1. A Better Investment Climate for Everyone
2005
world development report
A Better Investment Climate for Everyone
Context:
The 27th WDR.
World Bank’s 2 pillar strategy:
Improving the investment climate to create opportunities for people to improve their situations -- Focus of this year’s WDR.
Investing in and empowering people so they can take advantage of those opportunities -- Key aspects dealt with by WDR04 on delivering public services;

2. The investment climate
Private firms of all types are key actors in growth and poverty reduction
Create more than 90 percent of jobs.
Provide most of the goods and services consumed in society.
Pay most of the taxes needed for public funding of health, education, and other services.
Size of contribution depends largely on how governments shape the investment climate
The opportunities and incentives for firms to invest productively, create jobs, and expand.
Until recently, discussion of development often gave too little recognition to the central role of private firms in development:
Jobs
Goods and services, including those consumed by poor people
Taxes to fund public spending on health, edu and other social goals.
The WDR takes a broad view of the many factors influencing opportunities and incentives for firms to invest productively, create jobs, and expand.
Some of those factors are difficult for governments to influence (eg, geography). WDR focuses on role of government policies and behaviors, and hence amenable to change.

3. A better investment climate for everyone
Better for society as a whole, not just firms
Better for firms of all types.
The “for everyone” theme is not just a slogan. It emphasizes two important points:
1. The goal is to improve outcomes for society as a whole, not just firms. So regulation and taxes are important. And assessing quality of investment climate needs to take account of benefits to society through jobs, consumer goods, and taxes.
2. Goal should be to embrace firms of all types -- from farmers and microentrepreneurs to local manufacturing companies and multinationals -- as all have important and complementary roles to play in improving living standards and reducing poverty.
Most earlier work on this subject focussed on constraints facing foreign firms. While FDI can indeed make an important contribution to development, WDR goes much further. IC surveys cover over 26,000 mostly local firms in 53 countries. WDR team complemented this work with surveys of 3,000 micro and informal firms in 11 countries. Why?
--- Domestic investment dominates FDI in developing countries (left panel)
--- Informal economies huge in many developing countries (right panel).
And improving conditions for local firms also tends to benefit foreign firms.
WDR draws on new data:
Surveys of 30,000 firms in 53 developing countries, including 3,000 micro and informal firms in 11 countries.
Doing Business database, covering >130 countries

4. Private investment as % of GDP
Driving growth
Main sources of long-term growth are investment and productivity improvements
A good investment climate drives both, while protecting other social interests.
China, India & Uganda illustrate power:
Private investment as % of GDP
Growth experiences
China – Ave. nearly 10% p.a.
India – Doubled rate since 1970s.
Uganda – 8 times ave. rate in sub-Saharan Africa.
Links between IC and growth:
Not just about level of investment--real driver of long-term growth is productivity improvement. A good investment climate needs to encourage both.
While the WDR looks at many country case studies, China, India, and Uganda are referred to throughout the report to illustrate some basic propositions.
China: Unprecedented growth. Many commentators have had difficulty explaining this, and suggesting that policies were “heterodox”. WDR shows that growth largely explained by IC improvements, and strategy was pragmatic rather than eclectic.
India: Also strong growth performance -- albeit still not in the same league as China. Again, IC improvements dating from 1980s provide most of the explanation).
Uganda: Included to show that strategies not limited to large countries. Uganda has had growth rate 8 times the average in SSA -- mostly explained by IC improvements.

5. Growth closely associated with poverty reduction.
Reducing poverty
Growth closely associated with poverty reduction.
Percent per annum,
But also need to understand direct impacts
Jobs and self-employment are main paths out of poverty
Consumers; Users of property, infrastructure and finance; Potential recipients of tax-funded services.
“Pro-poor” IC reform strategies
Where poor people live, and activities poor benefit from.
World Bank not interested in growth for its own sake -- interested in reducing poverty and improving living standards.
Links between IC and poverty can be seen in two ways:
Aggregate evidence shows that highly correlated [although some of the nuances of this are discussed in Ch 1].
Direct impact on poor people through:
Jobs and self-employment: Top priorities of poor people in Voices of Poor Study.
Consumer goods: Eg, Better IC lowered food prices in Africa and Asia;
Users of property, finance, and infrastructure: Benefit poor people whether work or engage in entrepreneurial activities or not.
Recipients of tax-funded services: Growing private sector only sustainable source of rising taxes for public health, education, etc.
“Pro-poor” IC improvements?
Improve IC where poor people live (often rural, but also peri-urban or even urban slums (land title in Peru)
Improve IC for activities poor people benefit from, whether as workers, entrepreneurs, consumers, etc (eg, Durban efforts for informal traders).
Breadth of impacts means pro-poor strategies are not limited to those benefiting smallest firms.

6. Risks, costs, & barriers to competition
Firms evaluate government policies & behaviors across a range of areas as part of a package.
Stability & security
Regulation & taxation
Finance & infrastructure
Workers &
labor markets
Governance
Risks
Costs
Government policies and behaviors shaping the IC cover a truly broad terrain. :
Stability & security includes peace, macro stability, and securing property rights, including through verifying rights to land, improving contract enforcement, curbing crime, etc.
Regulation and taxation includes measures both at and within the border [ie, includes trade policy].
Finance and infrastructure are key inputs to investment activities. Within infra, focus on telecoms, power, and transport (ports and roads).
Workers and labor markets includes worker skills, labor market regulation, and measures to help workers cope with change.
Governance features (including corruption, credibility etc) affect content and implementation of policies in all areas.
But firms do not evaluate policies etc in each area in isolation: They look at as part of a package. Hence, WDR focuses on impact on three key factors influencing opportunities and incentives for firms:
Risks -- Because investment is forward-looking, uncertainty and risk chill incentives to invest.
Costs -- Influence the range of opportunities that might be profitable, and hence incentives to invest.
Barriers to competition -- Individual firms prefer, less rather than more competition, but evidence shows that competition is fundamental to a good IC.
[elaborated in next slides].
Barriers to competition

7. Dominate concerns of firms.
Policy-related risks
Dominate concerns of firms.
Improving policy predictability can increase likelihood of new investment by over 30%.
Many risks are inherent in any investment activities--eg, responses by consumers and competitors, etc. But governments also create many risks for firms --and indeed policy-related risks dominate concerns of firms in developing countries.
Pie chart shows that policy uncertainty and macro instability are the 2 top-rated concerns across countries (also true across firms).
WDR shows that improving policy predictability alone can increase probability of new investment by over 30%.
Many more specific manifestations highlighted in IC surveys. Eg,:
Unpredictable interpretation of regulation:
China is 34%; Uganda 40%; Philippines 49%; Indonesia 56%; Guatemala 90%.
Lack of confidence in courts to uphold property rights.
Malaysia is 19%; India 29%; Philippines 34%; Indonesia 41%; Bangladesh 83%.
Percent of firms
Percent of firms

8. Can be over 3 times what firms typically pay in taxes.
Policy-related costs
Can be over 3 times what firms typically pay in taxes.
Governments influence many of the costs faced by firms, and hence the range of potential investment opportunities that might be profitable.
While firms everywhere complain about taxes, these are often not the most important cost burden influenced by government. For example, the costs of infrastructure disruptions, weak contract enforcement, bribes, crime and burdensome regulation can amount to over 3 times what firms pay in taxes. Moreover, unlike taxes, these costs arte borne regardless of whether a firm makes a profit, and do not contribute to public resources for improving the investment climate or other social goals.
These numbers show the Indonesia has a relatively high-cost environment. These costs alone are estimated to account for 20.2 percent of sales. The breakdown is as follows:
Unreliable infrastructure (7.9%);
Bribes (4.0%)
Contract enforcement difficulties (3.45%)
Regulatory burdens (2.42%)
Crime (2.4%).

9. Policy-related costs (2)
Costs also have a time dimension
Firms often spend >10% of management time dealing with officials.
Individual procedures can be onerous.
Time spent with officials is time not spent improving productivity or innovating. The number for Indonesia is about 15%, Philippines is 11%, Malaysia is 10%.
Numbers from World Bank Doing Business database:
To start a new business:
2 days in Aust.; 30 in Malaysia; 41 in China; 151 in Indonesia; 203 in Haiti.
To enforce a simple contract:
48 days in Neth.; 69 in Sing.; 390 in Thailand; 570 in Indonesia; 730 in Nigeria.
Calendar days
Calendar days

10. Policy-related barriers to competition
Restrict opportunities, increase prices for consumers, and weaken incentives to innovate and boost productivity.
More competitive pressure, more innovation
Barriers to competition play a critical role in the investment climate. Barriers deny opportunities to some firms, increase costs for firms depending on inputs from protected sector, and reduce incentives for protected firms to innovate and increase productivity.
High risks and costs act as barriers to entry. But governments also influence by regulatory barriers to entry and exit and approaches to controlling anti-competitive behavior by firms.
Analysis in WDR shows that firms facing strong competitive pressure at least 50% more likely to innovate.
WDR also reviews experience with competition policy in developing countries (ch. 5).

11. Variations within countries & across firms
Conditions vary within countries
Small firms often suffer most 25 50 75
Have a loan from a formal financial institution
Confident that courts will uphold property rights
Believe regulations will be interpreted consistently
Percentage of firms
Large
Medium
Small
Informal
Many early efforts to measure the IC have focussed on creating a single score for each country. But more micro-level analysis in WDR shows how this can be misleading:
Big variations within countries (see China data in left panel). In India, firms in states with good ICs are 40% more productive than those in states with with poorer ICs. Rural areas tend to have worse ICs. Reinforces important role of sub-national governments.
Big variations on the impact across different types of firms. These differences can depend on industry etc, but WDR highlights impact of firm size, and shows that small and informal firms often suffer most from a poor IC (examples in right panel). This means that those firms benefit disproportionately from improving the broader IC.
China

12. More than changes in formal policies?
Corruption & rent-seeking
Credibility gaps
If a good IC offers so many benefits, why is progress often slow and difficult?
WDR emphasizes that its not about lack of money -- many IC improvements demand little from the budget, and the growth unleashed can increase tax revenues.
Rather, 4 deeper sources of policy failure need to be navigated that require going beyond the formal laws and policies on the books:
Restraining rent-seeking: Not just corruption, but also the disproportionate influence exercised by connected firms that lead to deep distortions. WDR shows that those firms enjoy a better IC, but actually innovate less.
Building credibility: Not enough to pass a new law etc if firms lack confidence that will be implemented and sustained. A big issue with some reforms implemented to meet conditionality requirements.
Building public trust: Not just about firms and governments. Governments need to nurture broader public support to enable and to sustain reforms. Can have a direct impact on credibility and hence investment response.
Ensuring policy responses match local conditions [square peg, round hole metaphor]. Too often, laws are transplanted uncritically from other countries, and can lead to poor or perverse results (Jamaica example in ch 5). Historically, a big issue when laws transplanted from colonizing countries -- many remain on books today. But tendency persists.
Public trust & support
Fit with local conditions

13. Persistence, not perfection, is key
No country has a perfect investment climate.
Focus on important constraints, and sustain a process of ongoing improvements.
Priorities need to be determined in each case
Big differences across, and within, countries.
Maintaining momentum is essential
Public communication
Consultation bodies
Mechanisms to review existing constraints
Processes to review new regulatory proposals.
The agenda is broad. But no country has a perfect investment climate---firms in rich countries have a long list of complaints!
Experience shows that even modest initial improvements can unleash a strong response when they target important constraints and are implemented in ways that give firms the confidence to invest---eg, enhancing pty rights in China, trade and reg reforms in India. Because the most important constraints vary widely across (and within) countries, these need to be assessed in each case --- WDR has extended discussion on priority setting.
No less important, the countries making best progress highlight the importance sustaining processes of ongoing improvements. Important for two main reasons:
Size of benefits from improvements in one area often depend on progress in other areas. Eg, benefits from trade reforms limited if still have rigid labor markets that prevent firms from responding to new opportunities (Latin America). Eg, benefits from trade and market liberalization in India, while evident, did not translate into stronger productivity improvements due to severe barriers to exit (DB shows insolvency processes take 10 years in India).
The way business is conducted is evolving more rapidly with technological progress, so need to keep all policies under regular review to keep up with changes and benefit from lessons of experience.
WDR provides examples of successful strategies to maintain momentum--but strong political commitment key.

14. Focus on delivering the basics
Benefit all firms and activities in the economy
Stability and security
Peace and macroeconomic stability are fundamental.
Secure property rights link effort to reward.
Regulation and taxation
Balancing social goals.
Goal is better regulation and taxation, not necessarily less.
Finance and infrastructure
Traditional approaches have poor track-record.
Improve investment climate for service providers.
Workers and labor markets
Skilled and healthy workforce.
Regulate to benefit all workers.
Help workers cope with change.
WDR emphasizes the importance of focussing on delivering the basic foundations of a good investment climate. These benefit all firms and activities in the economy -- and deliver disproportionate benefits to smaller firms, including those in the informal economy.
The WDR has a chapter on each of the four core areas where it reviews the impact on policies on the investment climate and discusses examples of successful reforms in all regions. In a nutshell:
Stability and security: Peace and macro stability are fundamental--without these, other reforms will have little impact. Security of pty rights plays a key role in linking effort to reward.
Regulation and taxation: Involve balancing preferences of firms with other social goals. But approaches in developing countries are often so poor that huge opportunities to improve approaches without facing difficult tradeoffs.
Finance and infrastructure: Key is to provide a better investment climate for providers of these services, including more secure property rights, decent regulation, and competition wherever possible.
Workers and labor markets: Too often, governments focus on protecting existing jobs rather than creating an environment for creating new jobs. Labor market interventions need to take account of interests of all workers, including those that are unemployed or in the informal economy.

15. Going beyond the basics?
Selective interventions
Many rationales, but no sure-fire strategies.
More ambitious the goal, and the weaker the governance, the longer the odds of success.
Not a substitute for broader improvements.
Can be a distraction, and can go spectacularly wrong.
International rules and standards
Committing to enhance credibility
Forgone flexibility; Possible legitimacy concerns.
Harmonizing to reduce costs
Institutional fit; competition between standards.
Cooperating to address policy spillovers
Common priorities; capacity constraints.
Going “beyond the basics” raises additional challenges.
Selective interventions
Given breadth of the agenda, some areas, firms or activities may benefit from reforms earlier than others (eg, infra development in a particular region). But beyond that, some government target sub-groups for particular policy privileges, from tax breaks, subsidized credit, market reservations, etc.
While govts have been experimenting with these approaches for centuries, experience shows no sure-fire strategies. At best, a modest positive impact. But very often ineffective, or even if they deliver some benefit not obvious that the intervention was cost-effective. And often just introduce deeper distortions and distract attention from broader-based measures. WDR reviews experience in particular areas and proposes simple guidelines to reduce risks.
International rules and standards
Having been growing exponentially. Now cover every aspect of the IC.
WDR shows that can help improve the IC, but also involves many tradeoffs. Need to be evaluated in each case.

16. The international community can help
Growth from better investment climate can dwarf value of aid flows
Manufacturing value-added vs. global aid flows
Investment climate improvements can deliver huge dividends in growth and poverty reduction. While hard to compare directly, the value-added in manufacturing unleashed by IC improvements in a single country can far exceed the value of aid provided worldwide (figure). This underlines the huge leveraging potential of international efforts to improve ICs.
The main responsibility for improving ICs lies with governments of host countries---they hold the levers, through their policies and behaviors, to make a huge difference. But the WDR points to several things the international community might do to help. The three main measures are:
Removing trade barriers and other market distortions in developed countries that undermine ICs in developing countries. By one estimate, the benefits to DCs could be worth more than four times the value of aid given for IC improvements.
Strengthening aid for IC improvements. The WDR highlights the importance of well-designed technical assistance --- and notes that currently this attracts fewer resources than the support provided to individual firms and transactions, which while important, has a narrower impact.
Tackling the substantial knowledge agenda. Still a vast agenda here, where progress can help provide further insights for policymakers in developing countries.
International community should do more
Reduce distortions in developed countries
Strengthen aid for investment climate improvements
Tackle substantial knowledge agenda.

17. Main messages
Improving the investment climate is critical to faster growth and deeper poverty reduction.
Reduce policy-related risks, costs, and barriers to competition.
Requires more than changes in formal policies.
Persistence, rather than perfection, is key to progress.
Focus on delivering the basics.
International community should do more to help.