Secretary Carlucci valued American Soft Power and Allies

Frank Carlucci2

Secretary of Defense Frank C. Carlucci transfers the rein of command of US Central Command from General George B. Crist (USMC) to General H. Norman Schwarzkopf (USA) on January 11, 1988

By Daniel F. Runde and Christopher Metzger

Legacy of Service

Former Secretary of Defense Frank Carlucci passed away last month. There is a generation who do not know his exemplary legacy of public service. For all those who remember him, Secretary Carlucci is best known for his later career as National Security Adviser and Secretary of Defense under President Reagan.  He is less known for his very important contributions to using American soft power to increase freedom and create deeper ties with allies while serving in Portugal; it is this part of his legacy that deserves more attention.

Before serving as a political appointee, Secretary Carlucci was a career ambassador and foreign service officer service in Africa and Latin America starting in the 1950s. But he really made a major contribution when he was ambassador to Portugal from 1975-1978. Secretary Carlucci was sent to Portugal during a period of utter chaos. From 1932 to 1968, António de Oliveira Salazar had ruled Portugal as a dictator, suppressing political freedom and establishing the Estado Novo (“New State”). Shortly after Salazar suffered a stroke and was replaced, 300 officers called the Armed Forces Movement and led by Francisco da Costa Gomes successfully completed a coup in what would be later be called the Revolution of the Carnations. By 1975, the Portuguese Communist party and other Marxist-Leninist groups had won virtual control of the government, and it seemed that all of the Lusophone and Ibero American countries in South America and Africa would fall to communism as well.

File:Frank Carlucci official portrait.JPEG

Official Portrait of Secretary of Defense Frank Carlucci on November 1, 1987

To this day, Secretary Carlucci is very highly regarded in Portugal for his leadership during the “Portuguese Revolution” of 1975-1976. Ambassador Secretary Carlucci famously remained in the country even after Otelo Sariva de Carvalho, a leading leftist member of the military, said they could “not assure his safety.” Leveraging USAID and other forms of American soft power, Secretary Carlucci was a key figure in Portugal’s democratization and ultimate election of its first Prime Minister, Mario Soares. According to an interview with Amb Carlucci by the Gerald Ford Foundation, “if Portugal hadn’t gone democratic, it’s really questionable whether Spain would’ve. And Spain set the pace for Latin America.”

Secretary Carlucci was also instrumental in the negotiations over the Azores islands in the Atlantic Ocean. The United States had stationed a fleet of planes at the Lajes field in the Azores islands since World War II. After the war was over, Portugal and the U.S. reached an agreement that granted the U.S. the right to use the Azores, while the Portuguese government retained ownership of the land and infrastructure. Our basing rights on these islands, near Northern Africa, have only grown in importance over the years.

Another part of Mr. Carlucci’s legacy in Portugal was his involvement with the Luso-American Foundation that continues to build ties between the U.S. and Portugal and the growing Lusophone (i.e. Portuguese speaking) world. At a time when the U.S. is considering how to maintain ties with countries that used to receive foreign assistance, the Luso-American Foundation is an example that deserves study and replication.

President Reagan named Mr. Carlucci national security advisor in 1986 and, just a year later, appointed him Secretary of Defense.  Though he is remembered primarily for these last two positions, it is the far-reaching impact of his time in Portugal that cements his legacy as a pivotal figure in the history of American foreign policy.

Daniel F. Runde is a Senior Vice President, holds the William A. Schreyer Chair in Global Analysis, and directs the Project on Prosperity and Development at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Christopher Metzger is the program coordinator for the CSIS Project on Prosperity and Development. 

 

Photo 1: National Archives/CCO
Photo 2: Ron Hall/CC0

The United States Needs a Stronger World Bank

By Pamela Cox

The World Bank, the leading multilateral institution whose mission is to fight poverty and boost economic development, is seeking a capital increase to continue its lending operations.  The capital increase request has generated debate in Washington D.C. about the World Bank’s future role in international development. Some advocate that the World Bank continue its current role as lender to poor and middle-income countries, but with a set of reforms to reflect twenty-first century realities. Others advocate that the World Bank shift its focus to only the poorest and fragile states. Yet others want to refocus the World Bank into a new type of financing institution for global public goods. Despite the differing views, the U.S. and other shareholders should continue supporting the work of the World Bank, while the World Bank needs to adapt its role to the changing world, building on its strengths.

In its 74-year history, the World Bank has changed its model several times, to respond to shareholders’ demands and global trends. Founded originally as the International Bank for Reconstruction and Development (IBRD) to finance post war reconstruction in Europe, the World Bank made is first loan to France in 1947. But as the Marshall Plan ramped up, the World Bank quickly shifted to financing projects in lower and middle-income countries constrained by access to capital. Recognizing the importance of promoting private sector-led development in these countries, the International Finance Corporation (IFC) was established in 1956 to do both debt and equity lending. As former colonies became independent but lacked credit worthiness to access capital markets, the International Development Association (IDA) was created in 1960 to offer very low interest long term loans (later changed to grants) to the poorest of countries.

The IBRD model of financing uses limited public money to leverage private financing from global capital markets, and to share burdens amongst shareholders. It is an investment bank – a point that is important when thinking about its future roles and focus. IBRD’s capital comes from its 189-member countries, who own shares based on economic size (the U.S. is the largest shareholder with 16.2 percent of shares). But only a small percentage of the capital is actually paid into the World Bank; the rest is held on country books. Since 1944, the U.S. has subscribed to $38.5 billion of shares, of which only $2.4 billion has been paid in. Together with the paid-in capital from other member countries, a total of $252.8 billion, IBRD has leveraged over $600 billion in loans.  In short, a small investment by the U.S., spread out over 74 years, has increased capital flows to the developing world 14-fold. Compared to direct on-budget support, which is the model of public aid agencies, this is a significant return for limited investment – and an effective use of scarce public resources.

What are the criticisms of the current World Bank model? Critics have argued that many of the middle-income countries that IBRD lends to have access to capital markets. Their World Bank loans are subsidized and this should not be the case. Others have argued that the World Bank should cease lending to middle-income countries and focus only on IDA-eligible countries, in particular in Africa and in fragile states. There are arguments about overlaps with other regional development banks such as the African Development Bank, Asian Development Bank and InterAmerican Development Bank, and that these institutions should take the lead instead.  Finally, some call for a complete transformation of the World Bank into an institution financing only global public goods.

The first critique is that the World Bank has provided subsidized loans to middle-income countries that can easily raise money in global capital markets. While World Bank loan rates for IBRD’s loans have often (but not always) been less than commercial loan rates on a country by country basis, one factor in setting interest rates has been the Bank’s ability to use its AAA rating and prudent debt to capital management to tap global capital markets on behalf of member countries which would not receive such favorable terms. In short, it spreads the risk.  Moreover, the World Bank recoups its costs on loans through its spreads, which are adjusted to reflect market and other factors. Loan charges are based on LIBOR plus a spread (which has varied over time). With this spread, the World Bank earns a modest profit after covering its administrative costs (which remain half of those of private investment banks).

Research looking at subsidies within the IBRD financing model[1] has shown that in fact, it is the middle income IBRD borrowers who have provided net subsidies to the World Bank, as funds from money made on IBRD loans generate profits which have been used to build  reserves, contribute to IDA, and modestly fund some global goods (agricultural research has been a significant beneficiary). Annual contributions to IDA from both IBRD and IFC profits have increased resources available for the poorest countries beyond the amounts the higher income countries would otherwise have contributed.

The second critique is that the World Bank should cease lending to middle income countries and focus only on IDA-eligible countries, and in particular Africa and fragile states.  Shifting IBRD lending to these types of economies ignores the nature of the financing model – and the benefits it offers all members of the institution. IBRD would be unlikely to retain its AAA credit rating and its ability to tap global capital markets at favorable rates if its pool of borrowers were the most economically stressed and lowest income countries. Indeed, the World Bank would doubtless have to rely even further on member country contributions, as IDA’s financing model is more akin to that of a public-sector development agency, with replenishments from contributing governments every three years. IDA provides a combination of grants and very low interest loans (which are heavily subsidized).

Recognizing the limitations of relying on donor contributions in an age of constrained government budgets, the World Bank has introduced elements of the IBRD model to raise more funds for IDA. In IDA18, the current replenishment, the World Bank will leverage IDA’s capital (in this case, IDA’s reflows): IDA has obtained a AAA credit rating and will supplement pledges from governments with borrowing on capital markets, raising about a third of new funds in this way.

Why should IBRD continue to lend to the middle-income countries? First, most poor people live not in the poorest and most fragile countries, but in middle-income countries. Some 2 billion people, living on less than two dollars a day, live in middle-income countries, which account for nearly 80 percent of the world’s poor. These poor people are concentrated in India, China, Nigeria, Pakistan and Indonesia – all lower or middle middle-income countries. Reaching these poor populations will require engaging in middle-income countries.

Second, the World Bank can be an effective financing partner to middle-income countries, helping to leverage a mix of financial flows to underwrite development. While it is true that many middle-income countries have increased access to world capital markets and foreign director investments, fund flows have been uneven in quantity and quality. Relying on global capital markets requires effective domestic monetary and financial sector policy management, as well as a level of domestic financial sector development. The good news is that in the last two decades, many middle-income have improved macroeconomic policy management in these areas. There is more to be done, and the World Bank has provided assistance for financial sector development and policy. Increased openness to global markets has risks, as was most recently underlined in the 2008/09 crisis which left many middle-income countries without credit lines and experiencing capital outflows. In this case, the World Bank Group was an effective countercyclical lender, providing financing for critical social and poverty programs providing a safety net.

Middle income countries will need to do more to generate domestic resources to help fund development programs, although realistically, lower middle-income countries have lower incomes and more limited revenue raising potential. The World Bank has provided assistance and financing to improve domestic resource mobilization, addressing budgeting and taxation in a range of lower middle-income countries.

In recent years, direct private investment has increased in developing countries, especially in high return projects: toll roads, airports, telecommunications. However, the private sector rarely invests in rural infrastructure or, outside of major cities, water, sewers, and transport. As is the case in most high-income countries, including the U.S., the public sector bears the burden of investments here. The World Bank has sought to “crowd in” the private sector in these projects. Through its investments, it has ensured good governance and environmental and social sustainability, encouraging private investors to buy in.

Third, the ranks of middle-income countries are increasing. Between 2001 and 2018, the number of countries classified was halved, as 33 countries moved into middle-income status (defined as per capita GNI between $1,005 and $12,235 in 2018). Only 31 countries are now classified as low income. IDA provides support to a total of 75 countries, which includes not only the lowest income but many small island economies which are not IBRD creditworthy (59 countries receive IDA-only lending), plus another 16 countries which receive a blend of IDA and IBRD resources (Nigeria and Pakistan for example). As countries graduate from IDA, their access to capital markets may remain limited due to lower incomes, and they will continue to face challenges of generating resources for development.

Fourth, the World Bank brings not only financing, but knowledge and technical assistance through its project lending. The World Bank does rigorous monitoring and evaluation of all projects that it funds, and shares results, providing one of the largest databases of development experience in the world. Project-specific data and results in turn contribute to the broad expanse of research done at the country and global level on a wide range of development issues. For middle-income countries, this knowledge is an important factor in seeking financing from the World Bank. In middle-income countries, the World Bank tends to finance more complex projects or it helps launch and spread new approaches (for example, conditional cash transfer programs which originated in Brazil as a safety net, and now have spread to Africa and other regions). In turn, experience from the middle-income countries is important to other countries, including low-income countries, in understanding what works in development. The World Bank partners with the private sector, especially on large infrastructure projects, providing its expertise in implementation, financing packages, governance, and social and environmental safeguards. It thus helps “crowd in” private investment.

Discussion remains on a suitable graduation policy for middle-income countries. Using an income cut-off poses some difficulties: as noted above, there are several small island countries in the Caribbean and Pacific which remain eligible for IDA under the “small states’ exception” due to their economic size. Other countries which are classified as “upper middle-income” have large numbers of poor people (Indonesia, China).

What about the critique of “overlap” between the World Bank and the other regional MDBs? Given the need for development capital, with the sustainable development goals requiring an estimated $1.4 trillion per year, there are more than enough projects and research that require funding – capital is scarce, and the World Bank and regional banks do not compete for investment opportunities. But one of the major differences between the World Bank and the regional MDBs lie in their focus: the World Bank is a global institution, leveraging knowledge and financing from throughout the world, and similarly spreading its lending risk amongst more countries. The regional MDBs are by definition regionally focused. This is important in some areas – regional MDBs have been able to be more flexible on issues such as lending for regional integration. But the World Bank has been able to provide leadership and focus on issues cutting across regions – from financial crises to safety nets to global warming, as argued below. World Bank shareholders who are middle-income countries use both the World Bank and regional institutions depending on the nature of the investments.

Finally, should the World Bank finance only global public goods and move away from its traditional country-level lending? It is difficult to see how this could be done—or if it could be done. Shifting to financing only global public goods cuts off key attributes that make the World Bank successful. One of the core strengths of the World Bank is its ability link its country relationships, in-depth country knowledge and project experience, with a global platform. The World Bank, through its country-based activities, gains deep knowledge of the range of development issues.  It also brokers knowledge amongst development practitioners (for example, the Latin American network of heads of units implementing conditional cash transfer programs, set up by the World Bank). But it marries that in-depth country knowledge with its global network.

The World Bank is a global platform that brings together a range of development actors—countries, project officials, the research community, the private sector—and provides a range of services. It funds projects. It does research. It provides technical assistance. It advocates for development issues (girls’ education, anticorruption, climate change mitigation). It advocates for global public goods. It brings together different actors: public sector, private sector, civil society. The strength of the World Bank is that it is both global and local.

Where the World Bank has been successful on climate change, for example, it has done this at many levels: through broad research and advocacy at the global level, but also through country-based research that led to financing projects on the ground to reduce emissions (for example in Mexico and Brazil) and mitigate climate change impacts. Without local focus and activity at the country level, the World Bank would be more similar to a global fund.  Indeed, existing global funds (for education or for health) have partnered with the World Bank and its local projects to deliver results. Through Education for All, for example, the World Bank invested in and carried out projects that served as vehicles for more aid financing for education; similarly, the Global Fund to Fight Aids, Tuberculosis and Malaria has relied on World Bank projects improving health systems.

As a multilateral institution, the World Bank provides a platform for countries to identify and set priorities at the global level. The evolution of focal development issues in the last twenty years—HIV/AIDs, migration, governance, climate change, to name a few—have all included World Bank research, advocacy and lending. The World Bank is a means to bring countries together around priorities—but also to get action. There are certainly other multilateral channels —the UN is a major one. But what sets the World Bank apart is its ability to get results on the ground through its lending and country relationships.

The World Bank brings other attributes. It has a strong track record of financial management, on both the borrowing and the lending ledgers. For this reason, it has been effective at managing additional funds (trust funds), including in reconstruction situations (Haiti, Indonesia). Unlike most private sector projects, World Bank investments are supervised, tracked and reported on—in a transparent way.

The U.S and other shareholders should continue supporting the World Bank. Many of the world’s most pressing issues require international cooperation and the World Bank is the premiere organization to lead these efforts. Promoting economic development, growth and the reduction of poverty helps stabilize states, reduce migration pressures—and create markets.  Disease knows no boundaries in the era of international travel, which can spread infectious disease globally in less than 24 hours. The 2008 financial crisis demonstrated the interlinkages of financial markets. Climate change is a global phenomenon, not a national one, and its effects are spread out across countries.

A strong U.S. presence has shaped the World Bank in the past and should continue to do so. The idea of setting up a bank for reconstruction and development—which emerged from Britain and the U.S.—was a way to tap American capital markets in 1944. And today the World Bank can help countries tap even larger markets. The pressure of using capital markets, rather than public budgets, forced the World Bank early on to invest in the project approach, strict monitoring, supervision and sound accounting of expenditures and outcomes. Over the years the U.S., through its role on the World Bank’s board, has pushed the institution to expand investments in health and education, improve financial accountability and reduce corruption, institute open procurement policies, put in place environmental and social safeguards, expand attention to gender issues, and promote private sector development.

Looking ahead, the World Bank needs to continue to adapt its role to the changing world, building on its strengths. Shifting to new ways of increasing IDA financing through borrowing is one example. The move to help countries boost domestic resource mobilization is another, as is the expanded role of the World Bank in leveraging private sector funds, which it has done in many instances (in large infrastructure projects). At the same time, the World Bank shareholder countries need to acknowledge the changing governance challenges. No longer is the institution a bipolar one (donors and recipients); it is a multipolar world now, and the share structure of the Bank (and the IMF) need to reflect this. The U.S. did not support a capital increase and shifting voting shares in the past, which in part led to the formation of China’s infrastructure bankthe Asian Infrastructure Investment Bank (AIIB)—leaving the U.S. without a seat at the table.

The World Bank continues to have much to offer—it has formidable knowledge and experience, it provides an open platform to bring countries and people together around global and development issues, and it gives value for limited investment. But there is a “pay to play” aspect. Unless the World Bank receives more capital, it risks continuing to shrink, and the space ceded to other actors and platforms where the U.S. has limited influence and impact.

[1] Willem Buiter and Steven Fries, “What should the multilateral development banks do?”  Working Paper No. 74, European Bank for Reconstruction and Development, June 2002

Land Grabbing in South America: Fueling Displacement and Inequality

Mackenzie Blog Pic

Photo of a woman in rural Paraguay, as part of a series of photographs that reflect the challenges and dignity of the rural poor being displaced at the hands of an agricultural export model. By Flickr user Ministerio de Cultura de la Nación Argentina under an Attribution-ShareAlike 2.0 Generic license.

By MacKenzie Hammond

As the global population continues to rise, land and other natural resources will only grow in importance. Foreign companies have taken advantage of cheap lands and corrupt governance in Latin America, Southeast Asia, and Africa to expand their operations. Worse yet, more than 60 percent of those crops are exported, often leading to rural displacement and food insecurity in developing countries. ‘Land grabbing,’ was first defined in the Tirana Declaration in 2011 as an acquisition of land that violates human rights, dictates unfair contracts, disregards impact on social, economic, or environmental conditions and ultimately causes rural farmers to lose their way of life. Land is packaged and sold to multinational corporations which uproot families and take land away from indigenous populations and the rural inhabitants without offering alternative options for employment.

Foreign investors, such as multinational corporations, promote their commitment to add value to the national economy of countries they invest. Although selling land to foreign investors can increase agricultural exports and contribute to overall economic growth, it does not always translate into economic inclusion for local land owners. Wealth does not trickle down from multi-national corporations to benefit local impoverished populations because increased mechanization reduces labor costs and agricultural employment opportunities. Throughout history, land ownership has been a key determinant of power and wealth. Today, land ownership continues to favor wealthy stakeholders and frequently disadvantages low-income communities. This article analyzes the impact of land acquisition in rural communities of South America and, specifically, the current initiatives in place to improve the livelihoods of impacted populations in Paraguay.

El Gran Chaco is a region in South America that extends across Paraguay, Argentina, Bolivia, and Brazil. The basin has been a focus of foreign investments in the last few decades because of low land and production costs, loose environmental regulations, and high returns. Land is easily acquired in these countries by foreigner’s due to weak land governance and an unequal distribution of resources. Some unenforced policy environments have enabled opportunities for exploitation. One intention of channeling foreign direct investment (FDI) into developing countries is to promote integration into an increasingly globalized market. Developing countries should export common commodities like soybeans, palm oil, and beef to new markets. For example, soybean exports from Argentina, Brazil, and Paraguay combined in 2016 were worth $24.3 billion and accounted for nearly 47 percent of the world’s total soybean exports.

The international demand for products, such as soybeans, and the required land-intensive processes have created extensive problems for the local populations excluded from participation in the global economy. These include increased urbanization and poverty, loss of economic opportunity, and negative environmental and health impacts. Many efforts are tackling the symptoms of the problem, but more attention should address the root cause of the problem – land ownership.

In recent years, local unrest has prompted governmental action in Brazil and Argentina to limit land grabbing. Argentina enacted a land acquisition act in 2011 which limited foreign land ownership to 1,000 hectares. Additionally, Argentina and Brazil have a tax on soybean exports, which puts a burden on producers, but supports the local economy. Argentina recently increased this tax to 50 percent, which has the potential to drive out producers. Through these actions, governments are taking a stance against foreign abuse on the resources and people of these countries.

While countries such as Brazil and Argentina are taking intentional actions to alleviate the issue, others are not taking the effective steps to protect the local populations or land. Paraguay, for example, lacks thorough restrictions on foreign investments for commodities like soybeans and struggles to properly enforce current laws that protect rural populations.

Case Study: Paraguay and the Soybean Monocrop

Paraguay has one of the most unequal land distributions in the world. Nearly 80 percent of agricultural land is held by only 1.6 percent of landowners. Former President Alfredo Stroessner sold or gave away 25 percent of Paraguay’s fertile land during his 35-year dictatorship. Over the years, wealthy land owners have sold their land to large private investors. Companies like Louis Dreyfus or Monsanto are among the many investors who purchase land in Paraguay because of its low valuations, tax incentives, and comparatively good agroecological potential. Since the 1990s, most of these investments have contributed to the expansion of soybean plantations. 75 percent of all arable land in Paraguay is dedicated to soybean plantations. Of these plantations, over 96 percent of soybeans cultivated in Paraguay are exported, primarily to Russia, the European Union (EU), and Turkey, where it is then used primarily for animal feed.

The versatility of soybeans makes it an attractive crop to produce, yet sharing the benefits of this industry has remained a challenge for Paraguay. Rural inhabitants who are uprooted from their land do not benefit from soy exports because soybean plantations increasingly use mechanized processes instead of physical labor. Rural populations not only lose their land but are left without a job to support their families. The expansion of soybeans has forced nearly 9,000 Paraguayan families each year to migrate to the cities in search of work and a better livelihood.

These displaced individuals need a plan for integration into the local economy, whether they have migrated to urban settings or attempted to stay in their rural environments. For example, the World Bank developed a strategy for Paraguay that aimed to improve financial inclusion, increase access to basic services for impoverished communities, and foster market integration for smallholder farmers. The country partnership strategy will be ending in 2018, and the World Bank has not released a progress report on the impact of this strategy yet.

In addition to multilateral organizations – human rights groups, local NGOs, and campaigns are helping attract attention to this immediate concern and provoke a response from the government. Organizations such as the Global Forest Coalition and Friends of the Earth are providing land-use planning methods, legal advice and training for farmers, and human rights interventions to protect the land and freedom of rural inhabitants. Others, like the International Fund for Agricultural Development (IFAD), aim to increase rural capacity in municipalities and organizations. Local government and civil society organizations (CSOs) can strengthen and empower small farmers through facilitated dialogue between affected citizens and government, community protection programs, and cooperation agreements.

Other development organizations in Paraguay link rural farmers to markets through partnerships with the private sector. This way, smallholder farmers are reintegrated into the supply chain of agricultural exports. Despite these efforts for economic integration in Paraguay, these challenges are deeply rooted in structural and political capacity issues that will require institutional actions to improve regulatory frameworks and laws that protect land owners and help those that have already been displaced.

Conclusion

The land management crisis extends beyond Paraguay and El Chaco, beyond soybeans and indigenous populations; more international attention should be given to the situation in Paraguay and in countries around the world where land and wealth divide populations, cause conflict, and destroy livelihoods. Land grabbing will continue to increase urban density and stretch resources, housing, and jobs; youth populations will have higher aspirations than what those jobs can provide; food demand will increase as populations do and agricultural production will struggle to fulfill it. These consequences will intensify if the root of this problem is not addressed proactively. Preventing future land grabs will require an integrated stakeholder response to secure effective and sustainable resource distribution, environmental and human rights protections, and government accountability and transparency.

Doing Business: Icebreaker – not Gospel

By Michael Klein

15 years of Doing Business

It takes less than a day in New Zealand to register a small business. It takes 230 days to do the same in Venezuela – that is, if one follows the law. There is a purpose to registration – notably identification for the tax and social security system.  Doing Business advocates sound rules, not their abolition.  Make the purpose simpler to achieve and people will comply more readily.  Business and job creation become easier. People can do business without paying bribes and without special connections. The informal sector shrinks. Safety nets can improve.  The Scandinavian countries are prime examples of how rules that are easy to use underpin both wealth creation and social safety nets. This illustrates what “Doing Business” is about.

By now the World Bank’s annual Doing Business report has been published for 15 years. It currently covers 190 countries.  Over the years it recorded 3,180 reforms worldwide.  Some 920 of these reforms have in part been triggered by the report.

The very fact that it is politically salient gives rise to periodic disputes, most recently in Chile.  The dispute has triggered broader debate. This note lays out my overall perspective on the report, which I helped launch in 2003 and oversaw until 2009.

To start with, a reminder of what Doing Business does.  In 11 indicator sets, the report records and codes formal rules that govern the life of business from entry to exit – how easy it is to register a firm, how complex to enforce a contract, and so on.  The data are based on the laws and regulations made by governments – not on expert assessments.  Details are available online for anyone who wishes to delve into the nitty-gritty.  The basic methodology of coding rules is state of the art and similar to the other main effort to capture official rules for businesses – the OECD’s Product Market Regulation indicators.

Doing Business Matters

Why does it matter?  Doing Business helps analyze basic institutions that underpin wealth creation and poverty reduction: first, rules that facilitate competition – the entry of new firms and the exit of underperforming firms – and, second, rules that allow businesses to invest and contract.

The Doing Business data are informative.  Peer-reviewed research underpinning the indicators shows their importance for matters like growth, employment creation, and the size of the informal economy.  The data characterize basic processes, for example, those used to enforce a contract.  It is not a priori clear that simpler enforcement leads to greater justice.  Research confronting the Doing Business indicators with perceptions of firms on fairness of outcomes suggests, however, that in fact “justice delayed, is justice denied”.   The data thus help understand how regulations relate to desired outcomes.

The official rules matter.  Lant Pritchett of Harvard and Mary Hallward-Driemeier of the World Bank confronted the Doing Business data with data from the World Bank’s enterprise surveys, which I also sponsored as a complement to Doing Business.  They found, unsurprisingly, that in real life firms do not always follow the law to the letter.  Yet, the key finding was that simpler rules for a given purpose make it more likely that the law guides firms.

At the same time it is obvious that the world is more complex than captured by the report.   The data do not constitute an investor attractiveness measure. They do not capture politics.  In fact, the report comes with its own “health warning”.  Those who think that fixing a few indicators will automatically lead to higher growth may be in for a disappointment.

Many data we use are imperfect.  GDP is a case in point.  Enrolment rates for education are rather imperfectly related to educational quality, and so on.  But the data help and are used in all sorts of ranking – witness the UNDP’s human Development Index.

The Doing Business Report is a diagnostic tool.  Like Cholesterol measurement in medicine it captures risk factors that matter.  Some people still do fine regardless, whereas others suffer even when their measure looks good.  So it is with economies.

Icebreaker

Informing debate.  Some 30 years ago I started working on analysis of markets and underlying institutions.  It was clear that good institutions matter.  When discussing with a government whether its rules for businesses were overly complex, it was hard to prove that things could be done more easily.  Who says that contract enforcement is taking too long?  Unsurprisingly, the defenders of the status quo argue in great detail that prevailing rules are the best they could possibly be.  Doing Business helps challenge such arguments by benchmarking performance.  It shows how other countries solve the same problem. It often reveals problems countries were not aware of.  It shows that things can be better.  It provides detailed ideas on what could be done.  It even provides contact persons in other countries with whom reform ideas can be discussed.

Providing perspective.  In 2006 I visited Ghana.  At the time a meeting of aid donors suggested that Ghana did not reform its business environment – pots of aid money were sitting around unused.  Ghanaian officials, however, claimed they were doing a lot.  Who to believe then?  As it happened, the Doing Business report of the year showed that Ghana was the third most active reformer of business environment rules worldwide.  The government “just did it” – without donor funded consultants.

Creating momentum. Without benchmarking and summarizing, the regulation agenda easily drowns in complexity.  Some 10 years ago, in Mexico private firms opposed a government reform of corporate governance.  They claimed it would make business harder.  The government argued its proposed law would improve markets.  Parliamentarians were confused.  Who is right – the bureaucrats or the people operating in the market?  A person in the government had the idea of using the Doing Business method to benchmark the draft law against other countries.  It turned out that the government proposal would bring corporate governance more in line with good practice. The objection by the private incumbents seemed based on preserving power, not enhancing transparency.  Doing business thus helped government win the parliamentary vote against vested business interests.

Benchmarking shines a light on matters that vested interests rather keep hidden.  Who cares if someone claims, that business registration processes are cumbersome in country A?  Interest rises when it is shown that other countries have simpler rules.  Political interest is really piqued when global rankings show country A looks worse than country B – particularly, if the latter is looked upon a bit askance in country A.  Political momentum is created without a penny of donor funding on the table.

There are those who argue that the global rankings of Doing Business should be dropped.   Indeed, the world is more complex than expressed in the rankings.  Yet, the aggregation of all the data is informative and it stimulates debate.  The challenge is to have a reasoned debate.  The disputes that I experienced typically led to eventual reform.

We also launched a companion project to Doing Business – “Women, Business and the Law.”  Most people debating Doing Business don’t even know about it.  It has escaped major disputes.  In retrospect, I wish we had devised a global ranking so that important issues of discrimination had a brighter spotlight too.

The way ahead

The agenda highlighted by Doing Business matters.  The data help diagnose issues.  The rankings create political momentum.  That leads to improvements.  In a nutshell, that is the case for the chosen approach.

What is to be done?  Implement well.  Make sure data mistakes are corrected and acknowledged when they happen.  Keep methodology changes to a minimum.  Explain the rankings well.  Help a sensible debate about reform unfold.  Use the report as a tool, not a gospel.

Emerging from the Darkness: Albania’s Informal Economy

Bruna Blog ImagePhoto of New Bazaar in Tirana, Albania by Flickr user Tokil under an Attribution-ShareAlike 2.0 Generic license.

By Brunilda Kosta

Last year, Albania took the third step in the government’s plan to reduce economic informality, an issue which has long restricted development and prosperity for the country. For this article, the informal economy is defined as activities which are legal but do not fully comply with state regulations. They include tax evasion, lack of business registration, and labor regulation avoidance. Such forms of informal economic activity are detrimental to a country’s economic growth, and seem to occur more frequently in countries that are undergoing structural reforms and transitional economic adjustments, such as Albania.

Numerous studies have showcased the high level of informality in Albania. Friedrich Schneider, Professor of Economics at the Johannes Kepler University (2010), estimated that in 2007 the Albanian informal economy was equivalent to 32.9 percent of GDP. A 2013 study conducted by the European Bank for Reconstruction and Development (EBRD) surveyed business leaders in Albania,  40 percent of whom admitted that they are forced to compete with the informal sector. Finally, in 2015 the Albanian government disclosed that the informal economy makes up 50 percent of GDP. These startling figures encouraged the government to institute reforms. In 2015, the Albanian government elevated its focus on informality and undertook diverse actions to mitigate the associated issues. This article analyzes the Albanian government’s approach to reducing informality and aims to come up with actionable and pragmatic policy recommendations for implementing effective reforms.

The Albanian government has struggled to integrate the informal sector into the economy for many years. The informal economy moved into the spotlight in August 2015 when Albania’s Prime Minister publicly announced that the government would make it a priority, but failed to provide a timeline or specific details on how to do so. Following this announcement, Albania’s Minister of Finance vaguely explained their ideas for addressing informality but did not lay out a public strategy. In April 2016, the Minister of Finance announced the next action, a strategy designed in collaboration with the International Monetary Fund (IMF); however, the strategy remained vague. The business community and economic experts argued that these actions were taken haphazardly and with the purpose of increasing government revenues. The third phase was launched in September 2017 and went into effect at the beginning of October the same year. The government announced that it will spare no efforts to “eradicate” informality. These recurrent actions produced encouraging outcomes such as additional revenues and an increased number of registered businesses and employees. Simultaneously, these actions have had economic and psychological consequences for business operations.

One of the key actors in the informal sector is employees. In Albania, informal employment is manifested in various patterns as displayed in the chart below: 39.75 percent of employees declared not to have a written contract with their employer, while 30.29 percent of employees declared that they do not pay for social and health security benefits (Figure 1). When compared to the averages for Southeastern Europe (SEE), the biggest difference was between the number of employees with no written contract. One reason behind this high level of informal employment could be the short-term benefits to employees such as earning extra income that would otherwise have been taxed. Nevertheless, aside from some rudimentary benefits, the drawbacks of staying informal outweigh the informal benefits. For example, operating in the informal economy prevents employees from reaping the benefits of the formal sector like earning a pension and having a higher salary. A recent study estimates that Albanian workers earn 29.3 percent more in the formal sector than in the informal, despite widespread belief of the opposite.

Figure 1: Informal employment patterns

Bruna Blog Chart

Source: Albanian Center for Economic Research (ACER) & Southeast Europe Leadership for Development and Integrity (SELDI), 2016

Another pattern of informality is underreporting income. This often occurs among firms that utilize only cash transactions, which is a widespread practice in Albania. A study of the National Business Forum in Albania found that businesses underreport around 30 percent of annual turnover.

Many of these statistics support, to some extent, the government’s efforts to address informality in the last several years. The Albanian government’s intentions were positive, but its approach to combating informality has been flawed. The purpose is to incentivize informal firms to transition into the formal market; however, coercing firms out of the shadows carries significant risks. In Albania, formalized firms struggle to survive because regulations are burdensome, which is a contributing factor to informality. Some challenges for Albanian business owners, according to the recently released Global Competitiveness Index include tax rates, corruption, and access to financing. This report is corroborated by the most recent Doing Business report 2018 for Albania, which shows that ‘paying taxes’ is a major obstacle to the ability for businesses to grow and succeed. The Albanian government should decrease the regulations placed on businesses, which could naturally facilitate the formalization process.

Fortunately, sustainable change is starting to occur. For example, it is worth applauding the government’s recent withdraw from its initial plan to include small businesses in the value-added tax scheme. This shows that the government’s genuine efforts to diminish the informal economy, coupled with effective dialogue with the business community, could yield positive results and generate a win-win scenario. Moreover, the government has stimulated notable positive results despite its lack of transparency and collaboration with the business community. For example, in 2016, Albania had an average of 56 registered firms per 1,000 people, while in 2014 it had 40 registered firms per 1,000 people. This shows that there was an increase in the number of businesses registered over the span of two years. On the other hand, more than 100,000 businesses deactivated their status or initiated their forms for closing procedure. The tough actions of putting people in jail raised psychological pressure and fear among businesses which disrupted normal business operations.

The fundamental question remains: how can the government encourage informal businesses to move into the formal sector, while minimizing the negative consequences of doing so? The following policy recommendations should be considered:

  1. The government should stop prematurely talking about actions without the knowledge base to support those actions. Working in the hidden economy in SEE is often socially embedded and not simply a matter of rational choice to maximize personal benefit. Hence, a comprehensive understanding of social norms, cultural customs, and historical facts should be understood first.
  2. The government should include interrelated issues that incentivize formalization. For instance, small businesses often fear that coming out of the shadows will mean more shakedowns by corrupt officials or entanglement in bureaucratic red tape. Corruption is a clear concern and burden for the business community and should be addressed by the government.
  3. Using structural reforms and technology to curb informality could also benefit government finances, growth, and poverty reduction.
  4. Tackling informality should be a joint effort strategy; the government should improve their dialogue with the business community and effectively engage with and accept their reasonable proposals.
  5. Finally, the government should design a clear strategy for informal economy mitigation, drawn on sectoral basis, and associated with a rational action plan.

It is difficult for any economy to eradicate informality entirely. However, bringing informal activity out of the shadow economy has the potential to boost tax revenues, increase productivity, spur economic growth, and improve the quality of life for Albania’s citizens.