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Published for the World BankOxford University Press


Oxford University Press

OXFORD NEW YORK ATHENS AUCKLAND BANGKOK BOGOTA

BUENOS AIRES CALCUTTA CAPE TOWN CHENNAI DAR ES SALAAM

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NAIROBI PARIS SÃO PAULO SINGAPORE TAIPEI TOKYO

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and associated companies in

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© 1999 The International Bank for Reconstruction and Development / The World Bank1818 H Street, N.W., Washington, D.C. 20433, U.S.A.

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This volume is a product of the staff of the World Bank, and thejudgments made herein do not necessarily reflect the views of its Board ofExecutive Directors or the countries they represent. The World Bankdoes not guarantee the accuracy of the data included in this publicationand accepts no responsibility whatsoever for any consequence of theiruse. The boundaries, colors, denominations, and other informationshown on any map in this volume do not imply on the part of the WorldBank any judgment on the legal status of any territory or theendorsement or acceptance of such boundaries.

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he World Development Report 1999/2000,the 22nd in this annual series, addresses thechanging development landscape of the early21st century. Development thinking hasevolved into a broad pragmatism, realizingthat development must move beyond eco-nomic growth to encompass important so-cial goals—reduced poverty, improved qual-ity of life, enhanced opportunities for bettereducation and health, and more. Experiencehas also taught that sustainable progress to-ward these goals requires integrated imple-mentation and must be firmly anchored inprocesses that are open, participatory, andinclusive. In the absence of a strong institu-tional foundation, the outcomes of goodpolicy initiatives tend to dissipate. Theselessons and insights are incorporated into theComprehensive Development Framework,recently initiated by the World Bank to ad-dress the challenges of development in amore holistic, integrated way by bringing inaspects such as governance, legal institu-tions, and financial institutions, which weretoo often given short shrift earlier.

Looking ahead, this report explores theenvironment in which the major issues ofthe 21st century—poverty, populationgrowth, food security, water scarcity, cli-mate change, cultural preservation—will befaced. Many powerful forces, both glacialand fast-paced, are reshaping the develop-ment landscape. These include innovationsin technology, the spread of informationand knowledge, the aging of populations,the financial interconnectedness of theworld, and the rising demands for politicaland human rights. The report focuses inparticular on two clusters of change—glob-alization and localization—because of theirimmense potential impact. They open upunprecedented opportunities for growthand development, but they also carry withthem the threats of economic and political

instability that can erode years of hard-earned gains.

Given their already present implications,it is not surprising that globalization and lo-calization are a central preoccupation of pol-icymakers around the world. Globalizationis praised for bringing new opportunities forexpanded markets and the spread of tech-nology and management expertise, which inturn hold out the promise of greater pro-ductivity and a higher standard of living.Conversely, globalization is feared and con-demned because of the instability and unde-sired changes it can bring: to workers whofear losing their jobs to competition fromimports; to banks and financial systems andeven entire economies that can be over-whelmed and driven into recession by flowsof foreign capital; and, not least, to theglobal commons, which are threatened inmany ways with irreversible change.

Localization is praised for raising levelsof participation and involvement, and pro-viding people with a greater ability to shapethe context of their own lives. By leading todecentralized government where more de-cisions happen at subnational levels, closerto the voters, localization can result in moreresponsive and efficient local governance.National governments may use a strategy of decentralization to defuse civil strife oreven civil war. However, when poorly de-signed, decentralization can result in over-burdened local governments without theresources or the capacity to fulfil their basicresponsibilities of providing local infra-structure and services. It can also threatenmacroeconomic stability, if local govern-ments, borrowing heavily and spendingunwisely, need to be bailed out by the na-tional government.

This report seeks neither to praise nor tocondemn globalization and localization.Rather it recognizes them as forces that

TForeword


bring new opportunities but also raise new or greater chal-lenges in terms of economic and political instability. Con-taining this instability and providing an environment inwhich a development agenda can be implemented to seizethe opportunities will be a major institutional challenge inthe coming decades. The discussion in the report focuses onthree main aspects of globalization: trade in goods and ser-vices, international flows of capital, and global environmen-tal issues, such as the dangers of climate change and destruc-tion of biodiversity. The focus of the discussion then shifts tothree aspects of localization: the decentralization of politicalpower to subnational levels of government, the movement ofpopulation and economic energy in developing countries to-ward urban areas, and the provision of essential public ser-vices in these growing cities of the future.

In discussing the appropriate institutional responses tothe challenges and opportunities of globalization and local-ization, the report draws on a vast array of national examplesand cross-country empirical evidence, including both devel-opment success stories and episodes of failure. There is nosimple answer to dealing with globalization and localization.Instead, the insights are rooted in pragmatic judgmentsabout how the existing conditions of society will affect whichpolicy choices make sense, or how one sequence of policies ispreferable to another, or how certain policies can comple-ment and sustain each other. The commitments and actionsof the national government remain central to any workabledevelopment strategy. However, the forces of globalizationand localization imply that much of the institution-buildingfor development will be taking place at either the suprana-tional or the subnational levels. In both cases, countries will

need to focus on development strategies that are imple-mented through mutual consent, whether through interna-tional agreements between countries, or through constitu-tional and institutional arrangements between different levelsof government and components of civil society within acountry. At both the global and local levels, institutions basedon partnership, negotiation, coordination and regulationwould provide the basis for sustainable development.

Globalization and localization are not likely to disappear,or even to diminish in intensity. They are driven by power-ful underlying forces like the new capabilities of informationand communication technologies, and a rising sense amongpeople all over the world that they are entitled to participateopenly in their government and society. As globalizationbrings distant parts of the world functionally closer together,and localization multiplies the range of policy environments,it may well be that successful development policies willachieve results more quickly, while failed policies will havetheir consequences exposed more quickly and painfully aswell. In such a world, exploring the institutional responses toglobalization and localization, and disseminating the insightsbroadly, offers enormous potential for advances in develop-ment strategy—advances that can be of great and lastingbenefit to the poorest people of the world.

James D. WolfensohnPresidentThe World Bank

August 1999

This report has been prepared by a team led by Shahid Yusuf and comprising Anjum Altaf, William Dillinger,Simon Evenett, Marianne Fay, Vernon Henderson, Charles Kenny, and Weiping Wu. The team was assisted byMohammad Arzaghi and Stratos Safioleas. The work was carried out under the general direction of Joseph Stiglitz.Throughout the preparation of this report Lyn Squire provided valuable advice and contributions. TimothyTaylor was the principal editor.

The team was advised by a distinguished panel of experts comprising Alberto Alesina, Masahiko Aoki, RichardCooper, John Dixon, Barry Eichengreen, Jon Elster, Alan Harold Gelb, Harry Harding, Gregory K. Ingram,Christine Kessides, Jennie Litvack, Wallace Oates, Anthony J. Pellegrini, Guillermo Perry, David Satterthwaite,Paul Smoke, Paul Spray, T.N. Srinivasan, Jacques Thisse, and John Williamson.

Many others inside and outside the World Bank provided helpful comments, wrote background papers andother contributions, and participated in consultation meetings. The preparation of some background papers andthe convening of several workshops was supported by the Policy and Human Resources Development Fundfinanced by the Japanese Government and a grant from the Government of the United Kingdom Department for International Development. These contributors and participants are listed in the Bibliographical Note. TheDevelopment Data Group contributed to the data appendix and was responsible for the Selected World Devel-opment Indicators.

Rebecca Sugui served as executive assistant to the team, and Maribel Flewitt, Leila Search, and Thomas A.J.Zorab as team assistants. Maria D. Ameal served as administrative officer.

Book design, editing, and production were coordinated by the Production Services Unit of the World Bank’sOffice of the Publisher.


OverviewThe frontiers of development thinking 2Globalization and localization 4Supranational issues 5Subnational issues 8Translating policies into actions 11

Introduction New Directions in Development ThinkingBuilding on past development experiences 14The many goals of development 18The role of institutions in development 21The record and outlook for comprehensive development 24A changing world 28

Chapter 1 The Changing WorldInternational trade 33International financial flows 34International migration 37Global environmental challenges 40New political tendencies in developing countries 43Emerging subnational dynamics 44Urban imperatives 46Implications for development policy 49

Chapter 2 The World Trading System: The Road AheadHow the global trading system benefits developing countries 52WTO mechanisms for promoting and maintaining liberal trade regimes 53Sustaining the momentum for trade reform 55International trade and development policy: the next 25 years 60

Chapter 3 Developing Countries and the Global Financial SystemThe gathering pace of international financial integration 70Toward a more robust and diversified banking systemThe orderly sequencing of capital account liberalization 79Attracting foreign investment 81Revitalizing international macroeconomic cooperation 84

Chapter 4 Protecting the Global CommonsThe link between national and global environmental issues 90Moving from national to international action 93The ozone treaties: a success story 94

Contents

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Climate change 97Biodiversity 102Exploiting the links between global environmental problems 103

Chapter 5 Decentralization: Rethinking GovernmentWhat is at stake? 107From centralized to decentralized governance 111Balancing political power between central and local interestsThe structure, functions, and resources of subnational governments 114Making subnational governments accountable 121Policies for the transition 122What lessons for the future? 124

Chapter 6 Dynamic Cities as Engines of GrowthWhat makes cities grow? 126The national government’s role in urbanization 130Local policies for urban economic growth 132

Chapter 7 Making Cities LivableThe unfinished urban agenda 140Learning from the past 142Service provision in developing countries 144Looking ahead 152

Chapter 8 Case Studies and RecommendationsMaking the most of trade liberalization: Egypt 157Reforming weak banking systems: Hungary 160Macromanagement under fiscal decentralization: Brazil 163Improving urban living conditions: Karachi 166Cultivating rural-urban synergies: Tanzania 169The shifting development landscape at the dawn of the 21st century 172

Bibliographical NoteAppendix Selected Indicators on Decentralization, Urbanization, and the Environment 213Selected World Development Indicators 223Index 292

Boxes1 Lessons from East Asia and Eastern Europe 172 Social capital, development, and poverty 3 Explaining power project outcomes in Sub-Saharan Africa 184 The Comprehensive Development Framework 215 A holistic approach to development in past World Development Reports 226 Institutions, organizations, and incentives7 Trends in disease and health care 278 Sustainable development 289 The growing threat of water scarcity 291.1 The global macroeconomics of aging1.2 The international Chinese network 40

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2.1 Regional trading arrangements and the global trading system: complements or substitutes? 542.2 Building technical expertise on trade policy: the Integrated Framework for Trade

and Development in the Least-Developed Countries 582.3 Child labor: how much? how damaging? and what can be done? 623.1 A continuing role for aid 733.2 What causes financial contagion? 753.3 Subnational governments face commitment problems too 833.4 Mitigating the commitment problem: the role of the World Bank 834.1 Global environmental issues 884.2 Preserving the ocean commons: controlling overfishing 924.3 The Global Environment Facility 944.4 NGOs and efforts to preserve the international environment 964.5 Falling costs for renewable energy 984.6 Taxes and quotas to reduce emissions 994.7 Trade measures in international environmental agreements 1045.1 Decentralization as the devolution of powers 1085.2 South Africa and Uganda: unifying a country through decentralization 1085.3 Bosnia-Herzegovina and Ethiopia: decentralization as a response to ethnic diversity 1095.4 India: a decentralizing federation? 1105.5 Decentralization in China 1135.6 Financing intermediate tiers of government 1185.7 The cart before the horse: decentralization in Russia 1236.1 Cities and urban areas: some definitions 1276.2 Rural-urban linkages 1286.3 The dispersal of industry in Korea 1296.4 Africa: urbanization without growth 1306.5 City development and land markets 1356.6 Regionalism and local economic development: lessons from Europe 1376.7 Know thy economy: the importance of local economic 1387.1 A spatial mismatch: Jakarta’s kampung residents 1477.2 Haiphong: partnering with consumers 1487.3 Manila: a positive corporate image as an incentive to reduce pollution 1517.4 Shenyang: social welfare in a struggling industrial city 1527.5 Bangalore: citizens’ report cards 1548.1 Five case studies 1588.2 The Arab Republic of Egypt at a glance8.3 Hungary at a glance 1618.4 Brazil at a glance 1638.5 Pakistan at a glance 1678.6 Tanzania at a glance 170

Figures1 Computers are linking the world 42 All but a few democracies have decentralized some political power 43 Trade is growing much faster than national income in developing countries 54 Countries are joining the WTO in increasing numbers 65 Private capital flows to developing countries have increased dramatically 76 There are more countries and more democracies 97 Urban population is growing—primarily in developing countries 10

information

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8 The incomes of rich and poor countries continue to diverge 149 Investment alone cannot account for variation in growth 1510 Infant mortality fell in most developing countries from 1980 to 1995,

even where income did not increase 1911 The number of poor people has risen worldwide, and in some regions the proportion

of poor has also increased 2512 Life expectancies have risen greatly in some countries, but others have suffered setbacks 261.1 Exports of commercial services have surged in most regions since 1990 341.2 An increasing number of developing countries is committed to trade reform 341.3 Nonperforming loans can account for up to 50 percent of all bank loans at the peak

of a banking crisis 361.4 Resolving bank crises can cost up to 40 percent of GDP 371.5 Foreign direct investment was less volatile than commercial bank loans

and total portfolio flows, 1992–97 371.6 Temperatures are rising as concentrations of greenhouse gases increase 411.7 More countries are becoming democratic 431.8 Most urban dwellers reside in developing countries 471.9 Asia and Africa are just beginning the urban transition 471.10 The largest increase in urban populations during 1980-2020 will occur in Africa and Asia 482.1 Foreign trade has increased in most developing countries since 1970 522.2 More of the world’s exports are covered by WTO disciplines, especially exports from

developing countries 532.3 More regional trading arrangements (RTAs) came into force in the 1990s than ever before 542.4 Many developing countries started liberalizing before the end of the Uruguay Round 562.5 Equal players? African representatives at the WTO 572.6 The composition of many developing countries’ exports was transformed in just over 10 years 592.7 New users initiated an increasing number of antidumping suits during 1987–97 602.8 When filing antidumping investigations, industrial and developing countries target

each other almost equally 612.9 Many countries bound their tariffs on agricultural products in the Uruguay Round at levels

well above estimated actual tariffs in 1986–88 632.10 Exports of commercial services increased in every region from 1985 to 1997 643.1 Since 1980 net flows of foreign direct and portfolio investment to developing economies

have grown enormously 703.2 Firms from developing countries are issuing more international debt than before 713.3 A growing pool of institutionally managed funds is invested abroad 713.4 A few developing countries received the lion’s share of FDI invested outside industrial countries

in 1997 733.5 Bank intermediation typically accounts for a larger share of the financial sector in developing

countries 764.1 Climate change jeopardizes crop yields, especially in developing countries 894.2 Atmospheric concentrations of ozone-depleting substances rose, then began to fall 954.3 A 1-meter rise in sea level would cut Bangladesh’s rice production approximately in half 1004.4 Energy consumption in developing countries is forecast to outstrip industrial country

consumption 1004.5 High-income countries use energy more intensely than countries in low-income regions 1015.1 Subnational expenditures are a small share of public expenditures, except in industrial countries

and large federations 111

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Definitions and data notesThe countries included in regional and incomegroupings in this report are listed in the Classifica-tion of Economies table at the end of the SelectedWorld Development Indicators. Income classifica-tions are based on GNP per capita; thresholds for in-come classifications in this edition may be found inthe Introduction to Selected World DevelopmentIndicators. Group averages reported in the figuresand tables are unweighted averages of the countriesin the group unless noted to the contrary.

The use of the word countries to refer to econ-omies implies no judgment by the World Bankabout the legal of other status of a territory. The termdeveloping countries includes low- and middle-income economies and thus may include economiesin transition from central planning, as a matter ofconvenience. The term advanced countries may beused as a matter of convenience to denote the high-income economies.

Dollar figures are current U.S. dollars, unless oth-erwise specified. Billion means 1,000 million; trillionmeans 1,000 billion.

The following abbreviations are used:

AIDS Acquired immune deficiency syndromeCDF Comprehensive Development

FrameworkFDI Foreign direct investmentGATT General Agreement on Tariffs

and Trade GDP Gross domestic productGNP Gross national productNIE Newly industrialzing economyNGO Nongovernmental organizationOECD Organisation for Economic

Co-operation and DevelopmentPPP Purchasing power parityWTO World Trade Organization

5.2 Local governments never control a large share of public resources 1126.1 Urbanization is closely associated with economic growth 1266.2 Most of the world’s urban population lived in small and medium-size cities in 1995 1286.3 Small cities had the fastest growing populations, and megacities the slowest, from 1970 to 1990 1306.4 As countries develop, central governments’ share of public investment falls 1337.1 Even low-income countries can achieve high levels of basic water and sanitation services 1407.2 Housing affordability varies significantly at low levels of income 1418.1 The population in Tanzania is increasingly urbanized 141

Tables1.1 World foreign direct investment stock, 1997 381.2 Political and functional decentralization in large democracies, 1997 452.1 Reported antidumping actions by members of the GATT and WTO, 1987-97 602.2 Share of parts and components in exports, 1995 665.1 The structure of subnational governments in large democracies 1165.2 Subnational borrowing controls in selected countries 1197.1 Infant mortality rate, Bangladesh, 1990 142


he development landscape is beingtransformed, presenting policymakerswith new challenges at the global andlocal levels. This report charts the wayforward by analyzing the contours ofthe new landscape and distilling lessonsfrom the past. It examines the unfold-ing dynamic at the supranational andsubnational levels. And it proposes newrules and structures to serve as a foun-dation for development policy in the21st century.

Fifty years of development experi-ence have yielded four critical lessons.First, macroeconomic stability is an es-sential prerequisite for achieving thegrowth needed for development. Sec-ond, growth does not trickle down; de-velopment must address human needsdirectly. Third, no one policy will trig-ger development; a comprehensive ap-proach is needed. Fourth, institutionsmatter; sustained development shouldbe rooted in processes that are sociallyinclusive and responsive to changingcircumstances.

These insights are central to how theWorld Bank envisions its work in the21st century and to the way in which itproposes to tackle the principal devel-opment challenges ahead. In addition

to reducing poverty, these challengesinclude issues of food security, waterscarcity, aging populations, cultural loss,and environmental degradation.

These challenges must be confrontedeven as many forces reshape the devel-opment terrain: innovations in technol-ogy, the spread of knowledge, the growthof population and its concentration incities, the financial integration of theworld, and rising demands for politicaland human rights. Some of these forces,like population growth, will work theirway gradually, giving policymakers timeto respond. Others, such as financial con-tagion, could batter apparently healthyeconomies without warning unless pre-emptive measures are in place. Some willgive rise to challenges, like social wel-fare funding, that most nation-states cancope with on their own. Others, such asglobal climate change, will be beyondthe reach of any one state and will callfor international agreements.

If they are managed well, these forcescould revolutionize the prospects fordevelopment and human welfare. How-ever, the same forces are also capable ofgenerating instability and human suf-fering that are beyond the ability of in-dividual nation-states to remedy.

T

Overview


This report views the changes that have been set inmotion as contributing to—and as manifestations of—two phenomena: globalization and localization. Global-ization, which reflects the progressive integration of theworld’s economies, requires national governments toreach out to international partners as the best way tomanage changes affecting trade, financial flows, and theglobal environment. Localization, which reflects thegrowing desire of people for a greater say in their govern-ment, manifests itself in the assertion of regional identi-ties. It pushes national governments to reach down to re-gions and cities as the best way to manage changesaffecting domestic politics and patterns of growth. Atboth the supranational and subnational levels, institu-tions of governance, negotiation, coordination, and regu-lation will play a critical role in promoting a new equilib-rium between and within countries—and in abetting thecreation of the stable environment that will make possi-ble the implementation of development programs.

The frontiers of development thinking

As the 20th century draws to a close, mainstream devel-opment thinking has evolved toward a broad pragma-tism. As with many subjects, a deeper understanding ofdevelopment involves a recognition that sweeping be-liefs are often incomplete, that layers of complexity areburied not far beneath the surface, and that wisdom isoften contingent on the particular conditions of timeand place. In recent decades both experience and intel-lectual insight have pushed development thinking awayfrom debates over the role of states and markets, and thesearch for a single, overarching policy prescription.

Investment in physical and human capital, for exam-ple, should encourage economic growth, and as a gen-eral rule, empirical evidence supports this proposition.But in a number of cases, high rates of investment andeducation have not been enough to deliver rapid growth.A similar lesson holds true for industrial policies. Manycountries decided, after experimenting with export sub-sidies, that the subsidies enriched business owners butdid little to speed economic growth. They saw well-intended industrial subsidies turn into a costly form ofcorporate welfare, an expensive way of providing tax-payer support for private jobs in a narrow range of in-dustries. Yet East Asian economies, making active use ofexport subsidies and credit allocation, experienced themost powerful sustained surge of economic developmentthe world had seen in decades. And China, which aloneincludes 40 percent of all the inhabitants of low-income

countries in the world, has had remarkable economicsuccess with a development strategy that involves only alimited dose of market liberalization and privatization.

The failure of centrally planned economies to keeppace with their market-oriented counterparts has dem-onstrated clearly enough that planning entire economiesat the central government level is not a productive pathto long-term development. But the experiences ofJapan, East Asia, and China make clear that it is possi-ble for a country to have an interventionist governmentand still enjoy extremely rapid economic growth over aperiod of decades.

Brazil also grew very rapidly in the 1960s, in part bymaking widespread use of import-substitution policies.These policies certainly appeared helpful to Brazil at thetime—at a minimum, they did not prevent a surge ofrapid growth—but this success does not mean that sim-ilar policies would make sense in other countries, or evenin Brazil three decades later. Similarly, certain policiesthat helped Japan develop in the 1950s and 1960s, gen-erated growth in East Asia in the 1970s and 1980s, andsparked China’s economic boom in the 1980s and 1990swere specific to the time and place. They may not haveworked well in other countries, nor are they likely to beappropriate in the opening decades of the 21st century.

In any given country, progress depends on a constel-lation of factors, and on shifts in their configuration thattake place over time. What is required is to step beyondthe debates over the roles of governments and markets,recognizing that they need to complement each other,and to put to rest claims that any particular policy in-tervention—in education, health, capital markets, orelsewhere—is the magic formula that will inspire devel-opment in all times and places. This shift in develop-ment thinking can be summarized in four propositions:

Sustainable development has many objectives. Raisingper capita incomes is only one among many develop-ment objectives. Improving quality of life involves morespecific goals: better health services and educational op-portunities, greater participation in public life, a cleanenvironment, intergenerational equity, and more.

Development policies are interdependent. No singledevelopment policy can make much of a difference inan unfavorable policy regime. Countries need inte-grated policy packages and institutional environmentsthat reward good outcomes, minimize perverse incen-tives, encourage initiative, and facilitate participation.

Governments play a vital role in development, but thereis no simple set of rules that tells them what to do. Beyond

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generally accepted rules, the role of government in theeconomy varies, depending on capacity, capabilities,the country’s level of development, external conditions,and a host of other factors.

Processes are just as important as policies. Outcomesof policies based on consensual, participatory, andtransparent processes are more easily sustained. Institu-tions of good governance that embody such processesare critical for development and should encompasspartnerships among all elements of civil society.

Creating new guidelines for developmentIn light of these propositions, the World Bank is intro-ducing a comprehensive development framework toserve a number of purposes: to sharpen the focus on themajor goals of development, to highlight the integratednature of policymaking, to emphasize the institutionalprocesses required to sustain development, and to co-ordinate development efforts.

The framework underscores the growing realizationthat the many elements that make up the developmentprocess must be planned together and coordinated inorder to obtain the best results—and sometimes in orderto arrive at any results at all. A school-building projectis a good example. Physically putting up the building isonly a start. Raising educational levels will depend onmany other things, such as effective mechanisms for se-lecting, training, and remunerating teachers adequatelyand sufficient resources to buy enough textbooks andsupplies.

What is true of a school-building project is also trueof privatization programs, social safety nets, and sus-tainable energy programs. The complementarities be-tween projects and processes are vital to success. A com-prehensive framework makes these complementaritiesexplicit by emphasizing the relationships among thehuman, physical, sectoral, and structural aspects ofdevelopment.

The human and physical aspects of development arewell known. Sectoral aspects stress the importance ofcross-cutting elements such as coordination, manage-ment, and maintenance of an effective enabling envi-ronment for private business and community initia-tives. Structural aspects focus on the need for goodgovernance, transparent decisionmaking, efficient legaland judicial processes, and sound regulatory systems.This identification of rules and processes as a criticalfoundation for sustained development adds a new di-mension to mainstream development thinking.

These items do not constitute an exhaustive list ofall the concerns development should embrace. Issues ofgender and equity are integral to every part of theframework. Moreover, as mentioned earlier, macroeco-nomic stability is a necessary condition for the successof development initiatives. How important each ofthese concerns is to individual countries depends on theparticulars of time and place. Every country will bene-fit from identifying and prioritizing its needs—an ex-ercise that reveals the economic or governmental weak-nesses and institutional failures that stand in the wayof full development.

Building institutions and partnershipsEffective development requires partnerships among dif-ferent levels of government, the private sector, donorgroups, and civil society. A comprehensive strategy issimply too demanding for any one level or area of gov-ernment or for a single donor. National governmentsneed to provide the guidance that agencies and organi-zations require to coordinate their efforts to removebottlenecks to development.

A solid foundation of effective organizations and en-abling institutions is a necessary precondition to devel-opment. In this context “institutions” are sets of rulesgoverning the actions of individuals and organizations,and the interaction of all relevant parties and the nego-tiations among the participants. Specifically, countriesneed institutions that strengthen organizations and pro-mote good governance, whether through laws and regu-lations or by coordinating the actions of many players,as international treaties and public-private partnershipsdo. Rule-based processes increase the transparency ofpolicies designed to create desired outcomes and of or-ganizations used to implement them.

The message of this report is that new institutionalresponses are needed in a globalizing and localizingworld. Globalization requires national governments toseek agreements with partners—other national govern-ments, international organizations, nongovernmentalorganizations (NGOs), and multinational corpora-tions—through supranational institutions. Localizationrequires national governments to reach agreementswith regions and cities through subnational institutionson issues such as sharing responsibility for raising rev-enues. Both globalization and localization often requireresponses that are beyond the control of a single na-tional government. Yet national governments will re-main pivotal in shaping development policies in an en-


vironment that circumscribes, constrains, and redefinestheir role. In an interconnected world in which coun-tries may continue to fragment, development agendasmust respond to both global and local imperatives.

Globalization and localization

Technological advances in communication have madeit possible to know in an instant what is happening in ahousehold or factory or on a stock market half a worldaway. The growing importance of services and informa-tion in the world economy means that an increasingproportion of economic value is weightless—that is, itcan be transmitted over fiber-optic cable rather thantransported in a container ship. At the same time im-provements in transportation networks and technologyare reducing the costs of shipping goods by water,ground, and air, and improvements in informationtechnology have made it easier to manage the new in-terconnections (figure 1). Multinational companiesnow rely on production chains that straddle manycountries. Raw materials and components may comefrom two different countries and be assembled in an-other, while marketing and distribution take place instill other venues. Consumers’ decisions in, say, Londonor Tokyo become information that has an almost im-mediate impact on the products that are being made—and the styles that influence them—all over the globe.

Rising educational levels, technological innovationsthat allow ideas to circulate, and the economic failureof most centrally planned economies have all con-tributed to the push for localization. National govern-ments have responded to this push in various ways.More countries have become democracies, and politi-cal participation through elections has expanded atboth the national and subnational levels. National gov-ernments are increasingly sharing responsibilities andrevenues with subnational levels of government that arecloser to the people affected by policy decisions (figure2). People are also forming NGOs to pursue objectivessuch as political reform, environmental protection,gender equality, and better education.

Globalization and localization are terms that provokestrong reactions, positive and negative. Globalization ispraised for the new opportunities it brings, such as ac-cess to markets and technology transfer—opportunitiesthat hold out the promise of increased productivity andhigher living standards. But globalization is also fearedand often condemned because it sometimes brings in-stability and unwelcome change. It exposes workers tocompetition from imports, which can threaten theirjobs; it undermines banks and even entire economieswhen flows of foreign capital overwhelm them.

Localization is praised for raising levels of participa-tion in decisionmaking and for giving people more ofa chance to shape the context of their own lives. By de-

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Note: Figure shows all countries classified as multiparty democraciesfor which data were available.Source: Freedom House, Freedom in the World, 1998; appendixtable A.1.

Figure 2All but a few democracies have decentralizedsome political power

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Source: Network Wizards, Internet Domain Survey, January 1999(www.nw.com.).

Figure 1Computers are linking the world


http://www.nw.com

centralizing government so that more decisions aremade at subnational levels, closer to the voters, local-ization nourishes responsive and efficient governance.But it can also jeopardize macroeconomic stability.Local governments that have borrowed heavily andspent unwisely, for example, may have to be bailed outby the national government.

This report does not praise or condemn globaliza-tion and localization. Rather, it sees them as phenom-ena that no development agenda can afford to ignore.While national governments remain central to the de-velopment effort, globalization and localization requirethat they engage in essential institution-building atboth the supra- and subnational levels in order to cap-ture the benefits of growth in the 21st century.

Supranational issues

National governments will inevitably face frustrationsin dealing with globalization, and these frustrations willbe magnified for small developing economies. But suchcountries stand to gain more from international tradeand finance than their larger counterparts, since theyface tighter resource and market-size constraints. At thesame time these economies may feel any disruption theglobal economy generates far more intensely. An eco-nomic shock that may feel like only a ripple to an enor-mous economy like the United States, or even to a rela-tively large developing economy like Brazil, is a tidalwave for an economy the size of Ghana or Bangladesh.When it comes to environmental issues, national gov-ernments can strike their own balance on domesticproblems by, for example, determining how to applypollution standards to regions that lie entirely withinthe country. But unless developing countries workthrough international agreements, they have little abil-ity to address global environmental problems like thethreat of climate change. This report considers three di-mensions of globalization: trade, financial flows, andenvironmental challenges.

Trade Foreign trade has grown more quickly than the worldeconomy in recent years, a trend that is likely to con-tinue (figure 3). For developing countries, trade is theprimary vehicle for realizing the benefits of globaliza-tion. Imports bring additional competition and varietyto domestic markets, benefiting consumers, and exportsenlarge foreign markets, benefiting businesses. But per-haps even more important, trade exposes domestic firms

to the best practices of foreign firms and to the demandsof discerning customers, encouraging greater efficiency.Trade gives firms access to improved capital inputs suchas machine tools, boosting productivity as well. Tradeencourages the redistribution of labor and capital torelatively more productive sectors. In particular, it hascontributed to the ongoing shift of some manufactur-ing and service activities from industrial to developingcountries, providing new opportunities for growth.

The creation of the World Trade Organization(WTO) in 1995 built on the General Agreement onTariffs and Trade (GATT) and is the latest multilateralstep toward creating an environment conducive to theexchange of goods and services (figure 4). A number ofother important measures must follow, so that the mo-mentum for reform is not lost.

Future trade talks will require a forward-lookingagenda for broader trade liberalization if they are to repeattheir past successes in opening markets. The MillenniumRound, which is scheduled to start in November 1999under WTO auspices, may be the first test of such an agenda. Reducing trade barriers in agriculture andservices should be high on the list of priorities. Trade inagricultural products is one area that offers many devel-oping economies real opportunities—if these opportu-nities are not blocked by trade barriers in wealthy coun-tries. Trade in services is another issue that must be

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Note: Trade is the sum of exports and imports of goods andservices.Source: World Bank, World Development Indicators, 1999.

Figure 3Trade is growing much faster than nationalincome in developing countries


addressed. Driven by advances in information and com-munications technology, it is growing explosively—25 percent between 1994 and 1997 alone. This type of trade offers another opportunity for developingcountries, which can readily supply many sought-afterservices.

Countries must make greater use of WTO mechanisms.For example, a country that wants to strengthen its com-mitment to reducing (and maintaining) low trade barri-ers can “bind” its tariffs by incorporating the decision tolower them into its international obligations at theWTO. The more countries view the WTO and interna-tional trade rules as mechanisms for advancing nationalgoals (rather than as obstacles to self-determination), thegreater will be the support for such institutions.

Public policies must take into account the plight ofworkers displaced by the forces of trade. These policiesmust address the concerns of displaced workers in gen-eral, since many workers will blame foreign trade forjob losses and wage cuts whether it is responsible ornot. Augmenting trade liberalization with labor marketpolicies that ease workers’ adjustment to the effects ofglobal trade will reduce pressure to close domestic mar-kets to foreign goods.

Governments must change policies that are still allowedunder existing trade rules but that hinder rather than pro-mote trade. For example, antidumping laws are allowedunder the WTO. They are intended to ensure that prod-

ucts are not sold below what is considered a “fair” priceon domestic markets. But such rules can easily be turnedinto barriers to imports, diluting market access and re-versing the gains from previous trade agreements. Onesolution is to treat the pricing decisions of importers and domestic firms according to the same criteria. Underthis approach only antitrust issues such as predation areremedied directly.

Financial flowsFinancial flows across national borders have risen farmore quickly than trade in recent years. These capitalflows can be divided into foreign direct investment, for-eign portfolio investment, bank loans, and official de-velopment flows. Foreign direct investment is made upof flows intended to purchase a stake in the manage-ment of a company or factory. Foreign portfolio invest-ment includes purchases of “paper” assets like equitiesand bonds (below the threshold required to give own-ers managerial control of physical assets). The increasein foreign direct investment and portfolio flows is par-ticularly striking (figure 5).

Flows of foreign capital offer substantial economicgains to all parties. Foreign investors diversify their risksoutside their home market and gain access to profitableopportunities throughout the world. Economies receiv-ing inflows of capital benefit in many ways. Initially,inflows raise the level of investment. When foreign di-rect investment is involved, management expertise,training programs, and important linkages to suppliersand international markets often accompany the capi-tal. Yet international capital flows, especially flows ofvolatile short-term investments, also expose developingcountries to certain dangers. Among these are sharpchanges in investor sentiment and waves of speculationthat can upset exchange rate regimes, imperil banks andlarge firms, and wreak havoc on economies. Putting thegenie of foreign capital back in the bottle is not possi-ble—and ultimately not desirable. But such capitalcomes with a challenge: to devise policies and institu-tions that tip the balance so that capital mobility bene-fits developing economies rather than injuring them.

Governments of developing countries can begin thisprocess by reforming their banking sectors and nurtur-ing capital markets. The paucity of mutual and pensionfunds and the weakness of stock and bond markets indeveloping countries make banks the primary providersof financial intermediation. Creating a robust bankingregulatory framework offers a substantial economic

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Figure 4Countries are joining the WTO in increasingnumbers


payoff. An effective regulatory regime creates an envi-ronment that encourages prudent risk-taking. A regu-latory structure for banking also sets out the conditionsfor establishing banks, the services they can provide, thelevel of capital they must hold, and the amount of in-formation they must disclose. And a sound regulatoryframework specifies the prudential steps regulators arerequired to take if these standards are not met.

Increased competition in the financial sector im-proves incentives for both banks and their customers.Competition increases as the domestic financial sectordevelops and securities, stock markets, and other inter-mediaries begin playing larger roles. Allowing foreignbanks to enter a country, especially when their homecountries have sound regulatory systems in place, boostsregulation by importing high-quality risk-managementstandards, regulatory practices, and trained managers.

Banks in developing countries must balance tworisks. Banks often raise short-term money on globalmarkets in one currency, such as U.S. dollars or Japan-ese yen, and then loan that money out for longer peri-ods in domestic currency. These banks run the risk oflosing their supply of short-term foreign money if themarket dries up, as well as the risk of losing much ofthe value of their assets if the exchange rate depreciates.

Countries can hedge these risks to some extent, but reg-ulations are needed to moderate the demand for short-term foreign borrowing in the first place. One suchmeasure could require that a part of all capital inflowsnot intended to purchase productive physical assets beset aside for a specified period, thereby raising the costof short-term borrowing from abroad.

In a world where financial markets continue to “goglobal,” developing countries need to work toward be-coming good homes for long-term foreign investment.Building an investment-friendly environment requiresa commitment to a transparent regime of investors’rights and regulations, a legal system that offers equaltreatment and protection to foreign and domestic in-vestors, sound macroeconomic fundamentals, and in-vestment in human capital. When investment is inte-grated into a well-functioning local economy, otherinvestors will always be ready to step in should one in-vestor decide to withdraw.

International institutions have a role to play in help-ing developing countries promote financial stability andinvestment. International banking agreements such asthe Basle Accords can serve as models for local bank ac-counting standards. The International Monetary Fund(IMF) can monitor economic performance and coordi-nate short-term relief for liquidity problems, dampen-ing the severity of a financial crisis. Trade agreementscan help keep responses to financial shocks from turn-ing into a beggar-thy-neighbor cycle of protectionism.Regional and international talks on coordinating macro-economic policies can seek ways to avoid actions thatfavor one economy at the expense of its neighbors.

Global environmental challengesJust as a country’s economy can be swamped by globaleconomic forces it has little power to control or deflect,its environment can be threatened by activities takingplace beyond its borders and its control. In some low-income countries the threats may be severe enough tojeopardize further sustainable development. Climatechanges, for example, could raise ocean levels, swamp-ing the homes of millions of people in low-lying coun-tries like Bangladesh. Governments acting alone, andeven regional organizations, cannot respond effectivelyto this kind of environmental problem. The responsemust be global. Industrial countries are responsible formost of the existing global environmental problems—especially man-made greenhouse gases—but develop-ing countries are catching up rapidly. Their capacity to

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Note: Private debt flows include bank loans and bonds. The Republicof Korea is included in the figures for developing countries.Source: World Bank, Global Development Finance, 1999.

Figure 5Private capital flows to developing countrieshave increased dramatically


contribute to future environmental damage increases asthey grow.

The world has already seen one genuine environ-mental success story in the Montreal Protocol of 1987,which brought all countries together to address a com-mon environmental threat. The Montreal Protocol at-tempts to solve the problem of chlorofluorocarbonemissions, which reduce ozone concentrations in theupper atmosphere. In the 1980s scientists realized thatallowing these emissions to continue unchecked woulddangerously increase ultraviolet radiation in the higherlatitudes, raising rates of skin cancer and cataracts anddamaging the environment. Thanks to the MontrealProtocol and follow-on agreements, global interna-tional production of chlorofluorocarbons has fallensteeply, and global cooperation to reduce ozone deple-tion appears to be succeeding.

The world faces a number of other pressing environ-mental problems that threaten the global commons. Per-haps the best known is climate change, which is associ-ated with increasing emissions of carbon dioxide into theatmosphere. Others include biodiversity loss, which isoccurring at an alarming rate; desertification; the deple-tion of fish stocks; the spread of persistent organic pol-lutants; and threats to the ecology of Antarctica.

The ozone success story provides a model for futureinternational agreements on global environmental is-sues. The scientific case for addressing the risk of en-vironmental damage needs to be made forcefully inopen and robust public debate. The world’s peoples andtheir governments must share the belief that the costsof environmental damage are heavy enough to justifyimmediate action. Alternatives to current behaviormust be technically feasible and reasonably inexpensive,and all countries must be willing to participate in inter-national accords. Sometimes this willingness will comeat a price, with high-income countries paying low-income economies to comply with an agreement andgroups of signatories imposing penalties on countriesthat fail to meet the standards the agreement sets. Fi-nally, the standards themselves must be flexible, becausevery rarely is there a “one size fits all” solution to globalproblems.

The conditions surrounding biodiversity and cli-mate change suggest that reaching international agree-ment on these issues will be more complex than it waswith ozone depletion. But the international communityhas already begun seeking solutions. The Conventionon Biological Diversity and the Framework Convention

on Climate Change created at the 1992 Rio Earth Sum-mit form a basis for moving forward. The Global En-vironment Facility (GEF) is a joint initiative of theUnited Nations Development Programme, the UnitedNations Environment Programme, and the World Bank.The GEF provides grants and concessional funds tocover additional costs countries incur when a develop-ment project also targets one or more of four global en-vironmental issues: climate change, biodiversity loss,the pollution of international waters, and depletion ofthe ozone layer. National governments can take a num-ber of actions that improve domestic welfare whilehelping preserve the global commons. Removing fuelsubsidies and improving public transportation, for ex-ample, not only are in the best interest of individualeconomies but also contribute to reducing global car-bon dioxide emissions that affect other countries.

Subnational issues

Even as globalization directs the attention of nationalgovernments to events, forces, and ideas outside theirborders, localization highlights the opinions and aspira-tions of groups and communities at home. Two aspectsof localization receive particular attention in this report:decentralization and urbanization.

Political pluralism and decentralizationLocalization has generated political pluralism and self-determination around the world. One of its manifes-tations is the increase in the number of the world’scountries, which has climbed as regions win their inde-pendence. Another is the change in countries’ choice ofgovernments. As recently as 25 years ago, less than one-third of the world’s countries were democracies. In thelate 1990s that proportion has risen to more than 60percent (figure 6).

The ability of people to participate in making the de-cisions that affect them is a key ingredient in the processof improving living standards—and thus in effective de-velopment. But political responses to localization, suchas decentralization, can be successful or unsuccessful,depending on how they are implemented. The follow-ing are several important lessons for governments toconsider when embarking upon decentralization.

Decentralization is almost always politically motivated.Often its primary objective is to maintain political sta-bility and reduce the risk of violent conflict by bringinga wide range of groups together in a formal, rule-boundbargaining process. Arguing about whether decentral-

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ization should happen is largely irrelevant; the way it isimplemented will determine how successful it is.

Devising a successful decentralization strategy is com-plex because decisionmakers do not always fully control thedecentralization process. Decentralization requires chang-ing the system of governance and establishing new po-litical, fiscal, regulatory, and administrative institutions.It involves not simply the decision to permit local elec-tions but also a series of choices about electoral rulesand party practices that will affect the options availableto voters. It involves more than a decision to devolve acertain type of responsibility—for education, say—tothe local level. It requires deciding which level of gov-ernment will be responsible for financing education(particularly in poor regions), which level will establishcurricula and develop instruction materials, and whichlevel will be responsible for the day-to-day managementof the schools, including hiring, promoting, and dis-missing teachers. So that decentralization does notoccur at the expense of equity, it requires granting rev-enue sources to subnational authorities and designing asystem of intergovernmental fiscal transfers to comple-ment local resources. It demands rules governing sub-national borrowing. And finally, it must include stepsto build the capability of subnational governments tocarry out their new responsibilities.

The elements of reform must be synchronized. The po-litical impetus that is often behind decentralizationprompts central governments to make concessions

hastily, and granting local elections is a relatively fastand easy step to take. But devising new regulatory rela-tionships between central and subnational governmentsis a slow and difficult task, as is the transfer of assetsand staff from the central to the local level. Equally dif-ficult is the conversion of a system based on annualbudgetary transfers between units of a centralized ad-ministration to one based on the assignment of taxesand expenditures at different levels of government.

National governments need to demonstrate their com-mitment to the new rules of the intergovernmental rela-tionship at the very outset. Precedents matter, becausethey affect expectations. One of the most importantprecedents a central government can set for newly de-mocratized subnational governments is to keep the cen-tral budget constraint hard. Local governments mustknow that if they overspend, the national governmentwill not bail them out and that local taxpayers andpoliticians will bear the burden of adjustment.

UrbanizationMore and more of the world’s population is movingfrom rural to urban areas. Twenty-five years ago lessthan 40 percent of the world’s population lived inurban areas; 25 years in the future this share couldreach nearly 60 percent. Of the urban dwellers of thefuture, nearly 90 percent will be living in developingcountries. Half a century ago just 41 of the world’s 100largest cities were in developing countries. By 1995 that

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Figure 6There are more countries . . . . . . and more democracies


number had risen to 64, and the proportion keeps ris-ing (figure 7).

Some national governments tax rural areas or placerestrictions on the prices of rural products as a way ofsupporting cities, on the grounds that such policiesencourage a “modern” economy. Other governments,concerned about the growing population of urban poor,have tried to discourage rural-urban migration, some-times by requiring official permission to move to a city.Neither course of action has worked especially well. Pre-venting individuals from moving in response to incen-tives generally fails, as national governments have notproven adept at deciding where households and firmsshould locate. Governments will be better off if theypursue development policies that benefit both urban andrural areas, recognize that the process of developmentwill spur urbanization over time, and plan accordingly.

Local governments can take steps to make theircities more hospitable venues for economic develop-ment. One important step is to maintain a sufficientlevel of investment in essential infrastructure, includ-ing water, sanitation, roads, telephones, electricity, andhousing. Increasingly, local governments are workingwith the private sector, which has an important role toplay in housing, on-site infrastructure, and municipalutilities. But municipalities will still be required to raisesubstantial sums to finance capital investment, particu-larly during the rural-urban transition. Private capitalmarkets are a promising source, but they require an ad-

equate legal framework and a firm central governmentcommitment against bailouts. Land use planning is animportant and useful tool, but the rules need to be spe-cific to local circumstances.

Countries do not need to wait until they becomewealthy to improve urban services. Innovative institu-tional arrangements can result in much better serviceprovision, even at low levels of income. Recent trendsin providing essential services point to the potential ofpublic-private partnerships.

n Housing. Private developers, voluntary agencies, com-munity organizations, and NGOs need to provide anincreased share. For its part, the public sector mustfocus on property rights, financing and subsidies,building regulations, and trunk infrastructure.

n Water. Large cities are moving to private sector pro-vision. Private concessions have already replaced pub-lic providers in Buenos Aires, Jakarta, and Manila.The role of government is to regulate this industryand foster competition.

n Sewerage. Governments are often unable to fund theheavy initial investment required for citywide solu-tions. But communities are managing, with the as-sistance of NGOs, to implement affordable solu-tions, providing a model for future efforts.

n Transportation. Public education and creative part-nerships can reduce air pollution. But the greatestpayoff is likely to come from channeling urban

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Source: United Nations Department of International Economics and Social Affairs, World Urbanization Prospects, 1998.

Figure 7Urban population is growing—primarily in developing countries


growth along public transit routes to create more ef-ficient transportation corridors.

It is sometimes argued that poverty alleviation ispurely the national government’s responsibility. Whilethe national government should play a prominent rolein providing subsidies to the poor, many services thataffect the poor most—water, health, education, andtransportation—are best managed at the local level inways that respond effectively to local needs.

Translating policies into action

Globalization and localization offer exceptional oppor-tunities, but can also have destabilizing effects. This re-port identifies some steps governments can take, singlyand together, to minimize potential crises. Nationalgovernments have a leading role, but international orga-nizations, subnational levels of government (includingurban governments), the private sector, NGOs, anddonor organizations all play vital supporting parts.These organizations are building the institutions—theformal and informal rules—that shape the way the

processes of globalization and localization will evolve.The report presents five case studies that illustrate howgovernments and organizations can capture some of thebenefits of these two phenomena and respond to poten-tial disruptions. The studies cover trade liberalizationin the Arab Republic of Egypt; the reform of Hungary’sbanking sector; Brazil’s efforts to structure the fiscal re-lationships between regional and national government;efforts of community groups and local developers toimprove living standards in Karachi, Pakistan; and thecreation of an urban-rural synergy in Tanzania.

The challenges for development are many: poverty,hunger, ill health, lack of housing, and illiteracy, to namea few. Much progress has been made, so that people insome regions such as East Asia are far better off thanthey were several decades ago. Even in Sub-SaharanAfrica, where economic performance has been dismal inrecent decades, life expectancies and educational levelshave risen. Still, the number of people living on less than$1 per day is rising. This trend can be reversed, to thebenefit of the world’s people, by harnessing the forces ofglobalization and localization in the 21st century.


he principal goal of development policyis to create sustainable improvements inthe quality of life for all people. Whileraising per capita incomes and con-sumption is part of that goal, other ob-jectives—reducing poverty, expandingaccess to health services, and increasingeducational levels—are also important.Meeting these goals requires a compre-hensive approach to development.

The last half-century has been markedby a mix of pessimism and optimismabout prospects for development. TheGreen Revolution held out the prospectof overcoming the Malthusian threat,and countries like India succeeded inachieving food security. But the world’sburgeoning population, combined withrelatively slow growth in the productiv-ity of food grains in the 1990s, is onceagain raising fears of food shortages.Some development approaches, such asBrazil’s import-substitution policies, ap-peared to work for a while but thenfailed. The more recent downturn in themost remarkable economic success storyof all—East Asia—has raised new ques-tions about development policies, as hasthe slow response to market reformsshown by the economies in transition.

Yet a consensus is emerging on the ele-ments of future development policy.

n Sustainable development has many ob-jectives. Insofar as raising per capitaincome improves people’s living stan-dards, it is one among many develop-ment objectives. The overarching aimof lifting living standards encompassesa number of more specific goals: bet-tering people’s health and educationalopportunities, giving everyone thechance to participate in public life,helping to ensure a clean environment,promoting intergenerational equity,and much more.

n Development policies are interdepen-dent. When a policy does not workwell, what is involved may be morethan just the individual strategy. Poli-cies require complementary measuresin order to work best, and a policyfailure can occur because these com-plements are not in place.

n Governments play a vital role in devel-opment, but there is no simple set ofrules that tells them what to do. Thereis consensus that governments shouldadhere to the policy fundamentals,but beyond that, the part the govern-

T

New Directions inDevelopment

Thinking

I n t r o d u c t i o n


ment plays depends on its capacity to make effectivedecisions, its administrative capabilities, the coun-try’s level of development, external conditions, and ahost of other factors.

n Processes are just as important as policies. Sustained de-velopment requires institutions of good governancethat embody transparent and participatory processesand that encompass partnerships and other arrange-ments among the government, the private sector,nongovernmental organizations (NGOs), and otherelements of civil society.

The idea that development has multiple goals andthat the policies and processes for meeting them arecomplex and intertwined has provoked an intense debateon the wisdom of traditional development thinking.This introduction draws on the threads of that debate toreview perspectives and lessons from past developmentexperiences. It emphasizes the need to reach beyondeconomics to address societal issues in a holistic fash-ion. The chapter then turns to the role of institutionsin development and points to the institutional changesthat will be necessary to ensure sustainable developmentin the 21st century. While development still faces manychallenges, the opportunities waiting to be grasped in thenew century hold out just as many exciting prospects.

Building on past development experiences

The evidence of recent decades demonstrates that whiledevelopment is possible, it is neither inevitable nor easy.The successes have been frequent enough to justify asense of confidence in the future. But while these suc-cesses may be replicable in other countries, the failureof many development efforts suggests that the task willbe a daunting one.

One measure of development is per capita GDP,which is often correlated with other indicators of well-being and so serves as a convenient starting point. Theaverage level of per capita GDP in developing countriesfor which data are available rose at a rate of 2.1 percentper year from 1960 to 1997—a growth rate that, if itkept rising, would double average per capita GDP every35 years or so.

But such aggregate data invariably mask an array ofvariations across times and places. For example, thegrowth rate of per capita income in developing coun-tries rose relatively quickly in the 1960s and 1970s andleveled out in the 1980s. An optimist might see signsof a return to rapid growth in the first half of the 1990s,but such signs have been less apparent in the aftermath

of the East Asian financial crisis that began in 1997. Inaddition, East Asia is the only region of the worldwhere incomes in low- and middle-income countriesare converging toward incomes in richer countries.

Compared to this regional success, the broad pictureof development outcomes is worrisome. The average percapita income of the poorest and middle thirds of allcountries has lost ground steadily over the last severaldecades compared with the average income of the rich-est third (figure 8). Average per capita GDP of the mid-dle third has dropped from 12.5 to 11.4 percent of therichest third and that of the poorest third from 3.1 to1.9 percent. In fact, rich countries have been growingfaster than poor countries since the Industrial Revolu-tion in the mid-19th century. A recent estimate suggeststhat the ratio of per capita income between the richestand the poorest countries increased sixfold between1870 and 1985.1 Such findings are of great concern be-cause they show how difficult it is for poor countries toclose the gap with their wealthier counterparts.

Standard economic theories predict that, other thingsbeing equal, poor countries should grow faster than richones. For instance, developing countries arguably havean easier task in copying the new technology and pro-duction processes that are central to economic develop-ment than industrial countries have in generating them.Capital, expertise, and knowledge should flow from

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Figure 8The incomes of rich and poor countries continueto diverge


wealthier countries that have these resources in abun-dance to those developing economies in which they arescarce—and where they should be even more productive.

Both past and present development thinking has de-voted much effort to uncovering explanations for whylow-income countries have difficulties in following thispattern.2 A number of studies show that low-incomecountries can grow faster than high-income countries(by about 2 percent per year), thus catching up gradu-ally over time, if they implement an appropriate mix ofgrowth-enhancing policies.3 And increasing experiencewith development outcomes is providing insight intothe complexity of the process and the multifaceted ap-proach needed to achieve this growth.4

The complexity of the development process has longbeen recognized. Arthur Lewis’s classic 1955 study TheTheory of Economic Growth includes chapters on profitincentives, trade and specialization, economic freedom,institutional change, the growth of knowledge, the ap-plication of new ideas, savings, investment, populationand output, the public sector and power, and politics.5

But over the years, various development processes havebeen singled out as “first among equals” in terms oftheir impact. The conceptual frameworks for develop-ment of the last 50 years, especially in their popular-ized versions, tended to focus too heavily on the searchfor a single key to development. When a particular keyfailed to open the door to development in all times andplaces, it was set aside in the search for a new one.

Development models popular in the 1950s and1960s drew attention to the constraints imposed bylimited capital accumulation and the inefficiency of re-source allocation.6 This attention made increasing in-vestment (through either transfers from abroad or sav-ings at home) a major objective. But the experience of recent decades suggests that a focus on investmentmisses other important aspects of the developmentprocess. Investment rates and growth rates for individ-ual countries between 1950 and 1990 varied consider-ably (figure 9). Some low-investment countries grewrapidly, while a number of high-investment countrieshad low growth rates.7 Although investment is proba-bly the factor that is most closely correlated with eco-nomic growth rates in these four decades, it does notfully explain them.8

Early theories of development, especially those asso-ciated with Simon Kuznets, also argued that inequalitygenerally increases during the early stages of develop-ment. Evidence from recent decades has not validatedthese theories, and it now appears likely that growth,

equality, and reductions in poverty can proceed to-gether, as they have in much of East Asia. Many policiespromote growth and equality simultaneously. For exam-ple, improving access to education builds human capi-tal and helps the poor, and providing land to poor farm-ers increases not only equality but also productivity. TheEast Asian countries also showed that countries can havehigh savings rates without high levels of inequality.

Development theorists of the 1950s and 1960s alsooffered a wide variety of rationales explaining why openeconomies and limited intervention would not sufficeto spur growth. Many development economists focusedon planning as at least a partial solution to the prevail-ing problems of low investment and slow industrializa-tion, especially as memories of the Great Depressionmade many policymakers skeptical about the virtues ofunconstrained market forces. Two other factors seemedto argue for an aggressive government role in develop-ment: the U.S. government’s close management of pro-duction during World War II, and the investment andGDP levels of the Soviet Union, which was then surg-ing forward under communism despite enormoushuman costs.

Over time, however, it became clear that while gov-ernments do have a vital role in the development process,only a few governments have run state enterprises effi-ciently. Returns to investment in the Soviet Union fell

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Figure 9Investment alone cannot account for variation in growth


almost to zero. Governments padded public sector pay-rolls and the overstaffing, combined with inefficiency,produced large deficits that imposed a fiscal burden anddiverted needed revenues. Concerns were also mountingthat governments of developing countries were makingpoor decisions in the macroeconomic sphere, leading toproblems such as inflation and the debt crises in LatinAmerica.9

In the late 1960s the attention of policymakers beganto shift toward an emphasis on human capital, which isoften measured in terms of school enrollment (as a proxyfor education) and life expectancy (as a proxy for healthstatus). In the last two decades investment in human cap-ital has shown impressive results. Rates of return on pri-mary education in low-income countries have been ashigh as 23 percent per year.10 But like investment inphysical capital, investment in health and educationalone does not guarantee development. In Sub-SaharanAfrica, for example, life expectancy and school enroll-ment rates have increased dramatically in recent decades,but as a group the economies in the region have had slowand even negative growth since the early 1970s.

By the 1980s the intellectual climate had shiftedagain. Confidence in government planning as a solu-tion had diminished dramatically. The primary con-cerns of the day were, in fact, government-inducedprice distortions (such as those associated with tariffs)and inefficiencies arising from government production.

Still, governments continued to be recognized ascentral to the development process. As the 1991 WorldDevelopment Report noted: “[M]arkets cannot operatein a vacuum—they require a legal and regulatory frame-work that only governments can provide. And marketssometimes prove inadequate or fail altogether in otherregimes as well. The question is not whether the stateor market should dominate: each has a unique role toplay.”11 At the same time, research was showing that themarket imperfections central to the discussion in the1950s and 1960s were (at least theoretically) morewidespread than had been previously believed. How-ever, as a response to public sector inefficiency, policydiscussion nonetheless focused on market-conformingsolutions: eliminating government-imposed distortionsassociated with protectionism, subsidies, and publicownership. A solution to the problem of excessive debtaccumulation was also put forward that involved adjust-ing the fiscal, monetary, and external imbalances ad-versely affecting price stability and growth. Like gov-ernment intervention and investment in education and

health in previous decades, reduced distortions andgreater austerity had become the central elements of thedevelopment agenda.

The evidence of the last two decades continues tosupport the need for macro stability and sector reform.Once again, however, an exclusive focus on these issuesproved insufficient. Some countries followed policiesof liberalization, stabilization, and privatization butfailed to grow as expected. Several African countries im-plemented sound macroeconomic policies but stillreached an average growth rate of only 0.5 percent peryear.12 Low-inflation countries with small budget def-icits face many alternate sources of economic instabil-ity, including weak and inadequately regulated finan-cial institutions, as East Asia discovered.

The lessons of small versus big government perfor-mance were also less clear than expected. In the Russ-ian Federation the move from inefficient central plan-ning and state ownership to decentralized marketmechanisms, private ownership, and a profit orienta-tion should have increased output, perhaps in tandemwith a slight increase in inequality. Instead, Russia’seconomy has shrunk by up to one-third, according tosome estimates, and income inequality has increaseddramatically. Living standards have deteriorated alongwith GDP, and health indicators have worsened.13

Other countries intervened to a relatively large ex-tent in markets and enjoyed rapid growth. The govern-ments of East Asian countries failed to follow many ofthe tenets of liberalization in the early stages of devel-opment, yet their societies have been transformed inthe last several decades.14 Even with a few years of zeroor negative growth in the late 1990s, their per capitaGDP at the turn of the century is many times what it was a half-century ago and far higher than those ofcountries that pursued alternative development strate-gies. The East Asian governments often pursued indus-trial policies that promoted particular sectors. They in-tervened in trade (although more to promote exportsthan to inhibit imports). They regulated financial mar-kets, limiting the investment options available to indi-viduals, encouraging savings, lowering interest rates,and increasing the profitability of banks and firms.15

Their policies placed heavy emphasis on education andtechnology in order to close the knowledge gap withmore advanced countries. More recently, China hasforged its own version of an East Asian–style develop-ment path. Its transition strategy for replacing the cen-trally planned economy with a market-oriented regime

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has resulted in extraordinary gains for hundreds of mil-lions of the poorest people in the world.

The twists and turns of development policy and thenature of the successes and failures around the world il-lustrate the difficulty of interpreting the developmentdrama. The situations in which success and failureoccur differ so much that it is sometimes not apparentwhich lessons should be extracted or whether they canbe applied in other countries. For example, the role thegovernment plays depends on a range of factors, in-cluding administrative capacity, the country’s stage ofdevelopment, and the external conditions it faces.

Despite the difficulty of drawing clearly applicablelessons from development history, current developmentthinking has been able to draw on country experiencesto suggest a range of complementary policies. Thesepolicies, if implemented together and in a way that takesinto account the situations of individual countries, arelikely to encourage development. Several factors that

played a part in the most impressive development suc-cess story of the last 50 years—East Asia—undoubtedlycontribute to growth and development in general: highsavings, strong returns to investment, education, trade,and sound macroeconomic policy. At the same time, de-velopment failures point to the importance of institu-tional structures, competition, and control of corrup-tion (box 1).

Studies of World Bank projects illustrate the manyelements necessary for successful development.16 Thesestudies show that projects in countries that adhere tothe macroeconomic fundamentals of low inflation, lim-ited budget deficits, and openness to trade and finan-cial flows are more successful than projects in closedcountries with macroeconomic imbalances. But theprojects need more than a stable macroeconomy inorder to succeed. For example, social projects are morelikely to succeed if they emphasize beneficiary partici-pation and are responsive to gender concerns. Studies

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The success of East Asia provides some notable lessons onsuccessful development strategies.

n Savings. All the East Asian countries had much higher sav-ings rates than other developing countries. From 1990 to1997, for example, gross domestic savings in the countriesof East Asia and Pacific were 36 percent of GDP, comparedwith 20 percent in Latin America and the Caribbean and 17percent in Sub-Saharan Africa.

n Investment. The East Asian countries managed to investthese savings productively, so that the return on capital in-vestment remained higher than in most other developingcountries (at least until the mid-1990s).

n Education. These economies invested heavily in educa-tion—including female education. The investments paid offin contributions to growth.

n Knowledge. The East Asian countries managed to narrowthe knowledge gap with high-income countries by investingheavily in science and engineering education and by encour-aging foreign direct investment.

n Global integration. The experience of East Asia’s economiesshows that developing countries have a greater ability toenter global markets for manufactured goods than many be-lieved possible several decades ago.

n Macroeconomic policy. The East Asian countries imple-mented sound macroeconomic policies that helped containinflation and avo

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