Morales is the Senior Policy Analyst of Action for Economic Reforms. This piece was published in the Yellow Pad column of Business World, 26 July 2004 edition.
The latest buzzword in the multilateral agency scene, particularly the World Bank, is “investment climate.” In March 2001, then Chief Economist of the Bank, Nicholas Stern, identified the task of improving investment climate as “the central challenge in reaping benefits from globalization.” By the next year, the Bank, through its Private Sector Development Strategy program, embarked on surveys and assessments of investment climate conditions in most countries. Today, the World Bank is set to release the World Development Report 2005, (WDR2005) preliminarily entitled “A Better Investment Climate – For Everyone,” by September 2004.
History shows that buzzwords, especially when they develop in affluent donor circles, eventually evolve into central themes of focus of research, and subsequently into policy work. Globalization and openness, institutions, and governance are but a few of the more recent examples of this evolution. In other words, buzzwords usually become identified as X-factors, or those which are identified to be bottlenecks or constraints to the process of development. The simplicity in logic appeals to those who believe in the monocausality of underdevelopment, that is, the belief that “underdevelopment is due to constraint X; loosen X, and development will be the inevitable result.” It is thus significant to understand what investment climate really means, and to monitor towards which directions policies may go.
In the draft of the WDR2005, investment climate as the World Bank uses it refers to the institutional, policy, and regulatory environment in which firms operate. It refers to the location-specific factors that shape the opportunities and incentives for firms to invest productively, create jobs, and expand. David Dollar, Mary Hallward-Driemeier, and Taye Mengistae, three economists who have done much work on this topic, use the analogy of sowing and reaping, saying that investment climate is that which dictates whether returns on potential investments are low and uncertain, perhaps due to regulations on the expropriation of multinational firm profits or perhaps to a high risk of diversion of the returns to their investments, or if these returns will be at levels acceptable to investors. Moreover, investment climate encompasses three broad categories of factors that have long been acknowledged to be of importance to business decision-makers, namely:
Macroeconomic and country-level matters, such as fiscal, monetary, exchange rate policies, and political stability
Governance and institutions, including bureaucratic harassment, and the financial and legal systems
Infrastructure necessary for productive investment, including transportation, electricity and communication.
The concept therefore is closely related to other concepts in the economics literature, such as “high-quality institutions,” “social infrastructure,” and “governance.” The main hypothesis that they want to test is that variations in “investment climate” across locations can explain much of the variation in growth rates of economies within the developing world.
What is of primary significance is that in its effort to assess investment climates across the globe, the World Bank has employed the use of firm-level survey instrument and has gathered firm-level data, instead of simply looking for national level aggregate data. In other words, by going down to the firm level, the survey instrument is able to look at the actual impact on the firm’s production and cost efficiency of deficiencies in infrastructure provision, policy implementation, and even institutional efficiency. Some examples of questions asked are:
* On the costliness of bureaucratic regulation and corruption: How much management time is spent either discussing or adapting to new regulation? As a percentage of sales, how much do informal payments cost? * On access to appropriate infrastructure: As a percentage of sales, how much do power losses cost the company? Does the firm have its own well or generator? * On access to international and resource markets: how long does it take for goods to clear customs? Do you have a bank loan or an overdraft facility?
The surveys were then conducted across a good sample of countries in various continents, and were stratified according to location within one country (so as to measure the effect of differences in local government regulation) and then according to sub-sector (so as to check for the possibility that certain factors may impact firms in one sector of the economy more than others). Size of the firm and its form of ownership are also taken into account. Because of these characteristics, the data garnered from these surveys is a treasure trove not only for researchers, but more importantly for policymakers.
What are the preliminary results? In pilot assessments of the investment climate in several countries, many traditionally accepted notions of “investor-friendly” policies have been confirmed by the firm-level data. For example, firm performance in China was positively correlated to investments in research and development, the share of the firm’s labor force that receives training from the firm, and access to financial markets, while time spent with regulators was negatively correlated with firm productivity. In India, where sub-national governments are given much leeway in defining their own state policies, regional gaps in overall business productivity are largely explained by inter-state disparities in labor market flexibility, the burden of industrial regulation in other areas, the power supply and telecommunications infrastructure. Bangladeshi firms have been found to have serious problems with the country’s infrastructure, governance and corruption, and access to finance.
More than confirming long-standing notions of “investor-friendly climate” however, there are other lessons that may be derived from these surveys that can inform policy as to how we can encourage investment and still pursue other societal objectives. The WDR2005 Draft is quick to extensively enumerate the seeming confirmation of the soundness of policies which they have long advocated. After all, infrastructure, good governance, and access to markets via liberalization are all standard ingredients in the World Bank’s Poverty Reduction Strategy Papers. Private sector fundamentalists and market ideologues will be delighted that access to markets of private firms is almost always directly correlated with higher firm productivity. But looking at the problem of underdevelopment more broadly, in other words acknowledging that the problem of underdevelopment is not simply a problem of low growth due largely to low investment, and therefore its remedies may not be solely limited to growth-enhancement, one finds that the data may be saying much more than what some are willing to hear.
This brings us to one of the major difficulties of the Draft WDR2005: its tendency to lapse into a framework that subscribes to the faith that growth is enough for the poor. This framework relies on the assumption that investments bring about economic growth, and this growth in turn results in poverty reduction. However, many theoreticians, policymakers, and development practitioners can attest to the fact that there are various types of economic growth, and not all result in poverty reduction. For example, a growth that is largely driven by asset bubbles and speculation will not have the same developmental impact as compared to one that is driven by labor-intensive industries like manufacturing, or the so-called pro-poor growth. Work in this area suggests that a bias for poorer sections of the population must be deliberately fostered so as to ensure that the benefits of growth accrue mainly to the poor.
If one then keeps in mind that for development to ensue, one needs to pursue a particular type of growth, what are the things that one should look for in the firm-level data on investment climate?
One must first keep in mind that investment climate refers to no single policy or structural characteristic of the economy. It is a confluence of factors affecting business, an overall picture made up of sectoral policies and conditions. As such, policymakers may be able to resort to policies that may be deemed “unfriendly” to business in pursuit of other societal goals (e.g. technology transfer requirements) for as long as the overall picture is still tenable. In other words, one need not pursue “investor-friendly” policies in every single sector. What is important is to have the proper mix of policies to ensure not just that investors are able to reap the benefits of their business but also the realization of other socio-economic objectives such as human capital build-up, employment generation, and even employment quality.
The firm-level data can inform us regarding investor preferences as to which areas of business conduct are most dear to them and which can be sacrificed. The economic mainstream has long asserted that investors are attracted to economies with scant regulation (which is usually assumed to translate into low corruption), a generous degree of labor market flexibility, and free access to credit markets. However, the revisionist accounts of the East Asian miracle economies argue that in moderate degrees, firms are quite tolerant of regulations across many areas of business conduct. China is a perfect current-day example of this argument. In spite of heavy regulation on firm conduct and huge bureaucratic regulatory burden, the firms in China are staying put; nay, they are flourishing. This tells us then that there are other factors that convince these firms that the cost of heavy regulation in China is more than offset by, among others, its efficiency in infrastructure provision.
Furthermore, businesses and investors across firm size, nature of work, and even location are idiosyncratically affected by investment climate, and this is something that World Bank also recognizes. If one however again departs from the mainstream notion that all investments are equally good in character, and recognizes that some activities are better than others, we can then ask the question “which investors prefer what?” Many multilateral agencies and conservatives dismiss the efficacy of selective and targeted policies geared towards encouraging certain business activities, saying that this is an avenue for rent-seeking and corruption. Again, however, the East Asian miracle is testimony to the viability and usefulness of such policies. South Korea is now one of the largest producers of steel in the world, thanks to the concerted effort of the government to promote this sector. There are admittedly dangers to such kinds of policies, but their efficacy is something that cannot and should not be so easily written off.
And so, one may ask, “What kinds of businesses are attracted by the huge tax incentives being given by governments in Asia, prompting many to be concerned about a so-called race-to-the-bottom?” Preliminary studies show that in fact, tax incentives attract footloose industries, or those which can easily transfer to other locations once the tax incentives are removed. These are also the industries that find no incentive to invest in human capital or show no concern for an economy’s long-term goals. Knowing which investors prefer what may be very helpful for developing countries to map out their policies alongside the development path which they wish to pursue.
The authors of the various investment climate assessments readily point out that there is much else that we can learn from the data. For sure, there is much more that we can learn from these firm-level survey data. As the case is for many however, the answers heavily depend on how we ask the questions. The concept of investment climate may offer us more lessons rather than affirmations of commonly held notions and beliefs.
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