_Some of the greatest successes in raising living standards have come about not by altering individuals' choices but by altering decisions made by governments._ (Besley 2012) A proactive and effective state is essential for development: it is needed to create a favorable investment climate and to facilitate poor people’s empowerment and their participation in economic life.<sup>3</sup> Governance and public sector management shape both the investment climate and the efficiency of delivery of the basic services that are at the center of the development agenda. Development requires an environment where markets can function and contracts are honored, and the maintenance of macroeconomic stability, infrastructure, defense, financial systems, and sound administrative, legal, and regulatory structures—which are all tasks for a government. The institutional framework of a country—information, property rights, legal systems, financial systems, and so on—should promote the functioning of markets and the welfare of its citizens. Physical infrastructure (public transportation, power, telecomm, and water) and basic public services (particularly in education and health, which are central to empowerment) have a vital influence on the ability of enterprises or farms to operate effectively as well as on the ability of individuals to participate. All these services depend on public action: government must either deliver them directly or create a regulatory and competition framework that channels private sector participation. The responsibilities of a government also include fostering health and education as well as the social, political, and physical environment that helps people participate in the decisions that affect their lives in the economic and social realm. The story of development is not about government getting out of the way, but about getting government to do the right things in the right way.

In both developed and developing countries, there are many examples of governments that have taken on more than they can manage, given their limited administrative capacity to design and implement policy or to provide basic health and education services. These examples, together with weak revenue raising capacity in many countries, have led some to argue that the state in developing countries should be extremely modest in its objectives and scope. There is some basis to this argument, but it must be set against the scale of the development challenge facing developing countries and the extensive range of state actions needed to foster inclusive growth. Developing country policies during the 1990s and 2000s—at least until the Great Recession of 2008—have improved: regulations and the business climate have been more conducive to growth; macroeconomic management has improved, exchange rates have been more stable, trade barriers have been reduced and openness has increased; and inflation, which typically does the greatest harm to poor people, has fallen significantly. At the same time, governance and institutional quality, as measured by the World Bank’s Country Policy and Institutional Assessment (CPIA) index, suggests a more sobering picture: there has been some—but little— average progress around the world in improving governance, controlling corruption, and improving institutional quality, with significant variation across countries.<sup>4</sup> The number of

> 3 See Stern, Dethier and Rogers (2005).

> 4 As discussed later, the CPIA index is composed of 20 variables in four groups: economic management, structural policies, policies for social inclusion and equity, and public sector management and institutions.

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