A Better Investment Climate

for Everyone

2005world development report

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.

3

A better investment climate for everyone

Better for society as a whole, not just firms Better for firms of all types.

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 >140 countries• Complemented for Uzbekistan by IFC SME Survey 2003

4

Driving growth

0 5 1 0 1 5 2 0

U g a n d a

In d i a

C h i n a

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.

5

47% 62%81%

23%

21% 16%

8%9% 14%

5%

18%

8%

2001 2002 2003

M ajor repairs of equipment and reconstruction of premises

HAVE NOT INVESTED INTO FIXED ASSETS

New construction and equipment

Transportation vehicles and other

In Uzbekistan the share of private SMEs who HAVE NOT INVESTED in fixed assets has doubled over the past three years (IFC SME survey 2003)

% of respondents

6

Risks, costs, & barriers to competition

Stability & security

Regulation & taxation

Finance & infrastructure

Workers & labor markets

Governance

Risks

Costs

Barriers to competition

Firms evaluate government policies & behaviors across a range of areas as part of a package.

7

Policy-related risks

Interpretation of regulation is unpredictable

0 20 40 60 80 100

Guatemala

Georgia

Kyrgyz Rep.

Armenia

China

Lack confidence in courts

0 20 40 60 80 100

Bangladesh

Kyrgyz Rep.

Georgia

Ukraine

China

Dominate concerns of firms.

Improving policy predictability can increase likelihood of new investment by over 30%.

Percent of firms Percent of firms

8

In Uzbekistan the legislative base is sometimes contradictory

(IFC SME Survey 2003)… and…For example, when assessing VAT liability on imported goods, the following regulations contradict each other:

Tax Code; Directive approved by a joint Resolution of the Ministry of

Finance and the State Tax Committee (dated March 7, 2003)

9

… Changes in regulations which impact businesses do not consider the opinion of entrepreneurs

In 2003, the Cabinet of Ministers adopted over 40 decrees and resolutions directly effecting the activities of SMEs.

But: recent launch of discussion groups through Chamber of Commerce a hopeful sign of change

“Why are regulatory documents which affect the business environment never publicly discussed with those who are being impacted by such changes?”

-- IFC SME survey - 2003 Focus Group participant

10

Policy-related costs

Taxes are rarely the biggest burden

11

Policy-related costs (2)

Costs also have a time dimension >10% of management time often spent dealing with

officials. Individual procedures can be onerous – and have

wide-ranging implications.

Starting a new business

0 25 50 75 100 125 150

Indonesia

Uzbekistan

Ukraine

Georgia

Armenia

Kyrgyz Rep.

Australia

Enforcing a contract

0 200 400 600 800 1,000

Serbia

Kyrgyz Rep.

Georgia

Uzbekistan

Ukraine

Armenia

Singapore

DaysDays

12

Policy-related barriers to competition

Restrict opportunities, increase prices for consumers, and weaken incentives to innovate and boost productivity.

More competitive pressure, more innovation

13

Variations within countries & across firms

0

25

50

75

Have a loanfrom a formal

financial institution

Confident that courts will

uphold property rights

Believe regulations will be interpreted consistently

Percentage of firms

Large

Medium

Small

Informal

Small firms often suffer most

0

5

10

15

20

25

Shanghai Beijing Chengdu

Day

s

0

1

2

3

4

5

6

7

Perc

ent

Days to obtain a mainline telephoneconnection% of production lost due to power outages

Conditions vary within countries

China

14

Investment climate constraints – priorities vary by country

Source: World Bank Investment Climate Surveys

Share of firms reporting ‘severe’ or ‘very severe’ obstacle

0

0.5

1Security & Stability

Regulation

Taxation

Finance

Infrastructure

Labor

Bulgaria Georgia Ukraine

15

Major business constraints in Uzbekistan in 2003 – some improvements but still major obstacles for private business

0% 10% 20% 30% 40% 50% 60%

Convertibility

Inappropriate functions of banks

Certification and Standardization

Licensing

Export-import operations

Registartion

Inspections

Permits and approvals

Payment operations at banks

Taxation

2003

2002

% of respondents

8987

8881

9492

7584

9695

3945

5062

4655

5650

3854

Answered to the question (in %)

Share of respondent who indicated that these processes were “rather problematic” or “very problematic”

16

Major business constraints in Uzbekistan: tax system and informality

65%

27%

8%

20%

29%

51%

up to 20% of a profit

20-50% of a profit

over 50% of a profit

hide

do not know /no answ er

do not hide profits from

taxation

“I am not against working fairly, however under existing conditions I hardly will be able to cover my costs. That’s why I have to hide part of my operational resources from official documentation.”

--Focus Group Participant

Under existing business conditions, please estimate the share of sales hidden from taxation by companies similar to yours?

17

Major constraints to business in Uzbekistan: discretionary power of controlling agencies

Controlling agencies have the right, without a court order, to:

Suspend banking operations on an account

Collect penalties on an indisputable basis

Suspend activities of an enterprise

Impose fines of up to 1000-times the minimum wage

BUT: Changes to penalty and sanction system are under preparation“At present, controlling agencies can come and basically “kill” my business

without even presenting evidence of wrongdoing on my part. Although, in accordance with our Constitution no one has a right without a court’s decision to deprive me of my rights, including the right to entrepreneurial activity”

Focus Group Participant

18% of respondents, who faced the problem

10%

27%

21%

37%

8%

35%

36%

55%

2%

21%

40%

66%

0%

Difficulties in convertingnational currency into

foreign currency

Banking bureaucracy

Periodic shortage of cashat banks

Difficulties with cashwithdrawal from local

currency account

2003

2002

2001

Major business constraints in Uzbekistan: access to cash

19

Major constraints in Uzbekistan: bureaucratic obstacles against foreign trade

19

Why are you not involved in export / import operations?

20

More than changes in formal policies

Corruption & rent-seeking Credibility gaps

Public trust & support Fit with local conditions

?

21

State capture can be costly

Source: World Bank Investment Climate Surveys

Evidence from Eastern Europe and Central Asia shows more influential firms face significantly fewer obstacles

And yet are 50% less likely to innovate, invest and create new jobs

0

10

20

30

40

50

60

Crime

Elect

ricity

Labor r

egula

tions

Licen

ses a

nd per

mits

Legal

sys

tem

Custom

s

Access

to fi

nanci

ng

Corruptio

n

Tax a

dmin

istra

tion

Policy

uncerta

inty

% f

irm

s re

po

rtin

g m

ajo

r co

nst

rain

tLeast influential firms

Most influential firms

22

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.

23

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.

24

Going beyond the basics?

Selective interventions Many rationales, but no sure-fire strategies.

The 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.

25

The international community can help

Growth from better investment climate can dwarf value of aid flows

Manufacturing value-added vs. global aid flows

International community should do more Reduce distortions in developed countries Strengthen aid for investment climate improvements Tackle substantial knowledge agenda.

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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.