Investors maybe undermining good governance across emerging markets by failing to price political risks into their investment decisions, the World Bank has warned.
The Bank’s 2007 report on global governance released yesterday surveys governance globally over the last decade. But in an interview with Emerging Markets, the report’s author Daniel Kaufmann, who is also director of global programs at the World Bank Institute, urged investors against complacency on governance standards given the abundance of global liquidity.
“There is a correlation between good governance and a country’s competitiveness, credit rating and foreign investment. Speculative investors will have short-term interests in mind, but governance needs to be better reflected in financial markets pricing.”
The message is a difficult one to communicate at a time of robust global growth and liquidity, especially in commodity-exporting emerging markets. At a forum organized by the Emerging Markets Trade Association (EMTA), investors warned that the link between responsible policies and economic growth was becoming elusive. Paul McNamara, portfolio manager at Augustus Asset Managers, asked pointedly: “Does anyone care about structural reform any more? There has been some in Turkey in recent years, but elsewhere, high growth is being driven by commodity prices or loose money.”
Countries that fall into the lowest quartile on every governance indicator, such as Angola, Chad and Equatorial Guinea, are currently achieving higher growth rates than their better-managed counterparts. However, Kaufmann denied that this makes it more difficult for the World Bank to push its reform agenda.
“People used to say this about Indonesia in the 1990s, but then the country crashed because of poor governance. Any country, especially an oil producer, can get a growth spurt and be poorly governed. But only if countries improve their governance will they grow in the long-term,” said Kaufmann.
Nevertheless, he acknowledged that in the past attempts to improve governance in these countries had been too top-down: “We need to focus less on public sector reform initiatives and on the demand side, for example, improving institutions of accountability outside the government such as civil society, the private sector and parliament.”
This sentiment was echoed by Arnab Das, head of emerging markets research at Dresdner Kleinwort, who argued that the market remained the most powerful weapon for driving governance improvements.
“This is not a top-down approach driven by the multilaterals, but there is a bottom-up approach in individual countries, and through corporate restructuring,” Das told the EMTA forum.
On a positive note, Kaufmann observed that these indicators undermine sweeping generalizations about Africa, and argued that businesses and investors should evaluate individual countries in their own right.
“We have seen improvements in Nigeria on voice and accountability; Tanzania on control of corruption; Ghana and Kenya on voice and accountability. But in contrast, governance in Zimbabwe and Côte d’Ivoire has deteriorated sharply on every dimension,” said Kaufmann.
He also sought to defuse recent controversy arising from the former Wold bank chief Paul Wolfowitz’s proposal to tie aid more closely with governance improvements.
“We don’t believe our indicators ought to be used for mechanistic purposes for aid flows, instead our study should be used as a tool to monitor in what way countries are improving,” argued Kaufmann.
However, Tim Kane, director of the centre for international trade and economics at the market reform think-tank the Heritage Foundation disagreed, telling Emerging Markets: “Only countries that are ascendant in institutional reform should get money.”
China is perhaps the highest-profile example of a major investment and lending destination with a questionable governance profile based on the World Bank criteria – it falls between the third quartile on the control of corruption. Kaufmann warned that the country could not sustain its rapid growth unless “it eradicates corruption, especially in its bureaucracy.”
Kane concurred, noting: “China is low on this index because there are inefficiencies and distortions in state planning as well as private sector corruption, but as the country seeks to boost domestic consumption these issues need to be improved.”
The World Bank report, Governance Matters, 2007: Worldwide Governance Indicators 1996-2006 (for details, please click here) is a climax of a long-standing research program which monitors countries performance on various indicators, comprising voice and accountability, political stability and lack of violence, government effectiveness, regulatory quality, rule of law and control of corruption.