Does better provincial governance boost private investment in Vietnam?

What determines the quality of local economic governance?Comparing Vietnam and Indonesia Neil McCullochDFAT, IndonesiaEdmund MaleskyDuke University, USA

1OverviewContext and key questionsDrivers of reform in VietnamDrivers of reform in IndonesiaExplaining the different incentivesImplications for policy in Indonesia

2ContextLarge literature suggesting a strong link between the quality of economic governance/economic institutions and economic performance (since North 1981, 1989, 1990)And a large literature arguing about causality (e.g. Acemoglu et al (2001), Glaeser et al (2004), Kaufman and Kraay (2002)Wave of decentralisation across many countriesIndonesia in 2001 now over 500 districtsVietnam in 2004 now 63 provincesHuge literature linking institutions and economic performanceAnd at the same time a huge wave of decentralisation across the developing world, including in Vietnam and Indonesia3Interest in local economic governanceIFC Doing Business at the city levelProvincial Competitiveness Index in VietnamLocal Economic Governance Index in Indonesia underlying assumption is that improving the quality of local economic governance will boost local economic performance.

Combination of focus on economic governance and institutions as the key to economic performance; and decentralisation has led to a lot of research over the last decade on local economic governance. These have mostly consisted of:Attempts to measure the quality of local economic governanceDonor programs to try and improve the quality of local economic governance4Key questionsWhat determines the large variation in the quality of local governance we observe across regions in Vietnam and Indonesia?What drives local level economic reform?Who are the key actors? What motivates them to reform? What constraints do they face?

Measuring Economic Governance the Provincial Competitiveness Index

6The 2011 PCI map

7Matched locationsRed River delta (Bac Ninh; Hung Yen)Mekong delta (Dong Thap; Ca Mau)121 semi-structured interviewsGovernmentEntrepreneursAssociationsDonors

Structural Drivers of Reform in VietnamCurrent level of PCI Yes - iveLeadership changesYes +iveVCCI diagnostic workshopsYes +iveBeing one of the major five citiesYes - iveHaving greater revenue autonomyYes +ive

And factors that dont affect reformHaving a higher education levelNoSize of the economyNoPrevious private investmentNoDistance from Hanoi or HCMCNo

What drives provincial economic reform in Vietnam?Qualitative Research4 provinces121 interviewsgovernment, business, donors, national experts, mediaQuestionsWho were the key drivers (government, party, private sector) and why/how did they achieve reform?

Vietnam Qualitative ResultsKey driver of local reforms was NOT central government mandated investment climate reforms. Rather

Decentralisation of investment approval provided an opportunity for local governments to drive their provinces growthInformal, local coalitions of party, government and business tackled problems togetherNeed capacity on both sidesStrong upwards accountability meant that the PCI did act as an incentive for reform for local provincial chairmenWhat drives reform in Indonesia?Lots of scholarship on Indonesian decentralisationLeadership (von Luebke, 2009)Elections and campaign finance (Aspinall and Fealy 2010, Mietzner 2013)Investment climate (Patunru et al, 2012)Drivers of growth (Suharnoko, 2009)Impact of decentralisation (Widharja and Pepinsky, 2011)

Von Luebke shows that Leadership is key. IGI agrees, as shows that good governance is not institutionalised but still personal/individualAspinall and Fealy, Mietzner have charted the explosion of democratic accountability yet without much improvement in performance; one explanation is the funding of election campaigns leaves leaders in hoc to local oligarchsPatunru et al, compare Solo and Manado. Find leadership and good planning key. But also found that it didnt much affect performance in the short-term.Similarly Bambang Suharnoko asked whether it was Endowments, Location or Luck that determines growth and came up with the rather unsatisfactory answer that a lot was luck!Monica and Tom found that endogenous institutional decline, labour immobility, and varying endowments undermine decentralisations potential benefits.11

Components of Local Economic Governance1. Access to Land and Security of Tenure2. Business Licensing3. Local Government and Business Interaction4. Business Development Programs5. Capacity and Integrity of the Mayor/Regent6. Local Taxes, User Charges and other Transaction Costs7. Local Infrastructure8. Security and Conflict Resolution9. Local RegulationsWhat determines the quality of local governance?Structural FactorsWhat we expectSize of economymight induce more rent-seekingNatural resourcesmight induce rent-seekingPopulation makes governance more complexCitymakes governance more complexRemotenessout of sight, out of mindEducationmight improve the quality of administrationEthnic or religious fragmentationmakes governance more complexStabilityInfrequency of land conflict; strong leader; pemda doesnt creates uncertaintyRent seekingLeader not corrupt; biased to investment; pemda doesnt increase business costs; no illegal collections; no distribution charges; no payments to police

14Results - what determines the quality of local governanceStructural factors matter and in precisely the way we expectBut they only explain 10% of overall variation - there is much still to play forStructural FactorsWhat we findSize of economyStrong negative effect on governanceNatural resourcesNegative but not significantPopulation Strong negative effectCityNegative but not significantRemotenessStrong negative effectEducationGreater SMP Net Enrolment positive but not significantEthnic or religious fragmentationNegative but not significant15EGILog non-oil RGDP-1.763(1.66)*Share of mining in GDP (2002)-0.108(0.03)Log population (2002)-2.426(3.71)***City-1.288(0.90)Log distance from Jakarta-1.221(1.60)Net enrolment middle school (2002)1.745(0.50)Ethnolinguistic Fragmentation-1.354(0.59)Religious Fragmentation-0.448(0.13)Constant124.927(6.19)***R20.10N19510% increase in RGDP gives a 0.17 reduction in governance. But the sd of the EGI is 6, so this isnt large. Even a 10% increase in population reduces by 0.24 again only 4% of the sd of EGI.16Upwards vs Downwards AccountabilityIndonesiaVietnamCompare their incentivesProvincial Party Chairman, VietnamBupati, IndonesiaIncentives/Rules of the GamePolitical promotion depends on economic performancePolitical promotion depends on compliance with central initiativesCentral oversight is strong and accountability is upwards.

Possible StrategiesSteal the state budgetElite state-business alliancesImprove the investment climateLikely outcomeLocal elite state-business alliances and associated performance (and corruption)Lots of efforts to comply with PCIIncentives/Rules of the GamePolitical promotion depends very little on economic performance and not at all on compliance with central initiativesCentral oversight is weak or non-existent. Accountability is to electorates, and to funders/local elites.Political campaigns require large financial resources and promotion depends on being able to contribute in a substantial way to the partyPossible StrategiesSteal the state budget Elite state-business alliancesImprove the investment climateLikely outcomeLots of corruption of state budgetLocal elite state-business alliances but focussed on rent-seeking not performanceMinimal efforts to boost the local investment climatePolicy SuggestionsStrengthen central/provincial monitoring and incentives

Revamp the decentralisation law to provide stronger oversight at Province and Centre (already happening)Tighten central/provincial monitoring of licensing/concessions Construct a credible tool for central/provincial monitoring of performanceHelp the province and centre use the tool; potentially link to rewards or punishments

19Policy SuggestionsEducating Brazilian voters about the results of independent audits put pressure on politicians to perform

Socialise the results of performance to district and provincial electorates and parties

2. Strengthen accountability to citizens

1. Strengthen central/provincial monitoring and incentives

20Policy SuggestionsChange the campaign finance laws to provide public funding for partiesPut strict limits on campaign expenditure

Reduce reliance of local leaders on oligarchs