Publications

Box 1. Does Governance Matter? Empirical Evidence from Japanese Foreign Direct Investment Flows

A study examining the locational determinants of Japanese foreign direct investment shows that the quality of governance in a country has a significant impact on the decision of Japanese private firms on whether to make investments in the country. Other factors are shown to exert an influence on this decision, namely, the exchange rate, wage rate, size of the local market, inflation, quality and depth of infrastructure (as proxied by the level of electricity generation per person), availability of skilled labor (as measured by the enrollment rate for secondary education), and presence of Japanese firms in the country. The authors use a conditional logit model to establish statistically that all these factors (including the quality of governance) affect the probability that Japanese firms will opt to locate facilities in a country.

The authors also show that governance plays a relatively more important role in the decision in sectors that are more capital- and technology-intensive. This is consistent with the theory that weak rule of law discourages investments that include large sunk costs.

Box 2. Four Pillars of Governance

The four key components of governance are accountabilty, transparency, predictability, and participation.

Accountability is the capacity to call officials to account for their actions. Effective accountability has two components: “answerability” and consequences. “Answerability” is the requirement to respond periodically to questions concerning one’s official actions. There is also a need for predictable and meaningful consequences, without which accountability is only a time-consuming formality. In addition, both internal (administrative) and external accountability are needed. Particularly with the dramatic improvements in information and communication technology, external accountability through feedback from service users and the citizenry can now be obtained at low cost and for a greater variety of government activities, and is an essential adjunct to improving efficiency and effectiveness of public service delivery.

Transparency entails low-cost access to relevant information. Reliable and timely economic and financial information is a must for the public (normally through the filter of responsible media). It is essential not only that information be provided, but also that it be relevant and understandable. (Dumping on the private sector vast amounts of raw economic information does not improve transparency.)

Predictability results primarily from laws and regulations that are clear, known in advance, and uniformly and effectively enforced. Lack of predictability makes it difficult for public officials to plan for the provision of services (and is an excellent alibi for nonperformance). Predictability of government economic actions is also needed as an indicator on which the private sector can rely to make its own production, marketing, and investment decisions. Most importantly, to be predictable, the application of economic regulations must be effective, fair, and uniform.

Participation is needed to obtain reliable information and to serve as a reality check and watchdog for government action. Among other things, participation by external entities is needed as a spur to government operational efficiency, and feedback by users of public services is necessary for monitoring access to and quality of the services.

Empirical evidence suggests that a strong civil society plays a critical role in advancing good governance.¹ Improving formal rules and organizations without any change in informal customs and ways of doing business avails little; importing procedures and mechanisms without reference to the incentive and local capacity framework is likely to be fruitless; interacting only with central government or, indeed, only with government, is not conducive to good implementation of reforms. Above all, governance intervention should encourage the formation of social capital, i.e., the stock of trust and information exchange at the base of civil society.

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1. See, for example, Robert D. Putnam, Making Democracy Work (Princeton: Princeton University Press, 1994).

Former centrally planned Economies

Overextension and overcentralization of the state
Lack of approriate legal framework and skills
Greater reliance on the market

Encourage carefully timed and and tuned process of decentralization.