Firms, Growth andthe Investment Climate

Mark SchafferCERT, Heriot-Watt University

Outline of talk

• What is the “investment climate”? (=IC)

• Enterprise restructuring and performance: lessons from 15 years of transition

• The IC and the growth of firms

• Findings from a study of 50 transition and developing countries for the Serbia ICA (joint w/ I. Goldberg and B. Radulovic)

What is the “investment climate”?(Alternatively: “business environment”)

“You might as well say: ‘the investment climate will be stormy in the morning, gradually clearing by mid-afternoon with scattered expropriations’.”

NB: curiously, the identity of the critic isn’t clear. Bill Easterly is the author of the paper...

…and appears as such in the published version...

…but in the working paper, the quote is attributed to “The President of the World Bank, April 2002”.

One critic writes:

What is the “investment climate”?(Alternatively: “business environment”)

But this scepticism is unfair.

=> importance ofeconomic institutions

The investment climate/business environment is the environment in which firms operate:

• Macroeconomic environment

• Infrastructure

• Competition

• Regulation

• Crime, corruption

• …etc.

What makes firms in transition economies adjust, restructure and grow?

Traditional distinction between types of firms in transition economies:

• State-owned firms (SOEs)

• Privatised firms

• New private firms

Performance of SOEs in transition economies

SOEs engage in “passive restructuring”

• Fall in output, change in product mix

• Gradual labour shedding, downsizing

• Wage restraint

• Basic cash flow management

…but not “deep restructuring”. Downsizing but not growth.

What makes SOEs in transition economies adjust and restructure?

• Competition

• Hard budget constraints

• Good business environment

Performance of privatised firms in transition economies

Initially, privatised firms look like SOEs

• “Passive restructuring”

In longer term, get 3 kinds of outcomes:

• Continued passive restructuring

• Deep restructuring (good)

• Looting and collapse (bad)

What makes privatised firms in transition economies adjust, restructure and grow?

• Competition

• Hard budget constraints

• Strong outside ownership, e.g., concentrated ownership blocs, foreign investors

• New management, i.e., new human capital

• Good business environment, esp. corporate governance framework and property rights protection (otherwise => looting)

Performance of new private firms in transition economies

• The initial engine of growth (Poland, China)

• Very strong performance - many startups, though also many exits

• Major source of job creation

Why so strong?

• Entrepreneurship, new human capital

• Property rights and corporate governance

What makes new private firms in transition economies grow?

• Competition (easy)

• Hard budget constraints (also easy)

• Strong ownership (very easy)

• Good business environment (hard), esp:

• Ease of entry

• Protection of property rights

• No “Grabbing Hand” of the State

Lessons and surprisesfrom 15 years of transition

Relatively few qualitative surprises:

• The private sector expected to lead growth

• Macro stability promotes growth

• “Market forces can work”

• ...etc.

All this and more was believed in 1989 and is still believed today.

Lessons and surprisesfrom 15 years of transition

Quite a few quantitative surprises

• Depth and length of the recession

• Time needed for privatised firms to turn round

• Importance of the new private sector

• “Market forces can work” ... perversely on a large scale in a poor IC (e.g., corruption)

• Importance of market-enabling institutions and the business environment/investment climate

The “investment climate” and the productivity and growth of firms

• World Bank and EBRD Investment Climate - Business Environment surveys (PICS, BEEPS)

• Firms asked to rate aspects of their IC/BE

• Goal 1: Learn about countries

• Goal 2: Learn about firms, IC/BE, growth

The “investment climate” and the productivity and growth of firms

Typical IC/BE survey question (scale 1 to 4):

“How much of a problem is X for the operation and growth of your business?”

• Macroeconomic stability

• Skills shortages

• Customs regulations

• Corruption

• Access to finance

• …etc.

The “investment climate” and the productivity and growth of firms

Usefulness of the “climate” metaphor

• Surveys provide info about the “country IC”

• Ex: customs regulations are rated a bigger problem in country 1 than in country 2

• Surveys also provide info about the firm and the “micro climate” it faces

• Key point: the obstacles reported by the firm also depends on the characteristics of the firm.

Meet Joe Btfsplk

Joe Btfsplk is a character from an old American cartoon, “Lil’ Abner”

Nothing ever goes well for Joe:

Indeed, he carries his climate around with him.

The “investment climate” and the productivity and growth of firms

Serious point: what firms report as their IC tells us about what kinds of firms they are.

What aspects of the IC do growing, investing firms say restrict their business?=> Policy should reduce these constraints

What aspects of the IC do poorly performing firms say restrict their business?=> Beware reducing these constraints!

“Productivity, Ownership and the Investment Climate”

• Authors: Itzhak Goldberg (WB), Branko Radulovic (WB), Mark Schaffer (CERT)

• Prepared for the WB’s Investment Climate Assessment (ICA) for Serbia.

• Based on survey data from 27,000 firms in 50 countries, 26 transition economies and 24 low/middle income market economies

• =>We ask: Is Serbia “different”?

Research strategy

Same two questions, prefaced by a third:

2. What aspects of the IC do growing, investing firms say restrict their business?=> Policy should reduce these constraints

3. What aspects of the IC do poorly performing firms say restrict their business?=> Beware reducing these constraints!

1. What are the characteristics of growing, investing firms?

1. What are the characteristics of growing, investing, high productivity firms?

• New private firms: faster employment growth, more investing, etc.

• … followed by privatised firms

• Foreign-owned and exporting firms have higher productivity

• Is Serbia “different”? No.

Answers: no surprises. A sample:

2. What do growing, investing firms say restricts their business?

• New private and investing firms complain about corruption and excessive regulation

• Foreign-owned, exporting and new private firms complain about infrastructure

• High employment-growth and investing firms complain about skills shortages

• Is Serbia “different”? No.

Answers: various. A sample:

3. What do poorly performing firms say restricts their business?

• Low-productivity firms,

• Labour-shedding firms, and

• Low-investment firms...

• …all complain about availability of finance.

=> Be careful about trying to make this aspect of the IC more friendly!

Answer: simple.

Firms, Growth andthe Investment Climate

Mark SchafferCERT, Heriot-Watt University