Business Page – October 24, 2004

This is the provocative title of the World Bank's World Development Report 2005, released late last month. The report notes that a good in-vestment climate with opportunities and incentives for firms - whether multinationals to micro-enterprises - to invest productively, creates jobs, and leads to a growth in the economy. Significantly, the report deems job creation and the provision of other opportunities for young people as essential to create a more inclusive, balanced, and peaceful world.

While there was perhaps already sufficient empirical evidence of the importance of the investment climate, a survey of more than 26,000 firms in 53 developing countries, and the Bank's Doing Business Project, which benchmarks regulatory regimes in more than 130 countries, both provide further insights into how investment climates influence growth and poverty. Like the World Investment Report which was addressed in this column last week, this report also provides experiences and guides to the options open to governments to create a better investment climate - an investment climate that benefits society as a whole, not just firms, and one that embraces all firms, not just large, politically-connected ones.

There is perhaps no more striking evidence of the link between the investment climate and poverty reduction than the performance of the economies of India and China. Indeed, investment climate improvements in China led to the most dramatic poverty reduction in history, lifting 400 million people out of poverty over 20 years during which time the proportion of that country's population living on less than US$1 per day has declined from 64% in 1981 to 17% now. India with a growth rate of approximately 7% in the mid-nineties saw a fall from 54% to 35% in the same group in the last two decades of the last century. It is the performance of these two countries that will be mainly responsible for the millennium development goal of halving the proportion of the world's population living in poverty by the year 2015.

The report identifies four issues which it considers critical to investment - improving policy predictability, economic and political instability, infrastructure disruption, corruption and inability to enforce contracts. Warwick Smith, the lead author of the report suggests that governments need to focus on improving the basic framework within which entities operate - stability and security, regulation and taxation, finance and infrastructure and worker and labour markets. He calls for education and worker training, effective labour regulations and the need for the government to help workers cope with the changes in industry and business as new firms enter while others exit.

The report notes that it is not necessary - indeed it might be undesirable - for all the changes to be made at one time, and cites China, India and Uganda as successes. It considers that the contribution firms make to society shape the opportunities and incentives for firms to invest productively, create jobs, and expand, and that these are largely shaped by government policies and behaviour. It notes that while governments have limited influence on factors such as geography, they have more decisive influence on the security of property rights, approaches to regulation and taxation (both at and within their borders), the provision of infrastructure, the functioning of finance and labour markets, and broader governance features such as corruption.

Driving growth

As population increases, particularly in the poorer developing countries, the imperative for economic growth becomes more urgent. An appropriate investment climate drives growth by encouraging investment and higher productivity. Investment underpins economic growth by bringing more inputs to the production process. While we in Guyana often mistakenly consider investment as meaning foreign investment, the report reveals that the bulk of private investment remains domestic.

It is, however, not just the volume of investment that matters for growth, rather it is the productivity gains that result. In other words, does the investment climate encourage higher productivity by providing opportunities and incentives for firms to develop, adapt, and adopt better ways of doing things - not just innovations of the kind that might merit a patent, but also better ways to organize a production process, distribute goods, and respond to consumers?

Fortunately businesses in Guyana are mercifully spared some of the problems identified as existing elsewhere, such as barriers to importing modern equipment and adjusting the way work is organised. Problems which we share, however, include sufficient comfort with what Joseph Schumpeter called "creative destruction" - an environment in which firms have opportunities and incentives to test their ideas, strive for success, and prosper or fail. A good investment climate makes it easier for firms to enter and exit markets in a process that contributes to higher productivity and faster growth. The report reckons that net market entry can account for more than 30 per cent of productivity growth, and that firms facing strong competitive pressure are at least 50 per cent more likely to innovate than those reporting no such pressure. There are still too many entities which believe that they have a right to exist - too big or old or connected to fail.

The critical role the investment climate plays in poverty reduction can be seen firstly at the aggregate level where economic growth is closely associated with reduction in poverty. As we stated above, both China and India are profound examples of what changes in policies can do and the benefit of clear rules of engagement when it comes to investments.

At the level of setting the investment climate, there should be absolute clarity and a completely objective and rules-based approach. Instead of the Investment Act providing the clarity and removal of political involvement in the investment approval process, it has in fact aggravated the situation, as bureaucrats at best second guess the politicians and at worst await political directions, while the public and more importantly, the business community, act as if unaware of the legislation. That community disengaged itself once the legislation was passed and must now accept some of the blame for its ineffectual operation; it should start asking questions of the government.

The Investment Act was intended to be supplemented by some kind of guide prepared by the Guyana Office for Investment (GO-Invest) but that office has been noticeably invisible and one wonders whether it is again the strain between the personalities in that office and the Ministry of Trade. Both heads of these entities should be concerned that Guyana is not among the countries in the Doing Business Project of the World Bank with which they must be assumed to be familiar.

Policy uncertainty is a major deterrent to investment, and Mr Smith said that the survey found that "the number one concern of firms was actually policy uncertainty - not knowing what the government would do next." He added that his team saw other manifestations of these policy risks as well. For example, more that 80% of firms in Bangladesh lacked confidence in the courts to uphold their property rights. Quite a large number of firms in many countries also find regulation to be "completely unpredictable."

The report notes the three major influences which the government exerts on the investment climate through the impact of their policies and behaviour on the costs, risks, and barriers to competition facing firms.

Next week we look at how this happens and how the influence can best be exerted.

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