as assumed by proponents of the interventionist view and private parties by themselves, given well-defined property rights and good contractual institutions, may be able to address most of these problems. Additionally, the costs of government failures are likely to exceed those of market failures, rendering direct interventions, at best, ineffective and in many cases, counterproductive. Therefore, this view recommends that governments exit from bank ownership and lift restrictions on the allocation of credit and the determination of interest rates. Instead, the argument goes, government efforts should be deployed towards improving the enabling environment—e.g., providing a stable macroeconomic framework, enhancing creditor and shareholder rights and their enforceability, upgrading prudential regulation, modernizing accounting practices, and promoting the expansion of reliable debtor information systems (Caprio and Honohan, 2001; Klapper and Zaidi, 2005; Rajan and Zingales, 2001; World Bank, 2005a).

The laissez-faire view is consistent with the general shift on thinking about the role of the government in the development process over the last decades. The experiences of developing countries in the 1970s and 1980s showed that widespread government intervention in the economy, through trade restrictions, state ownership of firms, financial repression, price controls, and foreign exchange rationing, resulted in the waste of large resources and impeded, rather than promoted, growth. Confidence in the ability of the government to foster economic development diminished dramatically, as growing evidence showed that government failure was widespread in developing countries and in many cases outweighed market failure (see, for example, Krueger, 1990; Srinivasan, 1985; and World Bank, 1983).<sup>32</sup> This led economists and policymakers to conclude that constraining the role of the public sector in the economy and eliminating the distortions associated with protectionism, subsidies, and public ownership was essential to fostering growth.<sup>33</sup> Much of this vision was reflected in the so-called “Washington Consensus” and guided most of the reform programs during 1990s.<sup>34</sup> Governments focused on creating a stable macroeconomic environment by reducing fiscal deficits and improving monetary policies. In line with the objective of reducing the role of the state in the economy, countries privatized government-owned enterprises, deregulated domestic industries, eliminated quantitative restrictions and licensing requirements, and dismantled agricultural marketing boards and other state monopolies. Many countries also reduced tariffs and other restrictions on imports and liberalized regulations on foreign investment. In recent years, the focus of the reforms has turned away from macroeconomic stabilization and liberalization and shifted towards improving the institutional environment (World Bank, 1999, 2002), consistent with the growing empirical evidence

> 32 The theoretical literature also started to focus on the causes of government failure, such as rent-seeking and capture by special interests (see, for example, Buchanan, 1962; Krueger, 1974; Stigler, 1971; and Tullock, 1967)

> 33 The view that better policies would lead to higher growth was also motivated by endogenous growth theories developed by Lucas and Romer in the mid-1980s which imply that government policies can influence not just the income level, but also countries’ steady-state growth rates. This literature provided the foundation to empirical work based on cross-country regressions to analyze the effects of policies on growth, which was started by Barro (1991). Durlauf, Johnson, and Temple (2005), Easterly (2005), and Temple (1999) provide critical surveys of this literature. See also Rodrik (2005).

34 The term “Washington Consensus” was coined by Williamson (1990). See World Bank (2005b) for a review of the reforms during the 1990s and a discussion of their policy lessons.

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