Making Sustainable Development Work: Governance, Finance and Public-Private Cooperation

Hearing that kind introduction, you folks might think I've never had a real job. I just want to assure you I was once a tour guide in Cinderella's castle, so you would know the President talks to people from the private sector. Since I'm a professor, I have the habit of having an annoying presentation style. There are no overheads, but I do have a prepared text if anyone is interested. I won't go through it all with you in the few minutes that I have. I'm really pleased to be a part of this, because as has been suggested, the idea of sustainable development is really important to the President.

By his request, I have chaired the Organization for Economic Cooperation and Development's  (OECD) working group on sustainable development. What I want to do today is talk about one important aspect, by no means all, that is uppermost in the President's mind. That is his proposal for a Millennium Challenge Account, which we in the administration view as not only an exciting change in development economic policy, but also as really getting at the core of the economics of sustainable development.

You are all aware, of course, that the President has announced his proposal for the Millennium Challenge Account. It is actually a quite significant increase in U.S. support with an annual appropriation of $5 billion when it's fully funded.

This is not a substitution for other things the United States does. This is an increment to the United States position. But it is an increment in a very important way, from an economic perspective, far beyond the dollars it represents. It is an increment in the sense of encouraging economic growth and prosperity. I'll try to make this clear in just a few minutes of remarks with you. I think it is a very important way of changing how we think about encouraging sustainable economic growth.

I would like to begin with a question from a very famous economist, Nobel Prize winner Robert Lucas, at the University of Chicago, who posed many years ago a question that stumped a lot of economists, which is: why is it that capital doesn't flow in markets from rich countries to poor countries? If you think about it, the simple economics you probably looked at in college -- maybe wished you had forgotten, some of you may want to embrace -- would tell you that in very poor countries you should have very high rates of return for incremental investment. You would expect to see capital flowing from rich countries to poor countries, and you would expect to see in poor countries, or in simple economic theory, an increase in saving to fund those opportunities.

That, of course, isn't the case. Now, the question is, why in a very important piece of that puzzle is developing financial capacity for growth actually much harder than the simple economic theory suggests? And in particular, there has just been a ground swell of research in economics in the past decade or so suggesting very, very large effects, quantitatively important effects of improved governance on the cost of capital investment in economic growth.

So if we think about financial liberalization in a country or we think about providing aid to a country, it is very difficult to get sustainable growth absent the sustainable institutions for growth. This work in economics over the past 15 years has indeed, remarkably -- some of you might think we're economists -- reached a consensus. And I think the President's proposals on pillars for his Millennium Challenge Account really reflect that consensus.

Good growth outcomes are associated in research and in the President's principles with three key things: ruling justly, investing in people or human capital, and pursuing economic freedom. Now, in thinking about what the role of this Millennium Challenge Account is, I want to reiterate that this is not a substitute for aid. But I would like to make a simple point.

If I had an overhead, I would make it for you graphically. Imagine if you were to plot aid in some existing period and then look at its effects on growth in a future period in a cross section of countries. If I look at aid, say, throughout the 1980s, what is the effect on growth in the 1990s? What you would observe if you were to have such a picture is a mildly downward sloping line.

To be fair, let's say its slope is roughly zero, which is not at all to say that aid is worthless, but simply to say that relying on the multiple goals currently in overseas development programs is unlikely to be very effective for poverty reduction. Now, what the MCA is centered on is really a very simple notion, that we must focus on poverty reduction. And the best way to do that, study after study in economics show, is through economic growth.

If I were to do another plot for you of economic growth versus growth in the incomes of the bottom quintile populations across countries, I would get a very pronounced upward slope to such a plot. That is, the old saying that a rising tide lifts all boats is actually true. It is very important in poverty reduction to focus on economic growth. Now, how should we think about this in the context of the Millennium Challenge Account? I noted this, of course, has been the centerpiece of the President's vision. And since the time of the President's articulation of what he envisions, there has been an interagency process under the leadership of Secretary Powell and Secretary O'Neill that has tried to think of what are the potential indicators that we can actually go out and measure that might be associated with promoting growth.

And just to give you a flavor of the kinds of things that we're looking at under the aegis of ruling justly, there are many measures associated with civil liberties in the population, political rights, enforceability of contracts, judicial independence and corruption. Those aren't simply a wish list of interesting ideas. They are the very variables that economists have identified as being most closely associated with promoting growth across and within countries.

Indeed to use one particular calculation from a recent study at the World Bank, a leapfrogging in the quality of governance -- for the technical aficionados among you, one standard deviation change in the efficiency of governance -- would lead to a threefold increase in per capita income. I say this just to remind you this is a very big potential effect.

With regard to investing in people, the administration is looking at a number of variables economists have identified as being most closely associated with human capital development. Some focus on education and health outcomes, such as school completion rates, not merely enrollment and public expenditures on health care. My Columbia colleague, Jeff Sachs, has documented repeatedly the importance of such factors in economic growth.

Finally, the other facet of our work in developing indicators has been to look for measures or proxies for economic freedom. And there we're reviewing a set of measures of macroeconomic performance, country credit ratings and support for open markets. Again, there is abundant evidence in the economics community to suggest that these variables are very positively associated with growth within and across countries.

Now, within each of these groups, of course, you have to have a way of picking which variables to look at to make the Millennium Challenge Account come to action. Of course, all other things being the same, we want indicators that are closely associated with economic growth. That's obvious. That's the point of the exercise. But one of the things we also feel is very important is that an indicator be transparent. Part of the MCA is challenge. That's the middle word. In order to challenge countries, we need to have a transparent way of saying, what are the policies that we think are associated with economic growth and sustainable development. And if a country fails to be accepted, we want a transparent way of communicating why that failure happened.

Now, ensuring the success of the MCA, of course, requires the development of how we are to use these indicators of performance. And although there have been no final decisions made, I just want to give you a flavor of the kinds of things that one might pursue. One possibility, for example, would be to aggregate indicators into an index, and then one could judge countries' performance based on such an index. Alternatively, one could set up "hurdles" on a variety of indicators and award success based on a subset of those indicators.

One thing that is general across all of those approaches is another old saw in economics or an old debate about rules versus discretion. And in the current context, of course, the whole purpose of the Millennium Challenge Account is to bring in some discipline, using specific indicators, as to how these new funds will be dispersed.

One polar approach here would be a pure rules-based mechanism, which would be to send geeks like me into a room with a computer to come out with an index and hand it to Secretary Powell. Another extreme would be pure discretion. That is, simply thinking through the aspects of a country and awarding aid.

Now, I characterize those as extreme because, of course, what this process is about is how to do it in the middle. No one would suggest, I think, that indicators based purely on these economic or statistical measures ought to determine solely the final allocation of MCA money, nor would it be the case that pure discretion is right. That, of course, was the whole point of the MCA. A lot of the discussion we're having is how to weight those two very important things and how to come up with a decision process.

Another problem, of course, with relying simply on the quantitative measures are lags in data. Real life can unfurl much, much faster. So this is certainly an item of ongoing discussion. I think there is great value, though, in trying to use very clear and concrete criteria at whatever step those criteria are being used.

I say this because a major feature, again, of the Millennium Challenge Account is its challenge nature. That is, the idea that we're trying to send a signal of what we think good policies are and what policies should be rewarded by additional assistance from the United States. So in that vein, I think it is going to be very important to have these economic measures at the core.

Now, in thinking of mapping the road ahead, the interagency team continues to work on the development of the indicators and on a whole set of questions as to how funds might be dispersed. That is, conditional upon selection, how much and through what mechanisms will funds be dispersed. And then there are also questions of accountability. If we're to have an approach that's shifting toward promoting growth, obviously, we want to have the right indicators before the fact. But by the same token, we want criteria for measurement. A great deal of discussion is being had there.

This is of great importance to the President. And I expect that we will be able to report to him very substantial progress this fall. And I think under these conditions -- that is, this new approach of using the key link between these governance measures, if you will, and growth -- the MCA approach will prove not only an exciting new development in aid, but a very exciting new contribution to economic development. Thank you.