Yet they have stirred up controversy. As is often the case with provisions that aim at changing the rules of the game, Sections 1502 and 1504 have pitted stakeholders that support their passage and full implementation against the interests of those that wish to water them down or greatly delay their implementation. Last Tuesday, Brookings and Global Witness hosted an event at the National Press Club to examine the debate surrounding these two provisions*…

Representative Jim McDermott kicked off the event by explaining that passing Sections 1502 and 1504 is only half the battle. The eventual effectiveness of these provisions largely depends on how the final rules are written and implemented. If well implemented, they could contribute to increased transparency, empower citizens to capture the gains from natural resource wealth and deny financing to dangerous armed groups in the Democratic Republic of Congo and the surrounding countries…

However, if opponents of these rules succeed in sufficiently watering them down, many of these gains will not be attained. With this in mind, panelists and participants from civil society, the private sector, financial sector and think tanks discussed the benefits, potential costs and implementation challenges of Sections 1502 and 1504.

The first part of the discussion, moderated by Simon Taylor from Global Witness, focused on the costs and benefits of Section 1504, which requires U.S. companies in extractive industries to report project-level payments made to foreign governments. Isabel Munilla from Publish What You Pay (PWYP) emphasized that with detailed information, citizens, civil society organizations and NGOs will be able to monitor corporate and government interactions, hold both groups accountable, and ensure that natural resource wealth contributes positively to local development and livelihoods. Daniel Kaufmann pointed out that data and research from around the world suggests that in the long run, with increased transparency and accountability, citizens could see up to a 300 percent development dividend from improved governance – i.e. their incomes per capita could triple.

Bennett Freeman from Calvert Investments suggested that transparent companies attract more investors because disclosure clarifies investment risks. And Laurel Green from Rio Tinto also supported implementation of these disclosure reforms, pointing out that such transparency can be a competitive advantage since firms can provide host governments with clear evidence of how they contribute to government revenues and communities. Yet not all companies may view such transparency reforms to their advantage. From an economic incentive standpoint, Kaufmann highlighted that, as with practically every rule, Section 1504 also means that there will be winners and losers. Companies that focus on efficiency and innovation stand to benefit, while those that derive gains from rent-seeking, monopolistic behavior or tax avoidance would have an interest in maintaining an opaque status quo.

Some large companies and industry associations that are opposed to the disclosure rule in Section 1504, such as Shell and the American Petroleum Institute, have suggested that project level disclosure will be very costly, position publicly traded firms at a competitive disadvantage, and possibly face in-country discrimination in places with lack of disclosure. There was discussion during the panel suggesting that these claims may be exaggerated.  The reality is that companies already have systems in place to track revenues and payments. In fact, even though Section 1504 is not under implementation yet, some large corporations— like Rio Tinto, Statoil and Newmont Mining, among others— already disclose payments in every country of operation. Further, as reported by some companies that are already disclosing, there does not appear to be compelling evidence that companies will face major penalties by non-transparent governments.

Some companies are also concerned that competitors could use disclosed information to their advantage. First, the information that should be disclosed does not appear to fall under the proprietary trade secrets category. Furthermore, since the rules cover all companies listed on the U.S. stock exchange, major companies like Shell, Exxon and BP are covered, as are some state-owned ones, like Petrobras and Petrochina. Last, and not least, disclosure requirements along the lines of Section 1504 are already being drafted in the European Union, and consideration of similar rules is also taking place in South Korea and Hong Kong, which would widen the network of companies covered and further level the playing field. If anything, firms listed in the U.S. can get a head start on those companies not yet covered by disclosure requirements.

Since it will be virtually impossible to roll back Section 1504 on transparency in natural resources as well as difficult for companies to oppose transparency from a public relations perspective, the strategy by companies opposed to disclosure has been to lobby for watering down the eventual rules issued by the Securities and Exchange Commission and to delay the effective implementation of the rules. The most important component in watering down such provisions would be to make disclosure a requirement merely at the aggregate country-level rather than at the project-level. This loss of this crucial detail would greatly reduce the impact of the measure. All the panelists during this session, including those from the private sector, argued in favor of detailed project-level disclosure.

In the second session, panelists and participants discussed Section 1502, which requires companies that source minerals from Congo-DRC and adjacent countries to disclose whether they use conflict minerals. The rule relies on the adverse reputational impact of such disclosure rather than mandating penalties for actually sourcing minerals from conflict-afflicted regions where militias may be benefitting from this trade. No reputable company wants their product associated with armed conflict, human rights violations, slavery and rape. Yet again there are some companies that support these reforms, while others oppose them.

Corinna Gilfillan from Global Witness, Delly Sesete from CREDDHO in the DRC, and several participants in the audience from the DRC region emphasized that although Section 1502 will not itself end conflict in Congo, it could hold companies accountable for sourcing from mines controlled by militias. The U.N. Group of Experts on Congo has already found that since the signing of the Dodd-Frank bill, there has been a reduction in the portion of mined minerals that is funding the conflict. By denying financing to the armed groups that perpetuate violence in the region, the provision can contribute to increased stability and improved human rights.

As with Section 1504, some companies are claiming that implementation costs associated with conflict minerals in Section 1502 will be very high. There are numerous estimates of these costs, ranging from the SEC’s estimate of $71.2 million to the National Association of Manufacturers’ (NAM) estimate of $9-$16 billion. Recent estimates produced independently by the Claigan Environmental consulting firm and presented by Bruce Calder during this panel suggest that costs to the industry are expected to be less than $815 million.

In fact, some proactive companies (both domestic and foreign) are already showing that tracking supply chains is both practically and financial feasible. Sandy Merber from General Electric and Tim Mohin from AMD discussed how pooling industry resources could help offset individual firm costs. The Electronics Industry Citizenship Coalition and the Global e-Sustainability Initiative have partnered with firms to develop the “Conflict Free Smelters Program“, which allows companies performing due diligence to trace their mineral supply chain down to the smelters who are certified as being either conflict free or not. Efforts are being made to now certify smelters in the DRC region under this program to help preserve access to the international markets for impoverished artisanal miners. Yet the companies that have already taken the lead in tracking the supply chain are a minority, and thus they are bearing a disproportionate share of the cost for so doing. Once the rules are issued and regulations implemented, this cost would be spread among a larger universe of firms.

There are concerns among some in the DRC that Section 1502 will have negative unintended consequences on citizens in the region. They suggest that the disclosure requirements are driving firms out of the DRC, citing falling mineral trade as evidence. Yet Section 1502, which has not yet even been implemented, cannot solely be blamed. Since April 2010, when the DRC-government-imposed six-month minerals embargo ended, trade in minerals has been on the rise. Sesete argued that much of the talk of unintended consequences was akin to fear mongering. He and others have pointed out that the mineral trade in that region is a relatively recent activity and citizens had (and continue to have) other sources to support their livelihoods. Further, he emphasized that the benefits of increased security and reduced violence and instability are too great to dismiss Section 1502 outright.

In the end, as pointed out by Mark Taylor from FAFO, the ability of Sections 1502 and 1504 to achieve their goals depends heavily on effective implementation. The final rules on these two provisions have yet to be released by the SEC. Therefore, the uncertainty surrounding the final rules has contributed to speculations on the cost (both to companies and countries) of implementation. The sooner these regulations come out and the clearer the standards they set are, the greater chance these provisions will have in maximizing the benefits to global transparency, accountability and governance.

As Senator Ben Cardin reminded the audience during his closing presentation, the importance of Sections 1502 and 1504 transcends U.S. companies and Central Africa. Indeed, while the SEC should carefully weigh potential benefits and costs in the implementation of Section 1502 and 1504, the balance should be in favor of transparency.

And the importance of leadership should not be ignored: these specific disclosures in Dodd-Frank will signal that the U.S. is taking the lead globally on these important aspects, potentially nudging other key financial centers to do likewise and thus benefiting governance, security and human rights in many corners of the world.

* On December 13, Brookings and Global Witness hosted The Transparency, Conflict Minerals and Natural Resources: What You Don’t Know About Dodd-Frank, an event examining Sections 1502 and 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The agenda and full transcript can be found here.  This article was co-authored with Veronika Penciakova and originally published in the Brookings website.

Analysts have focused on the immediate and narrow concern of how the SEC and Citigroup will respond to this challenge and on second-guessing what may satisfy Judge Rakoff. Three options exist: the agency could renegotiate a deal with the bank for a higher settlement and insert vague (and non-incriminating) language hinting at the bank’s culpability; it could allow the case to go to trial; or it could appeal the Judge’s decision. Some even suggest that the ruling may result in the SEC pursuing more cases administratively in the future…

Rather than adding to these ongoing media and expert analyses on the immediate response of the SEC and Citigroup to Judge Rakoff’s ruling, we* take a broader perspective. SEC v. Citigroup can be seen in the context of the intimate relationship between the agency and the powerful banks it regulates, one which has prevailed for years and weakened the regulatory power of the SEC.

The financial crisis and subsequent call for reform provided ample opportunity to tackle such undue influence and regulatory capture. Regulatory capture occurs when the regulatory evidence is unduly influenced by the interests of regulated entities. At the beginning of the new administration and during the early stages of the Dodd-Frank reform bill preparation, a rebalancing of power between the weakened regulator and powerful financial institutions was expected.

Yet, once the bill was adopted reality began to sink in. The reform bill failed to directly address the problem of banks that were too big to fail, and left crucial implementation matters to the discretion of weak regulatory agencies such as the SEC. It seemed that power shifted back from Washington to Wall Street again.

Rakoff’s challenge of the SEC exposes yet another example of how old power balances that favor financial institutions remain alive and well. The main question is not how the SEC can reword its settlement with Citigroup to satisfy judge Rakoff, but rather whether the judge’s ruling will serve as a wake-up call to the weak regulatory regime governing behavior of financial institutions and prompt concrete changes to the rules of the game.

The SEC has a history of regulatory capture

Whether covert or overt, elements of regulatory capture have been evident for some time. In the decade leading up to the financial crisis, deregulation in the U.S. financial sector weakened regulatory agencies. More generally, seven years ago I codified the extent of “state capture” and “legal corruption” through a survey of enterprises in over 100 countries. The extent of capture afflicting the U.S. was very high; it not only rated well below other industrialized countries, but found itself among the bottom half worldwide (figure 1). But at that peak time of financial exuberance and deregulation, there was little appetite to take such data seriously.

It got even worse. These data were collected months before an infamous meeting between bankers and the SEC that took place in April 2004 in New York City when the SEC readily agreed to significantly relax its regulatory stance vis a vis the largest investment banks, allowing them to amass massive amounts of debt. In return, once the agency would set up its supervisory program, the banks would submit to SEC reviews and restrictions on excessively risky activities. Yet the SEC’s supervisory hired only seven people to examine companies with combined assets of more than $4 trillion and completed no inspections after 2007.

Furthermore, preceding the financial crisis the SEC became aware that Bernard Madoff, who had served on the commission’s advisory committee and had been previously reported for securities violations, was mismanaging his customers’ funds in the tens of billions of dollars. Yet the agency failed to probe deeper and unmask his Ponzi scheme. The SEC also neglected to take action against financier R. Allen Stanford, who swindled investors out of $8 billion, although allegations of fraud and possible money laundering had been levied against him in the past.

Expectations of change were not realized

The onset of the financial crisis revealed the weakness of the financial sector and the extent to which regulators had been captured. It spurred public outrage and calls for change. When the new administration entered office it brought with it a clear appreciation for the problem of capture. As early as 2007, then Senator Obama during a major address on the ills of the financial sector at Nasdaq in New York recognized that “turning a blind eye to cronyism in our midst put us all in jeopardy” and that “we [were] going to have to adapt our institutions to a new world.”

Over three years later, regulatory reforms were adopted through the Dodd-Frank bill, which, at least on paper, signaled a move in the right direction toward stronger regulations and the potential for somewhat reduced capture. Yet, recent events are exposing weaknesses in the Dodd-Frank bill. The bill failed to address crucial implementation details and was vague in some regulatory matters, leaving discretion in the hands of weak regulators. Since the mid-term congressional elections last year, lobbyists for large financial institutions and their allies in Congress have been working hard to keep, as intact as possible, the deregulated status quo that prevailed prior to the financial crisis and the subsequent Dodd-Frank bill.

It is now evident that if not for the Federal Reserve Boards’ lack of transparency in supporting large banks during the crisis, the Dodd-Frank bill may have had a better chance at addressing the undue influence and systemic risk posed by these large financial institutions. The extent to which large banks teetered on the edge of collapse in 2008 and 2009 has only now come to light. This week, Bloomberg revealed that by March 2009 the Federal Reserve had secretly provided nearly $7.8 trillion in emergency funds to rescue the financial system, dwarfing the publicly known $700 billion Troubled Asset Relief Program (TARP). The trouble with this secret bailout is not the Fed’s emergency actions, but rather that the information remained so closely guarded for so long and that the Fed fought against its disclosure.

This secrecy may have been initially warranted to prevent further panic and a run on the banks, but the lack of transparency in the medium-term had a significant impact on regulatory reform. Had the information been disclosed earlier, including to members of Congress and the public, the evidence of systemic risk posed by large banks may have persuaded some to adopt a tougher Dodd-Frank bill. A stronger bill may have more directly addressed the problem of large banks, and in this context, further empowered regulatory agencies such as the SEC. In fact, had the details of the Fed’s bailout been disclosed, there may have been more support in Congress to break up the biggest banks. Lobbyists for the largest recipients of Fed funds made a winning case that such a breakup would punish “successful” institutions.

Regulatory capture of the SEC today impacts enforcement

The close ties between banks and the SEC is symptomatic of the sector’s influence over the regulator. A study by the Project on Government Oversight found that in the past five years, 219 former SEC employees filed nearly 800 disclosure statements for representing their clients’ dealings with the agency, and of these, about half (403) were filed by people who worked for the SEC’s enforcement division. Because former employees are only required to file such disclosures for two years after leaving the SEC, these figures only capture the most recent instances. Even the regulator’s top enforcement official has moved back and forth between the Justice Department, Deutsche Bank and the SEC.

Such close ties may ultimately affect enforcement. An internal investigation found that a former SEC official blocked the agency’s investigation of R. Allen Stanford for nearly seven years, and then went on to work for him. More recently, the SEC’s head enforcement official was investigated (but cleared) after Citigroup hired his former boss to participate in its defense against charges unrelated to the case before Judge Rakoff. Negotiations between the parties resulted in the charges against two executives being reduced. In an open investigation, the SEC’s inspector general is looking into allegations that the frequent hiring of former SEC attorneys by a particular firm has contributed to the agency’s failure to take appropriate actions against it.

One impact of such capture has been weak enforcement. While the SEC can take companies to court, extract civil penalties and bring contempt charges for repeat violations, the agency has only given ‘slaps on the wrist’ to those firms involved in the financial crisis. Instead, it has preferred to settle out of court with big banks. These settlements allow banks to merely pledge to desist from breaching antifraud laws again and pay penalties, which are typically not very onerous, considering the bank’s breach and benefits they derived, without ever having to admit to any wrongdoing.

Following Judge Rakoff’s ruling, the SEC defended its practice of settling out of court by arguing that settlements deter future bad behavior because they make firms pledge to improve business practices and impose monetary penalties. The agency suggested that were it required to extract an admission of guilt, more institutions would take cases to court. This would tie up limited SEC resources and force the regulator to pursue fewer cases. This line of defense relies on two flawed assumptions – that current settlements deter future violations and that a lower caseload would weaken incentives to comply with regulations.

Firms will opt to fully abide by the law (or not) depending on economic incentives – i.e. whether the benefits of abiding by the law significantly outweigh the costs. Currently, the costs imposed by the SEC are low. Pledges are virtually costless, and the penalties imposed by the SEC are small relative to the profits of these large institutions and the benefits they derive from improper behavior. Furthermore, the SEC has shied away from closely monitoring the Banks’ compliance progress, and has done little to impose high penalties for failure to comply with pledges made by banks.

Citigroup is a prime example. It is accused of negligence in the loss of $700 million of investor money, and agreed to pay $285 million, which is less than 8 percent of the bank’s profits in just the third-quarter of 2011 alone. Moreover, because these settlements do not require companies to admit guilt, the bank is further shielded from investors taking them to civil court, and the Justice Department is in less of a position to press criminal charges against executives.

A New York Times analysis found that over the past 15 years, at least 51 cases have involved recidivism by 19 Wall Street firms. In many of these cases, the SEC could bring contempt of court charges, but it has not done so in at least 10 years. Most major banks are repeat violators. Bank of America, for instance, has four violations for purposeful or negligent fraud in interstate commerce, and four for purposeful fraud by securities firms since 1998. During the same period, Citigroup amassed five violations for purposeful or negligent fraud in interstate commerce, and three violations for purposeful fraud by securities firms. None of these past cases were even mentioned in the SEC’s charges against Citigroup in the case before Judge Rakoff, and no contempt of court charges have been made against the bank.

Finally, the SEC should be in a position to welcome a somewhat lower caseload if the cases it more forcefully pursues do substantially increase the cost of non-compliance. If any corporate firm has a somewhat lower probability of being investigated, but faces a substantially higher cost if probed, it will be far less likely to violate regulations because the expected costs associated with illicit behavior increases. Increased costs, in the form of higher penalties, investor lawsuits and possible jail time for executives, would serve as a strong deterrent. Currently, no executives have been successfully prosecuted for actions leading up to the financial crisis. This is in sharp contrast to the aftermath of the Savings and Loan (S&L) crisis of the 1990s when of more than 1,100 cases were sent to the Department of Justice for prosecution, resulting in 800 bank officials going to jail.

Taking on very large firms and raising the costs of violating the law are not impossible tasks. It can be done. In fact, in 2008 American and European authorities went after Siemens, a German multinational company, for making large amounts of dubious payments globally. By 2010 Siemens had paid out nearly US$3.4 billion in investigations, back taxes and fines to end the probe. Fines to authorities in the United States and Europe cost the firm US$1.6 billion. In addition, in German court one senior manager and two executives were found guilty of wrongdoing and were fined and sentenced to probation.

Conclusions and Implications

Focusing only on the minimum the SEC can do to settle with Citigroup and to satisfy the specific challenge presented by judge Rakoff misses the much larger picture. The judge’s ruling brings to light, once more, the extent to which a regulatory agency may have been subject to capture and undue influence by financial institutions and also raises the possibility of challenging the current status quo. Selectively, let us suggest five areas that warrant attention:

1.  The debate on how to stem the undue influence of big banks should be revisited, and a spectrum of more stringent measures, even including the breakup of the biggest banks, ought to be seriously considered. Revolving door policies ought to be revisited and cooling off periods should be extended, especially for persons occupying sensitive positions that are particularly vulnerable to capture.

2.  The public ought to take stock of and debate the implementation and application of regulations by the SEC under the Dodd-Frank, focusing on how the bill is faring and codifying the interests and arguments behind the efforts by financial institutions and lobbyists to delay or water down implementation of relevant aspects of the bill.

3.  The cost of violating securities laws ought to increase substantially. Simply raising the monetary out-of-court settlement with no admission of guilt will not alter the incentive structure. Rather, the SEC and others should not avoid contempt of court challenges for recidivist banks. More generally, banks should end up in civil court more frequently; settlements should include admissions of guilt and allow the market and private sector to challenge illicit behavior by banks; financial settlements with the SEC should be larger by a multiple factor; and the Department of Justice should work closely with the SEC to obtain the necessary information to pursue criminal cases. The Congress should also seriously consider the recent request by SEC Chairperson Mary Schapiro to allow the agency to levy larger fines against securities law violators.

4.  Like Judge Rakoff’s decision, the extent to which all judges exercise their due responsibility by not merely rubber-stamping unfair out of court settlements that unduly benefit one party to the detriment of the social good and broader systemic risks, should be reviewed and publicized.

5.  In a transparent and evidence-based manner, an in-depth review should be undertaken to discern whether the Department of Justice has been overly weak in failing to pursue criminal cases against senior bank executives. More generally, there should be increased transparency and disclosure regarding information in the financial sector, including on the Fed’s actions, as well as increased public debate on how campaign finance and lobbying contributions affect voting records in Congress and on politicians’ undue influence in implementing the regulatory regime and their agencies.

These tougher transparency, regulatory and enforcement incentives would further raise the costs of violating securities laws because companies would face the added risk of investor lawsuits, and possible criminal prosecutions by the Justice Department against executives.

If Judge Rakoff’s ruling will set a precedent is unclear, and it depends greatly on the White House, Congress, the SEC, other judges, civil society and reformists in the private sector to seize this opportunity and to address the persistent and costly phenomena of capture.

*Article co-authored with Veronika Penciakova and originally posted by Brookings.

And it raised questions about building safety in this geographical area, which is not known to be earthquake prone.  Thus it has not been subject to the more stringent building codes that apply in places like California, not to speak about the large stock of very old structures which exists in the East Coast… 

In looking for an upside to the earthquake, other than the relief in realizing that there were no major injuries or damage, some may quip that the earthquake can be salutary, since Washington was in dire need of being shaken and rattled.  The problem with this argument is that the timing was off, since politicians are in recess and mostly far away, so they would have hardly noticed.  In fact, newswires, Facebook and Twitter were abuzz reporting just after the earthquake struck that the Capitol building had been evacuated.  But that should not have been difficult, at least in terms of evacuating the VIPs, since they were not around.

It is no secret that nowadays it is politicians who in the eyes of both voters and entrepreneurs are being regarded in particularly poor light.  Recently I wrote about this here, so will not repeat it, except for providing a summary graph showing how the US Congress is viewed by firm managers nowadays, compared with yesteryear, and also compared with other countries.  The picture is dire regarding the view on the U.S. Congress today, and starkly contrasts the view by firms of their Parliaments in other countries (seen in this chart, picked up by the Economist). 

But let us face it:  today’s earthquake is unlikely to make any difference to this view on a dysfunctional US Congress; the required shake-up is obviously much more fundamental, and political rather than geological in nature. 

Yet could it be that the earthquake may have had an effect, either way, on the stock market?   A brief look at what transpired at the New York Stock Exchange may, or may not, suffice.  At 1.48pm earlier today, August 23rd, a couple of minutes before the earthquake struck,  the level of the Dow Industrials Average (DJIA) stood at 11,063.  Right after the earthquake hit, the Dow dips slightly, but to quickly recover and then climb substantially, to end at 11,177 by closing time at 4 o’clock. 

Consequently, the Dow closed over 100 points (a full percentage point) above the pre-earthquake level merely a couple of hours earlier.  In short, the stock market rose quickly in the aftermath of the earthquake. 

Concluding from such simple empirical observation that earthquakes can help the stock market obviously belongs to the ’ridiculous statement’ list, or the ridiculist.

But nowadays I do not stand out pointing to this causal link, however ludicrous.  Add this assertion to the mix of statements about the economy that we have heard in recent weeks from politicians, merely stating that ’earthquake helped the stock market’ (based on the above evidence), while it may make it to the ridiculous list, it would not rate near the top in the ‘Politician Statements on the Economy Ridiculist’.

The competition for the top slot in the Economic Ridiculist has been fierce among politicians lately. Take for instance the claim that Bernanke’s monetary policies at the Fed are ‘treasonous’, reflecting not just disrespect for Shakespeare but an utter misunderstanding of economics, finance, and the Fed’s performance (which has been good).  Or the myriad of statements about the failure of the expenditure stimulis implemented by the US Treasury (they actually worked, more is needed).

Or the statements about the salutary effects of not raising the debt ceiling, reflecting ignorance about the distinction between stocks and flows, and between past IOUs and future expenditures.  Or the irresponsible call for major budgetary expenditure cuts as soon as possible, thereby increasing the likelihood of a recession.  Or the notion that egregious tax loopholes for oil companies need to be protected, and justifying it with the misleading claim that they can make a difference in increasing aggregate demand at the macro-economic level.

One can go on and on regarding basic economic and financial fallacies that prevail nowadays.  I merely wanted to illustrate the anti-intellectual and anti-knowledge environment that seems to have taken hold of the political discourse in Washington, adversely affecting policy-making and market sentiment.  This matters enormously, since it is already having dire consequences for the US economy and potentially for the world at large.

Paradoxically, in today’s globalized world, in contrast with the US (and with some countries in Europe), many emerging regions exhibit much improved macro-economic management than in the past, reflecting learning from experience, improved know-how and global dissemination of such know-how, graduate education in top schools abroad and at home, and, importantly (outside of the US), increased deference to technocrats on difficult economic and financial matters.

Take for instance Latin America, and countries like Chile, Uruguay, Brazil, Colombia, Costa Rica, among others.  Politicians increasingly understand the importance of relying on evidence, some modicum of science and expertise, and thus on technocrats, even if some macro-economic issues are obviously still subject to political and technical debates.  These countries also pay close attention to the financial markets, which do provide an important signal when deviation from common economic sense takes place among politicians and policy-makers.

Irrespective of ideological affiliation, nowadays in many Latin American countries politicians do understand that there is no room for ’voodoo’, or ‘supply side’ or any other extreme ’fundamentalist’ construct for economic policy.  In many of these countries any remaining divide regarding macro-economic policy does not follow an ideological divide, but is strictly generational instead.

Misunderstanding on the basics of economic policy was part of a certain political class two generations older than the current policy-makers in power.  The younger generation not only understands well the analytical and practical aspects of macro-economic policy-making, but the approaches taken are common to both (left- and right-of center) sides of the ideological spectrum.  And it is rare (though it can still happen) that politicians irresponsibly try to undermine a serious head of a Central Bank or a Minister of Finance who is technocratically carrying out her or his job steering the economy. 

It may be revealing for some members of the US Congress to undertake a study tour to some countries in Latin America.

By July 2009, Congressional approval ratings declined to just 32 percent. Just prior to the debt-ceiling debate three weeks ago, they stood at 18 percent. These poll figures contradict Gallup’s expectation that there would be a surge in Congress’ popularity following the 2010 midterm elections. It had been suggested that Congress’ ratings may rise since that had been observed following some prior midterm elections.  But not quite…

It may come as no surprise if the next Gallup poll, expected to come out in mid-August, shows Congress’ approval ratings hitting an all time low. Another poll, conducted by Rasmussen more recently, reported a few days ago that only 6 percent of U.S. voters rated Congress’ performance as good or excellent, a new low in their poll. Their previous monthly low was last month— only 8 percent of U.S. voters rated Congress as good or excellent.

These polls speak to the dim view that voters have of how well Congress has been doing its job in general— not just related to the debt ceiling paralysis. Since this picture, based on the views of citizens and voters is not unknown to many in Washington, there is no need to belabor it further.

What is less recognized in the U.S. is the extent to which the private sector holds a dim view of Congress, and how this contrasts with how the private sector views the effectiveness of parliaments in other countries.

From our large worldwide governance databank that include dozens of sources, we can draw from one particular source first, namely a large survey of enterprises around the world. The World Economic Forum conducts annual surveys of over 10,000 private sector executives in over 130 countries. A simple analysis of the reports of those enterprises suggests how abysmally low the U.S. private sector their Congress (first column, Figure 1).

   If one compares the ratings for the U.S. Congress (lowest by far of any institution in the U.S.) with that of other institutions, we find that U.S. respondents do not have a dim view of the whole public sector or of simply any public institution. In Figure 1, we see the large gap in how the private sector views Congress as compared with either the police or the judiciary.

We also see in Figure 1 how differently the private sector in other countries views their own parliaments.  In 2010, executives in India, Germany, the UK, Canada and Sweden, among dozens of other countries, reported that their Parliaments function much more effectively than U.S. executives.  It is also noteworthy that these ratings do not differ substantially across OECD countries, including the U.S., for institutions other than their parliaments.  It is not a generalized dim view of the U.S. private sector regarding public sector performance.  It is about their Congress.

    Moreover, in countries like Germany, Canada and Sweden, there has been a positive trend in private sector confidence in their legislative body, which contrasts with the U.S.’s downward trend (Figure 2). If we only look at the U.S., we see that today’s dismal ratings of Congress’ performance need not be the case given data from previous years. In fact, the private sector’s assessment of Congress’s effectiveness was much higher in 2002, but has steadily declined. By the time the 2011 data is available, it is highly likely that the downward trend regarding the views on the U.S. Congress will continue.

In fact, more broadly, our Worldwide Governance Indicators (WGI) point to the fact that for some time the U.S. has been far from a model country in governance. At the start of the past decade, there were 15 countries around the world with better governance on average than the U.S. By the end of the decade, there were over 25 countries with better governance than the U.S. Such subpar performance in general on governance performance can be attributed in part to the performance of Congress.

A dysfunctional U.S. Congress may be the talk of the town and the world today. But empirical evidence suggests that it need not be the case. Other U.S. public institutions are performing much better in the eyes of the public and the private sector. Parliaments in other countries are doing well and improving over time, which shows that legislatures can be effective. The U.S. Congress itself has seen much better days. The American people and the world are hoping that Congress can rise to the task at hand given the urgent need to raise the debt ceiling in order to avoid the threat of another global economic and financial crisis.

We thus ask what types of regulatory failure may have contributed to Japan’s nuclear crisis and assess whether the U.S. Nuclear Regulatory Commission (NRC) is at risk of committing similar errors*…

Regulatory failure occurs when the regulatory system is deeply flawed – such as when it over- or under-regulates or when the regulatory design is based on “old science”. Regulatory failure also happens when agencies inadequately fulfill their oversight, supervisory and enforcement functions. Failures by regulatory agencies can go undetected for some time until they are exposed by a crisis, such as the BP oil spill in 2010 and the financial crisis that originated in Wall Street in 2008.

When assessing regulatory failure, it is important to distinguish between at least three different types of failure: lack of resources, mismanagement and poor technical expertise, and capture of the regulator by the regulated.  Episodes of regulatory failure result from different combinations of subpar performance in some or all of these components.

Which dimensions were associated with the failures at Japan’s regulatory agency?  Does the U.S. nuclear energy regulator face similar challenges? Let us review each of the three types of failures in the context of Japan’s NISA and the U.S.’s NRC.

Lack of Resources: When regulators lack the resources to hire staff, provide adequate training and expend the money necessary to monitor industries, regulatory concerns may go undetected and failure may result. The evidence does not suggest that Japan’s NISA or the U.S.’s NRC lacked sufficient resources to effectively implement regulations.

Mismanagement and “Old Science”: The regulatory system may sometimes over-regulate (business start-ups) or under-regulate (in finance, oil and nuclear power) due to ideological reasons or inadequate use of the latest knowledge and techniques. Even when regulators have a sufficient mandate to regulate and are provided adequate resources, they may still be ineffective at implementing and enforcing regulations and overseeing the operations and preparedness of the plants. The lax application of regulations and resistance to adoption of the latest scientific know-how and technical expertise regarding risk assessments can cause regulatory failure.  Also, regulation and knowledge mismanagement can distort the incentives for industries to meet safety standards.

Japan: The Fukushima nuclear crisis has exposed NISA’s failure to respond to the evolving scientific data and technology and to enforce regulations stringently. Since the 1980s, NISA has failed to act on warnings it received regarding the resilience of reactor containment structures to core meltdowns and the ability of plants to withstand earthquakes and tsunamis. This is particularly worrying since Japan has historically been prone to both earthquakes and tsunamis. For instance, in 2007 a 6.8-magnitude earthquake resulted in 1,200 liters of radioactive water leaking into the Japan Sea. The plant operator, TEPCO acknowledged that the reactors had not been designed to withstand an earthquake of that size.

Japan’s nuclear power safety regulations appear to be based on assessments of maximum earthquake and tsunami events derived from the modern historical record. However, these methods do not take into consideration uncertainties that account for a non-zero likelihood of a more devastating future earthquake and tsunami, even though risk assessment models that do so currently exist. Moreover, NISA has largely left the task of risk assessments and emergency response planning to plant operators and has merely published voluntary guidelines on advances in regulations rather than issuing concrete binding regulations. NISA is only now starting to order nuclear power plants in Japan to inspect devices and equipment and formulate emergency plans.

NISA has been lax in ensuring the adherence to safety regulations of Japan’s nuclear power plants. In 1999, 20 tons of radioactive water leaked into the Tsuruga plant from a cracked pipe. Even though a similar pipe had sprung a leak in 1996, these pipes were not inspected in subsequent years. In 2004, five workers were killed when super-heated steam burst from a pipe at a reactor run by Kansai Electric. It was later discovered that the pipe had not been inspected in five years.

NISA has also remained passive in addressing the nuclear industry’s long history of deception and cover-ups by different private operators, including but not limited to TEPCO. In 2002, five top executives from TEPCO resigned over a string of safety record cover-ups, including the falsification of containment vessel tests and shroud safety records. In fact, in 2002 four major nuclear companies admitted to concealing evidence of cracked containment structures from NISA. In 2007, seven of the 12 public utilities admitted to having falsified past safety records.   And at a basic level, it is now emerging that TEPCO’s disaster response plans that had been drawn in case of an accident at the Fukushima plant were totally inadequate:  they merely called for one stretcher, a satellite phone, and 50 protective suits.  Again, this raises serious questions not only about TEPCO, but about NISA’s oversight.

United States: While a degree of regulatory laxity plagues the NRC, it results more from lax enforcement of regulations than from failure to heed warnings or private sector deception. The NRC’s Office of the Inspector General uncovered 24 instances in which nuclear plants failed to report defects in equipment that could pose safety risks. In the last eight years, the regulator has not imposed any penalties on plant operators for such infractions.

For 15 years, the NRC allowed a water containment system to leak in New York despite the problem being documented. In South Carolina, a plant operator had to shut down reactors twice in six months. One of the shutdowns was caused by a power shortage in an electrical cable that had been installed in 1986 and was not up to standard. In New Jersey, a nuclear plant was relicensed in 2009 even though it lacked a reactor containment shell that could withstand a jet crash. Within seven days of its relicensing, an ongoing leak of radioactive tritium-polluted water was uncovered. These regulatory oversights in the U.S. likely contributed to several accidents, but none are as severe as those in Japan.

The US regulatory system faces a particular challenge regarding the handling of the vast amounts of spent fuel. At the beginning of 2010, nearly 65,000 metric tons of spent fuel was being stored at U.S. nuclear power plants. The NRC does not have limits on the amount of time fuel can remain in spent fuel pools and has not mandated, for instance, the transfer of spent fuel to dry casks, which are located away from reactors. Currently, nearly 10 times as much fuel is located in spent fuel pools than in the reactors. This is worrying as the pools are not protected by containment shells as the reactor cores are.

However, whereas Japan has tended to use outdated risk-assessment methodologies, the NRC has been more proactive in utilizing the latest technology to address potential safety risks. Although in the U.S., the types of risks nuclear plants face are different (such as lower risks of tsunamis afflicting power plants), risk assessments carried out in the U.S. do consider each plant’s geographical location and all plants have to take into account the risk of potential terrorist attacks. In recent years, the regulator has adopted some new risk assessment techniques in their plant-by-plant reviews. Some of the modeling techniques used in the U.S. also takes into account the risks of potentially devastating future natural disasters.

In Japan, mismanagement results from the regulator’s failure to adopt the latest technology and to punish private sector deception. In the U.S., the problem seems to center around general weaknesses in regulatory oversight and lack of a spent fuel strategy. While the U.S. NRC’s mismanagement and challenges in technical expertise appear to be less severe than those of Japan’s NISA, improved regulatory enforcement by the U.S. NRC may still be warranted.

Capture: The incentives for regulators to effectively implement regulations can also become distorted when industry actors exert undue influence over the regulatory process.

Japan: The influence of the nuclear industry over NISA occurs through various channels. NISA is not an independent regulator and is therefore even more susceptible to outside influence. NISA is housed under the Japan’s Ministry of Economy, Trade and Industry (METI), which promotes the nuclear sector domestically and abroad. METI has very close connections to the nuclear industry and has been charged with distorting information presented to public officials on nuclear energy and orchestrating the defeat of alternative energy development legislation.

The METI has made it clear that expanding Japan’s nuclear power industry is of central importance to the government’s growth strategy. As such, it has been instrumental in the launching of the International Nuclear Energy Development of Japan Co. (JINED), a public-private partnership headed by TEPCO to sell nuclear reactor contracts to developing countries. In the fallout from disaster, it seems the government has recognized the danger of this conflict of interest and there are now reports that the Japanese government is considering splitting NISA from METI.

Japanese officials also have an incentive to be deferential to private sector counterparts since retiring public officials often obtain prominent private sector jobs in a practice called amakudari, or “descent from heaven” (a practice in the U.S. known as the “revolving door”). It is not uncommon for individuals involved in the nuclear sector to act at different times in the licensing, rulemaking and inspections process.

For instance, a director general of the Ministry of Economy, Trade and Industry (METI) obtained a job with TEPCO after leaving his regulatory post. Private nuclear power industry companies may also have a direct role in shaping regulations. When the government convened a panel to revise nuclear regulatory standards in 2005, 11 of the 19 members on the panel were from the nuclear industry.

United States: The NRC faces similar types of regulatory capture challenges, but the agency is an independent regulatory agency and therefore not involved in the promotion of the nuclear industry. Yet it receives 90 percent of its funding from industry fees, which potentially compromises its independence.

One report suggests that the NRC has acted in some cases more to safeguard the interest of the nuclear power industry than the public. Nearly half of NRC employees surveyed by the agency in 2002 said they feared raising safety concerns might undermine their career. Also, as is common in other regulatory agencies in the United States, NRC employees often pass through the revolving door. There have been some isolated cases when regulators have accepted gifts from and made decisions in favor of future employees prior to leaving the NRC. In one recent case, a commissioner voted on a matter that benefitted three nuclear companies, two of which he was negotiating an employment contract with at the time.

In the United States, the NRC is connected to the nuclear sector through industry efforts to influence the legislative process. Last year, the U.S. nuclear industry spent nearly $54 million to lobby Congress and employed 12 former members of Congress as lobbyists. Some of the top supporters of the nuclear power sector have also been some of the largest recipients of campaign contributions from this sector. There are many examples of this type of lobbying. For example, Exelon, one of the U.S.’s largest nuclear operators, contributed to the campaigns of the House minority whip and the Energy and Commerce Committee chairman and contributed to 14 of the 19 members in the House of Representatives from states where Exelon owns reactors.

Conclusion

The manifestations and extent of regulatory capture in Japan and the U.S. differ, with the problem seemingly more acute in Japan. However in both countries, regulators have had their incentive to regulate effectively distorted by the influence of the nuclear industry. In the fallout from the Fukushima crisis, the role of numerous actors will be scrutinized, including TEPCO and the Japanese government. But, the role of Japan’s nuclear regulator should not be underestimated.

By failing to sanction plant operators for safety infringements and to heed safety warnings, NISA allowed the private sector to continually skirt regulations. NISA may not have been properly empowered to mandate changes in the private sector. In addition, whatever de jure mandates they may have had, they did not forcefully implement in practice. To a significant extent, it appears that regulatory capture of NISA by Japan’s nuclear industry turned the regulator into a caretaker of industry rather than one for public safety.

The U.S.’s nuclear and regulatory situation differs from Japan’s. The evidence suggests that the NRC is not effectively enforcing regulations. The NRC’s regulatory struggles do not stem from private sector deception, but from a degree of regulatory capture (there are some instances of undue influence) and particularly from the weak enforcement of existing rules.

In the United States, the NRC will imminently be undertaking a 90-day review of the country’s 104 reactors.  But in addition an in-depth review should also be conducted by a fully independent commission (akin to the Kemeny Commission established in the aftermath of the Three-Mile nuclear power accident).  An independent commission could review how the NRC could more effectively implement existing regulations and conduct plant-specific “stress tests” of seismic risks with the purpose of revoking licenses in cases where standards do not conform to the risks exposed by the latest technology. The independent study should also look into an industry-wide strategic approach to safely managing the storage of spent nuclear fuel, which poses a particular risk in the United States.

*  This is a Commentary article at Brookings, co-authored with Veronka Penciakova

Thus, throughout his visit, Obama may confront issues far removed from Latin America.  Fittingly, or ironically, Latin America has not been a priority for U.S. foreign policy in recent years. From a national security standpoint, there are a few exceptions, such as two important countries Obama will not visit, namely Colombia and Mexico, where narco-violence has attracted U.S. focus.  Yet, that almost sums up the extent of U.S. foreign policy priorities vis-à-vis the continent so far…

But, this presidential visit ought not go to waste. President Obama chose Chile, not the Brazil powerhouse, or Argentina (a G-20 member that Obama will not visit), to publicly address the Latin America region.  On the world stage, Chile, which is not in the G-20, is considered a modest country.  In this regard, one can draw similarities to Obama choosing Ghana over Kenya or Nigeria for his address to Sub-Saharan Africa when he visited that region.

Obama will undoubtedly go through the motions and raise issues that the US and Chile have been working on for some time, including training, intellectual property rights, narcotics control, innovation, visa waivers, and the Trans-Pacific Partnership (TPP) trade negotiations with Asian partners.  Obama would be well-advised not to insist on signing a specific nuclear power agreement with Chile in this most-sensitive of times, considering the current events in Japan.  More generally, in light of the current reality in Chile, and the major crises unfolding around the world, Obama may want to deviate some from his official script.

For starters, departing from practices by some in the past, Obama should treat Latin Americans in general, and the Chilean leadership and people as equals,   After all, in spite of the superpower gap, Chile and the U.S. exhibit some striking similarities in their achievements and challenges.  For example, Chile is no longer a developing country, but rather a successful emerging economy and a full-fledged member of the OECD.  While Chile’s accession to the club of industrialized nations is recent, this commonality brings into stark relief another similarity between both countries:  both the U.S. and Chile share a similar quality of governance in most dimensions, as we see in Figure 1.

For instance, among over 210 economies around the world, on Government Effectiveness, Chile ranks 31^st and the U.S. 24^th; on Regulatory Quality, Chile rates 14^th and the U.S. 23^rd; and on Control of Corruption, Chile rates 23^rd in the world and the U.S. 32^nd.  On Voice and Democratic Accountability, the United States rates somewhat above Chile, while the converse is true for Political Stability/Absence of Major Violence/Terror.   Both countries have serious challenges regarding security and safety.  In Chile, this is due to high levels of common crime stemming partly from inequality. In the United States, the high homicide rate is partly due to ubiquitous availability and use of guns, which puts at risk high level politicians.

The fact that the United States’ quality of governance is not superior to that of Chile ought to be seen as evidence of Chile’s progress over the past couple of decades, and as a sobering reminder to the U.S. that it is not a model country on governance.  Model countries, such as Scandinavian economies and New Zealand, should serve as symbols for Chile and the U.S. of what is attainable.

Besides governance, Chile and the United States have commonalities and differences. Both countries have relatively deficient educational systems in dire need of bold reform (though even more so in Chile). Over the past decade, Chile has done much better than the U.S. in macro-economic management, sustaining fiscal stability and maintaining the integrity of its financial sector.  Conversely, Chile has much to learn from the U.S. regarding technological innovation.

Another common trait is self confidence.  Polls suggest that citizens in Chile, Israel and the U.S. tend to have very high self-esteem, while people in Japan, South Korea and Switzerland tend to be very humble.  Not surprisingly, the current heads of state of Chile and the U.S. also exhibit very high levels of self-confidence. On the one hand, such high self-esteem can create a blind spot to personal and countrywide challenges and shortcomings—both leaders have had low poll ratings recently.  On the other hand, such self-confidence, if coupled with boldness and risk-taking, can be a positive force for reform, as witnessed with Obama’s push for health care and financial reform last year and Piñera’s handling of the miners’ rescue.

Undoubtedly, in President Obama’s major public address to Latin America that will take place in Santiago, he will praise Chile’s performance. He would be wise to steer clear of condescending comments on the country and region, and instead focus on the shared achievements and challenges facing the U.S. and Chile.  To avoid meddling in internal politics, Obama should not apportion credit for Chile’s achievements to either the current (right-of-center) or past (left-of-center) governments. All Chileans, and every (post-Pinochet) leader, deserves credit for the country’s institutional and growth performance.

The fact is, in contrast to the destructive squabbling between Democrats and Republicans that dominate Washington politics, Chilean politicians, from all parties, even if they disagree on emphasis and details, have shared for years a common agenda on maintaining sound financial and macro-economic policies, sustaining robust growth and poverty alleviation and expanding social safety nets, open markets and good governance.

In his message to the region, Obama should focus on the region’s major constraint to future progress and social peace: glaring inequality.  He should not waste this opportunity by speaking lengthily on the obvious (to Latin Americans) virtues of democracy and protection of human rights.  With the exception of Cuba, and notwithstanding the challenges in a few countries like Venezuela and Nicaragua, these are not contentious issues for most every citizen or leader in the region.

The traditional political approach to inequality focuses on inequality of income, access to productive jobs and educational opportunities. It would behoove Obama to suggest that an underlying determinant of economic inequality is political inequality.  In Latin America, there is an enormous divide between the powerful elites and the rest of the citizenry.  The former wield disproportionate political influence in shaping the laws, regulations and policies—what we have dubbed as “state capture,”—and such excessive presence of “elites and business in government” has been a driver of economic inequality.

It would be a bold step for Obama to take a fresh approach to inequality and frankly talk about political inequality, vested interests and undue influence of corporate elites. These are particularly sensitive issues not only in Latin America (even in Chile, the otherwise “stellar performer”), but also in the U.S. Not only has economic inequality grown recently in the U.S., but the challenges of undue political influence and money-in-politics have become increasingly damaging, as Obama well knows. By taking this opportunity and talking frankly about economic and political inequality, Obama could move away from what otherwise may be just another public address, into a transformative message on shared achievements and shortcomings and the need for serious political reforms in Latin America and the U.S.

When U.S. presidents travel to countries in an emerging region, with their vast entourage of officials and executives, it is typical to see a focus on partnership agreements (and on vague grandiose pronouncements).  Obama’s trip to Latin America may be no exception, as illustrated by so many writings on specific ‘transactional’ agreements that may be signed on the visit.

But it is important to keep in mind that such bilateral transactional approach should not come at the expense of a commitment to to a few economic and policy fundamentals in the US:  establishing truly open markets (to goods, services, ideas and people) into the U.S., prudent fiscal policies to attain macro-economic stability, and making the financial sector more resilient, so to strive towards sustained growth in the U.S.  A pledge by Obama on these fronts, which would entail tackling domestic undue influence by protectionist, as well as Wall Street, vested interests, is likely to have more of a concrete impact on Latin America than signature of any bilateral transaction or particular partnership with a country in the region.

Even among those who write about capture in the US there is a lively debate regarding what constitutes capture, and which manifestations of capture matter in particular in the US.  The terminology has been steadily expanding, and include terms such as state capture (which we used and analyzed well over a decade ago first in transition countries), regulatory capture, cognitive capture, social and cultural capture, soft and hard capture, among others…

It can all get rather confusing.  Even more so because then there are other terms that do not explicitly contain the term capture but which are difficult to clearly distinguish from many of these notions of capture, including legal corruption, undue influence (in, say, private interests affecting public policy outcomes), vested interests, and cronyism.

And some of these notions, such as cognitive, cultural and/or social capture, are even difficult to disentangle from ideology.  So when is capture actually present, what manifestations of capture matter in particular, and what can be done about those?   And if it is not the case that the fox is guarding the hen house, or that public policy is being privatized (for the benefit of the few, rather than the broader public), aren’t we over-stretching the notion of capture, and thereby undermining it?  Further, by listing so many manifestations of capture (and related) that were ‘culprits’ in the recent financial crisis that originated in Wall Street aren’t we begging the question of which were the 3 or 4 key contributing determinants to the crisis?

It is therefore timely that the Fordham Law School and its Journal of Corporate and Financial Law will be holding their 2011 Spring Symposium on the subject of capture in financial services tomorrow, Monday February the 7th, in New York (here).  I have been asked to join a panel of experts, namely Lawrence Baxter, James Kwak, Steven Davidoff and Robert Weber. Rick Carnell will be moderating, and Senator Sheldon Whitehouse (Rhode Island) will keynote. The event is open to the public and even offers CLE credit for lawyers.

In my contribution I will be raising some of the above questions, and contribute some thoughts on approaches to the analysis of actual capture.  Since I am the foreigner in the panel, I will try to provide a bit of an international comparative perspective although the focus will be the US (after all, I have been in the country long enough).  And given my background as an empirical economist, I will let data do some of the talking, and emphasize the role of incentives, which sometimes is not given its due.

Without spin or political correctness, let me distill in brief some of the key messages the emerge from a review of the new data:..

1.  The world continues to under-perform on governance:  Serious governance challenges persist in every region of the world, at all income levels and in every dimension of governance:  voice and accountability, political stability/no violence, government effectiveness, regulatory quality, rule of law and corruption control.

2. The largest and most powerful economies in the world do not exhibit model governance or corruption control: Whether reviewing the performance of countries belonging to the G-2 (US and China), the G-8 or G-20, large and powerful world economies do not generally excel in any of the key dimensions of governance measured by the WGI.  Instead, the Nordic countries and New Zealand consistently exhibit the highest standards of governance across all indicators, including anti-corruption.

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3. But high quality governance is not limited to wealthy countries: Over 30 developing and emerging economies have higher governance and anti-corruption scores than industrialized countries like Italy or Greece, for instance.

4.  Where there is commitment to reform, significant improvements in governance can and do occur: Over the past dozen years, numerous countries from every region have experienced significant improvements in many dimensions of governance.  We identify such countries.

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5.  Yet, on average the world has not significantly improved in the quality of governance: Improvements in governance in some countries are balanced by declines in others and stagnation in many more.  Furthermore, some countries have also experienced reversals in governance performance over the past dozen years – following initial improvements in governance, some countries subsequently experience deteriorations (and viceversa).

6.  Good governance has a very high payoff: Industrialized countries with higher levels of corruption (as measured by the WGI), have higher budget deficits, suggesting that corruption is associated with financial stability in wealthy countries.  Further, our research indicates that in developing and emerging economies, better governance can significantly reduce poverty and raise living standards.

It is high time to take a deeper look in-house, in richer and poorer countries, and in national and global institutions.  Something is amiss.

But what if the quality of governance around the world has really been improving lately, including in the key wealthy nations, as well as developing countries generally?…

If such upward trend was clear, that would constitute good news for development, for MDG prospects, and for the world’s financial stability.

It is time to review the state of governance around the world to find out about this and related questions.  Tomorrow we will release a the new set of the Worldwide Governance Indicators (WGI), covering the 1996-2009 period for over 200 countries, as well as a new companion analytical report and a brief.   The key six dimensions of governance we measure are:  voice & accountability, political stability/violence, government effectiveness, regulatory quality, rule of law, and control of corruption.

Some of the findings may not be what some traditionally expect.  I will write about it, and all the data and joint work on this with my former World Bank colleagues will be found at www.govindicators.org

At best, it is premature to celebrate.  Five years remain to meet the eight Millennium Development Goals…

Laudable progress has been made in some regions, like East Asia, and on some targets in those regions, such as poverty.  But various MDG goals are likely to remain unmet by 2015, while other important and complementary development priorities, passed over by the MDGs, such as access to electricity, may not make sustained progress in the near future.  And much of the data on the MDGs predates the economic crisis.  Such data, complemented by more recent UN updates indicate very uneven progress and show evidence of setbacks due to the economic crisis.

The U.N. estimates that the world may reduce poverty from 46 percent in 1990 to 15 percent in 2015.  Typically such projections tend to be optimistic.  And even if attained on average, this would mask enormous variation across regions and countries.  For instance, in 2005, 17 percent of the population in East Asia lived in extreme poverty compared to 51 percent in Africa.  Since the economic crisis, preliminary evidence suggests that an additional 64 million people may have fallen into poverty.

And other targets will also remain out of reach. Prior to the economic crisis and to the rising food prices Latin America and Asia (driven by China) were on their way to halving undernourishment.  But, the dual crises have undermined progress worldwide.  The FAO estimates that nearly a billion people are undernourished nowadays, marking a disturbing increase since 1990.

The lack of progress on halving the number of people without access to sanitation is also of concern. In 2006, forty-five percent of people continued to live without access, indicating extremely slow improvement since 1990, and suggesting that the world may be very far from being able to attain this goal over the next 5 years.

The success of various MDGs is strongly interlinked. Research shows, for instance, that female empowerment, education and income help reduce child and maternal mortality rates.  It is then surprising that a ninth MDG does not exist: access to electricity is not only essential to improving the quality of life in developing countries, it is also crucial for the success of various MDGs.

For instance, today over 1.6 billion people lack access to electricity, which is central to improving productivity, increasing access to information technologies, enhancing educational opportunities, improving the quality of healthcare and increasing access to certain medicines.  Although the international community has acknowledged the importance of energy, most recently in a report by the UN, it has yet to take concrete steps to correct this oversight.

Apart from missing goals, there are many explanations for slow and uneven progress on the MDGs, ranging from insufficient donor commitments to the choice of indicators. But, as we have written about before a big part of the answer lies in the highly variable quality of governance across countries.  Our research suggests that improving governance and corruption control from the extremely low levels of Afghanistan to the subpar levels of countries like Kenya, or from the subpar level of Kenya to the higher level of Ghana, contributes significantly to major declines in infant mortality and increases in incomes.

Progress on various MDGs is strongly linked to governance. For instance, developing countries with high levels of corruption have a substantially greater portion of the population living in extreme poverty than countries with moderate corruption. A brief just released by Transparency International also suggest that in countries where the frequency of bribe payments is higher, literacy, maternal mortality and access to clean water are negatively affected.

Development outcomes generally, and the MDGs specifically, are also related to under-emphasized political dimensions of governance such as human rights and freedom of the press. For instance, in Uganda the portion of allocated public expenditure that reached schools rose from 13 percent in 1991 to nearly 95 percent in 1999 as a result of increased government transparency and public accountability.  And, increased citizen participation, media freedoms and gender rights are associated with lower poverty rates.  In fact the disappointing performance of the MDG on maternal mortality is related to the lack of progress on human and gender rights in many countries.

Ultimately, aid alone is far from sufficient to ensure goals are met. Calls for donors to meet aid commitments related to the MDGs are justified, but so are demands for donors and recipient countries alike to fulfill pledges related to good governance, transparency and accountability in industrialized and developing countries.

Just as access to electricity is often cited as the missing MDG, governance has also been the forgotten as a crucial cross-cutting umbrella pillar to achieving the MDGs.  It is no secret that that aid can be effective when there is satisfactory (or improving) governance in recipient countries and when it is efficiently and transparently allocated by donors — but not when misgovernance and corruption are rife.  Further, responsible governance and transparency in industrialized countries is critical for development effectiveness, as demonstrated by the high development costs of the economic crisis that was triggered by misgovernance in rich nations.

Therefore, instead of a glitzy gala at the Waldorf-Astoria in New York, the focus ought to be on addressing neglected MDGs that are far from being met in scores of countries, such as maternal mortality and sanitation, as well as addressing head on, and attempting to catch up, on the missing MDGs, such as electricity, as well as governance and anticorruption, which is a determinant of performance of each Millennium Development Goal.

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Note:  This is a revised and expanded entry of a very brief contribution on this topic issue to the Up Front Blog at Brookings, co-authored with Veronika Penciakova.