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Better Institutions Key to Poverty Reduction in Europe and Central Asia and Beyond

Press Release No:2002/074/S

Nick van Praag (202) 458-9262
Gina Ciagne (202) 458 2931

WASHINGTON, September 11, 2001--Weak institutions – tangled laws, corrupt courts, deeply biased credit systems, and elaborate business registration requirements – hurt poor people and hinder development, according to the World Development Report 2002: Building Institutions for Markets. The new World Bank report says that countries which systematically address such problems and create new institutions suited to local needs can dramatically increase incomes and reduce poverty.

"Without effective institutions, poor people and poor countries are excluded from the benefits of markets," says World Bank Chief Economist and Senior Vice President Nicholas Stern, who oversaw preparation of the report. "This report offers principles for reform based on the experience of people around the world who are grappling with the challenge of building more effective institutions."

Complex, Inefficient Institutions a Common Problem

Complex and inefficient institutions are a common problem, especially for poor people in poor countries. In Georgia, for example, registering a new business requires 13 steps and 69 days, and costs 60 percent of average annual income. By contrast, registering a new business in Australia requires only two steps, two days, and two percent of the average income per capita. In Slovenia, resolving a dispute over a returned check can take up to four years; in Singapore it takes just 35 days.

"Overly complex regulations are especially problematic in poor countries," says Roumeen Islam, director or the World Development Report 2002. "Rather than protecting consumers and businesses, these regulations lead to higher corruption, a diversion of energy, and lower productivity."

The report finds that simplifying judicial procedures can increase efficiency without sacrificing fairness. "To settle disputes that arise out of normal business transactions, people need access to efficient courts and judges that are accountable," says Islam.
Alternative conflict resolution systems, such as those based on social norms, also can improve poor people's access to legal services. In Russia, the treteiske courts are a successful example of a specialized court that incorporates strong elements of arbitration and conciliation.

Learning from Success

The report presents an analytical framework based upon careful analysis of the details of institutional design at the micro level. These include new surveys of legal systems, business regulations, and media ownership in around 100 countries.

The report argues that market-supporting institutions perform one or more of three functions: they ease or restrict the flow of information; define and enforce property rights and contracts; and increase or decrease competition.

According to the report, open information flows increase public demand for more effective institutions, thus improving governance and social and economic outcomes. Analysis of ownership structures in 97 countries found that state owned media tend to be less effective than private media in monitoring government. Countries with more prevalent state ownership of print and broadcast news outlets tended to have fewer political rights, higher corruption, inferior economic governance, less developed financial markets, and worse education and health (see figure).

Countries that have reduced government ownership of the media have often experienced rapid improvements in the amount and quality of coverage. In Poland and other transition countries, privatization of media firms, supported by broader market liberalization and knowledge transfers from foreign owners, led to a dramatic increase in the coverage of economic and financial news as well. But state ownership of the media is still high in many transition countries. In Turkmenistan, for example, the state maintains direct control over the press, with the President the official head of all major newspapers.

But highly concentrated private ownership can also restrict media freedom. During Ukraine's 1999 presidential election, for example, private media companies with links to the state gave the incumbent more airtime and more favorable coverage than that provided to the six challengers.

On property rights, the report finds that land titling procedures are often too costly and complex for the poor to access. Yet without clear title to their land, poor farmers are unable to offer it as collateral and may be discouraged from investing in improvements, such as better drainage or irrigation. In Tajikistan and many former Soviet countries, access is more difficult because land registries are closed to the public, and even obtaining information on land titling requires bureaucratic intermediaries.

In many countries, legal systems do not serve the needs of poor people, who are unable to pay legal fees or read complex judicial documents. Simpler procedures resolve disputes faster and at lower cost. For example, Romania established a small claims court, and competition between these and the general jurisdiction courts was key to improving efficiency.

One Size Doesn't Fit All

Learning from the successes and failures of other countries in building institutions can provide valuable guidance. But copying institutional models without considering whether they are needed by those they are supposed to serve, and the capabilities of governments and citizens, can waste scarce resources, the report says.

For example, in the early and mid-1990s the Kyrgyz Republic tried to establish a stock market by building stock exchanges and training people to staff them. However, there were so few listed companies and so little trading that the exchanges could not generate the fees to be self-sustaining. With hindsight, it is clear that conditions were not yet ripe for the creation of stock markets and the effort would have been better spent on other needs, such as improving accounting and information systems.

"In the development business there is a tendency to label approaches that have worked well in one or more countries as "best practice" and then try to transplant these to other countries," Islam says. "When it comes to institutions, one size doesn't fit all."

The report summarized its recommendations in four principles to guide policymakers in building more effective institutions:

· Complement what exists: The design of any single institution should take into account the nature of the supporting institutions, skills, technology as well as prevailing levels of corruption.

· Innovate: Institutions are not immutable. Be prepared to experiment with new institutional arrangements and to modify or abandon those that fail.

· Connect: Connect communities through open information flows and open trade. In particular, the exchange of information through open debate creates demand for institutional change.

· Promote competition: Foster competition between jurisdiction, firms and individuals. Competition creates demand for new institutions, changes behavior, brings flexibility in markets and leads to new solutions.

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