Transparency of Government (Part 1) - Breakthrough for Reforming the Shape of a Nation

In recent years, transparency, openness and disclosure have become all-too-familiar subjects of discussion, taken up as issues of utmost importance when considering how the public sector and policies should be. In the traditional arena of fiscal and monetary policies, for instance, transparency in budget formulation processes or in the central bank's policymaking processes has been drawing much attention from an institutional point of view. In April 2001, a set of measures for enhancing access to government information were implemented under the Law Concerning Access to Information Held by Administrative Organs (Administrative Information Disclosure Law). The effectuation of the law, which is designed to reinforce people's right to know, has prompted some positive moves among local governments. By proactively disclosing information and holding themselves accountable for their policies, some local governments are trying to open the way for people's participation in policymaking and policy evaluation processes so as to reform the administrative system into the one that better incorporates the ideas and opinions of the people, who are after all the recipients of public services.

Transparency has been taken up in various fields of economics but mostly only ever in an ad hoc manner. Here, I would like to discuss this issue in a series of three articles, taking a comprehensive approach. In this first article in the series I would like to explain, from an economics point of view, why transparency is particularly important for implementing effective governance in government organs and what substantial factors are hampering the improvement of government transparency.

Many readers might say it is a self-evident axiom that transparency is important in any organization. Indeed, in the case of the private sector, companies raising funds from the market - publicly-traded companies for instance - are required to disclose financial and other corporate information to investors in order to facilitate efficient allocation of resources. Also, the disclosure of government information is considered to be the most basic foundation of democracy. Even if the importance of transparency is well understood, however, it is not enough to actually enhance it. It must be elucidated how substantially conditions of transparency affect the governance of an organization and what mechanism exists to prevent the improvement of them. Otherwise, "improvement of transparency" may end up becoming a mere slogan.

There are several fundamental factors making it more difficult to implement government governance that is effective from a citizen's point of view than it is to realize effective governance in the private sector. In this article, upon referring to these factors I wish to emphasize that the "improvement of transparency" is the only available and decisively important means to enabling otherwise limited government governance to function properly. Greater transparency makes it difficult for government officials and politicians to ignore the interests of the general public when undertaking their duties, while at the same time enhancing citizen participation in politics and increasing competition among political parties. If the reinforcement of government governance leads to the further improvement of transparency, thereby creating a virtuous circle, it may eventually evolve into a major driving force for changing the shape of a nation.

In this first article, I will present a theoretical and conceptual framework for understanding government transparency. Then, in the second article, I would like to discuss concrete measures to improve transparency, focusing on two specific examples, namely, fiscal transparency and central bank transparency. I will also evaluate the transparency of the Japanese government's policy toward that of other countries. Finally, in the third article, I will examine the role of the media as a tool for improving government transparency.

From the viewpoint of economics, the issue of transparency can be better understood by focusing on "information asymmetry." A situation in which information asymmetry exists is described as a "lack of transparency" or "opaqueness" (Gerrats, 2002). In other words, the improvement of transparency means a mitigation of "information asymmetry" or "uneven distribution of information." Such a situation can be observed in various transactional relationships among economic entities.

Principal-agent model approach
It is a well known fact that the existence of information asymmetry in a principal-agent relationship causes the so-called "agency problem" (such as adverse selection and moral hazard). Therefore, the elimination or reduction of information asymmetry through the improvement of transparency is expected to contribute to solving the agency problem and reinforcing governance over an "agent." In the private sector, we can view the relationship between a company (corporate managers), and its investors (shareholders) and customers, as one of "agent" and "principal" respectively. In this case, the improvement of transparency occurs when the company discloses more information to its investors and customers. As for the public sector, we can also consider the relationship between the government (politicians) and citizens (voters) as one of "agent" and "principal" respectively, in which the transparency of government activities can be improved through greater information disclosure by the government and politicians.

"Exit" and "voice" mechanisms of governance and their influence on transparency
As such, when all the other conditions remain same, the improvement of transparency is expected to help reinforce the governance of an "agent" organization whether it is a private sector company or a government entity. However, the degree of importance of improved transparency - or the extent to which the governance mechanism can be reinforced - differs depending on the kind of governance mechanism adopted by the "agent."

As a way of imposing governance on an organization, Hirshman (1970) introduced two frameworks, namely "exit" and "voice" mechanisms. Let us take a look at these two mechanisms and compare their differences. When an "agent" acts against the interests of its "principal," the "principal" can impose governance by severing its relationship with the "agent." This is referred to as a governance mechanism by means of "exit." Governance can be also imposed by making demands and interfering, while maintaining a relationship with the "agent," which is referred to as a governance mechanism by means of "voice." Under the former mechanism, the "principal" decides whether to "exit" or not based on the performance of the "agent" (thus this can be defined as a "result-oriented" approach). In this case, information pertaining to the process through which the outcome was reached is not very important to the "principal." What about under the latter mechanism in which governance is implemented in an organization by means of the "voice" of opinion? If the performance of the "agent" is dissatisfactory, then the "principal" would try and force the "agent" to perform better by making requests, rather than replacing the "agent." In this case, the "principal" needs to examine the cause and process that led to the poor performance. Therefore, information disclosure and transparency improvement, key factors that enable such examination, are of far greater importance under the "voice" mechanism of governance than under the "exit" mechanism of governance.

Relationship with shareholders
In considering government transparency, it is helpful to first clarify the difference in the form of governance between the private and the government sectors, and then discuss the difference in the degree of importance of transparency. Let us first examine transparency in the private sector.

A company (management) has certain benefits in concealing information and keeping affairs opaque because such a situation makes it easier for corporate managers to pursue personal interests instead of those of shareholders. Nondisclosure of information, however, does not always work in favor of a company. The problem of adverse selection ("lemon cars") is one such example. When there is information asymmetry, it is difficult to fully evaluate the quality of a company and as a result the company tends to be undervalued in the stock market. In this case, a "good company" has an incentive to proactively disclose its information (signaling) in order to advertise the level of its quality to the market. On the contrary, a "bad company" has little incentive to disclose information. Therefore, simply counting on the autonomy of companies would not be enough. It is necessary to have financial analysts and rating agencies play the role of "information intermediaries" and/or to have regulations implemented mandating information disclosure (Healy and Palepu, 2000).

Meanwhile, shareholders also have a role to play in reducing information asymmetry. Major shareholders have an incentive to implement "voice" governance in their investee company. In order to monitor and interfere with corporate management, one must bear the substantial costs of information gathering, which involves high fixed expenses. Yet, the expected benefits for major shareholders - a rise in share prices and dividends multiplied by the number of shares held - would be big enough to pay off the costs. In this case, however, the gathered information would remain private in nature, even though it may be shared between the shareholders and the investee company. Thus, this would not lead to the improvement of transparency in relation to the general public (or people indiscriminately). Meanwhile, with regard to minority shareholders (individuals), the so-called "free-rider problem" tends to occur. That is, minority shareholders tend to leave the task of monitoring to other shareholders because the cost of information gathering is too high to bear and they know that they would not be able to savor all the benefits alone (other shareholders also benefit) even if they can afford the cost and monitor on their own. Therefore, governance by minority shareholders is primarily of the "exit" mechanism variety, in which they would sell shares in a company with poor performance, rather than of the "voice" mechanism type based on monitoring.

Relationship with customers
Let us take a look at the relationship between a company and its customers. Though not a principal-agent relationship in a strict sense, this is nevertheless an important relationship in that customers are able to provide governance to corporate management through the product market. Companies are required to disclose production information (ingredients, etc) in order to protect consumers; but in this area, the existence of information asymmetry between the company and customers would not be a big problem. The product itself (quality) and its price are all that matters to customers. How the providing company is organized and through what process the product is being produced are of little importance. High-price low-quality goods and services would be unable to find buyers and eventually be expelled from the market; and this is exactly how the "exit" mechanism of governance by customers works. That is to say, where there is sufficient competition in the market, governance would operate in the sense that customers opt for cheaper and higher-quality goods and services. Thus, from a company's point of view, how to establish favorable reputation for the prices and quality of their products and/or services is of greater importance than how to improve transparency to customers (Stiglitz, 1999).

Private-sector companies do have an incentive to refuse to disclose information in order to pursue personal interests. At the same time, however, they may also have an incentive to disclose more information because they may be undervalued on the market unless they ensure information transparency, as seen in the problem of adverse selection. Meanwhile, customers and minority shareholders also have a powerful means of governance (the "exit" mechanism). Even in a situation where transparency is not sufficient, customers and minority shareholders - though at a disadvantage in their ability to access corporate information - can sever their relationship with a company if they are dissatisfied with its performance and/or products, and switch to another.

Analogy with private-sector companies
To understand the problem of government-to-public information disclosure and the improvement of transparency, it is helpful to think from the viewpoints of "shareholders" and "customers," as is the case with private-sector companies.

Firstly, let us focus on people's role as "shareholders." The general public do not "own" stakes in the government in the same way that corporate shareholders hold stakes in their investee company. Yet, just like corporate shareholders have voting rights in shareholders' meetings, citizens have voting rights and can provide governance of the incumbent government by casting a ballot. That is, to analogize voters to the "principal," and the government and politicians to the "agent," under the "principal-agent" model.

In examining government governance by using this "shareholders" analogy, it should be noted that there are two distinct differences with private-sector governance (Tirole, 1994). The first is that citizens-voters "own" their government broadly and thinly. In other words, each voter is a "minority shareholder" who has only "one share" or "one vote." The second is that whereas corporate shareholders have common interests in terms of ups and downs in stock prices and dividends, voters' interests do not necessarily concur.

Secondly, let us take a look at the viewpoint of citizens as "customers." This is to focus on the taxpayer's role and capacity as recipient of government-provided public goods and services in exchange for the payment of taxes. However, it should be noted that the relationship between benefit and burden in receiving public goods and services is not necessarily clear, unlike the case of purchasing them from a private-sector company. More specifically, it is not clear how much one pays for each piece of public goods or services and whether one is receiving benefits of a level appropriate for the price. This is tantamount to purchasing necessary goods and services in one lump from a private-sector company without knowing the quality and price of each individual piece.

Government governance with no option to "exit"
The biggest difference between private-sector governance and government governance is the absence of an "exit" option in the latter (Stiglitz, 1999, 2001). The fact that neither voters as "shareholders" nor taxpayers as "customers," receiving public goods and services, have an option to "exit" from the incumbent government is very important when thinking about government transparency.

For instance, citizens, as "customers," cannot replace their government with another even if they do not like the public goods and services provided by it. Of course, it is theoretically possible to exercise an "exit" option. One can leave and go to live in another country if the problem is with the central government, or relocate inside his or her country if the problem is with a local government. This, however, does not sound very practical. In other words, "voice" is the only available choice for citizens in terms of providing governance to their government. Therefore it is imperative to focus on the process in which public goods and services are being provided, and seek for greater information disclosure and transparency of the government, if an improvement in the quality and cost of public goods and services is desired.

From the standpoint of voters, as "shareholders," it is hard to exercise the "exit" option of selling "shares." Rather, it is more important to express one's opinions by casting a ballot just like shareholders exercise their voting rights in a shareholders' meeting. As mentioned above, however, there is the problem of voters' broad and thin "ownership" of the government, which provides little incentive for individual voters to obtain information from the government. Far worse, the lower the level of government transparency and information disclosure the higher the cost of gathering it, which would easily lead to the further lowering of an incentive for citizens to monitor the government, thus creating a vicious circle. Therefore, it is critically important to improve government transparency so as to promote the participation of voters in politics and let the "voice" mechanism of governance function properly.

Specific interest groups hinder the improvement of transparency
In the context of the "shareholders" analogy, specific interest groups are the "major shareholders" of a government. These interest groups organize votes at the time of election to exert influence over the government and politicians. At the same time, through close contact with government officials and politicians, they routinely gather information. In this way, information asymmetry between the government and these groups is certainly reduced. Such information, however, would not be released to the general public, with the interest groups keeping their gathered information to themselves. As a result, even if specific interest groups are capable of monitoring government activities and reinforcing its governance, they would try to provide governance to the government and its politics only in a way that would serve their specific interests, often at the cost of the interests of citizens and individual voters. Therefore, as a means to improving transparency, having the government disclose more information to (an indiscriminate number of) citizens-voters is far more important than trying to reduce information asymmetry through monitoring of the government by specified interest groups. Collusive relationships between the government and specific interest groups would further lower the government's incentives to disclose information to the general public, and this makes it all the more important to improve transparency as a way of preventing such collusion and corruption.

Improvement of transparency and political competition
The lower the transparency of a government, the greater the cost of information gathering and this negatively affects voter participation in politics. Furthermore, it also hampers political competition among parties. When the incumbent government's information disclosure is insufficient, it increases the uncertainty felt by a nonruling party as to how much it can improve the "management" of the government in the event of its taking the helm of (taking over) political rule (Stiglitz, 1999, 2001). For instance, with regard to fiscal policies, had the outgoing government been tactfully hiding fiscal deficits which would leave a burden on future generations, the incoming government would be bound to a limited scope of fiscal policy options and forced to bear huge costs. In other words, the low transparency of a government increases regime "takeover costs," and thus the incumbent ruling party and government are able to maintain a politically advantageous position by strategically limiting information disclosure and keeping its affairs vague.

"Myth of government infallibility"
Information disclosure and transparency improvement in the governmental sector are of greater necessity than in the private sector. Nevertheless, government officials often have stronger incentives for hiding information. A case in which a government tries to hide its policy failures is one example. Up to this point, we have already examined a series of differences between private-sector governance and government governance. Yet another important difference is the degree of difficulty in performance evaluation. Compared to corporate performance, government performance is far more difficult to evaluate. Even if there are achievements, it is hard to recognize how far they can be attributed to government policies. Also, because a government is by its very nature a monopoly, it is difficult to evaluate its performance relative to that of others. In the case of the private sector, each company's efforts can be reflected in the quality and performance of its products, which hence materializes into sales (volume of) and earnings, thus enabling outsiders to evaluate its performance in a relatively objective manner. Also, by comparing one company's performance with that of others in the same business sector, one can distinguish factors attributable to corporate efforts from those which are not, such as macroeconomic or industry-wide factors.

This inevitable ambiguity in the evaluation of governmental activities provides room for a government to hide its failures. Where there is not sufficient transparency, it is possible for a government to conceal its failures and maintain the "myth of government infallibility." Moreover, with this comes the risk of falling into a vicious circle. When a government restricts disclosure of information its failures are slow to surface. Once the failure comes to light, however, the general public's shock is huge and their response fierce. Fearing this, the government would try all the more to hide information. On the other hand, when a government proactively discloses information, its failures cease to be a matter of such rarity, and there is less pressure for further information disclosure, thereby creating a virtuous circle (Stiglitz, 1999, 2001). It is thus extremely important to enhance information disclosure and improve transparency in order to break the "myth of government infallibility" and correct wrong policies as promptly as possible.

Cases in which information disclosure by government is undesirable
Of course, there is certain information that should be made an exception when demanding government transparency. Personal information and military secrets are among the types of information requiring such exceptional treatment. A government, however, sometimes refuses to disclose information that does not require such protection. Government officials often claim that the general public may be unable to understand certain information correctly, arguing that people might fall into a panic and possibly be guided in the wrong direction. Such a view, in an extreme sense, is tantamount to the ideas described in the "presuppositions of Harvey Road" that a country's policies should only be determined by a handful of the brilliantly elite because ordinary people are too ignorant; or to quote the Analects of Confucius, "The people may be made to follow, but may not be made to understand." In particular, with regard to the release of certain figures concerning government policies, a government quite often raises a red flag, pointing to the risk that the figures could be taken out of context. Of course, certain information could upset the general public. However, this cannot become an excuse for sealing it off forever. The disclosure of such information should be treated as a matter of timing. The problem of possibly upsetting the general public, meanwhile, is a matter to be solved by firmly establishing their trust in the government. Paradoxically, this can be achieved through the "improvement of transparency," as discussed below.

While transparency improvement is a more critical prerequisite for implementing effective governance in the governmental sector than in the private sector, a government does have stronger incentives for concealing information than private-sector companies. In order to break this impasse, the general public - those who are to benefit from greater information disclosure - need to put pressure on the government and politicians to disclose more information. Given the seriousness of the "free-rider problem," however, it is unlikely that individual voters will voluntarily act that way.

Rather, it would be more realistic to hope that the incumbent government and politicians realize that, in the long run, transparency improvement will help implement effective governance, and that they might work to enhance transparency for the sake of strengthening their own political power. It is still difficult for voters to evaluate the performance of individual politicians, but by improving transparency the incumbent government can better advertise its policy efforts to the electorate, which would enhance voter confidence and reinforce its political foundation. Ferejohn (1999) proposed a model showing that increasing the transparency of a government enables voters to evaluate government activities more accurately, meaning that they would re-elect those from the incumbent ruling party when the government performance is favorable. When there is greater transparency, the government's efforts can be more easily reflected in its performance, which in turn induces even more endeavor by the government thereby increasing voter confidence in it. For this theory to hold, however, active participation by voters in politics, as well as the possibility of a change of regime, must be ensured.

As discussed above, the absence of the "exit" option as a means to impose governance is the major reason why it is critically important to enhance the indiscriminate disclosure of information by the government. Increased transparency of a government would enhance voter participation in politics and competition among parties, thereby strengthening government governance by means of the people's "voice," and thus creating a virtuous circle. Even if specific interest groups, acting as "major shareholders," manage to solve the problem of information asymmetry with the government through monitoring government activities, it would not necessarily benefit the general public. This makes it all the more important to improve government transparency so as to enable citizens to provide governance to their government in a more direct and meaningful manner. Such greater participation by citizens would also help prevent collusions between the government and specific interest groups.

Increasing government transparency could be the breakthrough that eventually brings about a dynamic change in the government, politics, and even "shape" of a nation. When a government makes sufficient information disclosure and cost-benefit relationships become clearer in the eyes of citizens, the government - which bears accountability to the public - would have no choice but implement policies focusing on the needs of citizens, as recipients of public goods and services. This would mean a return by government officials to their original role as an "agent" commissioned by citizens, literally becoming the "civil servants" that their job title describes. Enhanced information disclosure would make it difficult for a government to resort to makeshift policies, such as implementing forbearance measures while postponing hard decisions on certain issues. In other words, there would be greater possibility of a change of political regime and more competition among parties. Voters, if provided with sufficient information to evaluate polices implemented by the incumbent government, would have greater incentives to participate in politics, whereby a more democratic political system would be established. All these processes eventually lead to the deepening of people's trust in the incumbent government and thus are beneficial to it. Improving government transparency is the only available, yet very potent, "weapon" for breaking the ongoing impasse and restoring people's confidence.

July 7, 2003

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