Washington, DC, September 28, 2004 - Accelerating growth and reducing poverty require governments to ensure a healthy investment climate by limiting the policy uncertainties, added costs, and barriers to competition that confront firms of all types, concludes the World Bank’s annual World Development Report for 2005, launched here today.

For example, China’s investment-climate reforms over the last two decades helped lift 400 million people out of poverty, and the manufacturing value added in China and South Korea alone is much larger than all global aid flows.

“A good investment climate is central to growth and poverty reduction,”said François Bourguignon, the World Bank’s Senior Vice President and Chief Economist, in 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 World Development Report surveyed more than 6,500 businesses throughout East Asia -- from farmers and micro-entrepreneurs to local manufacturing companies and multinationals -- and found that policy risks, macroeconomic instability, and corruption are key obstacles to doing business in the region.

The report highlights opportunities for governments to improve their investment climates by expanding the opportunities and incentives for firms to invest productively, create jobs, and expand. A more detailed examination of the investment climate in East Asia will appear in the half-yearly East Asia and Pacific Regional Update, to be launched November 9, 2004.

Arbitrary regulation and uncertainty about the content and implementation of government policiesis the leading concern of businesses in the region. Policy-related costs shouldered by firms can also be substantial, and make many potential investment opportunities unprofitable. The report found that improving policy predictability alone can increase the likelihood of new investment by more than 30 percent.

Macroeconomic instability and corruption ranked as the second and third most pressing concerns, respectively. The majority of firms in East Asia reported that paying bribes is required to “get things done.” Crime, corruption, and unreliable infrastructure services (such as electricity supply) can impose costs more than double those of government regulation. Together with weak contract enforcement and onerous regulation, these costs can amount to more than 25 percent of sales—or more than three times what firms typically pay in taxes.

Barriers to competition arealsopervasive and reduce incentives for firms to innovate and increase their productivity, which is key to sustainable growth.  High risks and costs restrict competition, as well as inadequate efforts to curb anticompetitive behavior by firms. According to the report, stronger competitive pressure can increase the probability of innovation by more than 50 percent.

Poor investment climates also hit small firms and those in the informal economy the hardest.  The Report found that these firms have more difficulty 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 improvements require changes to laws and policies, the report highlights four deeper challenges:

·         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.

·         Building the credibility of government policies.  Passing new laws has little impact if firms don’t believe they will be enforced or sustained.

·         Fostering public support for policy improvements.  Failure to build public support for creating a more productive society slows reforms and jeopardizes their sustainability.

·         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:

·         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.

·         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.

·         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.

·         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 many cases where such interventions have gone spectacularly wrong,” said Michael Klein, World Bank/International Finance Corporation Vice President 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

The Report cites China’s experience to demonstrate the potential returns to investment climate improvements. China demonstrates the significant impact of investment climate improvements in increasing growth and poverty reduction. China’s growth is officially reported at an average of eight percent a year for the past 20 years, and the share of its population below $1 a day fell from 64 percent in 1981 to 16 per cent in 2001.

The report emphasizes that a country does not have to reform everything at once. 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. It has since introduced a number of reforms to encourage the development of private business, attract FDI, and improve business regulations and infrastructure. While the country’s investment climate is still not perfect, the persistence of its reform process has yielded enormous benefits.

The International 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:

·         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.

·         Providing more, and 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.

·         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.

The report and related materials are available to the public at:  http://www.worldbank.org/wdr2005