Key issues and recommendations from the brainstorming of the Government of Kazakhstan and the World Bank: July 22, 2007

On July 22 2007, the government of Kazakhstan, the World Bank, and other international experts conducted a day-long brainstorming on key economic issues and policy.  The delegation of the government of Kazakhstan was led by Prime Minister Karim Kajimqanüly Masimov, and included other top level officials.  World Bank Vice-President Shigeo Katsu co-chaired the session with Mr. Masimov.  

At the request of the Government of Kazakhstan, the July 22 brainstorming addressed questions in four areas that are currently at the center of policy debates and reforms in the country:

• Reform of government administration
• Diversification and the 30 Corporate Leaders program
• Overheating and the banking Sector
• Housing and communal Services

International experts were invited to lead each of the discussions. Former Finance Minister of New Zealand Graham Scott presented world lessons in administrative reform, with relevance to Kazakhstan.  Professor Ricardo Hausmann, Director of the Center of International Development of Harvard University, addressed the question of diversification and the recent 30 Corporate Leaders program of the government.  Homi Kharas of the Wolfensohn Center of the Brookings Institution and Fernando Montes-Negret, Sector Direction for Finance and the Private Sector in the Europe and Central Asia Region (ECA), provided international lessons and recommendations on the subject of overheating and bank regulation.  Top World Bank social infrastructure experts, Lee Travers and Ellis Juan, offered knowledge and experience on housing and communal services.

In each session, a relevant official from the government of Kazakhstan, Kazyna, or the National Bank made a presentation pertaining to government goals, plans, and accomplishments in each of these four areas.  Each presentation was followed by a lively discussion in which the relevance of world experience for the particular case of Kazakhstan was considered and scrutinized.  Although some differences of opinion were expressed during these discussions, a general consensus among most participants was reached on a number of issues.    

On the subject of administrative reform, key issues and recommendations included:

• A strong long-run commitment of the government in policy and resources is essential to success.  Budgetary reform toward strategic, program-oriented, and results-based budgeting, which is aimed at increasing public service quality and efficiency, is a long, on-going process in many countries.  As administrative reform is difficult and lengthy, it is common for political momentum to diminish over time. 

• Start from a deep understanding of where you are today and what you can realistically achieve, not some abstract view of global best practice.  There is strong room for improvements in government administration in most countries, and basic principles of good governance travel well between countries.  Nevertheless, a successful reform program must be tailored to every country-specific environment. 

• Given the complicated and inherently long-term nature of administrative reform, the proper sequencing of measures is critical to success.  Each step should make a useful addition to performance and demonstrate positive results in order to sustain political momentum. 

• An important part of administrative reform concerns redefining the division of functions between government and the private sector.  When appropriate, the size of government can be reduced through privatization, contracting out, or ensuring the independence of agencies.  Not crowding out the private sector is important for improving efficiency.  The role of the government in the economy should be one of “steering, not rowing.”

• Try to avoid re-centralizing in order to strengthen accountability for quality of local services.  Higher-level officials may be tempted to use results indicators only as a means of increasing control and pressure on subordinates.  Yet successful results depend on motivating officials in ministries, local administrations, or budget organizations for the achievement of results through their own initiatives.

• It makes sense to customize administrative reform to Kazakhstan’s particular constitutional system, as opposed to the other way around.  A key aspect of administrative reform in many countries is the delegation of both more autonomy and more accountability for outcomes to chief executives of public agencies.  Yet the particular institutional environment and stage of reform are important factors in determining precisely how much decentralization is expedient. 

• Creating and monitoring an appropriate set of performance indicators for budget organizations is a complicated and important task.   Indicators should focus the attention of specific ministries and budget organizations on achieving overall national objectives (i.e. competitiveness, growth, welfare), but need to measure the specific contributions of the individual organizations of achieving these objectives, as well as accounting for available resources for this purpose.  Clearly, outcomes often depend on many different organizations, as well as on factors outside of their control.  A negotiation process with ministries and budget organizations is necessary to ensure that there is ownership and understanding of what is being expected.  Poorly chosen indicators can be very damaging to a reform effort.

• While good performance indicators can have major value for improving governance, they are not an end-all solution to evaluation and budgeting.  A good set of performance indicators can be important for motivating ministries and budget organizations toward the realization of key national objectives, and for increasing budgetary efficiency.  They are also important for the effective decentralization of authority in the realization of budget programs.  But many aspects of budgetary performance are inherently difficult or excessively costly to monitor.  Furthermore, the reallocation of resources toward areas of stronger performance indicators is limited by the needs of the population in critical government services.  For example, the discovery that certain medical services are very inefficient would not usually imply that the government should avoid funding such services.  Budgetary recipients should not be punished for poor government administration.     

• A common focus on strategic goals and outcomes can be important for improving the coordination and integration of government. The realization of key national objectives will clearly depend on coordinated efforts of many government bodies.  Even key objectives at the sectoral level, such as improvements of health outcomes, will typically depend on wide range of services, not all of which are under the jurisdiction of the Ministry of Health. For example, the improved management of borders is also relevant for such outcomes, which already implies needed inputs from customs, immigration, health, agriculture, transport, and other organizations.

• It is Important to involve citizens and stakeholders through consultative processes.  Consumer feedback is critical for monitoring the value and quality of government services.  The development of results-based budgeting depends on this information. 

• It is important to separate strategy and policy, as well as funding and service delivery.  In health, for example, the health of the population is a strategic objective, but service providers need to be responsible for specific service standards related to this goal (e.g. timely access, quality of care and volumes).  The goals for education can relate to the development of human capital to support productivity growth and competitiveness, while service providers should be focused on the development of critical competencies related to this goal.

On diversification and the 30 Corporate Leaders program, key points were:

• Many oil rich countries have had trouble sustaining growth in non-resource tradable sectors.  Dutch Disease, volatility from oil dependence, and limited positive spillovers to other sectors from specialization in oil appear to be contributing factors to this dilemma.  Prudent, responsible, and transparent macroeconomic policy, including the effective management of reserve oil revenues, can help alleviate the former two problems.  Kazakhstan has done well so far in that respect.

• Government diversification policies should take the form of gathering key information and proving of key public inputs (goods and services) to enhance productivity (Infrastructure, property rights, market access, human capital, R&D capabilities, etc.), not subsidies. “There is a difference between what firms want and what firms need.”  All firms want subsidies, especially inefficient firms that cannot function without them.  Firms with real potential to become “leaders” need other public inputs to boost their productivity and competitiveness.  To the degree that such policies provide temporary direct financial support, it would be better to focus on key suppliers to corporate leaders, not the leaders themselves.

• Aim to support firms (sectors) with an export-orientation that face the discipline of competition on world markets.  Avoid supporting firms that produce rents or have monopolistic positions on their output markets.

• A Selection of “corporate leaders” should be ex-post rather than ex-anti.  Support of public inputs for “corporate leaders” should be in response to promising proposals made to the government in a competitive process.  Firms or organizations should earn special support through their own promising initiatives. 

• Make interventions as less specific as possible.  Allow other firms to profit from the same inputs as corporate leaders.  For example, if regulation or property rights are improved in support of corporate leaders, there are natural spillovers to improving these areas simultaneously for other firms as well.

• Do not necessarily encourage downstream activities as priority areas for diversification.  Downstream activities are not necessarily “close” to their upstream neighbors in terms of needed knowledge and other inputs.  Pay particular attention to opportunities in the engineering and capital goods sectors, as these sectors are in a dense part of the product space, i.e. comparative advantage in these areas in one sector can be adapted to other sectors relatively easily.

• The selection of corporate leaders, and the government’s interaction with them, should be made in a very open, transparent manner that only supports the creation of new value for the country.   Popular opinion and civil society should be led to understand why the government chooses particular selective interventions, and the corporate leaders program should not give the impression of social support for the rich.

• Strong sunset clauses are needed to enable and require the state to abandon projects that are not successful.  Success of the policy will depend more on “letting losers go” in multiple trials, as opposed to “picking winners.”  In this case, multiple trials will provide important information for the future about failures as well as successes.  Often, governments have trouble politically of letting go of failed firms projects to the great detriment of incentives, efficiency, and market discipline required for achieving genuine competitiveness and diversification.

• Resource revenues can help simplifying the business regime (foreign trade, tax, other administrative barriers).  A lower overall tax burden can compensate for higher costs associated with a stronger Tenge. Yet the government should also carefully weigh any risks from increasing the dependency of state finance on oil.

On the subject of overheating and banking sector risks, key issues and points were as follows:

• The Kazakh economy has profited from a very rapid development of the banking sector.  Yet, the current trend of very rapid consumer credit growth financed by foreign borrowing poses significant risks.   Commercial banks are assuming growing risks, while real estate prices and capital flows are inherently volatile. 

• It is important to distribute risks with the goal of alleviating moral hazard. International creditors and Kazakh banks should not perceive that the government is implicitly insuring their risky activities.  Under such circumstances, creditors and banks will assume excessive and economically unjustified risks.  For sound bank incentives, creditors and banks should perceive that they will lose their own (significant) capital from a worsening in the performance of their credit portfolios.

• Credible commitment to sound bank problem resolution procedures, including the bankruptcy of insolvent banks, can help in allocating a significant degree of risk to the private sector, and thereby slow risk accumulation. Such procedures are also critical for reducing systemic risks from the emergence of problems in individual banks. Contingency planning is important for preparing the government, National Bank, and AFN to manage such a situation effectively.

• Prudent macroeconomic policy is critical for tackling the problem of overheating.  This includes an overall restrictive fiscal and monetary stance, as well as specific measures (i.e. reserve requirements) that can help absorb excess liquidity in the banking sector.

• Kazakhstan needs improved bank monitoring and supervision for the enforcement of regulations.  Banking laws and prudential regulations are basically sound in Kazakhstan, but their enforcement through monitoring and supervision remains somewhat weak.  The capacity of the AFN for bank monitoring, supervision, and risk assessment needs to be strengthened.  Banks with low genuine capital or poor financial positions will also be inclined to assume engage in excessively risky activities.  The AFN needs to be acutely aware of such situations.   

• International experience demonstrates that predicting or managing a financial crisis can be very complex.  The East Asian financial sector in the 1990s looked very sound to many observers, yet unraveled very quickly following changes in investor sentiment.  In a situation of accumulating risks, authorities need to be cautious that well-intentioned measures to crack down on excessive credit expansion could actually backfire in worsening banks’ positions, and thereby precipitating a crisis.   

• Financial Instability has been quite common in emerging markets: many countries have endured bouts of instability and rebounded quickly. Effective regulation and contingency planning can reduce the economic costs and duration of financial instability.

The final session on housing and communal services delivered the following central messages based on international experience in many countries, including Nordic countries, Poland, Bulgaria, Georgia, and Russia:

• Successful reform of housing and communal services requires strong political will and commitment of policymakers. Housing and communal services has proven to be one of the most difficult areas of reform in transition economies.  The problems are social as well as economic, and include the political economy of control, weak systems of direct social assistance, deteriorating infrastructure, and a cultural orientation that is not used to private responsibility for maintaining houses. 

• Apartment owners need to own and be responsible for their buildings.  Apartment owners in the post-Soviet environment are used to expecting that the state will finance and manage the upkeep of their building.  Changing culture and creating a sense of collective responsibility is not easy.  In a number of cases where formal transfer of ownership occurred, apartment owners did not coordinate to maintain the building, and continued to expect assistance from the state.

• Private sector participation can be important for success, but is not a substitute for deep and fundamental reforms.  Sound regulation, competition, and well-defined property rights are fundamental to the success of private sector participation. Some communal services inherently involve natural monopolies that require state regulation. 

• Separating communal service functions (ownership, oversight, service provision) are important to the institutional setup.  Responsibilities should be allocated through explicit contracting.  Housing management and maintenance are not natural monopolies, and thus are inherently different from communal services.  This opens opportunities for the potential entry of new private businesses and competition.

• A key objective of reform should be financial sustainability.  Economic efficiency and genuine responsibility necessitates the creation of a system that is self-sustaining over time.    

• Customers can be an important voice for improving communal service providers’ performance.  Monitoring consumer opinion can be an important tool for the government in choosing regulations to increase the quality and availability of consumer services. 

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