Accelerating growth and poverty reduction requires governments
to reduce the policy risks, costs, and barriers to competition
facing firms of all types -- from farmers and micro-entrepreneurs
to local manufacturing companies and multinationals, concludes the
World Bank's annual World Development Report for 2005, launched on
September 29.
"A good investment climate is central to growth and poverty
reduction," said François Bourguignon, the World Bank's senior vice
president and chief economist, when presenting the report. "A
vibrant private sector creates jobs, provides the goods and
services needed to improve living standards, and contributes taxes
necessary for public investment in health, education, and other
services. But too often governments stunt the size of those
contributions by creating unjustified risks, costs, and barriers to
competition."
The report, A Better Investment Climate for Everyone, draws on
surveys of over 30,000 firms in 53 developing countries, the bank's
Doing Business database, country case studies, and other new
research. It highlights opportunities for governments to improve
their investment climates by expanding the opportunities and
incentives for firms of all types to invest productively, create
jobs, and expand.
Policy-related risks dominate the concerns of firms in
developing countries. Uncertainty about the content and
implementation of government policies is the top-rated concern,
with other significant risks including macroeconomic instability,
arbitrary regulation, and weak protection of property rights. These
risks cloud opportunities and chill incentives to invest
productively and create jobs. Nearly 90 percent of firms in
Guatemala, and more than 70 percent of firms in Belarus and Zambia,
find the interpretation of regulation unpredictable. More than 80
percent of firms in Bangladesh, and over 70 percent of firms in
Ecuador and Moldova, lack confidence in the courts to uphold their
property rights. Improving policy predictability alone can increase
the likelihood of new investment by more than 30 percent, the
report found.
The policy-related costs shouldered by firms can also be
substantial, and make many potential investment opportunities
unprofitable. The bank's Doing Business in 2005 report, published
earlier this month, highlighted the heavy burden imposed by
outmoded or ill-conceived regulation. The World Development Report
2005 shows that regulation is part of a larger problem.
Unreliable electricity supply and other infrastructure, crime,
and corruption can impose costs that are more than double those of
regulation. Together with weak contract enforcement and onerous
regulation, these costs can amount to over 25 percent of sales, or
more than three times what firms typically pay in taxes. The costs
associated with unreliable electricity supply alone amount to over
10 percent of sales in Eritrea, India, and Kenya, while the costs
of crime exceed 10 percent of sales in Armenia, Azerbaijan, and
Peru. Bribes average more than six percent of sales in Algeria,
Cambodia, and Nicaragua.
Barriers to competition are also pervasive and dull incentives
for firms to innovate and increase their productivity -- the key to
sustainable growth. High risks and costs restrict competition, but
governments also limit competition through policy barriers to
market entry and exit, and through inadequate efforts to curb
anticompetitive behavior by firms. Nearly 90 percent of firms in
Poland report strong competitive pressure, more than twice the
share of firms in Georgia. Stronger competitive pressure can
increase the probability of innovation by more than 50 percent, the
report found.
The level and composition of risks, costs, and barriers to
competition vary widely not only across countries, but also within
countries. This is true among states and provinces in Brazil,
China, and India, but also across locations in smaller countries.
National and sub-national governments each have important roles to
play in improving the investment climate.
Poor investment climates also hit small firms and those in the
informal economy the hardest. The report found that these firms
have more difficulty in gaining access to finance and public
services, have less confidence in the courts, and find the
interpretation of regulation less predictable. Constraints that
involve fixed costs -- such as the need to self-generate
electricity -- also impose a disproportionate burden on smaller
firms.
Progress requires more than changes to formal
policies
"Over 90 percent of firms report gaps between policy and
practice, and the informal economy accounts for more than half of
output in many developing countries. Governments need to close
these gaps and confront deeper sources of policy failure that can
undermine the investment climate," said Warrick Smith, lead author
of the report.
While many investment climate improvements require changes to
laws and policies, the report highlights four deeper challenges
that governments need to address to improve their investment
climates:
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Restraining corruption and other forms of rent seeking. The
majority of firms in developing countries report having to pay
bribes when dealing with officials, and many rate corruption as
their most pressing obstacle. Policies and their implementation are
also distorted by the disproportionate influence exercised by
politically-connected firms.
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Building the credibility of government policies. Passing new laws
has little impact if firms don't believe they will be enforced or
sustained.
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Fostering public support for policy improvements. Failure to build
public support for creating a more productive society slows reforms
and jeopardizes their sustainability.
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Ensuring policy responses are adapted to local conditions.
Approaches that are transplanted uncritically from other countries
often lead to poor or perverse results.
Focus on delivering the basics
Governments should focus on improving the basic foundations of a
good investment climate to benefit all firms and activities in the
economy. The report reviews lessons of experience in the four core
areas:
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Stability and security. Secure property rights are central to a
good investment climate. In Poland, Romania, Russia, Slovakia, and
Ukraine firms that believed their rights were secure reinvested
between 14 and 40 percent more of their profits than those that did
not. Rights can be made more secure by verifying rights to land and
other property, improving contract enforcement, reducing crime, and
restraining expropriation by government.
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Regulation and taxation. Regulation and taxation make important
contributions to a good investment climate and to other social
goals. But too often approaches create unnecessary risks, costs,
and barriers to competition, and lead to a swelling of the informal
economy. Successful reforms include those that streamline
regulatory procedures, as in Uganda and Vietnam, improve tax
administration, as in Kenya and Peru, and modernize customs
administration, as in Morocco and Ghana.
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Finance and infrastructure. Finance and infrastructure are critical
inputs to most investment activities. Governments are getting
better results by improving the investment climate for providers of
these services, rather than by involving themselves more directly
in service provision.
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Workers and labor markets. A good investment climate helps connect
people to decent jobs. Governments need to foster a skilled
workforce and ensure that labor market interventions benefit all
workers (including those currently under-employed and in the
informal economy). They also need to help workers cope with change
in a more dynamic economy.
Going beyond the basics by targeting particular firms or
activities for special policy privileges is a risky strategy, the
report warns.
"Governments have been experimenting with selective
interventions for centuries. But international experience reveals
no sure-fire strategies, and such interventions have gone
spectacularly wrong in many cases," said Michael Klein, vice
president of World Bank/International Finance Corporation (IFC) for
Private Sector Development and IFC chief economist. The report
reviews experience with a range of approaches and offers guidelines
on ways to reduce the risks inherent with such strategies.
Persistence, not perfection, is the key
Citing the success of countries such as China, India, and
Uganda, the report emphasizes that everything does not have to be
done at once. Rather, significant progress can be made by
addressing important constraints that face firms, and by sustaining
a process of ongoing improvements. Improving property rights in
China launched a process that lifted 400 million people out of
poverty, with initial reforms followed by a succession of ongoing
improvements covering most aspects of its investment climate.
Because the main constraints facing firms can vary widely across
countries, even in a single region, priorities need to be assessed
in each case. To maintain the momentum of reform, countries as
diverse as Senegal, Turkey, and Vietnam have established dedicated
institutions for engaging stakeholders and reviewing constraints.
Effective public communication also plays a vital role in
sustaining progress, the report says.
The int'l community should do more to help
The growth and poverty reduction unleashed by investment climate
improvements in a country can easily dwarf the impact of
international aid flows. The report calls on the international
community to strengthen efforts to help developing countries
improve their investment climates by:
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Removing trade restrictions, subsidies and other market distortions
in developed countries that harm investment climates in developing
countries. This can deliver benefits to developing countries worth
more than four times the value of aid they receive to improve their
investment climates.
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Providing more effective assistance to help governments improve
their investment climates. Technical assistance on the design and
implementation of policy improvements can be especially potent, but
currently receives fewer resources than the support directed to
individual firms and transactions.
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Helping to tackle the huge knowledge agenda on investment climate
issues to provide more guidance to policymakers on the design and
implementation of policy improvements.
(China.org.cn September 29, 2004)