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.

Yet, what is not so well known is how the Dodd-Frank Act extends beyond Wall Street and even the rest of the United States. There are two provisions in it that are intended to promote transparency and governance in natural resources in countries outside the United States…

Section 1504 is the more general provision on transparency. It mandates oil, gas and mining companies registered with the Securities and Exchange Commission (SEC) to publicly disclose the tax and revenue payments made to any government.

The more specific Section 1502 requires that companies that use minerals from the Democratic Republic of Congo (DRC) and adjoining countries disclose whether such minerals are sourced from areas in conflict within that region, so to provide information as to whether the payments made by such companies may be funding armed groups in those areas…

While few would publicly argue against promoting transparency generally, it is no secret that these provisions have generated much discussion and controversy. This matters for how the provisions will be implemented in practice. Thus, it is important to seriously debate all sides of the issues surrounding these two provisions, including the criticisms leveled against them.

For instance, it is important to discuss whether Section 1504 — which mandates transparency requirements in oil, gas and mining-related payments to governments — does not impose new and enormous (multi-billion) costs of compliance, which may create a major competitive disadvantage on companies.

Further, do project payment disclosures really mean revealing trade secrets? If there are costs, how do they stack up against the benefits from transparency and disclosure in natural resources? And on the other hand, what are the benefits to transparency? How can greater transparency help improve the management of natural resources in a way that contributes to economic development and increase accountability?

As indicated, Section 1502 is aimed at cutting off financing to armed groups who have profited from trade in minerals and use this money to finance their operations. The issues of compliance costs and competitive disadvantage are also concerns for some parties with regard to this section on conflict minerals.

There are also additional questions that merit debate, such as assessing the potential benefits from denying armed groups from being financed by companies purchasing minerals and the reduction in violence and human rights abuses, versus the potential for disruption in trade on minerals from the DRC and adjoining countries. This may inflict undue “collateral damage” on some mineral-extracting areas that are not conflict-ridden.

On the other hand, these costs should be weighed against the costs of continued trade in conflict minerals. How high are these costs? And what are some benefits for companies and the DRC in developing a clean minerals trade?

These and many other relevant and related issues will be debated in a public event this coming Tuesday, December 13, at the National Press Club in Washington, D.C.   We at Brookings along with Global Witness will host a discussion to examine these two provisions in the Dodd-Frank Act.

Leading experts from civil society in the United States and Africa, the private sector, the financial sector and think tanks will participate in an interactive panel setting to review the priority issues surrounding each provision.

Representative Jim McDermott (D-Wash.), will provide the opening remarks while Senator Ben Cardin (D-Md.) will give the closing remarks. And Reverend Jim Wallis of Sojourners will also be speaking during the lunch break. The panels will provide ample room for debate among the panelists and between the panelists and the audience, aiming at bringing out the key issues from all sides.

Given the importance of these initiatives and the ongoing discussions on their implementation details, we expect a lively debate.

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 the forum’s co-chair, Brazilian Minister of Foreign Affairs Antonio Patriota, also stressed that through such multilateral cooperation the OGP could play a role in stimulating innovation, improving the quality of public services and contributing to national efforts in governmental transparency.  Throughout the forum, governmental and non-governmental representatives from around the world emphasized the important role that civil society organizations can play in encouraging openness, empowering citizens and promoting change through their own transparency initiatives.

The OGP Forum was an auspicious start to an ambitious project. However, achieving global transparency remains long and challenging, and only over time will the concrete contribution of this initiative be seen.   Yet, this inaugural forum showcased exciting initiatives and raised important questions, such as how to effectively build networks of governments, foster cooperation with civil society organizations, identify targeted reforms and use technology to foster a transparent environment.

Many governments have already made great strides in promoting transparency: For example, Brazil is now disseminating information on government spending and fund transfers data through their Transparency Portal;  the U.S. has embarked on efforts to publicly account for Recovery Act spending; and Kenya has published its national census, government expenditure and parliamentary proceedings data through its new Open Data Portal.

Civil society actors around the world are working to further the transparency agenda in diverse ways.  India’s NGO MKSS combats graft stemming from the implementation of the National Rural Employment Guarantee Act by painting employment and building material costs on walls outside of construction projects in rural areas.  Ushaidi Kenya maps citizen reports of acts of violence, while Chile’s innovative Ciudadano Inteligente promotes transparency and active citizen participation through new web technologies.

The OGP offers an opportunity for governments from around the world to share best practices in transparency reforms and the inclusion of both governmental and non-governmental participants facilitates collaboration between key stakeholders. Civil society organizations could continue to nudge governments toward increased transparency, as well as complement and reinforce ongoing reforms by disseminating information to the public and monitoring implementation. For instance, in Slovakia, the Fair-Play Alliance’s Z Nasich Dani (From Our Taxes) new online tool, which discloses the names the individuals behind companies who do business with the government, is complementary to the Slovak government’s online publication of public service contracts by allowing citizens to dig deeper into the relationship between companies and the state.

The OGP is also working to identify the transparency reforms to promote. The OGP used four criteria (fiscal transparency, access to information, senior official disclosure and citizen engagement) to identify around 80 eligible countries, but it is no secret that each country finds itself at a different level of openness.  Although it is noteworthy that the criteria extended beyond the existence of e-government to encompass deeper forms of transparency, the OGP will still need to strike a balance between emphasizing country-led solutions while encouraging deeper reforms and discouraging “open government” rhetorical window-dressing.

It is reasonable to expect very different paths; some countries may initially focus reforms in “high-risk” sectors, such as in the extractive sector in resource-rich countries, while others may focus first on engaging the citizenry in the policymaking process.  Either way, it is important to attain broad consensus regarding what constitutes concrete progress, versus mere pronouncements or decrees on paper only.

The important role of transparency reforms in combating corruption was the subject of a specialized panel at the OGP forum. For transparency to have more substantial impact on anti-corruption and development, deeper reforms may be needed. For instance, publishing official statistics and general budget data online can be a first step, but one ought not declare “premature victory” after tackling such generic “low hanging fruits.”

Indeed, well implemented freedom of information laws or well disseminated budgetary and procurement details at the project and municipal level can be expected to have larger effects.  Furthermore, there can be large payoffs to tackling the more politically difficult reforms, such as transparency in the drafting of laws and in policymaking, campaign finance, lobbying, the disclosure of officials’ assets, and fully disclosing which powerful private sector and media executives the leaders of government meet regularly with.

New technologies are only part of the answer. Twenty-first century technology has simplified and accelerated information dissemination and has lead to a new set of cost-effective and interactive tools that make it easier for the public to engage with the data. Many existing open data platforms can easily be adapted to visualize different datasets at a relatively low cost. For instance, the United States and Kenya now use the same platform to publish their government data. However, as the open government agenda evolves, there is the risk of becoming hypnotized by technological wizardry at the expense of the availability, timeliness and accuracy of the most relevant types of information.

In this context, civil society groups, think tanks and researchers may play a role in reviewing the quality of information and data being disclosed (or withheld), in monitoring and analyzing information citizens deem the most relevant, and in constructing and disseminating user-friendly worldwide transparency and governance databases.   Yet we also need to be mindful that country context matters. Online tools may be helpful in many situations, but in others putting information on a wall or disseminating it through community radio or a mobile text message may be a more effective in reaching people.

   Research and experience suggest that there are links between transparency, combating corruption and more robust democratic institutions. The OGP represents an opportunity to further the openness agenda by bringing governmental and non-governmental partners together to share experiences that could inform and complement the implementation of transparency reforms at home.  Last week’s OGP kick-off forum was a positive step toward global transparency.

But it was a first step.  Significant work lies ahead in the months to come.  The first order of business is to get the OGP formally and concretely off the ground.  Led by their founding country members (Brazil, Indonesia, Mexico, Norway, Philippines, South Africa, the United Kingdom and the United States – and hopefully India decides to rejoin), the OGP is expected to be formally launched by country leaders during the upcoming United Nations meetings in late September in New York.  In parallel, the critical role of civil society needs to be concretely detailed, and governments from eligible countries have to formally join the OGP and be prepared to make transparency reform commitments that can be mutually reinforced and monitored.

[This post was jointly authored with Veronika Penciakova and originally published as a Brookings Commentary]

Since this incident, Tunisia’s government has fallen and demonstrations have spread to Yemen, Jordan, Algeria, Sudan and Egypt, where only yesterday well over a million people took to the streets to demand the ousting of President Mubarak, whose days appear numbered.

And Yemen’s president has also announced that he will not seek re-election or hand power to his son, while the prime minister and government of Jordan was dismissed by the King after demonstrations.  The world has been watching and Middle East experts, politicians and pundits have weighed in on the unfolding events. Many wonder whether we could have foreseen this wave of unrest…

On the contrary, until a few days ago many pundits were still predicting that instability – let alone regime change – would not spread to Egypt. Some highlighted the apathy, cynicism, fatalism and fear of Egyptian citizens in predicting the persistence of the longstanding status quo in Egypt. “No Sign Egypt will take the Tunisian Road” was the title of a BBC article from Cairo just two weeks ago. It noted that “no one could describe Egyptian society as ‘aspirational’… Egyptians do not see any way that they can change their country or their lives through political action, be it voting, activism, or going out on the streets to demonstrate.”

Other major media outlets predicted that the status quo would continue in Egypt, citing limited freedoms as a distinguishing feature of Egypt. A recent Foreign Policy article suggested that Egyptian President Mubarak differed from the exiting Tunisian ruler because Mubarak cleverly combined limited freedoms with co-option and some opportunities for Egyptians to express their political grievances. The Economist argued that Egypt’s “relatively free press not only gives healthy air to protest, but acts as the sort of early-warning system that [Tunisia’s] Ben Ali, due to his own repressive tactics, sorely lacked.”

Time magazine predicted that no “Domino Effect” would result from Tunisia’s revolution, and that the U.S. would proactively prevent Egypt from following Tunisia’s path, while the Economist and BBC contrasted the weakness of Tunisia’s security forces with the superior training and equipment (largely provided by the U.S.) of Egypt’s. And a few days ago another expert explained in Foreign Policy why, in contrast with Tunisia, the army in Egypt would not side with the public, only to have the military announce days later that they respected the people’s legitimate demands.

To be fair, it is easy to criticize after the fact. However, most pundits focused on the differences between Middle Eastern countries to underscore the low probability of Tunisia’s revolution spreading throughout the Arab world. Consequently, not enough attention was paid to the fact that important similarities – notably perennial rulers, absence of freedoms, corruption, and a disenfranchised youth, all of which fueled people’s discontent – would far outweigh some perceived differences across countries.

Democratic Accountability

The Worldwide Governance Indicators (WGI), which has been compiled since the mid-1990s, measure six components of governance. One very important component is Voice and Democratic Accountability (V&A).[1] The V&A indicator measures not only whether countries hold elections, but also whether these are truly contested, legitimate, free and fair, whether the government is accountable to its citizens, and whether there are basic freedoms of expression and association, including protection of media freedoms, of civil society, and against human rights abuses.

The sobering reality is that in terms of Voice and Democratic Accountability, the Middle East has rated very poorly relative to the rest of the world for many years. With very few exceptions, there is little variation on this indicator across the region. Worse, even though the region began the past decade underperforming on V&A, most every country in the region has deteriorated since and ended the decade at even lower levels of V&A.

Figure 1 below shows the extent to which the Middle East has been afflicted by a severe deficit in accountability. In fact, all Middle East countries, with the exception of Israel, rank in the bottom half of the world on V&A. Within the Arab world, Lebanon and Kuwait are above the rest, but still remain in the bottom third globally. The remaining Middle East countries perform even worse, in the bottom quartile (25^th percentile or below) in the V&A component, including Tunisia and Egypt (both underperformed rather similarly). Countries like Iran, (North) Sudan, Syria, Saudi Arabia and Libya rank among the very bottom (10^th percentile or below).

From a broader global perspective, Egypt’s percentile rank, at a lowly 15.6 (out of a maximum of 100) in 2009 (meaning that over 170 countries around the world rated above Egypt) compares extremely poorly with countries like South Africa (67th percentile), Brazil (62), Ghana (61) and Indonesia (49). By the end of the decade, Egypt rated similarly in V&A to countries like Cote d’Ivoire, Angola and Congo.

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Figure 1 also illustrates the deteriorating pattern in V&A over the past decade for many Middle Eastern countries in contrast to other regions. It is noteworthy again that there was a sharp deterioration in V&A in Tunisia, while Egypt experienced a similar, though not as large, decline during this period. The data are admittedly of an aggregate nature and provide a broad benchmark for the performance of the Middle East.

However, in light of the recent emphasis on the very particular differences across countries in the Middle East region, it is noteworthy that the data point to an important similarity across the Arab world — namely that basic freedoms have been absent and deteriorating.

In fact, all the bottom eight Middle East countries in 2009 experienced a deterioration in V&A from 2000 with the exception of Iraq, which started from the very bottom. It would be naïve to suggest that all these countries are now equally vulnerable to major unrest or regime change or to insinuate that those countries rating immediately above this list (whose performance is also subpar) are not vulnerable.  There are multiple, complex and unpredictable determinants of unrest and regime change. But, starting with a hard-nosed look at the democratic deficit does help.

Youth Disenfranchisement and Their Resourcefulness

The disenfranchisement that has plagued the Middle East youth is also quite evident in the data. On average, young people account for about 30 percent of the Middle East population, compared with less than 20 percent in the developed world. In addition, youth in the Middle East tend to be economically and politically disenfranchised.

Even prior to the recent recession, youth unemployment rates in the Middle East and North Africa stood at an estimated 25 percent or twice the unemployment rate of the rest of the world. For some countries, including Egypt, the youth unemployment rate approached 30 percent or about six times its adult unemployment rate. Most of the youth live on less than $ 2 a day.

The socio-economic frustrations of the youth in the Middle East are only compounded by their inability to freely express themselves and demand change through democratic channels. They are witness to unfree and tainted elections, repression of the media and civil society and government corruption.

In addition, there are few mechanisms in place to hold governments accountable for their political and economic decisions. Where normal channels are unavailable, they resort to untraditional methods for venting their frustrations. In particular, they have resourcefully used social media (and gotten around government censorship) to connect, organize themselves and mobilize protest movements.

Accountability in Donor Aid by the Rich Countries

The recent events have made it evident to Western powers that citizens of Arab countries are determined to shape their own destiny. But, the unfolding situation in the region warrants a re-examination of the West’s historical support for autocratic regimes. Let us look specifically at how donors have responded to the democratic deficit in the Middle East over the past decade.

On aggregate, as Figure 2 indicates, donors have been oblivious to poor democratic governance in the region. In fact, while Voice and Accountability have deteriorated over the past decade, aid increased significantly, even when excluding the ‘special case’ of Iraq from this sample (from US $6.2 billion to $10.5 billion). In fact, almost all of donor development aid is channeled to Middle East countries that have low democratic accountability by the standards of other developing countries.

Some may defend such aid allocations by resorting to the realpolitik argument that aid, including “development aid”, is given to Middle East countries not only to raise living standards, but also to achieve political and security objectives with non-democratic allies.

The first problem with this practice is that governance deficits tend to undermine development and job creation for the low income and youth strata of the population, and thus breed discontent. The second problem is that nowadays citizen-led revolutions against non-democratic regimes can unpredictably be sparked almost anywhere.  Once the spark is ignited, they dwarf any possible “propping up” effect that foreign aid may have in perpetuating these regimes during seemingly stable times.

The events in the Middle East are a rude reminder that it is high time to revamp donor aid strategies so to concretely elevate the priority of democratic governance in development assistance.

They are also a wake up call for analysts (us included) to revisit how ‘political stability’ and country risk is assessed and measured in undemocratic regimes, and it is a reminder that uncertainty and unpredictability needs to be taken seriously.

Against the background of the newly found power of the people and social media, the dramatic events that are unfolding are also a rude reminder that in the global race to write instant analysis as events begin to unfold, a rush to make predictions is risky especially when little attention is paid to the comparative data at hand.

*  This blog entry was drawn from a Commentary article in the Brookings website co-authored with Veronika Penciakova and Selsah Pasali.

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.

…………

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.

The 2,500 page long Dodd-Frank Financial Regulatory Reform Bill has passed through the United States Senate. The bill will now be signed into law by President Barack Obama.  It signals a halt to the deregulatory process that the U.S. financial system has experienced for almost fifteen years.  The bill promises to strengthen consumer protection. In principle, it raises bank capital requirements, requires more collateral and margin requirements, enables a regulator to act against a very large and risky bank, and more.

These are overdue reforms…

Warts and all, and considering the political realities of legislative deals, having this bill is better than continuation of the regulatory vacuum.  But it is not a comprehensive systemic solution. This watered down bill will not effectively reverse the massive financial deregulation that took place, nor will it fully assure that the financial system will be effectively supervised and regulated so to avoid another systemic crisis.

Despite the length of the document, the regulatory reforms in this bill are vague.  Congress was reluctant to specify clear and detailed regulatory code into the bill. This means that the detailed homework in defining, detailing and interpreting the broad regulations is being passed on to the regulators.

Regulators will have enormous latitude and discretion in specifying these regulatory details, and in interpreting them during implementation.  And the notion of ‘regulator’ ought to be viewed broadly here, since they also include senior political appointees in government, such as the Treasury secretary, who will wield enormous influence in the regulatory reshaping, interpretation and implementation.

If recent history and our empirical work are any guide, such latitude and discretion handed to regulators and politicians in government can be very costly because of the likelihood of regulatory (or ‘state’) capture by powerful financial institutions.  Recent debates on this financial reform bill tend to focus on technical aspects, largely ignoring the politically sensitive issues surrounding the power of money and influence in politics with its perverse effect on financial regulation and its implementation.

Thus, I ask: how will politicians and regulators in government have the wherewithal to withstand pressures from Wall Street enabling them to make timely and tough decisions to break a very large bank (when the risk to the systemic so warrants)?  And even if a regulator dares to do so, how will it be implemented given the international ramifications of such an action?

We should not totally rule out that some regulators may carry out appropriate actions at times.  But we should also be mindful that the vested interests in a system captured by ‘money-in-politics’ would tend to bias decision-making against such timely and tough regulatory actions. Congress did not dare to look into this thorny issue of money in politics and its corrupting influence on political and regulatory decisions.

In this context, errors of omission in this bill are noteworthy.  Freddie Mac and Fannie Mae, the quasi-public housing finance behemoths that important culprits in the financial crisis, have been spared. Yet again, lawmakers carefully avoided addressing these institutions, which in the past have exerted undue financial largesse on politicians to influence them so that they could operate in a financially irresponsible fashion.

More broadly and understandably, given the interests of lawmakers and political realities, the bill is silent on the pervasive and pernicious role of money in politics influencing the whole regulatory system. Furthermore, the bill does not clearly re-erect a wall between traditional deposit banks and investment banking, which prevailed since the Glass-Steagall Act was enacted in 1933 until it was repealed in 1999.

Not that the U.S. is alone in facing challenges in regulatory reforms.  Progress on this front is even more questionable abroad: witness the time lags, lack of coordination and consensus on regulatory reforms among EU members, the U.K., the IMF and the Financial Stability Board (FSB).

The disarray in much of the continent across much of the Atlantic on these matters is also important for the effectiveness of the just passed U.S. regulatory reforms themselves.  This is because a modicum of coordination and harmonization across international financial centers is required for financial institutions not to shop around more lenient regulatory regimes.  It may be years until Europe gets its act concretely together on this.

Worse, the way the Basel Accord is being watered down right now as a direct result of  lobbying pressure by banks is likely to further erode the impact of the U.S. Regulatory Reform Bill on U.S. banks, since the Basel international supervisory rules may end up mattering more to all banks, including the US-based ones.

Thus, daunting challenges remain and need to be addressed head on, otherwise this Bill will not substantially enhance the stability of the financial system or alter the behavior of financial institutions in a meaninful fashion.

Paradoxically, this Bill may end up having a tangible impact on oil and gas companies. In fact, in ending on a positive note, let me focus on a little noticed side initiative within this bill which nonetheless is of high relevance for global development and anti-corruption efforts.  There is a resource transparency provision in the bill spearheaded by Senators Lugar and Cardin (supported by many others).

The provision mandates oil, gas and mining companies registered with the Securities and Exchange Commission (SEC) to publicly disclose the tax and revenue payments made to any government and requires that they disclose how they ensure that their payments do not fund armed groups in some countries. The information disclosed by these companies will be independently audited.

Even if this initiative is an obscure aside for many, this is in fact a commendable provision to enhance transparency in the extractive industries and in many resource-rich governments.

There are two priorities next on this important front.  First, transparency provisions ought to apply about full disclosure of the contracts signed between industry and governments as well.  Too often the terms of such contracts are not disclosed (let alone subject to public debate prior to their signing), which impairs the effective analysis of the disclosed data on revenues paid by oil and gas companies to governments.

Second, in the near future these mandated transparency reforms in the extractive industries ought to also be rolled out to security exchanges in financial centers in London, Frankfurt and elsewhere.

FIFA’s Monopoly and their obsolete Corporate Governance

 FIFA was founded in 1904 as a non-governmental and ostensible democratic organization concerned with the “good of the game.” Today not only is FIFA the only international body governing soccer, but its “product” is in extremely high demand and basically lacks close substitutes.

For instance, when FIFA recently objected to French and Nigerian government leaders interfering in the affairs of their respective national teams, both governments had little choice but to relent as their respective soccer associations were faced with sanctions and possible suspension by FIFA.  It would be political suicide for a country leader to be associated with sanctions against or the expulsion of a national soccer team, particularly since the public is strongly invested in the sport and influential private groups have strong financial interests in it.

A contrast between the development aid industry and FIFA is telling. Nowadays, emerging economies can choose between various multilateral development banks (MDBs) or bilateral aid donors based on which offers the most convenient financing terms.  Furthermore, development finance often has substitutes, such as foreign direct investment, trade and the country’s own reserves, thus their demand is more elastic.  Therefore, compared with access to international soccer, there is much more competition on the supply side of development finance, and there is a more elastic demand for such aid product. Developing countries therefore generally have far more bargaining power in negotiating with an aid institution than with FIFA, which is a monopoly in a market with very inelastic demand.

FIFA’s monopoly over international soccer, and the inelastic demand for its product, allow the organization to wield inordinate political and market power. This permits FIFA to extract immense rents from countries. In recent years, FIFA has generated revenues averaging about US$1 billion per year, with an additional US$ 3 billion generated in the year when the World Cup is held.  Most of its revenue is generated through their control over television and marketing rights for games.  FIFA extracts very large rents from countries hosting the World Cup while host nations foot the bill.  FIFA does not even pay taxes to host countries for in-country revenue; it demands, and pliantly receives, tax-exempt “diplomatic” status.

FIFA’s monopoly power in international soccer is also mirrored by its own outmoded and autocratic internal governance structure. FIFA has no term limits for committee members or its president. Since its inception, over a century ago, FIFA has only had eight presidents, their tenure averaging over 13 years each.[1] Further, key decisions, such as choosing the World Cup host, are made by very small FIFA committees rather than the general council. Ultimately, a select “club of old insiders” wields disproportionate influence.

While development aid institutions still need substantial reforms[2], it would be highly unrealistic nowadays for an international development agency, like the World Bank, to blatantly infringe on the national sovereignty of its member states by mandating them to make luxury infrastructure investments with their own national resources, subsequently extract the revenue flows from such investments. But this is what FIFA is effectively doing.

FIFA’s statutes impact sovereignty.  FIFA’s Statute generally prohibits country members from taking soccer-related contracts and disputes involving associations, club members, player and officials to their national courts of law. FIFA can impose serious sanctions on members violating their provisions.

FIFA imposes a large development costs on host countries. FIFA’s effort to bring the World Cup to Africa is laudable and is likely to generate some socio-political and reputational benefits for South Africa.  But, the costs for the host nation are huge, since FIFA mandates infrastructure investments but does not equally share the funding burden — far from it, in fact.  This is particularly troubling in the current World Cup, since South Africa faces enormous development challenges.  Of course, FIFA often is not the only culprit resulting in lavish expenditures at the expense of development:  it is not uncommon that some politicians in host countries would also favor extravagant investments, due to political payoffs or venality.

The total cost for South Africa in infrastructural investments in stadiums, roads and other projects is estimated to top about US$ 6 billion. For example, five new stadiums cost South Africa well over US$1.3 billion, significantly more than was originally envisaged.  Although the government and local people encouraged renovating existing stadiums, FIFA nixed this idea in favor of building new stadiums in locations with better views and away from poor neighborhoods. Take the existing stadium in Cape Town Township, which could have been renovated for a mere 5 percent (an estimated $30 million) of the actual cost to build the brand new Green Point stadium (US$600 million).

Similarly, a brand new stadium capable of seating well over 40,000 people was built in the small city of Nelspruit at a cost of US$ 137 million, where many of its  residents lack access to running water and there is not even a professional soccer team in town.[3]

The World Cup has boosted tourism. But with FIFA’s hospitality agents monopolizing most of the bookings, South Africa will get minimal tourism revenues.  Tourism services were granted by FIFA through a no-bid, sole source contract to Switzerland-based Match AG, where the nephew of FIFA’s president has an interest. Construction was also expected to provide a major boost in employment, but that has not been sustained.

A token fraction of FIFA’s estimated US$3 billion World Cup revenues may be given to South Africa after the games, yet it would barely make a dent to the billions already spent by the country.  FIFA will channel another share of their billions in revenues into many national soccer associations around the world, but mostly the money will not benefit local communities; instead it may serve as influence-wielding funding to secure support in maintaining FIFA’s corporate governance status quo.

Transparency

FIFA also faces transparency challenges both on the field and off the field.  On the field, referee errors during this World Cup have once again increased calls for technological assistance to refereeing, particularly through instant replays. Off the field, the lack of transparency in FIFA’s procurement and bidding has given rise to numerous scandals.

Calls for instant replays. Controversies over referee errors and questionable goals are not unique to this World Cup. However, the availability and use of modern technology can often reduce and double check referee errors. For example, modern technology in the form of an instant replay on the stadium’s big screen exposed the egregious referee mistakes during the England-Germany and Mexico-Argentina matches on June 27.

Although spectators and players tried to bring the error to the referee’s attention, long-standing FIFA rules state that referees cannot rely on technology to make decisions.  FIFA officials promptly ensured that no more replays were shown on the big screen for the remainder of the World Cup.

Off the field, lack of transparency in procurement and bidding has given rise to corruption scandals. Last year, a Swiss investigation concluded that FIFA employees received kickbacks from a Swiss sports marketing company ISL/ISMM.  The company was suspected of securing television rights to international sporting events, including the World Cup, by engaging in corporate bribery. One of the officials implicated was a FIFA executive committee member who received bribes totaling over $150,000.[4] There is also evidence that a lack of transparency and bribery featured in preparations for this year’s World Cup.  A recent report alleges that there was a lack of competitive bidding for stadium construction contracts and price-fixing for materials, both of which resulted in inflated construction costs.[5]

Selected Recommendations

 National political leaders, civil society and the media are key “actors” in breaking the FIFA’s monopoly and their obsolete corporate governance logjam:  

– Politically-induced FIFA reforms. A concerted challenge to FIFA’s monopoly powers by the highest political officials in member countries is warranted, supported by the country’s opposition parties and civil society.  With the support of the broad base of soccer aficionados who are becoming increasingly aware of how FIFA operates, national political leaders should take on the organization’s governance challenges (existing vested interests by some national politicians notwithstanding).  In a few months, the selection for the national venues for the 2018 and 2022 World Cups will jointly take place.  The political leadership of these future World Cup host countries may join Brazil, the 2014 host, in drawing other countries and FIFA to the re-negotiation table in an effort to establish a new and more equitable international soccer order.

– A more active monitoring role by the media and civil society: Mainstream media outlets around the world have been largely silent regarding FIFA’s glaring shortcomings. This is partly due to vested financial interests and the fear of alienating powerful constituencies. Yet, there is a significant segment of the media industry (including internet-based) that is not subject to the same pressures and can play a more active role in investigating and disseminating information on weak governance and reform options, further sensitizing citizens at large as well as influential shapers of policy.  The media should also play a more active role in holding their country politicians accountable in their investment decisions and payments to FIFA, and should further collaborate with civil society organizations that could do more to hold governments and FIFA more accountable regarding investment and financial decision surrounding a World Cup.

FIFA could actively work to reform and consider the following concrete suggestions:

FIFA should not undermine host country development objectives: Currently, host countries bear exorbitant preparation costs for World Cups, which are particularly onerous for emerging and developing economies.

– FIFA should refrain from mandating “white elephant”  investment projects, deter countries from embarking on wasteful investments (at times favored by some national politicians), and encourage host countries to engage in cost-savings and upgrades of existing infrastructure.

– FIFA’s financial contribution for World Cup preparations by host nations should be vastly larger, particularly in emerging economies and developing countries.

– Revenue-sharing arrangements should be revamped to increase the paltry share currently received by the host nation.

– Innovations in private sector initiatives and Public-Private Partnership (PPP) Infrastructure investments ought to be encouraged and explored much more actively in emerging economies.

FIFA should increase transparency on the field: While FIFA President Sepp Blatter has hinted at reconsidering his long-held opposition to changing the outmoded referee system, following the worldwide outcry over the England-Germany and Argentina-Mexico games, suspicions linger that FIFA’s ‘concession’ may simply reside in adding more referees in the sidelines, rather than introducing new, accurate, and transparency-enhancing technology.

– FIFA could allow instant replays for contested goals. If instant replay technology is too expensive to implement worldwide, for starters it ought to be used at large international tournaments, like the World Cup.

FIFA should improve transparency in procurement:

– FIFA should replace its sole sourcing procurement with a high-tech public procurement portal for all soccer-related contracts, and likewise the host country ought to have an e-procurement portal, which includes all preparatory investments as well.  Procurement contracts would be subject to competitive bidding, banning sole sourcing contracts above a minimum amount.  These reforms would result in large cost savings for countries and deter conflicts of interest and corruption.

– It should also institute a hotline for reporting alleged improprieties. To promote and protect impropriety reporting, FIFA and the host nation should have in place stringent whistle-blower protection policies.

– FIFA should institute a public debarment system for corrupt firms, similar to that already under implementation by various MDBs such as the World Bank, where companies found engaging in corruption are publicly banned from bidding.

FIFA should improve their own corporate governance and transparency:

– FIFA should institute public disclosure requirements for the assets and incomes of FIFA officials and their relatives and those of the national soccer associations.

– FIFA should institute term limits for committee members and its president and limit the number of committees that representatives can be on. Furthermore, FIFA’s congress should transparently vote on important items, such as the World Cup host country, rather than leave the decision to a small committee.

This Sunday evening, the world will have a new soccer champion. The colorful vuvuzelas will quiet down as spectators after a festive night. The World Cup fervor will be on hold until 2014.  Both South Africa’s President Zuma and Brazil’s President of Lula will attend this Sunday closing ceremony and final game, for the passing of the baton from this World Cup event to the next.

By the next World Cup, in 2014, President Lula would have long been replaced by a new president of Brazil who will lead the nation at their Cup, consistent with their democratic principles that also govern South Africa.  But unless crucial reforms are implemented soon, such democratic transfers of power will remain absent at FIFA.  Before 2014, it is imperative for FIFA to draw from such good examples of national leadership and governance to help FIFA reform, and for it to be governed as a 21st century global institution, one that becomes a real partner of sovereign nations pursuing development objectives.

[2] Such as in how transparently and competitively their heads are selected (as with FIFA)

[3] If no sizable regular audience is in attendance in the Nelspruit stadium following the Cup, then the ‘unit cost’ of this investment could end amounting to US$34 m. per game played.  Similarly, even if some sports events take place in the Green Point stadium in Cape Town, the unit costs is likely to end up being very high and the rate of return highly negative.  And so on.

[4] Other examples of corruption allegations exist, some recent.  Last week allegations surfaced against the Football Federation of Australia (FFA) over its bid to host the 2022 World Cup to the effect of alleged attempts by FFA officials to buy the votes of FIFA’s executive committee members. Further, allegedly the FFA also attempted to influence FIFA Vice President Jack Warner by paying for his national team, Trinidad and Tobago, to fly to Cyprus.

[5] For detailed information on possible conflicts of interest in the 2010 World Cup refer to Herzenberg, Collette, ed. Player and referee: Conflicting interests and the 2010 FIFA World Cup, Institute for Security Studies, April 2010

Note: this article was co-authored by Daniel Kaufmann and Veronika Penciakova (also at the Brookings Institution), and is an Op-ed in the Brookings homepage.