1 Distribution, Efficiency and Voice: Designing the Second Generation of Reforms Joseph E. Stiglitz Senior Vice President and Chief Economist, The World Bank July 14, 1998 Conference on Asset Distribution, Poverty and Economic Growth Sponsored by the Ministry of Land Reform and the World Bank (Brasília, Brazil)

2 Outline of the Talk 1. Equity Affects Efficiency: Land Reform 2. Second Generation Reforms 3. Voice and Participation --IFIs and their clients --Central bank independence

3 Growth with Equity In 88 growth spells: 77 benefit the poorest fifth of the population changes in inequality were modest (roughly half small positive and half small negative). Savings rates are uncorrelated with income or inequality. SOURCE: World Development Indicators 1998

4 Equity and Efficiency Second Fundamental Theorem of Welfare Economics Equity and efficiency can be separated. Some Assumptions of the Theorem: Lump sum taxes and transfers Perfect information, complete contracts, and complete markets Perfect competition

5 Inequality and the Principal- Agent Problem Inequality  “Principal” delegates use of assets to the “agent.” If information is incomplete, this creates “agency costs.”

6 Example of Sharecropping Sharecropping is an imperfect response to costly monitoring: (i) Less effort (ii) Less investment (and more depreciation) (iii) Tenant may use low risk / low return techniques

7 Land Reform Thus a theoretical rationale for land reform. But, land reform often leads to: Falling output Eventual reconcentration of land Why? And what can be done?

8 Increasing Output After Land Reform Increasing access to capital Credit constraints and high interest rates Use of peer monitoring in micro-credit programs Increasing development and dissemination of technology Small farmers have an incentive to “free ride” Importance of extension programs Complementarity with educational investments

9 Sustaining Land Reform If x t is the distribution at time t, the land distribution at t+1 will be: x t+1 = A x t. With fixed institutional arrangements, the distribution will generally return to its unique equilibrium land distribution (x*): x * = A x *

10 Endogenous Institutional Arrangements If the transition depends on the distribution: x t+1 = A(x t ) x t Then there may be multiple equilibrium land distributions: x * = A(x * ) x * and x ** = A(x ** ) x **

11 Institutions Depend on Government Policy If A = A(G), then the equilibrium depends on government policy: x * (G) = A(G) x * (G)

12 Problems with Sustaining Land Reform Through Direct Restrictions 1.They can often be avoided 2.Restricts use of land as collateral 3.Inhibits the response of labor to changing circumstances

13 Sustaining Land Reform: Conclusions 1.Land reform can be self-fulfilling 2.Further distributional changes after land reform may be inevitable 3.Government policies (credit, technology, and education) can complement land reform

14 Second Generation Reforms Equity as a goal in itself Equity as a means to greater efficiency Examples:Land reform Education

15 Limitations of the “Washington Consensus” Overly Narrow Instruments: For instance, (i)Competition as a complement to privatization and trade liberalization (ii)Importance of legal and institutional development (iii)Financial market regulation essential

16 Limitations of the “Washington Consensus” Overly Narrow Goals: Development is not just increased GDP: (i)Improved living standards (ii)Sustainable development (iii)Democratic development (iv)Equitable development Development is a transformation of society

17 Common Premises of Contrasting Visions of Development Both the planning model of the 1960s and the “free market” model that followed assume: (i) Developed and developing countries differ only in terms of the amount of capital and the efficiency of its intersectoral allocation (ii) This problem warrants a technical “solution”

18 The Importance of Government (i)Successful development of the United States, and other economies, involved government. (ii)Prior to active governments, societies did not develop. (iii)Capitalist economies were highly volatile with many social/economic problems before active governments.

19 Puzzles of Development Southern Italy has free trade with the North and same macroeconomic policies, but much slower growth The Former Soviet Union became more market oriented, but output fell sharply. Destruction of social and organizational capital.

20 Voice and Participation If development is about the transformation of all of society, then reforms need to involve entire societies. Evidence shows that participation and civil liberties help project implementation. Importance of ownership: persuasion and self- determination. Cannot get social/organizational capital from abroad.

21 The Relationship Between IFIs and Their Clients Genuine change cannot be imposed Policy advisers as interlocutors, facilitating change Reforms require a sense of fairness -- about the policies and the process

22 The Independence of the Central Bank Macroeconomic decisions affect everyone. These decisions are made under great uncertainty. They are not just technical decisions for experts, but involve trade-offs and political judgements. Thus the process matters. Many independent central banks, for instance, do not represent all of society, e.g. no workers on the governing boards.

23 Key Questions for Monetary Policy 1.What is the NAIRU? 2.What are the costs of inflation? 3.Is there a precipice (i.e., does increased inflation lead to more inflation)? 4.Is the cost of reversing inflation high?

24 The Outcome of Central Bank Independence 1.Lower inflation 2.But, no improvement in growth, unemployment, or variability.