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"What is the best government?
That which teaches us to
govern ourselves"
--Johann Wolfgang von Goethe

The Quality of the Public Sector
Vito Tanzi
October 19, 1999

Prepared for delivery at the IMF Conference on Second Generation Reforms


  1. The Role of the State

  2. The Importance of Rules

  3. The Quality of Public Institutions

  4. Measuring the Quality of the Public Sector

  5. Concluding Remarks


I.  The Role of the State

Human beings are social animals, as a consequence they tend to aggregate in groups. Aggregation generates markets and the need for social institutions. Markets and economic activities are characterized by specialization; it is specialization that leads to exchanges and exchanges involve contracts. Contracts may be explicit or implicit; when they are explicit, they require the need for social institutions that enforce them. Individuals also need protection for their property and for themselves; and groups need protection against other groups. Thus any aggregation of individuals requires the existence of at least some rudimentary institutions that can be considered a minimal state.1 Such a state protects individuals against those individuals who do not live up to the established social norms and it protects groups against other hegemonic groups. It also enforces contracts and protects property. These are the essential elements of a state in a primitive society or of a minimal state in any society.

As societies become more complex, and, perhaps, as the groups that constitute them become larger and less homogeneous, the state must assume additional responsibilities if it wishes to contribute fully to the welfare of the individuals. For example, markets are not efficient when they are distorted by monopolistic tendencies or when essential information is not available to the participants or is too costly for them to obtain. This leads to the need for the state to regulate markets and to provide at least some essential information. Thus, institutions must be created to satisfy these needs. See World Bank (1997).

There are certain goods (defense, city streets, etc.) that only the state can provide because private individuals will not find in their interest to provide them. The reason is that once these goods are provided, the provider will not be able to exclude from their use individuals who do not wish to contribute to the cost of providing them. Thus, if these goods are essential, they must be provided (but not necessarily produced) by the state. These are the public goods of the public finance literature. Also, certain goods or activities generate positive or negative externalities not captured by those who consume or produce them. This implies that if the state does not intervene, the market is likely to underproduce or overproduce these goods or activities. Thus, once again, there may be a need for the public sector to deal with these externalities.2

All the above are examples of a general role of the state that in the public finance literature goes under the name of allocation. See Musgrave (1959). Although some problems of allocation can be dealt with by the use of regulations, often, if the state must perform this role, it will need resources. In principle the state could directly appropriate these resources by forcing individuals to contribute their time or their wealth for the production of the required goods--as it does, for example, with compulsory military service or with some forms of expropriation. However, a more efficient alternative is to use resources raised through taxation. Thus, there is a need for a tax system and for institutions that collect taxes. In all these activities the state is expected to minimize the cost that its activities impose on the market and on society at large. Thus, a public sector of high quality requires an efficient tax system and an expenditure system that minimizes inefficient and unproductive spending.

In addition to the essential or fundamental role of the state associated with the allocation of resources, a role that has been explicitly recognized and described by economists at least since Adam Smith's Wealth of Nation, in this century two or, perhaps, three additional roles have been assigned to the state. These are (a) redistribution of income, (b) stabilization of economic activity, and (c) promotion of economic growth and employment. Although these additional functions are not seen by many economists as fundamental or as essential as the allocation of resources, in the second part of the 20th century they have acquired great importance.3

A market produces goods and services and provides incomes to those who participate in it. Depending on the initial positions of the individuals as to ownership of real assets, of financial resources, of human capital and talent in general, and depending on effort and, perhaps, luck and risk taking, a given pattern of income (and wealth) distribution is created. This distribution may be more or less even and may or may not match the prevailing social view of what degree of inequality is considered acceptable. Furthermore, because of physical or mental handicaps or because of some other characteristics, such as old age and unemployment of some members of society, some individuals may not be able to generate a satisfactory income. In these cases, and in this century, the public sector has been expected to assist them.4

The assignment of a redistributive role for the state has changed dramatically the character of its intervention in the economy because it has introduced in its actions what are purely political considerations or objectives. In fact, while, at least in principle, the state's role in allocation can be derived from technical and thus objective analysis, the redistributive role cannot be derived in the same way. There is no objective way to determine what is the ideal Gini coefficient or the ideal ratio of the top quintile to the bottom quintile of the income distribution of a country. Thus, these decisions are unavoidably influenced by the biases of the government in power.

Programs aimed at redistributing income often require a lot of resources and institutions with the mandate of promoting these programs. For this reason, they lead to a large growth in public spending and in the level of taxation.5 At times, the redistribution objective has been pursued through progressive taxation. But more often it has required large bureaucracies and much public spending. For example, in many countries a large proportion of the civil service is engaged in the provision of education and health services and a large share of total spending is for social programs including pensions.

Markets do not operate smoothly but are characterized by fluctuations that at times may become recessions or even develop into serious crises or depressions. These recessions lead to growing unemployment and the loss of output and, in the second part of the 20th century, they have created another major justification for public sector intervention namely, the maintenement of full or at least high employment and the stabilization of output. Thus, once again, the promotion of this Keynesian objective must be carried out by government officials and will require some relevant institutions. These officials must have the capacity to change tax revenue and public spending to influence aggregate demand in desirable directions and must have the information and the wisdom to make the right decisions.

Finally, in recent decades, governments have also promoted policies aimed at raising the rate of growth. Import substitution and industrial policies have been examples of attempts at raising the growth rate. Manipulation of the work week and public investment in particular activities and regions are examples of attempts at raising employment. Once again particular institutions are responsible for these policies.

In the rest of the paper I will define the quality of the public sector as the characteristic that allows the government to pursue its objectives in the most efficient way. Although it is difficult to separate the two, I will maintain that high quality public sector is not necessarily the same thing as high quality economic policy. A high quality public sector is simply the instrument that facilitates the formulation and the implementation of good policy. Even a high quality public sector cannot guarantee a consistently high quality economic policy because, at given times, the policymakers running the country may attempt to promote poor policies. However, one would have some hesitation to call a public sector of high quality if poor policies were frequently pursued and one would expect to find a high relation between the quality of the public sector and the quality of economic policy. This definition of the quality of the public sector may differ a bit from that of good government used by other writers. For example, La Porta et al (1998) define good government as one that is "good for capitalist development." They do not distinguish between quality of public sector, as defined in this paper, and quality of public policy. A poor public sector will, of course, render the pursuit of good policy more difficult mainly because it will not provide the government with the needed information and it will not guarantee that the policy decisions will not be distorted in the implementation stage.

II.  The Importance of Rules

In the previous section I described the broad categories of state intervention in the economy. Each of these categories is made up of many specific programs. In democracies with market economies the mandate for intervention given to the state is often, first, specified by a constitution and then by many laws and regulations that give a specific content to the rather general principles enunciated by the constitution.

The role of constitutions

The principles expressed by the constitution may be clear but are generally not very specific. The constitution must be a living document that guides action but it cannot be one that addresses specific situations or that anticipates activities that did not exist at the time the constitution was written. It has been reported that Napoleon rejected the draft of the constitution that the best legal minds of his time had prepared at his request because he felt that the document was too specific and, thus, potentially too restrictive and likely to become obsolete. He preferred a statement of general principles that could be interpreted flexibly over time.

Examples of constitutional principles that are not too clear abound. A well known example is Article 81 of the Italian Constitution that seems to restrict deficit financing but that, over the years, was interpreted in ways that did not prevent the occurrence of large fiscal deficits. Examples of too restrictive constitutional limits are also not uncommon. An important example is the Brazilian Constitution. In recent years that document has occasionally prevented the national government from making important and needed reforms in fiscal federalism and in pension systems. Another is the Indian Constitution that has prevented the introduction of a national value added tax or the Pakistani Constitution that limits the scope of any sales tax imposed by the Central Government to goods only.

In conclusion, the importance that the constitution plays in determining the quality of the public sector cannot be exaggerated.6 It is the constitution that allows or disallows certain actions on the part of the governing body and on the part of the citizens. Thus, at least in principle, the laws and the regulations that govern a country must be consistent with the constitutional principles as interpreted by a Supreme Court or by an equivalent body. Some economists, such as James Buchanan have seen the role of the constitution as establishing limits to the expanding role of the public sector. See also, Forte (1998).

It follows that in some circumstances, and again Brazil comes to mind, a change in the constitution that removed obstacles to desirable and important reforms may be a necessary condition for raising the quality of the public sector and of public policy.

Rules and regulations

While the constitution sets, or at least should set, the general principles that guide the country's policies, the latter are permitted and directed by specific laws. It is possible to generalize that the quality of the public sector is enhanced when the laws are relatively few, are clearly written--and thus not subject to conflicting interpretation--are comprehensive, and are not in conflict among themselves. Difficulties have arisen when the laws are too many, are not clear, do not cover all relevant areas of economic activities, or provide conflicting signals.

Among European countries it has been reported that while some of them have only about 5000 active laws others may have as many as 200,000. It may thus be difficult to find one's way in this legal jungle. The legal system may be affected by a problem conceptually similar to that associated with Y2K. It occurs because each time a new law is enacted, all the existing laws should be checked to ascertain that all the elements of these laws are consistent with the new law. When the existing laws are many, and especially when they are not very clear, it is especially difficult to ascertain this. Thus, at times, one discovers that elements imbedded in laws enacted in the past, but still on the books, may conflict with the new law. When this happens the directives to the citizens as well as to the institutions charged with implementing the programs contemplated by the laws get confused. This problem could be referred to as one of legal inconsistency. It is a problem that often characterizes the relations between national and subnational governments or between, say, pension and health programs on one hand and annual budget laws on the other.7 Zoning laws and laws dealing with the environment have also suffered from this problem. Thus, at times, a law and, thus, a given institution authorizes a certain use but another law and another institution prohibits its. This conflict may lead to costly mistakes.

Thus, to repeat, the quality of the public sector is enhanced when the laws are written clearly, when they do not lead either the public or the public officials to conflicting interpretations, when their number is as small as feasible, and when they are not in conflict among themselves.

Laws are often accompanied by specific regulations.8 These regulations explain procedures or elaborate on the content of the laws. In some cases the laws are so complex as requiring a very large regulatory body. For example, the regulations covering the U.S. Internal Revenue Code cover 35,000 pages. The Code itself is some 1500 pages long. Regulations issued by an executive authority or by a regulatory agency can themselves be very complex, may not be easily accessible by the public, and may overlap with other regulations. In some countries they may not even be published.9 Because many forms of regulations do not require budgetary appropriations or formal approval by the legislature, they tend to be less scrutinized by the political authorities. The interpretation of regulations is often left to the bureaucrats who administer them. Therefore, the possibility of confusion or even abuse is very high. Regulations have been identified by the relevant literature as one of the major causes of corruption because the bureaucrats in charge may abuse them to derive personal advantage. See Tanzi (1998).

Because of the dynamic character of economies, and because of fast technological change, it is common to find public sectors with too many anachronistic or even damaging regulations and too few regulations related to new economic activities.10 Many countries are now struggling to create needed regulations for the financial and banking sectors, for the use of the information superhighway (internet), for genetic research, for the use of some drugs and for other similar, important, new areas.

In conclusion, a high quality public sector must have enough clear rules to guide economic (and other) activities but not rules that are so many or so vague as to give excessive power to the bureaucrats or uncertainty among those who make economic decisions. In general, the rules should specify what is not allowed rather than authorize what is allowed. Discretion by bureaucrats should be kept to the minimum. For some countries it has been reported that some specific activities--say, a request for tax incentives or an application to open a small enterprise--may need 30 or 40 authorizations signed by public employees in as many agencies or offices. See De Soto, 1989.

An important step would be to make a periodic inventory of all the existing regulations, say, every ten years, so that the regulatory budget could be pruned of redundant and anachronistic regulations while complementing it with new required ones and while clarifying the confusing ones. Such a process, while costly, would raise the overall quality of the public sector.

In addition to the formal constitutional rules and the rules specified in the laws and in the regulations, the quality of the public sector may be affected by many informal norms or arrangements that influence the behavior of the public sector. Informal norms that influence the choice of presidents, ministers, and other high level officials; norms that characterize appointments in the civil service; norms that influence the contacts between the state and the private sector, or between various parts of the public sector also contribute to its quality.11 Being of an informal nature, these norms are difficult to change. Still the application of arm's length relationships to all aspects of public sector behavior should be a goal in the search for a higher quality public sector. See Tanzi (1995).

III.  The Quality of Public Institutions

The constitution, the laws, and the regulations establish the legal powers of the public sector, or, putting it differently, they set the rules of the game that should determine the behavior of the public sector. The importance of these rules cannot be underestimated. In fact, several authors including Buchanan, Alesina, von Hagen, Tabellini and Persson, and Milesi-Ferretti have argued that arrangements such as fiscal federalism and fiscal decentralization, proportional or nonproportional representation in parliaments, the choice of presidential versus nonpresidential types of governments, the role of the ministry of finance as a superministry, the rules that apply to the budgetary process--for example, whether it is top down or bottom up,--whether parliament can modify the content of budgetary proposals or whether it must vote on the whole budget and so on have a significant impact on macroeconomic outcomes and, presumably, on the quality of the public sector.12

I will not review this literature which, at times, has given conflicting results. While recognizing its importance, I will focus on other aspects and, specifically, on the quality of the public institutions. It is after all these institutions that confront the citizens and that implement the policies. But, of course, the formal rules may affect the quality of the institutions and vice versa. The legal rules are just a set of instructions although, of course, they can contribute to the determination of the quality of the public sector. Until the game is played, these rules remain just pieces of papers; and the game is played by the institutions charged with carrying out these instructions. They may or may not carry the instructions in a faithful and efficient way.13 The public sector is composed of many institutions, some more important than the others. It is the performance and the efficiency of these institutions that, to a large extent determine the quality of the public sector.

The quality of the public sector may be affected by the absence of some essential institutions or by the poor performance of the existing institutions. For example, in many countries, there are no institutions responsible for enforcing competition or for forcing full disclosure on the part of financial institutions or for keeping good accounts on the part of enterprises. As a consequence the market may function less well because of monopoly powers or lack of essential information. The performance of public institutions depends on many factors including (a) tradition and reputation, (b) the resources they have available, (c) the clarity of their mandate, (d) their organizations, (e) the incentives that they face, and (f) the quality of their leadership and staff.

Take one of the most fundamental institutions as an example, namely the tax administration. Its performance will depend, in part, on its tradition and on its reputation. A tax administration that has been efficient, honest, and proud in the past is likely to continue to be so in the future unless it faces truly fundamental shocks. Its performance will also depend on the resources that it has available to hire capable employees, to invest in new technology, to pay good salaries, to carry necessary audits and so on. The clarity of its mandate--for example to enforce fairly and objectively the tax laws--is important. Its day-to-day independence from politicians is also important. When the mandate becomes unclear, either because the laws are not transparent or because the institution is subjected to political interference that force it to accommodate the special circumstances of some taxpayers, then problems develop. This, for example, has been the case in some transition economies and in some developing countries.14 In these countries, political interference has reduced the quality of the tax administration. The organization of the tax administration is also important and so is the set of incentives that it faces. If an institution is poorly organized, or if good or bad performance is equally compensated, the contribution of this institution to the quality of the public sector will be low.15

This brings into the picture two other important and related aspects of public institutions namely (a) the synergy among public institutions and (b) the enforcement mechanisms. I will treat these as two separate aspects although, to a large extent, they are two faces of the same coin.


Like different elements of an ecological system, public institutions work together and support one another so that it may not be possible to have, say, a first class tax administration in an environment where other institutions such as the treasury or important ministries or the judiciary do not function well. Often the same weakness or diseases affect different institutions. This implies that attempting to improve just one institution when the others need equal attention is not likely to generate the desired results in the long run. This has been the experience in transition economies where, for example, the establishment of a good treasury system has not improved much the quality of public expenditure management when the budgetary process has continued to generate budgets that were so unrealistic that no treasury could finance or manage them. In some of these cases the result has been the accumulation of arrears on the part of government and, as a counterpart, the accumulation of tax arrears by the taxpayers.

Inter-institutional externalities (either positive or negative) are very important and must be recognized and dealt with in any attempt at improving the quality of the public sector. For example, when the judiciary does not work well, many other institutions suffer. A holistic approach that addresses problems in different institutions at the same time is likely to be necessary. However, such an approach must be guided by a clear strategy and by the proper sequencing of the changes made.

Enforcement mechanisms

The quality of the public sector will depend to a considerable extent on the existence of control and enforcement mechanisms. Some of these mechanisms must operate within the institutions themselves. For example, efficient internal auditors' offices can improve the functioning of the institutions and can provide some guarantees that they will not stray away from their basic mandate. But these mechanisms may not be sufficient. In other cases the mechanisms will cut across institutions. This happens when institutions specialized in controls and in enforcement have the responsibility of checking the behavior and the performance of other institutions.

Examples of the latter are the General Accounting Office (GAO) in the United States, the Court des Compts in France, the General Auditor's Offices in Latin American Countries, and La Corte dei Conti in Italy. At times, however, these auditing institutions focus too much on whether the institutions have complied with the letter of the law rather than with the spirit of it. Thus, in many cases, the performance of the institutions has attracted less attention than whether they have complied with some legalistic requirements. This kind of auditing is of limited value except, perhaps, for insuring accountability because it does not promote the quality of the public sector in its fundamental objective of delivering services to the public.

In recent years a movement to focus on performance and on output, rather than on formalities and on input, has started. This movement has had its strongest expression in New Zealand and Australia and, in some form, it is spreading to other countries. It has brought with it many changes in contractual arrangements and in organizations in public institutions. For example, in the countries that have adopted it, tenure on civil service jobs has gone and many constraints on the actions of heads of departments have been removed. The government, as the principal, now makes contracts with an agency on what it must deliver and the heads of these agencies become personally responsible for the outcome. If the agreed goals are not met, the contracts of the heads of the agencies are not renewed. The final impact of this change on cultures different from those prevailing in New Zealand and Australia remains to be assessed.16

In addition to the internal controls and those performed by auditing institutions such as the GAO or the Court des Compts there are some other institutions whose working and efficiency are an essential ingredient in the quality of the public sector. Among these the system of justice is of the greatest importance. The role of the justice system in enforcing contracts, in protecting property, in ensuring the safety of individuals, and in improving the efficiency of other institutions is fundamental. Thus, it is not an exaggeration to state that the quality of the public sector of a country depends to a large extent on the quality of its justice system. It is for this reason that the system of justice is receiving a lot of attention in many countries including European countries, such as, France, Italy, and Portugal, and the majority of Latin American countries.

In many countries the justice system has been in crisis in recent years. Individuals and property are not protected, contracts are not enforced, processes take years or even decades to be concluded, and so on. In many cases individuals who break the law are not punished, are punished lightly, or are not punished until much later when the deterrent effect of the punishment is lost. In some countries, the slow moving or even corrupt system of justice has provided an implicit incentive to tax evasion, to corruption and to other crimes because those caught committing these crimes could count on the inefficiency of the justice system to escape punishment. In some countries it takes ten years for the government to determine whether someone accused of tax evasion ought to pay the unpaid taxes. And, often, the penalties imposed are insignificant. This is a good example of the cross-institutional externality mentioned earlier. The same may happen with those who do not live up with the terms of contracts. For example, the proliferation of bad loans and of financial crises is in part a direct consequence of the low and much delayed penalties on those who do not live up to their financial contracts.17

When justice is corrupt or inefficient, it becomes unjust because some people are more adroit at taking advantage of its weak points. The poor and the more law abiding citizens are the ones who end up paying the higher price and economic activity suffers. Equal access to justice, and to a justice that is administered in a timely fashion must remain one of the fundamental goals of the state. If this goal is not met the quality of the public sector will remain poor. See Guigon (1999).

IV.  Measuring the Quality of the Public Sector

Although knowledgeable individuals have some a priori notions of the quality of the public sector of countries, it would be difficult or even impossible to get objective measures of that quality. In principle one could conduct surveys of perceptions of such quality using the same techniques adopted in the surveys of corruption. However, the informational requirements on the part of the respondents to give acceptable results would be extremely high; thus, the quality of the responses would be low. It might be easier to evaluate the quality of the major institutions that make up the public sector and somehow weight their importance to the quality of the public sector. However, given the number of such institutions and the knowledge required to assess them, such an enterprise would also be extraordinarily costly and not necessarily successful in achieving the desired results. An alternative way would simply measure the economic and social performance of a country. This alternative would focus on the output and attribute the results to the quality of the public sector. However, this approach would also have its limitations.

In recent years some institutions and some scholars have begun to focus on particular features that capture some significant aspects of the quality of public sectors. The IMF, for example has been focusing on data that countries could produce and make available to the public. Some of these data relate to the public sector. The assumption would be that countries that are willing and able to generate such data, and are willing to make them available to the public, have a higher quality public sector.18 The Fund has also started to assess the transparency of fiscal policy and fiscal institutions. This evaluation is done against a set of principles of fiscal transparency. The assumption is that lack of transparency is an indication of a lower quality of the public sector and that this lack of transparency promotes inefficiency and various problems of governance. In time there might be transparency reports for most countries. These would provide proxies for informal assessments of the quality of the public sector.

In recent years, there has been a lot of attention paid to issues of governance and corruption in public institutions. These issues also bear on the quality of the public sector. It has been recognized that lack of transparency in the way institutions operate promotes inefficiency and corruption. There is now a large literature on transparency and on corruption. Australia and New Zealand, have once again led the way in promoting techniques aimed at increasing transparency. The new "architecture" of the international financial system has recommended that countries become more transparent in their policymaking. More transparency would probably mean less corruption and generally a higher quality and better performing public sector. However, much needs to be learned about these relationships. It must also be recognized that tests of transparency may be superficial or deep. Superficial tests would not be very useful in understanding what is going on in a public sector and deep test may require a lot of highly specialized resources.

Corruption is a sign of a public sector's lower quality. Various groups have been generating corruption indexes for a large number of countries. These indexes purport to measure perceptions of corruption. It is likely that to some extent, and assuming that the perceptions reflect reality, these indexes of corruption can also be taken as proxies for the quality of the public sector. However, caution is needed because, quite apart from the quality of the corruption indexes, a country could have a totally honest bureaucracy or even political leadership and very inefficient policies and institutions. While important, corruption is only one aspect of poor public sector quality.

Some authors, such as Rauch and Evans (1999) have provided estimates of bureaucratic performance for many developing countries thus providing measures for yet another variable that has a bearing on the quality of the public sector. On the other hand, Keefer and Knack (1997), after defining institutional quality as "objective evaluations...of the institutions that protect property and contractual rights" attempt a measurement based on various indicators. It is questionable whether what they measure is the quality of public sector institutions.

There are other variables that may provide information on the quality of the public sector. Some would relate to its efficiency, some to the policies followed. For example, the relationship between spending in a given category--say health and education--and the outcome of that spending--such as lives saved, successful operations, reduction in the incidence of certain diseases, educational achievements--would be an indication of efficiency. See Gupta et al (1997). On the other hand, measurements of fiscal sustainability might be indications of poor policy rather than of poor quality of the public sector.

V.  Concluding Remarks

The quality of the public sector can be assessed only against the role of the state. If the public sector allows the state to promote its goals in an efficient and successful way, it can be argued that the public sector is of high quality. However, the goals must be realistic because even a very efficient public sector will be unable to cope with unrealistic goals. Thus, in general the quality of the public sector cannot be measured by the quality of the policy outcome although the two are obviously closely linked.

In general, an efficient public sector should be able to achieve the state's objectives with the minimum degree of distortion of the market, with the lowest burden of taxation on the taxpayers, with the smallest number of public employees and with the lowest absorption of economic resources by the public sector. The public sector must be transparent in its processes and transparent in its outcome. Corruption should play no role in the decisions made by the bureaucrats and the political leaders. And the resources in the hand of the public sector should be put to a use that maximizes their social rate of return.

The equity aspects of the public sector are also important because the pursuit of equity, as distinguished from efficiency, is now one of the fundamental goals of the public sector. Given its impact on the use of resources and on growth, a public sector that, through all its aspects, promotes equity must be deemed to be of higher quality than one that doesn't.


De Soto, Hernando, 1989, The Other Path (New York: Harper and Row).

Forte, Francesco, editor, 1998, Le Regole della Costituzione Fiscale, Politeia, Anno 14-N. 49/50.

Guigon, Elisabeth, 1999, "Justice: Du Ministére des Affaire au Ministére du Droit," Le Monde, September 1, p. 12.

Gupta, Sanjeev, Keiko Honjo, and Marijn Verhoeven, 1997, "The Efficiency of Government Expenditure: Experiences in Africa," IMF Working Paper 97/153.

La Porta, Rafael, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny, 1998, "The Quality of Government" (mimeo, Second Draft, August).

Keefer, Philip and Stephen Knack, 1997, "Why Don't Poor Countries Catch Up? A Cross-National Test of An Institutional Explanations," Economic Inquiry, Vol. XXXV, July, pp. 590-602.

Musgrave, Richard A., 1959, The Theory of Public Finance (New York: McGraw-Hill).

Rauch, James E. and Peter B., Evans, 1999, "Bureaucratic Structure and Bureaucratic Performance in Less Developed Countries," forthcoming in Journal of Public Economics.

Schick, Allen, 1998, "Why Most Developing Countries Should Not Try New Zealand's Reforms," The World Bank Research Observer, Vol. 13, No. 1 (February) pp. 123-31.

Skaperdas, Stergios and Constantinos Syropoulos, 1995, "Gangs as Primitive States" in The Economics of Organized Crime, edited by Gianluca Fiorentini and Sam Peltzman (Cambridge: Cambridge University Press), pp. 61-82.

Tanzi, Vito, 1995, "Corruption: Arm's Length Relationships and Markets" in The Economics of Organized Crime, edited by G. Fiorentini and Sam Peltzman (Cambridge: Cambridge University Press).

_____, 1998a, "Essential Fiscal Institutions in Selected Economies in Transition," Discussion Paper No. 53 (November 1998), Collegium Budapest, Institute for Advanced Study.

_____, 1998b, "Corruption Around the World," Staff Papers, International Monetary Fund (December).

_____, Forthcoming, "Rationalizing the Government Budget: Or Why Fiscal Policy is So Difficult" in Economic Policy Reform: The Second Stage, Edited by Anne O. Krueger (The University of Chicago Press).

World Bank, 1997, The State in a Changing World, World Development Report, 1997 (Washington, DC: The World Bank).

1There is now an extensive literature that argues that even gangs or criminal associations of individuals require some organization that is a rudimentary form of government. See Skaperdas and Syropoulos (1995).
2The traditional state intervention is to tax those who generate negative externalities and to subsidize those who generate positive externalities.
3These other roles had not affected the behavior of governments until this century.
4In previous centuries religious groups played a similar role in helping the poorest.
5The World Bank, op.cit., has argued that the process of taking over new functions has distracted the state from its fundamental role.
6This of course assumes that the rule of law is well established in the country so that the constitution is taken seriously.
7For example, the budget law may establish a given budgetary allocation for the health sector but the laws that determine the performance of the health sector may imply a much higher spending level.
8Regulations may be legislated and thus be laws themselves or they may be issued by public agencies to complement the laws. The discussion here refers mostly to the latter.
9In a country in which I worked many years ago tax incentives regulations were not available in any form. Thus, the bureaucrats making the decisions had all the knowledge and their decisions could not be challenged by the taxpayers.
10A couple years ago, it was reported that in California, bread had to be sold in pieces of exactly a well specified weight. This regulation, which was still on the book, had been introduced at the beginning of the century when most buyers did not have scales so that they could be easily cheated by unscrupulous bakers.
11 In some countries high positions are almost inherited. In others jobs in particular institutions are passed from one to another member of the same family. In others, party affiliation facilitates access to government jobs or a change in government creates a large number of vacancies because many jobs are considered as political.
12For example, Ricardo Hausmann has argued in support of a politically independent Fiscal Council that would restrict annual public debt accumulation to agreed levels. The analogy to a central bank independence is obvious.
13In a recent paper I have argued that public policy is often distorted by the prevalence of principal-agents problems. See Tanzi (forthcoming).
14See for example, Tanzi (1998a).
15Rules that apply to hiring, promotions, firing and similar issues for public servants obviously play an important role in the determination of the quality of the public sector.
16For a skeptical assessment of this change see Schick (1998).
17In many countries bankruptcy has become almost a trivial matter with little consequences.
18The data themselves might tell more about the quality of public policy than the quality of the public sector.