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Knowledge forDevelopment

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SUMMARY

THE WORLD BANK

WASHINGTON, D.C.

4 SUMMARY

possibilities for improving human well-being are so im- instead was that Malthus had underestimated how quicklymense, we return to these twin themes throughout the Re- knowledge-in agriculture, in transportation, in mecha-port, beginning with the story of the green revolution, nization-would transform food production. By the sec-which shows dramatically how knowledge gaps and infor- ond half of the 20th century, world food supply was moremation problems-and their solutions-play out in the than keeping up with population growth.real world. Since the early 1950s, Asia and South America have

more than doubled yields of staple crops (Figure 3; Africa,The green revolution: A paradigm of knowledge which also lags in other measures of development and

for development knowledge, has seen only modest yield increases). Global

Few stories better illustrate the potential of knowledge for gains in output per hectare have been dramatic, particu-development-or the obstacles to diffusing that knowl- larly for wheat, maize, and rice (Figure 4). And althoughedge-than that of the green revolution, the decades-long, the impact of the green revolution on the poor was initiallyworldwide movement dedicated to the creation and dis- a matter of controversy, time has made it clear that poorsemination of new agricultural knowledge. This quest, people have benefited significantly, through higher in-breeding new seeds for enhanced agricultural productiv- comes, cheaper food, and increased demand for their labor.ity, was undertaken in the early postwar years by a vast The early steps in the green revolution mostly involvedarray of agents-nonprofit organizations, governments, narrowing knowledge gaps. The first step was to narrowmultilateral institutions, private firms, banks, village the gap between what scientists already knew about plantmoneylenders, land-rich farmers, and landless laborers- genetics and the widespread ignorance on this score in de-all working, deliberately or not, to improve the daily bread veloping countries, reflected in the unavailability there of(or rice, or maize) of people everywhere. The English econ- new crop strains based on this knowledge. This gap wasomist Thomas Malthus had predicted in the 18th century narrowed largely through the research and developmentthat the population of any country would eventually out- efforts of governments and nonprofit organizations. Butstrip its food supply. What the green revolution showed why was their action necessary? Why didn't private, for-

profit firms make a greater effort to address food security?

Figure 3 Why didn't they, for example, try to commercialize exist-ing scientific knowledge about genetics by developing

_ *. _ ** * ~* * more productive plant varieties themselves?

The answer is that the knowledge embodied in the

Yields have more than doubled in much of seed of a new plant variety is not easily appropriated bythe developing world. any breeder, seed company, farmer, or even country. The

varieties most suitable for transfer to developing countries,once transferred, could be easily reproduced. Farmers hadonly to collect the seeds from the plants grown from the

3.0 - Asia original seeds and replant them. That meant no repeat/ South business for seed developers, and not enough profit toAmerica make their effort worthwhile.

2.5 - Put another way, improved seeds, like many other re-

a, / / search outputs, have many of the characteristics of a publica, 2.0 - / }~/good. A public good is one whose full benefits in the forma,) / / of profits cannot be captured by its creator but instead leak

. - out to society at large, without the creator receiving com-° 15 - _*~ pensation. Because private entrepreneurs have diminished

incentives to provide such goods, the tradition of entrust-

1.0 - ~ ~ ~ ~ ~ ~~ ~Aria ing public entities with providing them is long. (A goodexample is the agricultural research the U.S. governmentfunded in the 19th century.) Indeed, it is widely recog-

0.5 - nized in many fields that, without some collective action,there will be far too little research into developing newknowledge.

0 After the first modern seed varieties proved successful1955 1965 1975 1985 1997

in the early 1960s, many developing countries establishedSource. FAO, various years national agriculture research organizations, as some had

already done, mainly with public funding, to develop

SUMMARY 5

second-generation varieties better suited to local condi- Figure 4tions. As a result, the number of new varieties of rice andmaize released by national research organizations doubledbetween 1966 and 1985.

To disseminate this knowledge, developing-country Productivity gains in some staple crops havegovernments established agricultural extension services. been dramatic.At first the main job of the extension agents was to inform 100 -

farmers about the new seeds and techniques. But the bestextension agents-and the most effective extension ser- ° D

vices-quickly learned that listening was also an impor-tant part of the job. By listening to farmers and learning 80 -

from them, extension agents not only gained a better un-derstanding of the farmers' needs and concerns. They also :

sometimes stumbled upon seed varieties and cultivation 60 -

techniques that the researchers had missed. This two-way oflow of information furthered the local adoption andadaptation of green revolution technology.

At this point in the story, the focus shifts to informa- c4 -4c

tion problems. The driving force in the early stages of the 2

green revolution had been the creation, dissemination, and L_

adaptation of agricultural know-how. But the potential of 20

these innovations could not be unleashed until millions of 0

small farmers planted the new seeds. For this to happen, avariety of information problems had to be addressed. Inparticular, what assurance did farmers have that the seeds owould work? Why should a farmer risk his livelihood onthe say-so of an extension agent? This uncertainty, coupledwith the inability of the poor to obtain credit-anotherclassic market failure closely related to information prob-lems-had significant implications for the rate of adoptionof the new seeds. lack. Even when the poor have assets (small landholdings)

Large landholders and farmers with more education that could be pledged as collateral, weak legal infrastruc-were among the first to try the new seeds, for a variety of ture, including lack of land title and ineffective courts,reasons. Farmers with extensive landholdings could limit means that enforcement of collateral pledges may betheir risk by trying new seeds in test sowings on only a part weak. Without enforcement, incentives to repay are lim-of their land. They could also more quickly recover the ited, and this weakens incentives to lend. The result is thatfixed cost of their early adoption by applying what they the poor often cannot borrow.learned across their larger farms. Educated farmers were In recent years microcredit schemes have arisen to ad-better equipped to find out about the new varieties in the dress these problems. But at the time of the green revolu-first place, and to learn the changes in cultivation practices tion, poor farmers' lack of credit, combined with theirneeded to make the most of them. Perhaps most impor- scant education (also partly attributable to lack of credit)tant, however, more-prosperous farmers had ready access to and other factors, meant that they were often the last tocredit and the ability to absorb risk. Poor farmers, unable adopt the new crop strains. The resulting lag between theto borrow and lacking insurance or the savings to fall back introduction of new seeds and their widespread use can beon in the event of failure, could only watch and wait until seen in the slow expansion of areas sown with new vari-their wealthier neighbors proved the value of the new seeds. eties (Figure 5).

Why didn't banks or village moneylenders lend small The costs of these delays were significant. If all the in-farmers the money to buy the new seeds and fertilizer? formation problems could have been addressed-that is,Many poor people would repay small loans at reasonable if farmers could have been immediately persuaded of theinterest, if such loans were available. But the costs of iden- potential of the new seeds, and if mechanisms had existedtifying the good credit risks among the poor are high rel- to provide credit to poor farmers-the productivity gainsative to the size of the loans they would take out. Unsure from the green revolution would have been even greater.which prospective borrowers will repay, lenders charge One study found that, for a farm family with 3.7 hectares,high interest and require collateral, which the poor often the average loss of potential income over five years from

8 SUMMARY

an open trading regime, foreign investment, and technol- world, including in developing countries. Many develop-ogy licensing. ing countries have found that by establishing and enforc-

Improving the policy and business environments to ing intellectual property rights standards that comply withcreate conditions favorable to trade, especially exports, is international practice, they gain access to foreign marketsone of the most important ways for countries to obtain and to foreign technology through direct investment andknowledge from abroad. To compete in the global mar- technology transfer.ketplace, exporting firms must meet international bench- Developing countries can take advantage of the largemarks for efficiency and design. As a result, exporters tend global stock of knowledge only if they develop the tech-to invest more in knowledge than firms that do not export. nological competence to search for appropriate technolo-

Openness to foreign direct investment goes hand in gies and to select, absorb, and adapt imported technology.hand with an open trading regime, and it provides benefits The green revolution showed how new seed strains had tofor the acquisition of knowledge in its own right. Because be further developed to suit local conditions. Even inmultinational investors are global leaders in innovation, manufacturing, knowledge produced in other countriestheir activities in developing countries can be important in often has to be adapted to local conditions, such astransmitting knowledge. Valuable knowledge spillovers weather, consumer tastes, and the availability of comple-can occur through their training of local staff and through mentary inputs. Similarly, progress in education, healthcontacts with domestic suppliers and subcontractors. Both care, and agricultural extension all require local knowl-are evident in Malaysia, where the local plant of the U.S. edge that cannot be obtained from abroad.firm Intel Corporation now subcontracts a growing part of In fostering the domestic creation of knowledge, gov-its production to new firms set up by former Intel engi- ernments have a special role in supporting potentially pro-neers. Such spillovers are not limited to manufacturing; ductive research, while establishing the necessary condi-they also occur in relatively low-technology service indus- tions for the private sector, in response to market forces,tries, such as food services and hotels. to apply the new knowledge created. Many developing

Technology licensing plays a growing role in develop- countries are reforming their public research and develop-ing countries' efforts to acquire knowledge. International ment to make it more responsive to the market. Brazil,licensing and royalties payments worldwide increased from China, India, Korea, and Mexico have launched vast pro-$7 billion in 1976 to more than $60 billion in 1995. grams to help focus public laboratories on the needs of theTechnology licensing is an effective way to get access to productive sector. Their measures include corporatizingsome of the new proprietary technologies. Domestic firms research institutes, improving the pay and recognition ofcan also use licensing to leverage technological develop- researchers, and offering firms incentives to contract di-ment by negotiating access to the underlying design prin- rectly with the public labs.ciples of the licensed technologies, as many Korean firmshave done. Policies for absorbing knowledge

As the world moves toward a knowledge-based econ- The explosion of new knowledge, accelerating technolog-omy, there has been a trend toward stronger protection of ical progress, and ever-increasing competition make life-intellectual property rights. This trend is reflected in the long learning more important than ever. To narrowrecently completed agreements in the World Trade Orga- knowledge gaps, societies must ensure basic education fornization on the trade-related aspects of intellectual prop- all and provide opportunities for people to continue toerty rights. Intellectual property rights try to balance the learn throughout their lives. Basic education is the foun-incentives for the generation of new knowledge with those dation of a healthy, skilled, and agile labor force. Lifelongfor its dissemination. That balance is difficult to achieve. education beyond the basics enables countries to continu-The balance is also evolving, as new technologies bring ally assess, adapt, and apply new knowledge.new issues for negotiation, such as the protection of bio- In the past 30 years, developing countries have madetechnology, biodiversity, and computer and information enormous strides in expanding enrollments at all levels,technologies. particularly in primary school. These achievements have

Developing countries should participate actively in been invaluable and should be maintained and expanded.continuing international negotiations on these issues, to We have seen, for example, the importance of basic edu-express their concerns that tighter intellectual property cation in furthering the adoption of improved agriculturalrights shift bargaining power toward the producers of techniques. A growing economy, even a low-income one,knowledge and increase the knowledge gap by slowing needs people with up-to-date technical skills to participatethe rate of adaptation. These concerns about intellectual in the global economy. Countries should consider sup-property rights have to be balanced against their advan- porting expanded adult education and training. In manytages: they stimulate the creation of new knowledge in the cases the most cost-effective way of doing so is to support

SUMMARY 9

the private sector's activities in this area, for instance by es- ward the limits of our ability to store and transmit knowl-tablishing standards and accreditation procedures, and in edge. Now the convergence of computing and telecom-some cases by providing subsidies, especially for the poor. munications appears ready to shatter those limits, making

Improving the education of girls is particularly impor- it possible to send vast amounts of information anywheretant in countries with large knowledge gaps. The benefits in the world in seconds-at an ever-decreasing cost. Thisof female education, today widely recognized, include new technology greatly facilitates the acquisition and ab-better child nutrition and health and reduced fertility. sorption of knowledge, offering developing countries un-The recent success of a program in Bangladesh demon- precedented opportunities to enhance educational sys-strates that well-planned government actions can have far- tems, improve policy formation and execution, and widenreaching impacts. even in societies where girls' education the range of opportunities for business and the poor. Onehas long been neglected. Nationwide, only about 20 per- of the great hardships endured by the poor, and by manycent of Bangladeshi women were literate in 1990, and others who live in the poorest countries, is their sense ofonly a third of students in secondary schools were girls. isolation. The new communications technologies promiseSince then a program to provide stipends and tuition to reduce that sense of isolation, and to open access togrants to girls enrolled in secondary school has rapidly in- knowledge in ways unimaginable not long ago.creased female enrollments. By 1996, half a million girls A growing number of developing countries are takingwere receiving stipends, and as many girls as boys were en- advantage of these opportunities to leapfrog to the newrolled in participating schools. technologies, largely skipping such intermediate stages as

But to sustain economic growth and to compete in the copper wires and analog telephones. Already Djibouti,global economy, countries must go beyond basic educa- Maldives, Mauritius, and Qatar all have fully digitizedtion, as Korea has done. By 1960 Korea had achieved uni- telephone networks. In this they have stolen a march onversal primary education-the basis for a well-educated some industrial countries where half or more of the tele-labor force-which fueled the economy's needs as it in- phone network continues to rely on older technology,dustrialized. Incentives were also put in place for extensive more expensive and lower in quality.private investment in tertiary education, so that by 1995 Throughout much of the developing world, however,more than half of college-age adults were enrolled in a col- access to even basic communications technology is avail-lege or universitv. Of these, more than 80 percent were able only to the fortunate few. South Asia and Sub-Saharanenrolled in private institutions, and private spending on Africa have only about 1.5 telephone lines for every 100tertiary education exceeded public spending. people, compared with 64 lines per 100 in the United

Tapping the private sector is one way to stretch limited States. Lower incomes account for part of the difference,government resources; a complementary measure is to im- but many people in developing countries who are readyprove the quality of public education. To do this, and to and willing to pay for a telephone are unable to obtainaddress some of the information failures afflicting educa- one. Standing in their way are inefficient state monopoliestion, many countries are experimenting with new ap- and regulatory regimes that unintentionally restrict sup-proaches to providing it. These changes take several forms: ply. Worldwide, an estimated 28 million people, nearlydecentralizing administration, increasing school auton- all of them in developing countries, are on waiting listsomy, switching to demand-side financing, increasing in- for telephone installation. Given the long and uncertainformation about individual educational institutions, and delay, many others who want a telephone and could af-fostering competition among private, nongovernmental, ford one simply have not bothered to apply.and public providers. In El Salvador, after its civil war, the Fortunately, countries can eliminate these bottle-government improved and expanded the community- necks-and lower the costs of telecommunications so thatmanaged schools that had sprung up when the public sys- many more people benefit. This can be done by adoptingtem broke down. Even the poorest communities set up a regulatory system that promotes and ensures competi-and managed such schools, actually improving quality. tion, to prevent firms with monopoly power in some areasOne reason is that parents monitor the teachers vigor- of service provision from using it to gain a strangleholdously. As a result, students lose only about half as many over others. In most cases, expanded competition shoulddays to teacher absenteeism as in conventional schools. come before privatization, to avoid turning a state mo-

nopoly into a private one.Policiesfor communicating knowledge in the Developing countries are discovering that private in-information age volvement can rapidly extend telecommunications services,Advances in communications have transformed society even when incomes are low. Before its reform, Ghana'sbefore: movable type, photography and telegraphy, the telecommunications system was dominated by a money-telephone, television, and the fax machine all pushed out- losing state monopoly, only one in 400 people had a tele-

10 SUMMARY

phone, and there was a 1 0-year wait. The government sold reason to hope that new technology can make a big con-30 percent of the state firm to a consortium of domestic tribution to narrowing knowledge gaps.and Malaysian investors, approved a competing nationalfranchise that also included foreign investors, licensed five Policies for addressing information failuresnew cellular providers, and approved several Internet ser- Part Two of the Report describes how markets thrive-orvice providers, one of which now has an aggressive pro- wither-depending on the flow of information, and howgram to provide rural access through collaboration with the information failures are especially pervasive in developingpost office. In 1997, the first year after the reforms, the countries. Although information failures can never benumber of fixed lines increased by 30 percent, to 120,000, eliminated, recognizing and addressing them are crucial toand the pace of installation is expected to accelerate. effective markets and therefore fundamental to rapid, eq-

One problem that often remains with privatization is uitable, and sustainable growth. As the green revolutionthat some isolated rural communities are not served, be- showed, information failures in the market for knowledgecause they have too few people stretched out across too itself or in related markets (such as for credit) can limit themuch territory to attract private service providers. The returns to acquiring knowledge. Put another way, coun-problem for government is knowing how much subsidy is tries can increase the return to acquiring and using knowl-needed to encourage private service to these communities. edge by ensuring that markets function as well as possible.Chile has had encouraging success with subsidy auctions, a Whatever actions governments undertake, significantmarket-like innovation that induces firms to reveal infor- information imperfections and the corresponding marketmation about their costs, to the benefit of the poor. The failures will remain, and this fact has important implica-government awarded subsidies on a competitive basis to tions for policy design. Because these imperfections arefirms providing telephone service to small and remote lo- greater in developing countries, and the institutions forcales: firms bid against each other for the right to service addressing them often more limited, market failure willthese areas. Unexpectedly, for half the locales and nearly also be more prevalent. Policies need to account for this.60 percent of the target population, firms proved willing to For instance, rural extension schemes should recognizeprovide pay phones at no subsidy at all. With additional that farmers may face credit rationing, may be able to bor-rounds of bidding going forward, it is expected that 98 per- row only at extremely high interest rates, and may havecent of Chileans will have access to pay phones by 2000. only limited ability to absorb risk. This will limit their

Expanding telecommunications holds the promise to ability to take advantage of new assistance, for example inimprove every developing country's capacity to absorb the form of improved seeds.knowledge, for example by providing opportunities for A comprehensive strategy for the effective use of knowl-high-quality, low-cost adult learning. The Virtual Univer- edge requires that governments seek ways to improve in-sity of the Monterrey Institute of Technology in Mexico formation flows. But governments suffer from informa-is a consortium of collaborating universities, including 13 tion limits of their own, and an appreciation of theseoutside the country. It enrolls 9,000 degree and 35,000 limits should inform decisions about the scope and naturenondegree students each year in Mexico and other Latin of public action. It is not just the size of the market failureAmerican countries. It delivers courses through printed that matters-it is also the government's capacity to dealtexts and live and prerecorded television broadcasts, with with it. But as the discussion below makes clear, developing-communication between students and faculty aided by country governments have helped to improve markets incomputers and the Internet. many ways by addressing information failures.

The African Virtual University, headquartered in Part Two develops in detail the types of informationNairobi, seeks to increase university enrollments and im- problems that plague developing economies. It then ex-prove the quality and relevance of instruction in busi- plores the steps that governments can take to deal withness, science, and engineering throughout Africa. In each those problems in three areas where information failuresparticipating country, a local institution is competitively are especially severe: financial markets, the environment,selected to oversee operations. This institution provides and measures for the poor. Here we look at three ap-hardware and software for interactive courses, registers stu- proaches to information problems that cut across all thesedents, supervises study programs, offers a structured study areas: providing information to help verify quality, moni-environment, and awards local course credit. The univer- toring and enforcing performance, and ensuring two-waysity has installed 27 satellite receiver terminals throughout information flows. We highlight throughout how govern-Africa and developed a digital library, to compensate for ments are experimenting with innovative mechanisms tothe dearth of scientific journals in African universities. Al- reduce the costs of collecting, analyzing, and applying in-though it is too early to assess results, such initiatives are formation. By addressing information failures up front,

SUMMARY 1 1

governments are discovering new solutions to seemingly the average then prevailing in a group of high-incomeintractable problems, especially those that afflict the poor. economies, its annual GDP growth would have increased

by 0.6 percentage point.Providing information to help verify quiality Governments can also promote specialized private in-Governments can smooth the workings of markets by re- stitutions to verify the quality of goods and services. Forquiring the disclosure of information that reduces the example, the ISO 9000 quality certification procedurescosts of market transactions, especially information about are private standards to which firms voluntarily adherethe quality of the good. service, or institution involved. In as a means of guaranteeing the quality of their processesIndia in the 1950s, when rising production costs led pro- and products. Such certification is especially valuable toducers to dilute milk, buyers were unable to determine the developing-country exporters eager to establish a reputa-quality of milk sold in the market. Dairy producers who did tion for quality among skeptical buyers. In this case, gov-not dilute their milk could no longer compete, leaving the ernments need do little more than publicize the availabil-market to low-quality producers. Milk quality was restored ity of the certification process.when the government took steps to ensure quality by es- This example shows that direct public action to settablishing reputable brand names and distributing an inex- standards is not always necessary. Instead, governmentspensive, handheld device for measuring butterfat. The re- can establish an institutional and legal environment, in-sults were not only more and better milk but also healthier cluding trademark protection for brand names, that fosterschildren and higher incomes for dairy farmers. private standards setting. Producers of goods whose qual-

In education and labor markets, accreditation and ity is not fully apparent at the time of purchase-whetherskills certification inform employers about the education cola drinks, cars, or computer games-can use brandand skills of prospective workers. Given the increased im- names to establish a reputation for quality. This enablesportance of lifelong learning and the increasing variety of producers to charge a premium for quality, which makessettings in which education is provided, certification will it worthwhile to market high-quality goods, which in turnbecome increasingly important, and governments should benefits consumers. Of course, brand names can addresshelp set and validate the standards used. information problems only if the government establishes

In the financial sector, which is particularly prone to and enforces legal standards to prevent brand piracy.information problems, accounting and auditing standards Generation of information by agents other than themake it possible for investors to compare information government also shows promise in addressing complex en-across firms. Standardization of balance sheets, income vironmental issues. The International Forestry Resourcesstatements, cash flow statements, and the notes to these and Institutions Research Program in the United Statesstatements allows companies to report on their situation brings together a network of collaborating research centersand activities in a consistent way, so that investors can throughout the world. The centers agree on a commonmake better-informed judgments about where to put their research method. They support the collection of primarymoney. Developing-country governments can hasten the data on forest conditions, management, and uses. Andspread of good accounting standards by imposing ac- they interpret and analyze information gathered in thecounting and disclosure requirements on publicly traded field. In this bottom-up approach, a university-based proj-firms. ect serves as a clearinghouse for locally provided infor-

Similarly, common and rigorous standards make it mation with global implications.possible to assess the health of banks, by enabling out- Governments are also experimenting with self-revela-siders to assess the adequacy of loan-loss provisions, for tion mechanisms to achieve disclosure of information atexample, and by ensuring that collateral is valued realisti- lower cost. The Chilean auction scheme already men-cally. Improving such standards is important for an effi- tioned elicited information about the level of subsidy re-cient financial system and for economic growth. Confi- quired without the government having to investigate thedence in financial institutions enables them to attract cost structure of each firm. A similar approach has beenmore capital and avoid the dangers that arise from under- applied to social safety nets, ensuring that the benefits ac-capitalized banks. crue to the poor while minimizing leakage to the non-

Improvements in accounting standards are important poor. Means-testing, the approach commonly used in in-for the efficiency of the financial system-and for growth. dustrial countries, is expensive and often unworkable inStudies show that countries with sound accounting sys- developing countries, because the household incomes oftems have more-developed financial intermediaries and poor people cannot be reliably determined. An alternativefaster growth. One study estimated that if Argentina had that reveals the needed information at close to zero cost israised its accounting standards in the early 1990s to self-targeting, whereby benefits-be they wages or food

1 2 SUMMARY

for work-are designed so that they are attractive only to have since helped maintain banking stability. In Thailand,the truly needy. relaxed limits on real estate lending led to a boom-and

then a bust, which contributed to the Asian financial crisisMonitoring and enforcing performance of the late 1 990s. Retaining ceilings on real estate lendingBesides the means to verify the quality of the goods or ser- might have helped avoid the problem.vices they buy or sell, participants in markets need a legal In banking and finance, as in other areas, the appropri-system to enforce contracts. Typically the problem in de- ate approach to monitoring and enforcement dependsveloping countries is not the absence of laws. Instead, it is both on the circumstances of the country, such as banks'the lack of credible enforcement: courts may be slow, and capacities for risk management and the nature of the risksthey are often corrupt, making judicial reform a necessary facing the country, and on the capabilities of the regulatorypart of economic reform. Many countries would benefit authorities. Simple rules such as ceilings on real estatefrom special courts to deal with various specialized legal is- lending, restrictions on the rate at which that lending maysues, such as the enforcement of commercial contracts and increase (speed limits), and limits on exposure to foreignthe treatment of bankruptcy. In these countries, enforce- exchange risk are often appropriate responses in countriesment and, more broadly, laws that require disclosure are that have limited regulatory capacity and face a volatile ex-meaningful only if there are penalties against dishonesty ternal environment. These countries may also favor stricterand fraud. capital reserve requirements to provide incentives for pru-

But even when the legal system works, it is costly to dent lending. Incentives for good behavior are important,use. So, in both industrial and developing countries, eco- because even the most effective monitoring and enforce-nomic arrangements seek to be self-enforcing, to provide ment remain imperfect.the right incentives on their own, with the legal system as Countries with more sophisticated financial marketsthe backdrop. Thus, credit markets are enhanced by a legal may find that the scope for evading certain regulations hassystem that allows individuals to post collateral and other increased with the arrival of new financial instruments,security for loans and allows creditors a reliable means of such as derivatives. They will have to adjust their regula-collecting debts when debtors fail to repay. Bankruptcy tions accordingly. In some cases they will have to abandonlaws are therefore another essential part of a well-func- certain outmoded regulations, and in others increase dis-tioning legal system for modern private sector activity. closure requirements. Many industrial countries are shift-Other government functions, such as land titling, also en- ing to regulation based on oversight of financial institu-hance the use of collateral. Similarly, land reform can en- tions' risk management systems. Although this can be ansure that more poor farmers have collateral, enhancing important complement to transaction-based regulation,their access to credit. they are not likely to be a perfect substitute, especially in

The provisions of commercial law that determine the developing countries. The dramatic failures of some fi-damages that may be collected if a party breaches a con- nancial institutions in the industrial world, large lossestract can provide important incentives to fulfill commit- in others, and the questionable lending patterns of somements. Again, achieving the right balance is crucial. If banks-including their lending to risky countries arounddamages are too difficult to collect, there will be too few the world-cast doubt on the adequacy of these systems.incentives to fulfill contracts; if too easy, and injured par- The International Monetary Fund and the Bank for In-ties are overcompensated, parties may claim breach of ternational Settlements are looking into new ways of en-contract under false pretenses. Criminal prosecution of suring the stability of these systems.fraud, undertaken when a party deliberately or repeatedly Just as government need not set standards directly, soengages in promises that it does not intend to fulfill, can it need not undertake all necessary monitoring and en-be an important supplement to civil action. forcement. Part of the success of Argentina's reforms

The government must also monitor and enforce per- comes from having "multiple eyes." By increasing the num-formance, especially in finance and banking, where failure ber of market players-such as subordinated debt holders,to comply with standards may not be readily apparent. who have their own incentives to keep an eye on theGood accounting procedures are of little use if firms traded banks-regulators have increased the chance that any fail-on the stock exchange are permitted to hide bad news or ure to comply with the new standards will be detected andconceal profits. Monitoring and enforcement are also cru- exposed.cial in banking, given the risks of contagion (systemic risks One of the most promising innovations in third-partyfrom which the whole economy suffers) and the cost to enforcement is the group lending exemplified by Bangla-taxpayers of banking failures. Government action in these desh's Grameen Bank and Bolivia's Banco Solidario. Inareas can have repercussions for the entire economy. After Grameen Bank's model, would-be borrowers first formsuffering a costly banking crisis in the 1980s, Argentina small groups. Although the loans go to individuals, alladopted strict liquidity and capital requirements, which members of a group understand that if any member de-

SUMMARY 1 3

faults, none will receive subsequent loans. This gives them Trust was essential in a health program in the state ofan incentive to monitor each other's performance, in- Ceara, Brazil, where a third of the people live in extremecreasing the probability of repayment. Since the groups poverty. Starting in the 1980s, the government hired 7,300form voluntarily, borrowers can use their knowledge of workers (mostly women) as community health agents attheir neighbors to exclude the riskiest, thus mitigating an- minimum wage, with 235 nurses to supervise them. Re-other common problem for lenders. Group lending also cruiting people who already cared about health, the pro-gives borrowers, many of whom have limited exposure to gram gave them varied tasks and responsibility for results.formal institutions of any type, an opportunity to learn in It also launched a media campaign to raise awareness ofthe company of neighbors about how credit works, and to the agents' efforts and the new health services. Motherskeep abreast of each other's ideas and progress. Govern- who previously had hidden their children from govern-ments can promote group lending by incorporating the ment health workers gradually began to see the agents asidea in public credit programs, by subsidizing the startup friends. As a result, vaccination rates for measles and poliocosts of nongovernment programs, and by providing gen- rose from 25 percent to 90 percent, and infant mortalityeral information about the approach. dropped from 102 per 1,000 live births to 65 per 1,000.

Another innovative example of third-party monitoring Because poor people know their own needs and cir-is community enforcement of environmental standards. cumstances, taking time to listen to them can greatly im-Environmental officials in Indonesia, frustrated with weak prove outcomes. In Rwanda in 1987, high charcoal priceslegal enforcement of water pollution standards, hit upon created demand for more fuel-efficient stoves. A stove pat-the idea of collecting information on compliance and terned on a Kenyan model proved unpopular in early tri-disclosing it to the public. The resulting program, called als; tests in 500 households led to changes in size, color,PROPER, collected firm-level data on pollutants and door design, and portability. Government assistance, man-compiled those data into a single index. A color-coding aged by a team of women, involved publicity campaigns,system assigned black to the worst establishments and market surveys, training programs for stovemakers, andgreen to the best (none of the firms earned gold, reserved limited initial assistance for modernizing stovemakingfor exemplary performance). Even before the information equipment. Private entrepreneurs then took over produc-was made public, firms hurried to improve their ratings. tion and sales, without subsidies. Three years later, one inAfter publication, citizens' groups used the ratings to pres- four urban households was using the redesigned stove,sure underperforming factories to clean up. Regulators, achieving fuel savings of 35 percent.meanwhile, could focus their limited enforcement re- Scientists at the Institut des Sciences Agronomiques insources on the worst offenders. In the first 15 months of Rwanda and at the Centro Internacional de Agriculturathe program, roughly a third of the unsatisfactory per- Tropical in Colombia collaborated with local womenformers came into compliance with the regulations. farmers to breed improved bean varieties, after they real-

ized that listening to the women farmers in selecting cropEnsuring two-way informationflows varieties could greatly improve outcomes. The two orMuch of the discussion so far has focused on ways to fa- three varieties that the scientists first selected led to onlycilitate the flow of knowledge from those who have much modest increases in yields. The women were then invitedof it to those who have less: from industrial countries to to examine more than 20 bean varieties at the research sta-developing, from governments to citizens, from teachers tions and to take home and grow the two or three theyto students. But effective communication must be a two- thought most promising. They planted the selected vari-way street. Sharing knowledge with the poor requires an eties using their own methods for experimenting. Thanksunderstanding of their needs and concerns-and earning largely to their better knowledge of the terrain and theirtheir trust. Only then can they be offered knowledge in a personal interest in achieving higher yields with the breedsform that they can use and will accept. Almost always, lis- they had selected, their selections outperformed those oftening to the poor is the first step in doing this well. And the scientists by 60 to 90 percent.through listening, public action can benefit from knowl- Beneficiary participation in the design and implemen-edge that the poor themselves have to offer. tation of projects is another way of learning from the

Building trust should be a priority for any program poor. The World Bank uses beneficiary assessments in itsseeking to provide knowledge to the poor. Access to social fund projects, in which communities receive fund-knowledge is of little benefit if people do not trust the ing for projects they themselves have selected. In Zambia,source. Health workers can suggest good contraception for example, the views of the poor were incorporatedtechniques, but poor women might not use them because through open consultations in public village meetings.they suspect that the workers do not understand their life Beneficiary participation has been shown to have a pow-circumstances. Similar concerns lead many poor people to erful impact on project outcomes. A study of 121 ruralavoid schools and unfamiliar jobs. water supply projects in 49 countries found that 7 out of

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