Malik Public Sector Management Division Technical Department Latin America and the Caribbean Region 7lhis publicatit ws refec =he ~ging w~rkprognun of sectorruar~ and aalyis of &e PuMic ScorManag Divisia in the La~n Ameica and the Cmibbean Regin Technica Depar~nast of the WorD Bnk Iupa e ip , o swimulate d,aw&mm mng saff m key issuesjfacing te secbor. ie f~dings, uneq>retanns, and conc~usions apssed in Ms paper ar enaitl tose of the author(s) and should not be auribued in &n Vanner zo the World Bak, o iis q@liaed organiations, or to the ~menber of is Boani of Execuxve Dim~ctors or the co10res Mhey reprwen. ... officers shall not interfere in the political affairs of any member; nor shall they be influenced in their decisions by the political character of the member or members concerned. Only economic considerations shall be relevant.to their decisions... .with due attention to considerations of economy and efficiency and without regard to political or other non-economic influences or- considerations". Articles of Agreement, IBRD, Articles M. & IV, Section S and 10, February 16, 1989. U... participation, ownership, and involvement [of the poor] lead to more effective and sustainable development. First and foremost, it is the government's responsibility to ensure that its citizens are fully involved in the development decisions which affect their.lives. ... we need to take account of the linkages between poverty and governance issues-accountability, transparency, and adherence to .the rule of law. We have to. recognize,that corruption, unjustified military spending, and civil strife often divert government's attention and resource from development." Plenary Address of Mr. Sven Sandstrom to.International. Development Conference on "Overcoming Poverty: Global Priority January. 12,1993. 1. Introduction. As the above quotations show, over the past four decades, interpretation of the Bank's role in its interaction with borrowers has undergone a significant change. Viewed in a historical context, this has been a rather evolutionary process resulting from both changing world events and an increasing awareness that growth and development have several intricately interwoven non-economic elements which cannot be ignored without negative consequences to the system. 2. During the early decades of Bank operation, the prevailing view in most borrowing countries was that if there were deficiencies in the system, the government had to take an active role in addressing them. Consequently, several countries nationalized many institutions, created parastatal ones and used their legislative powers to provide incentives and penalties and to influence various sector activities aimed at increasing output, creating employment, and assisting in development. In their relation with the Bank and other lenders and donors, many countries established several areas which were defined as "off limits* to them. These included: population (birth control, family planning, etc.), education (curricula, teaching methods, etc.), civil service reforms (salary, qualifications, job security, etc.), the electoral system, nuclear and environmental issues, privatization of state enterprises and military expenditures. 2 Evolution in the Banks' Role Eggson Raioal-Istumn Demonstan of Need to demonstrate viable ahcnativm Special Project Units. Viable Models Off-fis aman of inervention. Individual Pwqjects. Macrosconomic Limited impact of project approach. Need Stmcana AdjustmenLoans(SALs). -Chan ia address macroeconomicissues via SubseclorRefrus. mpovingsseate.- arpen focusesctorlosiuaos. .SectorAqjustasmrLosm(SECAU). Policies an. joUles,alc,to premal geator . ad Policy Refbmk lovesanent ifficiency. social Developmeas Need so Include, buma, ecoondc, socio* Techcal Assbance for ludicial, - ubumiandIArzsc hfactrs inthe lumRmweanalbeachs .develpmespracs.. Refaus. Box 1 3. For many years, the Bank and other lenders and donors took these conditions as given and they devised various ways of working within this constrained framework. Because most of the existing institutions in the countries were generally weak and ineffective and the Bank was not ready to embark on a comprehensive reform process so early in its lending program, special project units were created. Apart from providing a bypass to existing bottlenecks and assisting in the efficient implementation of various demonstration projects, such units were expected to be later absorbed by their parent ministries or agencies and become the nuclei of the improved organizational structure needed to continue future operations and effect reforms at the national level. 4. Although relatively successful as pilot and demonstration projects, it became apparent that many of the early-generation Bank projects were too ambitious in scope (christmas tree projects), and perhaps not cognizant enough of the operational complexity of achieving and sustaining project goals. For most early-generation projects, apart from counterpart funding and logistical problems, there were serious inter-agency rivalries and conflicts among various ministries and the staff of the special project units (who were generally perceived as an elite group with better salary, working conditions, etc., usurping the power of established agencies). Several of these problems proved to be rather intractable as the needed institutional, financial and other reforms and modifications which the Bank expected to occur never materialized. Thus, although the project units had some initial success, it was not long before the inefficiencies of the system once again surfaced in project units approach with many of the same legal, institutional and administrative problems which plagued established entities. 5. As institutional deficiencies worsened and expectations on the role of special project units did not materialize, the Bank began to re-focus its attention upon basic structural impediments within the existing framework. This approach was marked by the elimination of 3 special project units with greater focus placed upon existing institutions and assistance to improve subsector and overall macroeconomic policies. Structural adjustment lending (SAL) began in 1980 with the additional goal of ameliorating the acute balance of payment crises in many LDCs in the late 1970s. Gradually, structural adjustment lending was expanded and deepened through sector adjustment operations (SECALs) which included technical assistance to improve the operational efficiency of existing agencies. These changes were based upon a growing awareness and conviction that the policy environment is as important, as the physical and institutional framework in inducing growth and development'. 6. After the negative impact of various institutional rigidities and weaknesses on many of the initial technical assistance efforts became apparent, the focus shifted to more basic questions regarding justification of the appropriateness of existing institutional, administrative, financial, legal, civil service and other such systems, along with issues surrounding governance and accountability questions.2 7. It now appears that most of the areas which were once considered off limits to lenders and donors are now slowly being opened to closer scrutiny.- As stated during a recent symposium, "Concern over corruption and waste of resources inevitably arises in discussion of improved governance," and, "donors have a responsibility to ensure that the human dimension is not lost in pursuit of the equally essential process of economic reform." To a large degree, evolution of this new attitude is due to a variety of factors, including the worsening economic performance of most LDCs over the past two decades, their large debt overhang, a move toward democratically elected governments in many countries, and more recently, the disintegration of the Soviet Union and superpower alliances which, for decades, influenced how aid and support were provided. 8. Although the international environment is today much different from what it was a few decades ago, there are several important deep-rooted socio-cultural, political, economic, See, for example, "Issues of Governance in Borrowing Members - The Extent of Their Relevance Under The Bank's Articles of Agreement." Memorandum of the Vice President and General Council, November 1990. For an elaboration of governance issues, see Managing Development: The Governance Dimension, A Discussion Paper June 25, 1991. Task Force on Governance, and Governance: Experience in Latin America and the Caribbean, LATPS Occasional Paper Series, March 29, 1991. Measures which enhance government implementational capabilities are recognized in what the Report on Adjustment Lending II calls the "political economy of adjustment." "Democracy and Development." Address by the Chairman of OECD/DAC at the International Symposium on Democratization and Development Assistance. October 8-9, 1991, Ministry of Foreign Affairs, Japan. Accountability in Latin America and the Caribbean, is newsletter sponsored by USAID, IDB, IBRD, IMF, OAS and other UN affiliates in an effort to reduce inefficiencies due to mismanagement and corruption in the region. 4 budgetary and financial and other elements which have not changed much over this time; these must be taken into account before any workable diagnostic and prescriptive measures can be arrived at. To a large extent, recognition of the importance of these factors is reflected in the Charter of the newly formed European Bank for Reconstruction and Development (EBRD) where the preamble explicitly calls for "the fundamental principles of multiple democracy, the rule of law, respect for human rights and market economics among borrowers. "5 9. The issues raised in this context include the following: How does one convince city- council members to vote for improved property tax collection or increases in such taxes when these members are the owners of most of the lands which would be so taxed? Similarly, for a police commissioner, customs director or other such official, the prevalent systems in many countries provides a *market" for various choice positions, equipment, facilities, etc., to go to the highest bidder; how can those who benefit from these arrangements be convinced to relinquish their lucrative positions? And why would a mayor or city treasurer be interested in reforming financial accountability in the system when the existing system allows them greater flexibility and discretionary actions? Similarly why would a judge or a judicial employee be interested in streamlining court procedures when these complexities allow them to maintain control over the system for their personal benefit. At a wider and more important level, what incentives would a politician be left with if jobs, contracts, housing units, subsidies, etc., are awarded by qualifications and merit, through a transparent and neutral system? The following analysis is an attempt to highlight some of these factors and discuss their implications for lenders and donors. Although it abstracts and greatly simplifies some very complicated relationships, it does provide a representative picture of the most salient elements involved in the process. 10. Socio-Cultural Factors. In order to gain a better understanding of what is occurring in many LDCs today it is useful to briefly review the socio-cultural context within which changes are being proposed and effected. For decades, Bank staff and other lenders and donors have focused their attention almost entirely upon quantitative aspects of project design and implementation. Part of the reason was because of the *off limits* area mentioned above; however, another important reason was that in quantifying the problem in this way, this eliminated many of the subjective elements of the analysis. Thus, for example, in reviewing the operation of an entity, one can say that it has an overhead ratio which is high when compared with similar entities elsewhere. Similarly, for arrears, it can be stated that the current rate is too high. In such cases, the technical recommendation naturally follows; these figures have to be improved over a set period. In establishing improvement targets, not much is mentioned about the underlying causes of these figures; to get overheads down, for example, expenditures and/or staff must be reduced. What do these entail? How feasible is it to expect such actions? Until recently, a type of "black box" approach existed in this area under which the dynamics of the process needed to effect desirable changes were not explicitly subject to any detailed scrutiny. Articles of Agreement, European Bank for Reconstruction and Development (EBRD), Articles I, II and VIII, May 29, 1990. 5 11. When discussing countries or regions, there is the tendency to think in terms of homogeneity among the population and within various geographical areas, statistics, etc. (e.g. in terms of population size, GDP, health indicators, growth rate, physical conditions, etc.). In general, most of the LDCs were created through rather arbitrary means which resulted in political areas comprised of people having a large number of different characteristics arising from differences in race, national origin, region, tribe, tradition, religion, language, etc., some of these being more pronounced than others, but, as evidenced in several regions today, each having the potential to ignite protracted and debilitating conflicts. This is an important factor which is very often overlooked in understanding development issues and implementation of reform programs in a country. 12. In many societies, socio-cultural practices require that group members assist each other at the expense of outsiders. In an environment of limited economic opportunities, population differences can become a powerful criteria for reinforcing such zero-sum decisions. Consequently, upon getting into office whether by democratic or other means, jobs and other benefits would generally accrue to those affiliated with the group in power, with existing staff either shunted aside or fired, depending upon the circumstances. It should be noted parenthetically that such a situation has also occurred in the DCs;' however, while in the DCs the practice may have weakened over time and through legal prohibitions, and is now only applied to high-level political positions, for the LDCs, this may permeate the system and reach as low as the janitorial level. In several countries, years of conflict resulted in uneasy truce with some type of power-sharing mechanism; however, even after decades of co-existence it does not take much to rekindle old animosities. In other cases no accommodation is made and the group in power dominates and yields no concession to others, irrespective of ability, efficiency and other such considerations. Finding examples of such cases involves no more than picking up a newspaper today. 13. Although some institutions in the LDCs were initially created with a genuine intention of addressing the needs of the population, indications are that they were invariably conceived in an ad-hoc manner to mirror systems elsewhere, with no serious consideration given toward their overall applicability culturally, geographically, economically, etc. Consequently, several studies analyzing laws, rules and regulations, etc., of various entities, have documented many contradictions or inconsistencies. One basic problem found in most LDCs today is the proliferation of redundant entities which are highly overstaffed with inappropriately qualified employees at all levels. In reviewing many of these entities, several common features appear both within and among various countries. The staff are generally not appropriately qualified and the few who do have some of the needed skills are poorly paid with a high turnover rate. Most employees have more than one full-time job and absenteeism is very high as they seek to divide their time among these jobs.' There is an acute quantitative and qualitative deficiency of basic 6 In the US, for example, it was not until 1883 that the US Civil Service Law was enacted-to end a widespread patronage system. 7 Ministers in several countries usually have more than one job. This raises both conflict-of-interest and efficiency questions. 6 office facilities (desks, chairs, working space, typewriters, telephones, etc.), and the existing stock of vehicles and equipment which are not misappropriated are poorly maintained. A common practice in some countries has been to have outgoing staff remove all documentation and institutional memory records as they leave. Thus, apart from the tendency to use subjective and non-transparent criteria to create and overstaff institutions in the system, the level of skills deficiency, weak institution memory, low salaries and poor facilities add to the problem. A review of the situation in many countries also shows another factor which helps to perpetuate the system - the high financial and political cost of retrenchment. Even if political and union pressures can be overcome, in order to legally terminate employment in the civil service and other areas, a separation package amounting to a large multiple of the annual salary may have to be paid along with other benefits. The tradition has therefore been to increase the payroll as each incoming group appoints additional staff. It should also be recognized that leaders are well- aware that swelling the openly-unemployed ranks in a country can aggravate a volatile situation and lead to demonstrations, violence and even changes in government. 14. Governance Factors. In terms of accountability, in most of the borrowing countries, the system of checks and balances, monitoring and control through such devices as budgeting and audited statement of operations is woefully deficient. Part of the reason .for this can be attributed to poor staff quality; however, in most cases, factors involving control and access to records, the dominance of the public sector, lack of transparent procedures and little or no penalties for non-compliance, all work to foster waste and corruption.' In many countries, the existence of a one-party system over decades, with weak or absent independent media investigative and reporting ability, add to the accountability problem. To a large extent, such waste and corruption are products of the system. If, as surveys in several countries indicate, the official monthly salary is not enough to meet even basic food needs of an average family for a few days, one has to seek other ways of earning enough for survival. It should be stressed here that not all employees succumb to temptations and questionable practices in order to survive; many of them strive to keep the system functioning in spite of overwhelming odds. There are also those who, after trying for a while, enter the private sector or migrate to other countries and thus further contribute to the 'brain drain" problem, which, in some countries is now a major impediment to reform and development.9 See Democracy and Development, op. cit. The issue of a "brain drain" arises frequently in North-South debates. However, its nature, origin and pattern of occurrence go much deeper than such debates indicate. In some countries, the Opush" factors can quickly become dominant; for example, when jobs . are not awarded on qualification and merit, this frustrates the qualified candidates who are bypassed as it deprives the institution of qualified staff. Even for qualified staff who are selected, an important push factor is the low salary level which is steadily eroded by inflation. When crime, violence and other such security threats are added, incentives increase for leaving the country, especially if this is accompanied by "pull" factors of better working conditions. Once the cumulative effects of these factors results in migration, later efforts at expatriate recruitment tend to have limited success once they have re-established their livelihood elsewhere. 7 15. Most of the questionable practices which began, perhaps as a necessity for survival a few decades ago, have now grown into an art form in many countries in spite of recent intensive exhortations and actions of some leaders for a return to honest government, better services, etc. Corruption and exploitation of weaknesses in the system is not a recent phenomenon, nor is it restricted to the LDCs. As recent headlines in the press from several countries show, corruption has permeated their system to an incredible level. Still, in comparisons between DCs and LDCs, the level of pervasiveness, degree of public acceptance, economic impact, etc., differ substantially. Also, for most cases in the DCs, misappropriated resources are likely to remain in the country as savings or investments, while for the LDCs, indications are that most of the misused funds which are obtained by high-level officials find their way overseas. In terms of prosecution, penalties, asset reclamation, etc., the DCs and LDCs again differ greatly in their approach. 16. The growing chorus for privatization, market orientation, institutional reforms and accountability at all levels of government, is based upon the premise that individuals acting in their own self-interest would promote the "invisible hand" effect of improved economic welfare for all. In most of the LDCs today, many individuals are acting in their own self interest; however, they operate within a highly bureaucratic and distorted system within which they strive to maintain their well-entrenched positions and associated benefits. For example, a private businessman can enter into partnership with a few influential officials and develop a system to produce housing units, process foodstuff, originate finance etc., at a substantial economic profit. Under such circumstances, from their viewpoint, why would there be interest in seeking out or allowing the entry of other competing lower-cost systems in the country, even though such systems can dramatically reduce costs and have a significant impact upon sector employment and output? Before any significant progress can be made in dealing with most governance issues and institutional reform programs, reformers have the unenviable task of convincing various groups throughout the system that they have to adopt a more long-term focus and that the reform process is not a zero-sum one under which some would gain only if others lose. 17. In the majority of countries with such problems, the collective force of such special- interest groups is powerful enough to thwart most well-meaning but poorly-organized efforts aimed at eliminating their privileged positions and establishing a competitive framework. This is a key point to understand when considering the chances of success of any proposal to effect free-market institutional changes; there are many powerful individuals who receive immense gains from their entrenched positions at all levels of the existing system and they will not voluntarily yield their positions unless they are threatened by a superior force or they can be persuaded to accept alternative incentives. In a different but somewhat related way, there are similarities to the situation in many DCs where, for example, redundant military bases, weapons systems, subsidized tobacco and other farm programs, etc., cannot be easily terminated because lobbyists and those who currently benefit from the system would lose jobs, suffer short-term dislocations and withdraw support from the politicians advocating such changes. 18. As more and more countries move to democratically-elected systems, the length of time in office becomes another important factor influencing the nature and dimension of policy decisions which are taken. Most central governments are elected for four or six-year periods 8 while local administrations may have even more frequent elections. Several countries prohibit multiple terms for presidents, governors, mayors, etc. Since the gestation period for most national development programs could extend well beyond an election term, this generally poses a conflict for those who place priority on achieving substantial or visible results during their term in office. The situation is further complicated by the fact that during the pre- and post- election period, most of the senior-level staff are distracted by election tasks or job uncertainty. Consequently, many important ongoing and new operations suffer delays until the election effects are clear and a new administrative term begins. 19. Another factor to note is that most of the LDCs are functioning in a crisis-management mode where the day-to-day requirements of governments do not leave much time and other resources for intermediate or long-term programs. Little or no resource can therefore be devoted to such important but less visible areas as maintenance of plant and equipment, transport facilities, environmental effects of settlement or industrial activities, etc., although there is clear recognition of the high economic rate of return of such investments. In this regard, the LDCs have a common problem with several cities in the DCs which are struggling with widening budget deficits and a host of underfunded maintenance and capital investment programs.10 The Bank and other lending and donor agencies have long advocated greater attention to maintenance investments; however, until recently, their lending policies in this area have generally not been clearly observed and most lenders and donors have not generally followed up and insisted that borrowers focus upon maintenance issues, the tendency still being to yield to borrowers' insistence upon financing for new operations. 20. While factors such as those described above can provide strong incentives for politicians to take the least controversial route in managing their economies, the democratization process, along with lack of other viable options, have led some policymakers to advocate significant institutional reforms and adoption of austerity measures. Even though many countries have achieved a great deal, the results of these actions are still not clear. There are cases where reform proposals have drawn a great deal of criticism, protest and sometimes, violence from various groups who feel threatened by their adoption. Many governments have been thrown out of office as a direct consequence of efforts to change the system. As a lesser form of reaction, in one country, fourteen government ministers were impeached and removed from office over a ten-year period because they advocated or supported proposals for such policies as increasing the price of petroleum and floating the exchange rate. Apart from intimidating policymakers, such actions also paralyze the legislative system as attention is diverted to the impeachment and debate proceedings. 21. To some degree, such a situation is similar to cases where individuals who lose their jobs strive to maintain their pre-loss consumption pattern, with the expectation that their income-loss is temporary and they do not have to make any painful changes to their life-style. In an analogous manner, countries accustomed to low oil prices or a tradition of populist governments, 10 Washington D.C.'s water system, for example, suffers an estimated 24-40% unaccounted-for water loss, with much of the distributional network being over one hundred years old. 9 for example, are not inclined to change their spending habits when they encounter revenue declines. When both policymakers and the population believe that their losses are temporary and they would soon return to their previous situation, achieving changes in public expenditure or individual consumption patterns is almost impossible. In the petroleum-dependent countries, such expectations have been occasionally bolstered by periodic surges in oil prices which tend to reinforce expectations of such occurrences and make it more difficult to accept adjustment measures. After almost a decade, it appears that most countries in the region have finally accepted the need to adjust to a changed environment. However, in some countries, this acceptance is still being resisted, especially if the adjustment process does not appear to take account of the negative impact upon those who suffer disproportionately from it. 22. The focus of this paper has been upon areas which are not explicitly taken into account in Bank/borrower relations. As it shows, the underlying issues transcend any specific discipline; however, unless an appropriate framework is established to include consideration of the areas mentioned here, an already uphill task would be made even more difficult. Other Reports in the Series No. 1 : Governance: Experience in Latin America and the Caribbean, March 29, 1991 No. 2: State-Owned Enterprise Reform in Latin America, July 25, 1991 No. 3: Systeme D' Analyse De Capacite InstitutionneHe Pour L' Ajustment Structurel, December 26, 1991 No. 4: A Preliminary Analysis of the Bank's Approach to Core Ministry Restructuring with a Focus on LAC Activities, February 25, 1992 No. 5: Computerization of Core Financial Systems in Government, April 15,1992 No. 6: Civil Service Reform in Latin America Lessons from Experience, May 1, 1992 No.7: Institutional Development in the Latin America and Caribbean Region: Lessons of Experience and Recommendations for Improvement, June 23, 1992 No. 8: Performance Measurement in the Public Sector, July 9, 1992 No. 9: Institutional Capacity Analysis and Development System, (ICADS), July 14, 1992 No. 10: Institutional Development, October 16, 1992 No. 11: Corrupcion: Un Peso Muerto de Ineficiencia e Inestabilidad No. 12: Institutional Capacity Analysis and Development System (ICADS): Two Case Studies at Country and Sectoral Level