A better investment climate for everyone
By Christopher Ram
October 31, 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.
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.
We continue this article influenced by the publication of World Bank's World Development Report 2005, released late last month. This report has both relevance and lessons for us in Guyana since it seems to be addressing issues with which we have been familiar and indeed concerned for a very long time. We noted that the report had identified uncertainty of policies as one of the major barriers to investment, as well as the three major influences which the government exerted on the investment climate through the impact of their policies and behaviour on the costs, risks, and barriers to competition facing firms. It was not enough for the government to address one or two of them - a government serious about attracting investments both local and foreign had to tackle all three, and variations in investment climates around the world highlighted the potential for improvement.
It only takes a superficial look to see how government policies and behaviours influence the costs of doing business and hence the range of investment opportunities that might be profitable, with taxes being the most obvious example. But the role of governments is not only to regulate the level of taxes - they must also provide those public goods, supporting the provision of infrastructure, and addressing market failures which no single entity can or should do, even in a private- sector driven economy.
The supply of electricity has been a bugbear of this country for close to a quarter of a century, and has created severe dislocations not only in the manufacturing sector but across the economy and the society. No business can operate with unreliable and inadequate electricity and the cost of the back-up system has been enormous and debilitating. This explains why this column considers any comparison of electricity tariff with other countries completely academic. It is not just the cost of acquisition of back-up facilities or the fuel consumed, but also the disruption and the salaries and wages and physical facilities which have to be made available.
The physical considerations are indeed formidable, as, for example, road access and potholes which do serious damage to vehicles. There are, however, the less visible costs such as crime, corruption, statutory compliance or the inefficiencies of the marketplace which can cause serious distortions, or the unnecessary barriers which impede the rate at which business can enter or exit the market. Not that we have done nothing in certain sectors, but ironically those areas we have addressed have generally placed a necessary cost on entities in the sectors on which some controls have been placed such as the insurance and financial businesses.
Our court system is riddled with problems such as contract enforcement, ownership difficulties and the speed with which simple legal processes are completed. Which serious country would shut down its companies' registry for months or would allow for delays of years in settling important business issues? What type of credible complaint mechanism exists to deal with the corrupt official who insisted on being paid tens of thousands of dollars for a straightforward licence? The businessperson who is an active and guilty a participant in this illegality usually compounds it by hiding the transaction for his auditors. It may not be in the books but it is a cost all the same.
Noting that costs also have a time dimension, the report notes the large variations in the time taken to obtain a telephone line and to clear goods through customs, as well as in the time managers need to spend dealing with officials. In the more developed countries it takes just a couple of days to register a business, but several months in Third World countries.
Government's role is to maintain a stable and secure environment, including protecting property rights. It should be recognized that policy uncertainty, an unstable economy and a decision-making process that at best appears illogical, inhibits opportunities and chills incentives.
This is not to suggest that governments must bear firms' risks or that the firms should not do serious, professional and independent research. Businesses by their very nature are forward-looking and therefore risky, but those are normal and reasonable costs of doing business, regardless of the country. The government's role is to see that it does not make it any more risky.
Barriers to competition
Naturally, firms love monopoly, but barriers to competition benefit some firms while denying opportunities and raising costs for other firms and for consumers. They can also dull the incentives for protected firms to innovate and increase their productivity. In this regard, the government does little to help, and even after criticising the most generous package of incentives granted to Barama by the PNC, the government is reported to have extended the same concessions for another ten years.
Despite its avowed intentions to free up the telecommunications sector, it has watched like any helpless citizen as ATN dragged out any attempts to introduce competition into the sector.
Once again reflecting our own conditions, the report notes that over 90 per cent of firms in developing countries report gaps between formal policies and what happens in practice. The report notes the basic tension underlying this gap because of the mismatch between the objectives of firms - both local and foreign - and those of the societies in which they operate. This tension is most evident in taxation and regulation.
Most firms complain about taxes, but taxes finance public services that benefit the investment climate and other social goals. Many firms would also prefer to comply with fewer regulations, but sound regulation addresses market failures and can therefore improve the investment climate and protect other social interests.
Without a sound and possibly legally-instituted investment regime, developing countries behave as though they have little choice, and when the crunch comes the big and influential company almost invariably gets what it wants.
But governments must recognize that the investment climate is for everyone and the creation of a good investment climate that balances the interests of all, including the government is the real challenge it faces.
A process, not an event
The report adds that no country has a perfect investment climate, and that perfection in even one policy dimension is not necessary for significant growth and poverty reduction. Experience shows that progress can be made by addressing important constraints in a way that gives firms confidence to invest, and by sustaining a process of ongoing improvements. The important thing is to start. Minimum tasks include strengthening government capabilities, enhancing the court system, reducing crime, improving domestic taxation as well as regulation and taxation at the border.
Conclusion: Where to start?
After considerable persuasion over several years, the President assented to the Investment Act 2004 on March 31, 2004, the deadline for the tabling of the National Budget. Out of this should have come an Investment Code, the designation of investment priorities and the appointment of an Investment Promotion Council. Abso-lutely nothing has happened since, and it is tempting for the cynic to conclude that it was only because of the pressure from the United States Agency for International Development (USAID) and the PR to be had from crowing about it in the 2004 budget speech that the act was passed. We could not have a more wrong reason.