*EPF308 09/05/01
Byliner: Sullivan on Democracy, Governance and Market
(CIPE exec director says rules should be fair, enforced) (2470)

(Following is an article that appears in the September 2001 issue of the State Department's electronic journal Economic Perspectives titled "Addressing Global Poverty." The entire journal can be viewed at: http://usinfo.state.gov/journals/journals.htm)

Democracy, Governance, and the Market
By John D. Sullivan
Executive Director, Center for International Private Enterprise

Since the early 1980s, there has been an unprecedented trend toward democracy and market-based economies. Nonetheless, much remains to be done to reinforce this progress and prepare nations for the political and economic realities of the 21st century, including globalization. Even long established democracies such as Colombia, Peru, and Venezuela have seen their political and economic stability threatened. Other countries, including Turkey, Indonesia, and Ukraine, face severe pressure as they attempt to establish democratic rule-of-law societies.

Contemporary history has shown that countries with democratic, market-based systems are best equipped to respond to the challenges of globalization. Three aspects of democracy have proved to be crucial to long-term economic and social development.

-- A stable democratic system is the best guarantor of political stability, which is essential for long-term economic growth.

-- Democratic practices such as transparency and accountability are essential for effective and responsive government and for efficient and prosperous economic activity.

-- Sound legal and regulatory codes backed by the rule of law must exist for business to thrive in a market economy.

STRENGTHENING DEMOCRATIC GOVERNANCE

Experiences of the 1980s and 1990s demonstrate that failure to incorporate democratic governance as part of economic reform seriously jeopardizes the reform agenda. For much of the last 20 years it was fashionable to speak of the Washington Consensus, a reform program based on macroeconomic stabilization, fiscal reform, and other adjustments to economic policy. Recent developments, especially in Eastern and Central Europe as well as in Indonesia and Argentina, demonstrate the limits of this approach. Equal attention must be paid to the key institutions in society and to the process through which government decisions are made. Building democracy and a market economy has to begin by making sure that the rules of the system are open and fair for all.

The intellectual foundations for efforts to build a broader and more comprehensive democratic reform agenda stem from the field of New Institutional Economics developed by Ronald Coase and Douglass North, who won the Nobel Prize for their work. The institutional approach simply says that rules are important in conditioning outcomes. Put more elegantly, the success or failure of any effort to achieve a long-lasting transition to democratic market-oriented systems depends on the design and functioning of the institutional framework.

To highlight the importance of institutions, let me point out three common myths about the relationship between the state and the market.

The first myth is the belief that once private enterprise constitutes a substantial portion of an economy, it has become a market economy. History abounds with examples where this has not been the case. The Philippines under Ferdinand Marcos and Indonesia under Soeharto are classic examples of economies that were capitalist based on private enterprise. But they were not open-market systems. Economists call this type of behavior rent seeking. The rest of us call it corruption and cronyism. The greater the degree of systemic corruption in a society, the less its economy functions on market principles.

Many different types of market economies are possible, and there are real distinctions among institutional structures in different countries. But all market economies feature a competitive system in which the rules are the same for all participants. Only a fully functioning democracy can sustain such a system over time.

The second myth is grounded in a misconception that the business community or the private sector in general is a homogeneous monolith that either supports or opposes certain policies or leaders. This is not the case. Most countries have several business communities, each with its own interests and objectives. In the economy of a single country there can be the state sector, private sector, and informal sector. Within the private sector there might be firms and entrepreneurs who work mostly in international trade, while others produce solely for the domestic market. Clearly, these two groups will not always support the same policies. Nor will they always favor market-oriented reform.

Firms created behind protectionist trade barriers -- and with strong links to and benefits from government -- tend to support the status quo. Often they also are quite anti-democratic. Conversely, firms that have been locked out of government favors, small entrepreneurs, and those engaged in international trade often lead the demand for change. Because the business community is so diverse, it would be wise for these firms and entrepreneurs to form partnerships with business associations, think tanks, foundations, and other organizations with a vested interest in an open economy and a democratic political system.

The third myth is the most dangerous. It is the belief that markets will spontaneously emerge if government stops intervening in the economy. This is far from true. The government must establish consistent, fair rules and laws so a strong market economy can emerge. Government institutions and self-regulating organizations have key roles in ensuring that rules are enforced. Credible, fair bank supervision is one example.

Without binding rules and structures that govern all players, anarchy follows. Business then becomes simply "casino capitalism" in which investments are only bets that people will keep their word, that companies will tell the truth, that workers will be paid, and that debts will be honored.

FOREIGN ASSISTANCE AND DEVELOPMENT

Getting the relationship right between government departments, business organizations, civil society, and market institutions is vital. Foreign assistance programs run by donor countries and international financial institutions must seek to achieve concrete objectives, such as:

-- Promoting development of the laws and institutions necessary for open, market-oriented economies, including those covering property rights, antitrust and competition, banking, and accounting standards.

-- Increasing citizen participation in the democratic process by allowing business groups and other parts of civil society to participate in the day-to-day decision-making process.

-- Creating open systems of feedback to government, including legislative hearings, regulatory review panels, citizen advisory panels, and other communication channels between society and the state.

-- Fostering private voluntary organizations and freedom of association.

-- Building support for -- and understanding of -- the rights, freedoms, and obligations essential to a democratic private enterprise system.

-- Enhancing an entrepreneurial culture by providing incentives to innovate, save, invest, and launch new firms.

-- Simplifying compliance systems to enable micro and small businesses to join the legal, or formal, economy and mainstream of society.

-- Expanding access to business and economic information necessary for informed decision-making by all parts of civil society.

STRENGTHENING THE ROLE OF BUSINESS ASSOCIATIONS

As advocates for the private sector, business associations in industrialized nations play a vital role in encouraging good governance and sound policy-making. In most emerging market economies, however, such associations are only beginning to realize the importance of "strength in numbers" and why it is in the business community's interest to promote a democratic process. Mobilizing small and medium-sized enterprises is especially important to create the critical mass that drives reform.

One tool to affect public policy is a national business agenda that identifies policy reform as the highest priority for the business community in the near term. The agenda specifies the reforms in terms of laws and regulations and offers concrete suggestions for change. Key to the agenda is participation. Programs in countries as diverse as Egypt, Paraguay, Haiti, and Nigeria have followed similar steps:

-- Meeting with members in open forums to identify barriers to business growth and job formation.

-- Analyzing policies and forming recommendations.

-- Publishing in the media to gain input from concerned parties.

-- Formulating policy reform programs.

-- Publicizing the agenda.

-- Presenting the agenda to the president and key ministers in a national meeting.

-- Ongoing advocacy directed at the government, including the executive and parliament branches.

The Nigerian Association of Chambers of Commerce, Industry, Mines, and Agriculture (NACCIMA) has used its agenda for several years to coordinate economic reform. In 1999, this task assumed critical importance due to the country's struggle to create a true democratic system after years of military rule. Given pressure on NACCIMA from both Nigeria's political transition and its continuing economic crisis, developing and publicizing the national business agenda demonstrate NACCIMA's remarkable ability in the face of considerable hardship.

The National Association of Businesswomen (NABW) in Malawi created a national call to action to redress grievances experienced by women entrepreneurs. The association held regional forums across the country to identify the major issues facing women, including lack of information and access to credit. From these meetings the NABW developed a national business agenda and advocated before government in support of legislative changes that would boost the growth of women-owned enterprises in Malawi.

REMOVING INSTITUTIONAL BARRIERS TO PARTICIPATION

Members of the informal sector produce legitimate products without proper permits or legal status because they lack the resources to comply with burdensome, excessive rules and regulations necessary to participate in the formal economy. In many countries, the informal sector can account for up to 50 percent of the official economy. Entrepreneurs are locked out of the formal economy and political process as they work in low-income, low-growth business activities. A large and growing informal sector results from fundamental flaws in government processes and is proof that a market system hasn't been created.

Hernando de Soto of the Institute for Liberty and Democracy (ILD) in Peru was one of the first to recognize the challenges the informal sector presents to political and economic reform. Lack of secure property rights is central to his thesis that millions of people are condemned to poverty and sidelined from their countries' political discourse. De Soto's path-breaking research literally changed the nature of the debate about markets and democracy. De Soto and his ILD team are building market institutions in such diverse settings as Egypt, Mexico, and the Philippines, and de Soto will soon be turning his attention to Russia.

COMBATING CORRUPTION TO SUPPORT DEMOCRATIC VALUES

Business communities in developing countries are realizing that corruption is costing them money and they must do something to eliminate it. Corruption not only economically hurts the business community and the citizens of developing countries, but it has a destabilizing effect on democracy and the general well-being of a nation. Combating corruption can bring about broad reforms and improve the functioning of governance.

The National Association of Entrepreneurs (ANDE) in Ecuador created a research and advocacy program targeted at eliminating opportunities for corruption. ANDE has focused not on past corruption or any particular group, but on the need to initiate reforms that will change the direction of business and institute clean governance practices.

ANDE's studies showed that since the Republic of Ecuador was founded more than 160 years ago, some 92,250 legal norms had been created -- and 52,774 were still in force in 1997. The number of overlapping, unclear, and contradictory laws and regulations has created an environment of legal chaos, leaving the application and enforcement of laws to the discretion of bureaucrats. Since Ecuador is a civil code country its courts could not reconcile law or create precedents. ANDE recommended creating a seven-member judicial committee empowered to codify and reconcile existing law. ANDE's advocacy campaign succeeded so well that the judicial committee it recommended was included in Ecuador's new constitution.

Another approach to combating corruption is to help build the watchdog role of the media in society. The Center for International Private Enterprise (CIPE) has launched a network of 500 journalists throughout Latin America called Journalists Against Corruption or PFC, its Spanish initials, PFC supports journalists dedicated to investigating and exposing waste and unethical conduct in government and corruption in all sectors of society. PFC is a network, clearinghouse, and service provider for these journalists and the organizations that support them. It encourages enhanced investigations and reports about corruption, offers investigative assistance, and advocates on behalf of journalists when they suffer reprisals. In 2000, protests from PFC resulted in the prompt release from jail of two Mexican journalists who had been reporting on corrupt practices and drug trafficking by the police.

PROMOTING SOUND CORPORATE GOVERNANCE

Another focal point is the promotion of sound corporate governance principles that attack the supply side of the corruption relationship. Since the high-profile scandals during the Russian and Asian financial crises, corporate governance issues have surfaced as key reform issues in developing countries and transition economies. One lesson learned from these crises is that weak or ineffective corporate governance procedures can create huge potential liabilities for individual firms and, collectively, for society. Corporate governance failures can be potentially as devastating as any other large economic shock. As M.R. Chatu Mongol Sonakul, former governor of the Bank of Thailand, remarked: "The Asian financial crisis showed that even strong economies lacking transparent control, responsible corporate boards, and shareholder rights can collapse quite quickly as investor's confidence erodes."

Even countries with few large firms may want to begin looking at the question of corporate governance since it is now being adapted to meet the needs of family-owned companies. Even more important are the privatized firms and those still in the public sector. Ensuring good standards of corporate governance in these areas greatly enhances the faith of the public in the integrity of the privatization process and helps ensure that the country realizes the best return on the national investment.

CONCLUSION

Combating corruption, fostering corporate governance, strengthening women's business associations, and reducing barriers to formality have created new opportunities. Each action serves as a focal point to push forward with market reforms and adopting democratic practices. Sound corporate governance requires a framework of market institutions as well as sound business practices based on democratic principles. Similarly, ensuring that women and entrepreneurs of modest means have access to the business system as participants and leaders helps ensure that an open market economy exists for all, not just for a favored few.

As Roque Fernandez, a brilliant former Argentine finance minister, once said: "The Cold War is over and the University of Chicago won." He was referring to the market-oriented economic reform agendas being pushed throughout Latin America and much of the rest of the world. I'm hopeful we can add critical new dimensions to this view by bringing about a broader and profoundly democratic agenda based on transparency, accountability, property rights, and other fundamental rules societies and economies can use to govern themselves.

Note: The opinions expressed in this article do not necessarily reflect the views or policies of the U.S. Department of State.

(The Washington File is a product of the Office of International Information Programs, U.S. Department of State. Website: http://usinfo.state.gov)
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