THE EVOLVING ROLE

OF THE STATE

AGO, A CANADIAN FARMER AND AN recall Thomas Hobbes' insight, in his 1651 treatise
ACENTURY
Ivorian probably felt little connection with their Leviathan, that life without an effective state to preserve
governments, and none at all to each other. Government order is "solitary, poor, nasty, brutish and short."
affected their lives oniy to the extent that it provided a This Report aims to show how every state, regardless of
handful of classic public goods, such as law and order and its point of departure, can improve its effectiveness and
basic infrastructure, and collected taxes from them. move ever further away from this doomsday scenario.
Today the state has expanded dramaticallyand the Toward that end, this chapter begins with a reminder of
world has shrunk. The same farmers' descendants send how we got here. Surveying the history of the state from
their children to government-run schools, receive medical its early beginnings, it shows how notions of the state's
treatment from publicly supported clinics, rely on an role have evolved to produce, in both industrial and devel-
array of publicly provided services, and may benefit from oping countries, a dramatic expansion of the state and,
government price controls on the seed and fertilizer they more recently, a change of emphasis from the quantity of
buy, or the wheat or coffee they sell. These later genera- government to the quality. The chapter then lays out a
tions of Canadians and Ivorians are therefore likely to be simple framework for rethinking the state, introducing a
much more concerned than their ancestors were about the two-part strategy for greater state effectiveness that the
effectiveness of government and the checks and balances rest of the Report explores. The message is that the state
on its decisions. And they are likely to be much more can rise to the challenges it faces, but only by, first, match-
aware of how their own government's performance com- ing what it tries to do to what it can do, and second,
pares with others'. Vastly expanded communications, working to increase the number of things it can do capa-
trade and investment, radio and television, friends and rel- bly by reinvigorating public institutions.
atives traveling to foreign lands as tourists or migrant
Where the state began
laborersall of these give Canadians and Ivorians today a
much better idea of how the government services they From earliest times human beings have banded together
receive measure up to those in other countries. The state's into larger associations, starting with household and kin-
behavior, and the consequences of that behavior, are being ship groups and extending through to the modern state.
scrutinized like never before. For states to exist, individuals and groups have to cede
This scrutiny might lead to better government. But if authority in key areas, such as defense, to a public agency.
states are unable to respond constructively to the chal- That agency has to possess coercive power over all other
lenges they face, the result could simply be further erosion organizational forms within a designated territory.
of the state's credibility, as the gap between what the state States have come in all shapes and sizes, depending
can do, and what people ask it to do, widens even further. on a mix of factors including culture, natural endow-
The terminal phase of this process is visible in the recent ments, opportunities for trade, and distribution of power.
agonies of Angola, Somalia, and Zaire. The state collapses The ancient Athenian state, for example, was under-
from within, leaving citizens bereft of even the most basic pinned by slavery and colonial spoils. Further east, elabo-
conditions of a stable existence: law and security, trust in rate state structures were built from early times on the
contracts, and a sound medium of exchange. These crises basis of state ownership of land or, in Mugha! India and
20 WORLD DEVELOPMENT REPORT 1997

Box 1.1 State and government: Some concepts

State, in its wider sense, refers to a set of institutions that of offices, which is more narrow in conception, and the
possess the means of legitimate coercion, exercised over relationship between government and the governed.
a defined territory and its population, referred to as soci- The first classification is based on the relationship be-
ety. The state monopolizes rulemaking within its terri- tween the executive and the legislature. In a parliamen-
tory through the medium of an organized government. tary system the executive's continuance in office de-
The term government is often used differently in dif- pends on its maintaining the support of the legislature.
ferent contexts. It can refer to the process of governing, Members of the executive are commonly also members
to the exercise of power. It can also refer to the existence of the legislature. A prime minister may be the most
of that process, to a condition of "ordered rule." "Gov- powerful member of the executive, but important deci-
ernment" often means the people who fill the positions sions within the executive are usually made collectively
of authority in a state. Finally, the term may refer to the by a group of ministers. In a presidential system the
manner, method, or system of governing in a society: to executive's position is independent of the legislature.
the structure and arrangement of offices and how they Members of the executive are not normally also mem-
relate to the governed. While keeping these distinctions bers of the legislature, and ultimate decisionmaking
in mind, we also use the terms state and government col- authority within the executive lies with one person, the
loquially and sometimes interchangeablyas they are president.
often used in discussion and writing around the world. The second classification concentrates on the distri-
Government is normally regarded as consisting of bution cf power between levels of government. In a
three distinct sets of powers, each with its assigned unitary state, all authority to make laws is vested in one
role. One is the legislature, whose role is to make the supreme legislature whose jurisdiction covers the whole
law. The second is the executive (sometimes referred country. Local legislatures may exist, but only with the
to as "the government"), which is responsible for im- sufferance of the national legislature. In a federal state,
plementing the law. The third is the judiciary, which is local legislatures are guaranteed at least a measure of
responsible for interpreting and applying the law. autonomous decisionmaking authority. In a confedera-
Classifications of government are many but have tion, a group of sovereign states combine for specified
tended to concentrate on two criteria: the arrangement purposes, but each state retains its sovereignty.

imperial China, highly developed systems of administra- of the public and private spheres have not. Whether in
tion and tax collection. The combination of public own- Niccolô Machiavelli's The Prince, Kautiliya's Arthashastra,
ership of land and a complex bureaucracy long impeded Confucius' writings, or Ibn Khaldoun's The Muqad-
the emergence of modern, market-based economies in dimah, the discussion has revolved around the mutual
these regions. rights and obligations of states and citizens. Almost all
Yet despite this diversity of origins, states over time came these traditions have included a role for the state in pro-
to acquire several common and defining features world- viding basic public goods (although the weight accorded
wide. Modern states have a consolidated territory and pop- to public, as opposed to private, goals has varied consid-
ulation, and within these they play a centralizing and coor- erably). Using public resources to provide critical public
dinating role. Sovereign authority commonly encompasses goods and to raise private productivity is nothing new.
separate judicial, legislative, and executive functions (Box Beyond these minimal functions, however, there has
1.1). Since the eighteenth century, through conquest and been much less agreement on the appropriate role of the
colonization, nation-states have incorporated most of the state in promoting development. Seventeenth-century
world into their own mutually exclusive territories. As em- mercantilists saw a major role for the state in guiding
pires disintegrated and minority groups established claims trade. Not until Adam Smith wrote The Wealth ofNations
to statehood, the number of nations increased sharply. in the late eighteenth century was it generally recognized
Membership in the United Nations jumped from 50 inde- that the market was the best instrument for realizing
pendent countries in 1945 to 185 in 1996 (Figure 1.1). growth and improving welfare. The state, on this view,
was best held to certain core functionsproviding public
Modest beginnings goods such as defense, ensuring the security of persons
The configuration of states has varied widely across conti- and property, educating the citizenry, and enforcing con-
nents and centuries, but arguments over the proper roles tractsdeemed essential for the market to flourish.
 THE EVOLVING ROLE OF THE STATE 21

Figure 1.1 One world, many more states Box 1.2 U.S. government action to support
market development: Some examples
Number of United Nations member countries
200 The United States is the country that produced and
believes in the dictum that "That government is
180 best that governs least." Whereas in many parts of
160
the world the role of the government has evolved
gradually, the United States was founded on a rev-
140 olution. The framers of the Constitution explicitly
asked, What should be the role of the government?
120 Yet even in the United States, where laissez-faire
and distrust of government are central to the fram-
100
ing of the state's role in society, government action
80 has often proved critical to the growth and devel-
opment of markets. For example:
60
The global telecommunications industry has its
40 roots in U.S. government support for the first
20 telegraph line between Washington and Balti-
more in the early 184 Os.
0 The enormous increase in agricultural productiv-
1945 1949 1959 1969 1979 1989 1996 ity in the nineteenth and twentieth centuries can
be traced to the federally supported program of
Note: Data are as of the end of the year. Source: United Nations research and extension services dating from the
data.
Morrill Act of 1863.
The Northwest Ordinances of 1785 and 1787
committed the government to supporting educa-
tion, and to devoting the revenues from the sale of
But even then, state intervention went on to play a certain lands to that purpose. And in 1 863 the
vital, catalytic role in the development and growth of mar- federal government helped establish the public
kets in Europe, Japan, and North America. In the United university system.
States, where state involvement in the economy has histor- In 1863, in the midst of the Civil War, the Con-
ically been more limited than in Europe or Japan, govern- gress recognized the need for a national financial
ment was instrumental in constructing the first telegraph system and passed the National Banking Act,
line, which spurred development of the telecommunica- establishing the first nationwide bank supervi-
tions industry, and in agricultural research and extension, sory agency. In later years the government cre-
which stimulated productivity gains (Box 1.2). ated the Federal Reserve System (the U.S. central
In the nineteenth century the state's role in redistribut- bank) as well as a series of public financial inter-
ing income was still quite limited. Redistribution in mediaries.
Europe came mainly through private charity and other The interstate highway system and federal support
voluntary action. Tax systems were usually restricted to for the establishment of railroads are cases of vital
customs, excise, monopoly, and commodity taxes. Income public involvement in transport infrastructure
taxation, which had been introduced in France and Britain that helped the development of markets in the
by the end of the eighteenth century, was not a major United States.
source of revenue. The first faint stirrings of the modern
welfare state were seen in Germany, at the end of the nine-
teenth century, where Chancellor Otto von Bismarck in-
troduced the first nationwide systems of social insurance. the Russian Revolution of 1917, which led to the aboli-
tion there of most private property and put the state in
The expanding state in industrial countries. control, through central planning, of all economic activ-
States remained small by modern standards until well into ity. The second was the Great Depression of the 1930s,
this century. A series of dramatic events in the aftermath which caused such economic devastation in the noncom-
of World War I marked the turning point. The first was munist world that states were spurred to experiment with
22 WORLD DEVELOPMENT REPORT 1997

countercyclical policies to restore economic activity. The half decades between 1960 and 1995, governments in the
third event, unleashed by World War II, was the rapid industrial countries swelled to twice their starting size
breakup of European empires. That geopolitical change (Figure 1.2), with much of the expansion driven by
as well as the clamor for social insurance in the industrial increases in transfers and subsidies.
economiesushered in fifty years of policy debate focused Indeed, by the early 1990s it was fair to say that most
around a more activist role for government. industrial-country governments spent more time moving
The postwar paradigm coalesced around three basic money around the economy in the form of transfers and
themes, all of which commanded broad, if not uniform, subsidies than they spent providing traditional public
agreement. This three-pillared consensus remained largely goods. Spending on defense and on law and order had
undisturbed until the first oil price shock of 1973. First was shrunk to some 10 percent of general-government outlays,
the need to provide welfare benefits to those suffering from while over half of all tax revenues were transferred to indi-
transitory loss of income or other deprivation. Second was vidual beneficiaries (Figure 1.3). Demographics accounted
the desirability of a mixed public-private economy, which for some of the shift, as aging populations forced an
would often mean nationalizing a range of strategic indus- increase in outlays for pensions and health care. But
tries. Third was the need for a coordinated macroeconomic national preferences also made a difference. Thus, from a
policy, on the grounds that the market alone could not point of rough equivalence in 1960, the Swedish state
deliver stable macroeconomic outcomes that were consis- grew to nearly twice the size of that in the United States
tent with individuals' objectives. In time, the goals of by 1995, in terms of both spending as a share of income
macroeconomic policy were made explicit: full employ- and public employment as a share of the population.
ment, price stability, and balance of payments equilibrium.
States thus took on new roles and expanded existing And in developing countries
ones. By mid-century the range of tasks performed by Governments in developing countries were also reaching
public institutions included not only wider provision of into new areas. They, too, grew dramatically in the second
infrastructure and utilities, but also much more extensive half of the twentieth century (Figure 1.2). Initially, much
support for education and health care, In the three-and-a- of the growth came from state and nation building after

Figure 1.2 Governments the world over have expanded since 1960

Central government spending (percentage of GDP)

40
1960-64
35 1970-74
1980-84
1990-94
30

25
- a-
20

15

10

0
OECD countries All developing Sub-Saharan East Asia and South Asia Latn America Middle East and
countries Africa Pacific and Caribbean North Africa

Note: Data are in Current national prices. Data for Middle East and North Africa for L960-64 are unavailable. Source: IMF, various years Ia) and
(b); World Bank data.
 THE EVOLVING ROLE OF THE STATE 23

Figure 1.3 Transfers and interest payments have grown

Composition of central government spending (percentage of total)

OECD Sub-Saharan East Asia and South Asia Latin America Middle East
countries Africa Pacific and caribbean and North Africa
100

80

60
Consumption
Investment
40

20
I Interest, transfers,
and subsidies

0 I I I
Note: Data are averages for the years indicated. Source: IMF, various years )a).

the collapse of colonialism. The ups and downs in in- the state a central role in correcting them. Centralized
ternational commodity markets also had an impact. planning, corrective interventions in resource allocation,
Resource-rich economies such as Mexico, Nigeria, and and a heavy state hand in infant-industry development
Venezuela tended to use the revenue bonanzas from the were part and parcel of this strategy. Economic national-
oil price rises of the 1970s and other commodity booms ism was added to the mix, to be promoted through state
to expand their public sectors, sometimes with reckless enterprises and encouragement of the indigenous private
abandon. Oil-importing countries, under the imperative sector. By the 1960s states had become involved in virtu-
of fiscal austerity, were less able to expand their spending. ally every aspect of the economy, administering prices and
Perhaps more significant than these forces has been the increasingly regulating labor, foreign exchange, and finan-
shift in thinking about the role of the state over the past cial markets.
fifty years. Most developing countries in Asia, the Middle By the 1970s the costs of this strategy were coming
East, and Africa came out of the colonial period with a home to roost. The oil price shocks were a last gasp for
strong belief in state-dominated economic development. state expansion. For the oil exporters they created a
The state would mobilize resources and people and direct bonanza, which many threw into even greater expansion
them toward rapid growth and the eradication of social of state programs. As long as resources were flowing in,
injustice. State control of the economy, following the the institutional weaknesses stayed hidden. The oil-
example of the Soviet Union, was central to this strategy. importing countries, for their part, got caught on a tread-
(How it was followed in one country, India, is described null of heavy borrowing of recycled petrodollars to keep
in Box 1.3.) Many Latin American, Middle Eastern, and the state growing. The costs of this development strategy
African countries also followed this postwar pattern of were suddenly exposed when the debt crisis hit in the
state-dominated, import-substituting industrialization. 1980s and oil prices plunged.
This belief was reinforced by the popularity of state The collapse of the Soviet Unionby then no longer
activism worldwide. The Great Depression was seen as a an attractive modelsounded the death knell for a devel-
failure of capitalism and markets, while state interven- opmental era. Suddenly, government failure, including
tionsthe Marshall Plan, Keynesian demand manage- the failure of publicly owned firms, seemed everywhere
ment, and the welfare stateseemed to record one success glaringly evident. Governments began to adopt policies
after another. The new interventionist credo had its coun- designed to reduce the scope of the state's interven-
terpart in the development strategy of the day, adopted by tion in the economy. States curbed their involvement in
many developing countries at independence, which em- production, prices, and trade. Market-friendly strategies
phasized the prevalence of market failures and accorded took hold in large parts of the developing world. The
24 WORLD DEVELOPMENT REPORT 1997

Box 1.3 Evolution of the role of the state in India: The past fifi:y years

When India became independent in 1947, income per ment schemes, but only a small fraction of the rising
capita had been stagnating for haifa century, and mod- subsidies actually reached the poor. Competition
ern industry was minimal. between political parties drove subsidies up at every
The Nehru years, 1947-64. India's first prime min- election. The resulting large fiscal deficits (8.4 percent
ister, Jawaharlal Nehru, saw industrialization as the key of GDP in 1985) contributed to a rising current
to alleviating poverty, and a powerful state with a account deficit. India's foreign exchange reserves were
planned economy as essential if the country was to virtually exhausted by mid-1991, when a new govern-
industrialize rapidly, accelerate public saving and in- ment headed by Narasimha Rao came to power.
vestment, and reduce the role of foreign trade and The reform phase, 1991 to the present. Rising interest
achieve self-sufficiency. Unlike many East Asian coun- payments on India's foreign debt meant that neither
tries, which used state intervention to build strong pri- the central government nor the state governments
vate sector industries, India opted for state control over could continue to finance both subsidies and heavy
key industries. Believing the potential of agriculture public investment. The former won out, and the gov-
and exports to be limited, Indian governments taxed ernment began to woo private and foreign investment.
agriculture by skewing the terms of trade against it and Thus, impending bankruptcy drove the reform process
emphasizing import substitution. They saw technical and changed the state's role from that of principal
education as vital for industrialization. investor to that of facilitator of entrepreneurship. This
Garibi hatao, 1966-77 Under Prime Minister shift was expected to free up government finances for
Indira Gandhi, two major shifts took place in the role more social spending, but in practice the fiscal crunch
of the state. First, the neglect of agriculture was re- prevented a significant increase.
versed through state activism in subsidizing new seeds Rao's government abolished most industrial and
and fertilizers, agricultural credit, and rural electrifica- import licensing, devalued the rupee, drastically re-
tion. The green revolution took off, and by the mid- duced import tariffs, liberalized the financial sector
1970s India was self-sufficient in grain. The second and foreign investment, and allowed private invest-
shift was the tightening of state control over every ment in areas previously reserved for the government.
aspect of the economy. Under the slogan of garibi The new coalition government that came to power
hatao ("abolish poverty"), banks were nationalized, in 1996 has by and large sustained these reforms.
trade was increasingly restricted, price controls were And the 1997 budget takes very positive steps in that
imposed on a wide range of products, and foreign direction.
investment was squeezed. The state achieved a stran- Thus the old national consensus on socialism has
glehold on the economy. Yet growth of gross domestic given way over the course of a few years to a new
product (GDP) failed to accelerate, remaining during consensus on liberalization. But formidable challenges
this period at 3.5 percent a year. remain. Most parties agree on the need for reform,
The spending boom and rising fiscal deficits, 1977-91. yet no party is eager to retrench surplus labor, close
Between 1977 and 1991, most stringent controls on unviable factories, or reduce subsidies. The reforms
imports and industrial licensing were gradually relaxed, so far are a positive step but must be extended
stimulating industrial growth. The government and accelerated if India is to catch up with the East
expanded antipoverty schemes, especially rural employ- Asian tigers.

pendulum had swung from the state-dominated develop- health, and infrastructure as often asor more than
ment model of the 1960s and 1970s to the minimalist they cut low-priority programs, bloated civil service rolls,
state of the l980s. and money-losing enterprises. Cuts came primarily in cap-
As often happens with such radical shifts in perspective, ital budgets and, in Africa, in operating and maintenance
countries sometimes tended to overshoot the mark. Efforts outlays, further reducing the efficiency of investment. The
to rebalance government spending and borrowing were result, seen most starkly in Africa, the former Soviet
uncoordinated, and the good was as often cut as the bad. Union, and even parts of Latin America, was neglect of the
To meet their interest obligations, countries mired in debt state's vital functions, threatening social welfare and erod-
squeezed critically important programs in education, ing the foundations for market development.
 THE EVOLVING ROLE OF THE STATE 25

The consequences of an overzealous rejection of gov- power can help resolve problems of collective action that
ernment have shifted attention from the sterile debate of would otherwise reduce the social benefits of insurance
state versus market to a more fundamental crisis in state markets, or prevent mutually complementary private
effectiveness. In some countries the crisis has led to out- investments from being made, to take just two examples.
right collapse of the state. In others the erosion of the state's At the same time, however, the state confronts unique
capability has led nongovernmental and people's organiza- challenges both in clarifying its objectives and in ensuring
tionscivil society more broadlyto try to take its place. that its employees pursue them. First, even though elec-
In their embrace of markets and rejection of state activism, tions and other political mechanisms help mediate
many have wondered whether the market and civil society between citizens and the state, citizens' mandates can
could ultimately supplant the state. But the lesson of a half- remain vagueand powerful special interests continually
century's thinking and rethinking of the state's role in try to direct the focus of government in their favor. Sec-
development is more nuanced. State-dominated develop- ond, monitoring performance is difficult in many govern-
ment has failed, but so will stateless development. Devel- ment activities such as primary education, environmental
opment without an effective state is impossible. protection, and preventive health care. This can make it
hard to set standards or put other mechanisms in place to
Rethinking the state: A framework ensure accountability. Both problems can lead to state
A central difficulty in redefining the state's role is that the bureaucracies being granted enormous room for discre-
ground beneath governments' feet is always changing. If tion. When that happens, state officials at all levels may
we consider how global economic and social forces have pursue their own agendas rather than the society's. Haiti
changed prevailing notions of the state, it is clear that it under the Duvaliers provides a vivid example of where the
retains a distinctive role in providing the public goods that use of arbitrary public power for personal profit, rather
promote economic and social development. And market than for the social good, can lead.
failures continue to offer powerful economic arguments In many countries the voluntary sector has stepped in
for state intervention (Box 1.4). But changes in technol- to address some of the gaps in collective goods and ser-
ogy are transforming the nature of market failure: in infra- vices left by market and by government failure. The vol-
structure, for example, technology has created new scope untary sector brings its own strengths to the table, but also
for competition in telecommunications and electric power its own weaknesses. It does a lot of good in increasing
generation. And many of the most successful examples of public awareness, voicing citizens' concerns, and deliver-
development, recent and historical, entail states working ing services. Local self-help organizations are sometimes
in partnership with markets to correct their failures, not the preferred providers of local public goods and services,
replacing them. because of their closeness to local concerns. But their con-
Equity also remains a central concern of the state. New cern is often for certain religious or ethnic groups and not
evidence, especially from East Asia, shows that the famil- society as a whole, their accountability is limited, and
iar tradeoff between growth and equity is not inevitable, as their resources are often constrained. The challenge, then,
was once thought. Appropriately designed policies in basic for the state is to build on the relative strengths of private
education and health care can reduce poverty and increase markets and the voluntary sector while taking into
equity while promoting economic growth. Neglecting account and improving its own institutional capability.
these social fundamentals of development can be fatal. But All these considerations point to a two-part strategy to
the mere fact of market failure, and other problems of improve the state's ability to enhance economic and social
inequality and insecurity, does not mean that only the welfare. The first task is to match the state's role to its
state canor shouldresolve these problems. The state's existing capabilityto establish the institutional rules and
coercive authority within its boundaries gives it unique norms that will enable the state to provide collective goods
strengths in seeking to address these concerns, but also and services efficiently. The second is to reinvigorate the
unique weaknesses. Governments must keep a firm eye on state's capability through rules, partnerships, and compet-
both in deciding whether, and how, to respond. itive pressures outside and within the state.
The state's unique strengths are its powers to tax, to
prohibit, to punish, and to require participation. The Matching role to capability: What states do and
state's power to tax enables it to finance the provision of how they do it
public goods. Its power to prohibit and punish enables it Part Two of this Report discusses the first part of the strat-
to protect personal safety and property rights. And its egy: matching the state's role to its capability, to improve
power to require participation enables it to minimize free the effectiveness and efficiency of public resource use. It
riding: those who would reap the benefits of public goods advocates ways in which states can provide the fundamen-
can be made to pay their share of the costs. The same tals for development, especially where capability is low
26 WORLD DEVELOPMENT REPORT 1997

Box 1.4 The economic rationale for state intervention and sonie definitions

Market failure and the concern for equity provide the crease prices and profits. Governments have addressed
economic rationale for government intervention. But this problem by regulating private monopolists or
there is no guarantee that any such intervention will providing the good or service themselves. Changes in
benefit society. Government failure may be as com- technology have created new scope for competition in
mon as market failure. The challenge is to see that the services once considered natural monopolies, such as
political process and institutional structures get the telecommunications and power generation.
incentives right, so that their interventions actually Incomplete markets and imperfect or asymmetric info
improve social welfare. mation are pervasive problems and can result in ineffi-
Ma rket failure refers to the set of conditions under cient outcomes. Markets are incomplete whenever
which a market economy fails to allocate resources effi- they fail to provide a good or service even though the
ciently. There are many sources of market failure and cost would be less than what individuals are willing to
many degrees of failure. The implications for the role pay. Imperfect information on the part of consumers
of the state and the form of public intervention can be can lead to systematic undervaluation of some ser-
quite different in each case. vices, such as primary education or preventive health
Public goods are goods that are nonrival (consump- care. Asymmetry of informationwhen suppliers
tion by one user does not reduce the supply available know more than consumers, or vice versacan lead to
for others) and nonexciudable (users cannot be pre- excessive or supplier-induced demand, for example in
vented from consuming the good). These characteris- the provision of medical care. Problems of adverse
tics make it infeasible to charge for the consumption of selection and moral hazard can lead to the failure of
public goods, and therefore private suppliers will lack insurance markets. Adverse selection occurs when buyers
the incentive to supply them. National public goods, of a service tend to impose higher-than-average costs on
such as defense, benefit an entire country; local public the service provider, or when sellers are able to exclude
goods, such as rural roads, benefit a smaller area. Pri- such high-cost customers. Health insurance provides
vate goods are those that are both rival and excludable, an example: those who are more likely to need care are
common property goods are nonexcludable but rival (an more likely to buy insurance, and more likely to be
example is groundwater irrigation), and club goods are turned down by insurers. Moral hazard is present when
nonrival but excludable (examples are interurban high- persons carrying insurance have an incentive to cause or
ways and toll roads). allow the insured-against event to happen. An example
Externalities arise when the actions of one person or is the tendency of health care consumers to seek, as well
firm hurt or benefit others without that person or as providers to provide, more treatment than they need
firm paying or receiving compensation. Pollution is an when a third party, the insurer, is paying most of the
example of a negative externality, which imposes Un- cost. Governments have sought to address these prob-
compensated costs on society; the broader benefit to lems by ensuring widespread coverage and holding
society at large of a literate population is a positive ex- down costs. They have done this by either regulating
ternality of primary education. Governments can curb private insurance, financing or mandating social insur-
negative and promote positive externalities through ance, or providing health care themselves.
regulation, taxation or subsidy, or outright provision. Equity may prompt state intervention even in the
A natural monopoly occurs when the unit cost of absence of market failure. Competitive markets may
providing a good or service to an additional user distribute income in socially unacceptable ways. Persons
declines over a wide range of output, reducing or elim- with few assets may be left with insufficient resources to
inating the scope for competition. But left to operate achieve acceptable living standards. Government action
freely, monopoly providers can restrict output to in- may be required to protect the vulnerable.

(Chapter 3). Chapter 4 looks at more demanding state from activities that will not be undertaken at all without
functions, such as regulation and industrial policy, and state intervention to activities in which the state plays an
shows how getting the right Lit between roles and capabili- activist role in coordinating markets or redistributing assets:
ties is vital for improving the state's effectiveness. Table 1.
presents a framework for thinking about these issues. It Countries with low state capability need to focus first on
classifies the functions of government along a continuum, basic functions: the provision of pure public goods such
 THE EVOLVN6 ROLE OF THE STATE 27

Table 1.1 Functions of the state

Addressing market failure Improving equity

Minimal
functions
Defense tipoverty programs
Law and order Disaster relief
Propert :hts
Macroecono nagement
h

Intermediate g ing
functions nonopo, .rmati.

Basic educati rtyregu urance (he distributive pen

Environment Antitrust ife. pensio Family allowan
protection :;ncial regula Unemployment
er protectio ins

Activist ting private Redis

functions
Fostering markets sset redistribution
ster initia

as property rights, macroeconomic stability, control of olies. The design of regulation needs to fit the capabil-
infectious diseases, safe water, roads, and protection of ity of state regulatory agencies and the sophistication of
the destitute. In many countries the state is not even pro- markets, and give greater emphasis to personal respon-
viding these. Recent reforms have emphasized economic sibility.
fundamentals. But social and institutional (including Although the state still has a central role in ensuring the
legal) fundamentals are equally important to avoid social provision of basic serviceseducation, health, infra-
disruption and ensure sustained development. structureit is not obvious that the state must be the
Going beyond these basic services are the intermediate only provider, or a provider at all. The state's choices
functions, such as management of externalities (pollu- about provision, financing, and regulation of these ser-
tion, for example), regulation of monopolies, and the vices must build on the relative strengths of markets,
provision of social insurance (pensions, unemployment civil society, and state agencies.
benefits). Here, too, the government cannot choose In protecting the vulnerable, countries need to distin-
whether, but only how best to intervene, and govern- guish more clearly between insurance and assistance.
ment can work in partnership with markets and civil Insurance, against cyclical unemployment for example,
society to ensure that these public goods are provided. aims to help smooth households' income and con-
States with strong capability can take on more-activist sumption through a market economy's inevitable ups
functions, dealing with the problem of missing markets and downs. Assistance, such as food-for-work programs
by helping coordination. East Asia's experience has or bread subsidies, seeks to provide some minimum
renewed interest in the state's role in promoting mar- level of support to the poorest in society.
kets through active industrial and financial policy.
Reinvigo rating the state's capabi/ity
Matching role to capability involves not only what the Reinvigorating the state's capabilitythe second, equally
state does but also how it does it. Rethinking the state also vital part of the reform strategyis the subject of Part
means exploring alternative instruments, existing or new, Three. Its theme is that such improvements are possible
that can enhance state effectiveness. For example: only if the incentives under which states and state institu-
tions operate are changed. Improving capability is not
In most modern economies the state's regulatory role is easy. The modest successes, and many failures, of techni-
now broader and more complex than ever before, cov- cal assistance efforts over the decades underscore that it is
ering such areas as the environment and the financial a matter of changing the incentives that determine behav-
sector, as well as more traditional areas such as monop- ior as much as it is one of training and resources. The key
2S WORLD DEVELOPMENT REPORT 1997

is to Find rules and norms that create incentives for state A remote, imperious state, whose deliberations are not
agencies and officials to act in the collective interest, while transparent, is much more likely to fall into the downward
restraining arbitrary action. This can be achieved through: spiral of arbitrary rule and decreasing effectiveness. Chap-
ter 7 looks at the benefits of making government reach
Rules and restraints. Mechanisms for enforcing the rule out to people and grant them a greater role in deciding
of law, such as an independent judiciary, are critical and implementing policy. And it shows how, carefully
foundations for sustainable development. Along with pursued, decentralizationthe transfer of powers and
appropriate separation of powers and the presence of resources to lower levels of governmentcan support this
watchdog bodies, they also restrain arbitrary behavior. effort. Finally, Chapter 8 provides a reminder that collec-
Competitive pressure. Competitive pressure can come tive action increasingly involves looking across national
from within the state bureaucracy, through recruitment borders. The chapter examines the various ways in which
of civil servants on the basis of merit. It can come from national governments can and must cooperate to meet
the domestic private sector, through contracting out demands that, although felt at home, can only be
for services and allowing private providers to compete addressed effectively at the international level.
directly with public agencies. Or it can come from the
Strategic options: Initiating and sustaining reforms
international marketplace, through trade and through
the influence of global bond markets on fiscal decisions. This two-part strategy for improving state effectiveness
Voice and partnership. The means to achieve trans- is far easier said than accomplished. The difficult job for
parency and openness in modern society are many and reformers will be not only devising the right kind of
variedbusiness councils, interaction groups, and con- reforms but combating the deep-seated opposition of
sumer groups, to name a few. Institutional working those with a vested interest in the old ways. Matching
arrangements with community groups can contribute role to capability means shedding some roles, including
to greater state effectiveness by giving citizens a greater some that benefit powerful constituencies. Proponents of
voice in the formulation of government's policies. And a more capable state will quickly discover that it is in
partnerships between levels of government and with many people's interest to keep it weak. Nevertheless,
international bodies can help in the provision of local politicians have an incentive to undertake reforms if they
and global public goods. result in net gains to important constituencies. Windows
of opportunity occasionally open in response to crisis or
All three mechanisms are a recurrent theme of Part external threat, and effective political leadership is skilled
Three, which starts (in Chapter 5) by looking at the basic at devising strategies for building consensus or compen-
building blocks of a more effective public sector. The sating losers.
emphasis there is on rules and forms of competition to Part Four explores the challenge of initiating and sus-
enhance the three basics: policymaking, service delivery, taining reforms of the state (Chapter 9). Its central argu-
and the lifeblood of the public sector, the civil service. But ment is that constraints on reform are largely political and
history tells us that rebuilding public trust in govern- institutional. Hence fundamental institutional reform is
mentand therefore its capabilitywill involve putting likely to be long term, but reform opportunities arise, or
restraints on arbitrary action. These issues are taken up in can be created, and these must be seized. Finally, Chapter
Chapter 6, which analyzes the checks and balances in the 10 lays out the prospects for change and the reform
constitutional structure of the state and the best ways to agenda for each developing region. The message is that
control arbitrary behavior and corruption. reform will be difficult and must be tailored to its cir-
A third layer, which supports the other two, is efforts cumstances, but the special challenge of' collapsed states
to open up the government and make it more responsive. provides a salutary reminder of the risks of failure.