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World Development Report 2005 Press Briefing

Francois Bourguignon
World Bank Chief Economist
Warrick Smith
World Development Report Director

Washington, D.C., Tuesday, September 28, 2004



MR. NEAL:  Good morning, ladies and gentlemen.  I'm sorry we're a little bit late. 

Welcome to this launch of the World Development Report 2005:  A Better Investment Climate for Everyone.  My name is Chris Neal, and I'm the External Affairs Officer for the Development Economics Department, which is the department in which this sits in the Bank.

I'd like to remind everybody that we have an embargo at noon today, so please, no stories out on the wires until 12:00 noon to make the rules fair for everyone.  On my immediate left is Francois Bourguignon, the Chief Economist for the World Bank, and he'll be introducing the theme.  Then, we'll move on to Warrick Smith, who is the lead author of the World Development Report 2005 team on the investment climate, and he will go into some detail on the main messages of the Report; and then, finally, Michael Klein, who's the Vice President for Private Sector Development and Chief Economist at the International Finance Corporation. He will complete for us, and explain how some of the messages of the WDR can be found in our operational work.

So without further ado, I'll pass it on to Francois Bourguignon.

MR. BOURGUIGNON:  Thank you very much, Chris, and welcome to this release of this year's World Development Report, the title of which is A Better Investment Climate for Everyone.  This is the 27th report of this type by the Bank.  As you know, these books are intended to take stock of the current state of knowledge on a key development topic, and this year's report addresses the important questions of how governments can improve investment climate of their societies to increase growth and reduce poverty.

Improving the investment climate is the first pillar of the Bank's overall strategy for poverty reduction, and from that point of view, this report complements last year's WDR, Making Services Work for Poor People, which addressed the key aspect of the second pillar of that strategy:  investing and empowering poor people, an objective directly related to the Millennium Development Goals.

Of course, investment climate and empowerment are two mutually reinforcing goals.  A better investment climate provides better opportunities for poor people, whereas an empowered population provides a more efficient and productive labor force for firms. 

Each World Development Report aims not only to capture the existing state of knowledge in some area of development but also add to that knowledge through new research.  In the case of this year's WDR, those new contributions include the following.  This WDR relies on early results of the Bank's program of Investment Climate Surveys, which is covering 30,000 firms in 53 developing countries.  This sample of firms has been extended by 3,000 surveys of micro and informal enterprises in 11 developing countries; in addition to that, country case studies from all regions reviewing lessons of experience in designing and managing investment climate improvement with special focus on the fascinating experience of China of India; and finally, the integration of the findings of the Bank's Doing Business Report, the second edition of which was released earlier this month, into a broader analytical framework and confronting the findings of that report to data on actual firm behavior.

I would summarize the main messages of the Report in four simple points, and I will then leave Warrick Smith to get into more detail.  First, a good investment climate is critical to growth and poverty reduction.  Of course, it contributes to expanding opportunities and incentives for firms of all types, from micro-entrepreneurs to the informal economy, to the formal economy, to multinationals to invest productively and create jobs and expand.  But society as a whole also benefits from a better investment climate through more and better jobs, more affordable goods and services and through the public services that can be financed from taxes on the growing private sector.

Second, how to get a better investment climate?  Essentially, through reducing unjustified costs and risks faced by firms and through eliminating barriers to competition.  What are these costs and risks?  Essentially, weak contract enforcement, corruption, crime, unreliable infrastructure, and burdensome, inefficient regulation; but also must take into account risks like policy uncertainty, insecure property rights, or macroeconomic instability, which are also powerful deterrents to investment.  I was visiting Colombia recently and discussing with entrepreneurs there.  I was told that one of the main deterrents for the present state, the present investment climate, was the fact that the fourth tax reform in three years was being considered by the Government.  This is typically the kind of policy uncertainty we are referring to here.

Third conclusion:  progress requires more than change in formal policies.  It is not sufficient to pass a new law.  We have or we observe in the surveys a gap between formal policies and what happens in practice.  The problem is to change things on the ground, not only in the books.

Finally, this is report is important for identifying priorities.  Experience in China, India, but also Uganda, suggests that impressive progress can be obtained by tackling the most important issues rather than spreading effort on the whole range of investment climate determinants.  The whole issue is that of identifying priorities and to deal effectively with that.  And this report should help countries in doing so.

But now, let me turn to Warrick, the lead author of the Report, to present its findings in more detail.  Thank you very much.

MR. SMITH:  Good morning.  Let me elaborate slightly on Francois' brief opening remarks and just as context clarify, as with all World Development Reports, this is a product of a team who lock ourselves away for about a year beavering away feverishly on some of these topics.  So I am representing a larger group.

Just to elaborate slightly the main messages, as Francois mentioned, really, the links with growth and poverty reduction are what motivate this exercise.  We're not particularly interested in improving conditions for firms' sake, but really, what is the contribution to society and more particularly to poverty reduction, and you'll see in the Report, that's reflected throughout.

Let me go straight through some of the broader points.  The caption we chose for the Report is "A Better Investment Climate for Everyone," to really capture two senses. 

One is we believe a good investment climate is not just good for firms but good for society as a whole, including through job creation, taxes and the like, but also, that it embraces firms of all types and sizes.  Now, a large amount of work has been done over the years on the perspectives of foreign investors in developing countries, and we review the evidence in the Report and certainly show that foreign investment can and very often does deliver substantial benefits to developing countries. 

But what had really been missing from the analysis, to a large degree, were the perspectives of local firms.  And that's important for many reasons, not least in the figure on the left shows about 80 percent of investment in developing countries is actually domestic, not foreign, so it's a very large part of the economy, and improving conditions for that part of the economy is obviously very important.

But more than that, a large part of the economies in developing countries, actually, activity occurs in the informal sector.  They're either not registered businesses, or they're not complying at least partly with normal laws, regulations, and policies, and the figure on the right gives some indication of that.  So we found it really important to understand not just large local firms but even right down to the smallest local firms, whether they be street vendors, people working markets, home workers and such like, and that is what really motivated us to extend the Bank's program of Investment Climate Surveys to understand the perspective of microentrepreneurs as well.

Francois already alluded to the fact that we talk a little bit in this report about the experience of China, India, and Uganda.  Let me just give you why we chose those three countries.  I think in China, the growth record in that country of the last 20 years has simply been unprecedented, and it's also been matched by really dramatic reductions in poverty.  Around 400 million people have been lifted out of poverty.  And for some time, some commentators were speculating that somehow, China was heterodox, doing something unusual.  We wanted to really understand what was going on there.

We also looked at India, which is a country that is often contrasted with China, partly because of the size and the poverty impacts, to see what was done there and how that played out.  Again, some of the investment climate reforms implemented in that country led to a doubling of growth rates since the seventies.  So we wanted to understand what was driving that. 

And there's always a concern that when you talk about large economies that somehow, what we're saying is not fully relevant to other developing countries.  So we looked at the experience in Uganda, a relatively small, landlocked country in Africa, to work out why was it that that country has managed to grow at something like eight times the average in Sub-Saharan Africa and see what we could distill from those experiences.

Now, on poverty reduction, we looked at this in two ways.  I think it's reasonably well understood now that there is quite a strong association between growth and poverty reduction, but we weren't really satisfied with that.  We really wanted to go beyond aggregate numbers and look at the direct impacts on opportunities and living standards of poor people, and so, you also find in the Report discussion of how particular reforms have led to expansion of jobs, higher wages, reducing the costs of goods consumed, which we see in many countries as a result of this, but also improving opportunities for people in their noncommercial lives.  For example, some of the research we draw on shows that in Peru, improving title to land for urban and slum dwellers allowed people to work more hours outside the home.  So we go through some of that evidence.

And when we think of the investment climate and in particular, the way governments influence it, it covers a truly huge set of policy areas, which traditionally, many technicians view in isolation.  There will be finance specialists and infrastructure specialists and macroeconomists, et cetera.  But I think the reality is firms don't evaluate any of these in isolation.  They view them as part of a package.  And so, as well as trying to understand what constituted good policies in each of these areas, we spend some time in the Report trying to understand how they fit together.

And we thought the most useful framework to try and have that discussion was really to isolate how they impact on firms, which, as Francois indicated, we looked at the impacts on the risks firms face, because obviously, that affects the incentives they face to invest and create jobs; on the costs they bear, which influences the range of opportunities that might be profitable, and therefore, the level of activity, but also on the impact on competition, because I think we now know that long-term growth is not driven by investment alone.  In fact, experience shows that a very large part of growth is driven by improving productivity, and competition is really the key force behind enhancing productivity.  So that's the three elements of the framework.

Francois has already mentioned that policy uncertainty is the single largest concern of firms in developing countries.  So while there are always concerns about taxes in every country, there are always concerns about infrastructure and regulation, there's policy uncertainty:  basically, firms not knowing what the government will do next, whether that be continual changes to laws or simply poorly-defined laws or the future direction of government policy is perhaps the single biggest challenge, and work we've done shows that if governments can improve the predictability of their policies, that measure alone could increase the likelihood of new investment by over 30 percent.  So we are not talking about small differences here but quite large differences.

But even these sources of risks come in many shapes and forms.  We talk about two here, and they're illustrated in the bottom frames there:  whether or not firms have confidence in the courts to uphold their property rights.  Remarkably, more than 80 percent of firms in Bangladesh simply lack confidence that the courts will enforce their contracts and protect them from government incursions.  So that obviously has quite a substantial impact.

And also, while regulation has many impacts on firms, including through costs, even the uncertainty about how it will be interpreted in practice is a huge concern in Guatemala.  Something like 90 percent of firms report they simply do not know how officials will interpret the regulations, so it is not changing regulations, but existing regulations, how they will be applied in practice.

Now, when we look at costs, I guess the most obvious costs that governments visit on firms are taxes, and as I mentioned, firms everywhere complain about taxes.  That's not unique to developing countries or to rich countries.  But when we look at experience in developing countries, we find that oftentimes, other things that governments influence can amount to three times or more than three times what firms pay in taxes.

This is just a sample of countries.  In Tanzania, for example, something like 26 percent, 27 percent of sales can be attributed to difficulties in enforcing contracts, regulatory burdens, bribes, crime, and unreliable infrastructure.  And we can see here that the level varies quite a bit across countries, but so does the composition, which is some insight that you really need to evaluate these obstacles country-by-country rather than relying on a general formula.

Costs also have a time dimension, and the Bank's Doing Business Report, I think, has done some really useful work in documenting how many days it takes to register a business and many other things.  The surveys show us that in a large number of developing countries, management spend more than 15 percent of their time dealing with officials as opposed to working out how to build a better mousetrap or better market their products.  So the interface with government is not trivial.

I mentioned the fundamental importance of competition in the mix.  Even though individual firms typically prefer less competition, all the evidence shows us that this is actually key to driving productivity improvement and growth in the long-term, and some of the work we show actually demonstrates that firms that face stronger competitive pressure are more than 50 percent more likely to innovate in various forms, and so, we see that as a truly integral part of the investment climate.

Some other things we try to draw out in the Report is that there are variations within countries as well.  It's been common up until recently to say country X gets a seven, and country Y gets a four, and some kind of notion of listing.  But when we actually dig a little deeper and look at experience of firms, we see large variations within countries.  These numbers focus on China, where in individual cities, there can be quite substantial differences in things like the amount of losses visited on firms by unreliable electricity or delays in getting access to a telephone.  But we see the same phenomenon is true in smaller countries as well.  So again, in identifying priorities, national-level indicators don't take you very far.

We also know that these investment climate conditions impact on firms differently, and in fact, bad investment climate or difficult investment climate tends to handicap small firms and firms in the informal economy the most.  And to us, that's very important, because it suggests that if governments can make progress on dealing with these issues, they actually provide disproportionate benefits to smaller firms and firms in the informal economy.  And of course, firms in the informal economy include a great number of poor people working as microentrepreneurs, so we think that's useful.

More than changes in formal policies, we really were asking ourselves the question:  if the investment climate is so powerful, if the benefits are so clear and the evidence so compelling, why isn't it that more governments aren't making much faster and broader progress in improving their investment climate?  And so, the analysis we did really pointed to four main issues.  One is issues of corruption and rent-seeking.  No country is immune from these pressures.

When we look at the impact of this, it's not just in the level of bribes contributing to high costs but oftentimes quite deep distortions of policies to favor particular insider firms.  And some of the work we've done in the Report shows that while, indeed, connected firms enjoy a more favorable investment climate, the surveys tell us that they're actually likely to contribute less in terms of innovation and productivity.  So these distortions can have a large impact.

Credibility gaps:  probably, that's a function of governments building their reputations, but when governments have a tradition of passing laws that aren't implemented, it's not surprising, perhaps, that firms don't place a lot of stock on those laws or policy statements.  And so, we see the governments that are making progress here are making quite serious efforts to build up their reputations and their credibility, taking their policies and their actions seriously.

We also look at the role of public trust and support.  While that may have traditionally been seen as not a normal topic in this area, more for the out of politics, perhaps, but what we've seen again and again, it's the governments that go to the trouble to build consensus for new directions.  Not only does that facilitate introducing the reforms, but it means that those reforms are more likely to be sustained through changes in governments.

And perhaps the most dramatic evidence of that comes from some of the Baltic states, where in Estonia and Latvia, they have each had an almost record number of changes of government, almost a change of government for every year since independence, but the confidence of firms in the direction of policy is very strong.  Firms, notwithstanding such a high turnover of governments, have a high level of confidence on the future direction of policy.

The last images, really, the metaphor is a square peg in a round hole, and there's still a tendency in many countries to basically try and copy laws and policies from other countries in the hope of adopting best practice.  And in fact, in many cases, that works, and that's actually quite useful.  In other cases, some adaptation is required, and fairly to make that adaptation can be kind of costly, and we document.

That phenomenon often dates back to colonial times, where developing countries inherited countries from their colonizing or occupying country but still persist to this day, there's still a tendency to try and leapfrog and often create laws or institutions that don't really fit local conditions.  For example, they may not have sufficient safeguards against the misuse of discretion by employees.

Now, Francois has already mentioned what I think is some of the strongest good news in the Report, and that is that perfection is not required.  When we look at experience in China, India, and Uganda, nobody would suggest that they have a perfect investment climate.  In fact, none of the rich countries would also have a perfect investment climate.  If you ask firms in the U.S. or Europe, they will have a long list of complaints.  But really, the challenge is working out what are the constraints that are holding back firms and then maintaining a process of ongoing improvements.

And we see how that's demonstrated by experience in India, China, Uganda, and many other countries.  And so, really, maintaining momentum is part of the challenge.  Many of the reforms that were implemented by governments in the eighties and the nineties were often seen as one-off events, like creating an independent central bank, or they privatized an enterprise, and they felt they could sit back and relax.  But we see experience in rich countries confirms this is an ongoing process, and it requires governments to really gear up for managing that agenda.

We argue in the Report that the strongest benefits to governments are to try and improve the conditions facing all firms, rather than trying to single out individual firms for special policy privileges, and we review the experience and the debates there, and you'll find that summarized in the Report.

Because we're the World Development Report, we also try to look at what the international community might do to help developing countries make progress here, and I think the first point we would make is that the leveraging effect here:  if you can help developing countries improve their investment climates, you can really unleash growth that is substantial, substantially more in the data shown here.  The manufacturing value added in countries like China, India, South Korea, is many, many times that of total aid flows to all developing countries.  So there's a little bit of comparing apples and oranges here, but just to give you a sense of the relative magnitudes, they're quite huge.  So as a point of intervention for the development community, this can be really quite powerful.

And so, we're arguing that the international community can do several things, one of which is actually to deal with trade barriers and market distortions in the developed countries that actually impose costs on developing countries.  Indeed, estimates prepared in the Report suggest that the benefits of developing countries of dealing with those trade barriers could deliver benefits to developing countries on the order of four times more than the aid that they currently receive to improve their investment climate, so we're talking about quite large multiples here.

But we also argue that international assistance is important.  And particularly, well-focused assistance, helping governments design and implement some of these reforms can have quite big dividends.

Let me finish there, and Michael can speak to how this may relate to the Bank's operation.

MR. KLEIN:  Just a few final remarks on the perspective of operations on this World Development Report.  It's not just a book, but it also helps those of us who work in over 70 countries in the world on working with governments to improve the investment climate.  And I want to make three points:  number one, the World Development Report focuses us squarely on the micro foundations for growth.

The other week, I was in Mexico at one of these seminars about competitiveness, and lots of people in Mexico are worried about being out-competed by China, which is taking market share in the last two or three years from Mexico in the U.S., and how can this be?  We have had macroeconomic reforms, privatization, all of this, and here are the Chinese with their Wild East capitalism, and billions of sweatshop laborers are taking away our market share.  We need to go back to government intervention, industrial policy, this, that and the other.

And here, the kind of messages of the World Development Report come in very strongly, making the point, number one, industrial policy, government intervention, is not the crucial thing here.  What macroeconomic reforms need to be complemented with is an emphasis on the institutional detail, the micro foundations for growth.  And lo and behold, look at China.  That's actually what China is improving in.  And so, that's one of the key messages, as Warrick had pointed out.

The second point I want to make is in many ways, make it relevant for the poverty reduction mission of the World Bank.  We are trying to embrace what you might call the Hernando de Soto agenda:  helping people get out of the informal sector, making it easier for them to set up formal businesses or be employed by formal businesses and to benefit from formality through better property rights, the ability to have access to finance, et cetera.

Last point:  the WDR points out that lots of issues are country-specific or, even within a country, region-specific.  So how do you sort through all this puzzle that is set up?  The only way forward is better data, better detailed, disaggregated data.  We want the Minister of Economy to have what the Alan Greenspans of this world have:  better policy-relevant data. 

And so, we have had now for two years these efforts that have been mentioned:  the Investment Climate Surveys, asking firms about what they perceive the constraints to be and the Doing Business project, which looks at laws and regulations and how they are structured.  And we hope that all of this will actually give the Economy Minister a better tool to manage the micro foundations for growth.  And we integrate that into our operations by having tools that not only set better goals based on these data but also monitor progress.

Thank you.

MR. NEAL:  Thank you, Michael.

We have about half an hour for questions, so the floor is open.  Here in front?  Could you please identify yourselves, too, so the speakers know whom you represent?

QUESTION:  Hi.  My name is Maria Gonzales, and I am a representative of [inaudible] Newspaper.

I wanted to ask you, in this report, you said that China, India, and Uganda are doing so well, and Latin America is doing so bad.  So I wanted to ask you, because the Region has been following the recommendation of the IMF, and that's why I don't understand why are the Latin American countries doing so bad.  Where was the mistake?  What have these countries been doing wrong?

MR. SMITH: Just to clarify, we don't actually say that Latin America is doing poorly.  We are not really in this Report preparing a scorecard.  We look at the experience of China, India and Uganda only because they represent highly successful strategies, and we look at them in some detail, and we actually--

QUESTION:  Latin America in the last 20 years has not been used to poverty at all.

MR. SMITH:  So let me speak a little bit to how we have handled it in the Report, and perhaps my colleagues can elaborate on this, particularly Michael, who was there recently.

What we see in many countries in Latin America in the early round reforms focused on trade reforms and macroeconomic reforms and this kind, and saw some benefits from that, but not all the countries in the Region have dealt with the microeconomic reforms, the details of property rights, registering businesses, things of this kind.  In fact, if I remember correctly, in Mexico, it takes 421 days to enforce a contract, compared with about 40 days in the Netherlands. In Mexico, I understand it takes 58 days to start a business compared with 2 in Australia.  Registering property in Mexico takes 74 days.

We don't have Investment Climate Surveys for Mexico, but these are some small flavor of some of the unfinished agenda, which very much in our Report is saying really affect the attitudes of individual firms, whether or not they will engage in new business and, very importantly, whether or not they will hire more people, which is one of the main pathways out of poverty.

I don't know whether Michael or Francois want to elaborate.

MR. BOURGUIGNON:  I think it is important to make a distinction between the micro foundations that we have been referring to in this Report and in this press conference and the macro factors.  You refer to the fact that in Latin America, much of the advice given by the IMF was followed by the countries, and this did not help them--this is fine.  Here, we are looking here at macro policies, and as it was said here, it is certainly the case that at some stage, macroeconomic stability will have a positive impact on the investment climate.

So this is something positive, but investment climate includes many other things besides macroeconomic stability, and the factors on which we insist in this Report are all these other factors.  Warrick mentioned a couple of indicators in the case of Mexico; if we look at other countries, we find that the appraisal of investment climate is not uniformly good.  Brazil would be another country where many people have complained about the difficulty of doing business there--but not all countries in Latin America are like that.  Chile is probably a country where a lot of progress has been made in the investment climate lately.

MR. NEAL:  Michael, do you want to add something?

MR. KLEIN:  Yes, just to add one thing.  All this work on data that I mentioned before that is new brought a real surprise, and for us, including myself, who have worked a lot on America, we always image market economic reforms, privatization, et cetera.  But when you see the data when it comes to the nitty-gritty of the business environment, Latin America tog ether with Africa has the most complicated business environment in the world.  Of course, it varies from country to country, and Chile looks a lot better than others, but that's the general pattern.

MR. NEAL:  The gentleman from India.

QUESTION:  Parasuram, Press Trust of India.

Have you compared the efficiency of state-owned corporations with private-owned corporations, and does the Report have any views on it, or do you have any views on it?

Secondly, there are also complaints about private enterprise, too, because they avoid taxes by transferring profits from one country to another and avoid taxes, and also lobby Members of Congress or legislators to reduce taxes.

Do you have any views on those?

MR. SMITH:  I heard the first part of the question; I just want to clarify the second part.

QUESTION:  The second part is that there are also complaints against private enterprise in many countries, because they avoid the due taxes by shifting the taxes around and having tax shelters and also lobbying Parliament or Congress to reduce the taxes very unfairly.

MR. SMITH:  Thank you.

Yes, on the question of private versus public ownership, this Report deals with this only tangentially, but it makes a couple of points that I think are quite important from the investment climate standpoint.

In a number of countries still, public sector monopolies exist which preclude opportunities for private firms.  In other cases, state-owned firms are competing nominally with private firms and often on a very unlevel playing field, because the state-owned enterprise often enjoys special exemptions from taxes and regulations and such like.  So we speak to that as an issue.

But perhaps more important, we look at the experience in infrastructure and financial services, where many countries still rely on state-owned banks or state-owned providers of these services, and in the past, governments have really focused on meeting political goals and not necessarily thinking about what is required to provide sustainable services.  So we document in this Report that governments who try to create a better investment climate for providers of infrastructure services and for providers of financial services seem to be making the best progress--so, looking at things like the security of property rights for providers of infrastructure, making sure regulation is reasonable, and in many areas including infrastructure, letting competition play a much stronger role, and that we document the cases of quite strong results achieved in many countries by following that approach.

On the question of compliance with tax and other obligations, yes, I think this is something we deal with throughout the Report.  If given a choice, most firms would prefer to pay less taxes and comply with fewer regulations.  That is only natural, and I think it is true of individuals as well.  If I were given a choice, I would probably prefer not to pay taxes and not to comply with regulations.

So this is, if you like, something we just take for granted, and the challenge for government is to actually create an environment and a framework where the compliance burdens are not too high.  And that is one of the things we point to in the Report is a number of developing countries have adopted laws, regulations, and institutions that are not at all well-adapted to local conditions.  For example, in Haiti, it takes 203 days to register a business.  Why?  I'm sure no one in Haiti said how is the best way to design this scheme; more likely they inherited that regime from an occupying power, probably over a century ago, and it has been left to ossify.  And we have seen good progress, and we document some of it in the Report, where tax reforms, not just lowering tax rates but improving the administration of taxes, reducing the administrative burden, actually encourages more firms to enter the formal sector and contribute to taxes, and it contributes to higher compliance.  And we document experiences of this in I think almost every Region.  Certainly I recall some good examples in Ghana, Peru, and elsewhere.

So taxes are always a contentious issue.  We think that a reasonable tax regime is a very important part of the investment climate, but the answer is not to simply give more exemptions but create more of a level playing field and try to reduce the compliance costs associated with any particular tax regime.

MR. NEAL:  This lady over here.

QUESTION:  Channa Balzer [phonetic], with the Brazilian newspaper, Valore Economico [phonetic].

Some recent polls, especially in Latin America, have pointed out the worry of the businessmen in the Region about credit costs and credit access.  Since we have seen that China has been one of the greatest rates of growth in the world, and they surely have access to cheap credit, mainly from state banks, do you think the countries in Latin America that are not growing should pursue something like China, subsidized credit for companies; and if not, what should they do to lower the cost of credit to the companies since they have these country constraints due to the risk?

MR. SMITH:  I think we discuss in the Report the relative importance of access to finance and the cost of finance and also different strategies that governments have adopted to try to improve the situation.

And just a clarifying point on China--in fact, many aspects of China's financial sector are deeply dysfunctional.  While state-owned firms have access to subsidized credit, many firms do not--in fact, many would say that that is one of the largest unfinished pieces of the agenda in China is to actually have functioning finance markets.

But we also look at experience in the Report of a number of countries who have tried to improve access to funds and the cost of funds, including some experience in  Brazil, and I think the unfortunate news for governments is that the old approaches of either trying to subsidize credit or to direct credit to insist that banks give a certain proportion of loans to particular groups usually only benefit the small number of influential large firms and don't actually make sustainable progress.

So we very much see in the finance sector what we would call a "back to basics" approach--how do you actually get credit flowing at a reasonable cost--and a large part of that is securing property rights, whether it be verifying access to title to land, improving contract enforcement, and having more competition between providers of finance, including banks and other sources, and also dealing with information problems.  Often, banks and other financial intermediaries are not in a good position to evaluate the credit-worthiness of individual firms, so many countries are creating credit bureau to facilitate sharing of that reputation information.

But again, we took the finance question very seriously and looked at experience in a wide range of countries, and unfortunately, it simply doesn't seem to work as subsidized credit.  In fact, if I have the numbers here for Brazil, we looked at the rural credit scheme, and something like 57 percent of loans go to the largest 2 percent of firms, and the smallest 75 percent of firms in Brazil receive just 6 percent.  So if you are a large and influential firm, these schemes may be very attractive, but in terms of improving the general business environment, perhaps less so.

And I think when we looked at the Investment Climate Surveys in Brazil, it is a little bit understandable why it might be difficult to have access to finance.  Seventy-six percent of firms in Brazil find policy unpredictable, so this actually constrains their ability to do things.

The courts--40 percent of firms lack confidence in the courts, and that applies to banks as well, so if they are making a loan to someone, they really have confidence that the courts will enforce that loan, and if you don't have confidence in the courts, you are less likely to make a loan, or you will ask for a much higher rate of interest.  So this is on top of macroeconomic issues which can also have a big impact on the cost of finance.

MR. BOURGUIGNON:  Yes, only a word on the cost of credit in Latin America and in Brazil in particular.

Again here, the macroeconomic situation is quite important.  Where you are in a country where the rate of interest on international markets for sovereign bonds is more than 10 percent, with a very high spread between foreign and domestic--I mean, the rate of interest--on the foreign and domestic bonds--then it is very difficult to have a low rate of interest within the country.  Or, if you want to go through a subsidized rate, then you must have a very strong rationing of the subsidized credit, and we know how difficult it is to manage, to administer, rationing in this kind of situation.

And if you are too generous in terms of subsidized credit, then the risk that you have is that the money will not be used for investment purposes but will be used for speculative purposes, because people will be arbitraging between the subsidized rate of interest and the rate of interest they can get on the market.

So it is a difficult situation, and it is difficult to imagine that in the long run, there is any other solution for those countries, in particular Brazil, to grow at a fast speed; it is hard to imagine that the microeconomic situation should not have improved.

MR. NEAL:  The gentleman in the fourth row here.

QUESTION:  Mr. Kaiser [phonetic], from El Pais, Spain.

Gentlemen, you say in the Report that nothing so undermines the investment climate as the outbreak of armed conflict.  I miss in the Report something about Iraq and the situation in the Middle East.  I mean, what are your perceptions or your investigation on that field?  This is one question.

And in relationship with what Mr. Klein says, what should the Latin American countries do if they, with the exception of Chile, have the more complicated system of the world?

MR. SMITH:  Just on the peace point, the Report speaks to the global situation and doesn't provide any country-specific recommendations, but it does give the example of Somalia, for example, where serious conflict, civil disturbance, really kill any incentives to invest or to create jobs. 

So there is always a little bit that goes on in the shadows of the economy, but that's really our argument, that until governments create basic stability, political stability, deal with armed conflict and macroeconomic stability, there is very little prospect for making progress anywhere else.

So these are, if you like, the minimal conditions, but they are not sufficient conditions, which is perhaps one of the lessons from the Latin American experience.  It is not enough just not to be at war and to have macro stability.  You do need to deal with the macro level as well.

MR. KLEIN:  Yes, the investment climate in Iraq is pretty bad.


MR. SMITH:  A survey?

MR. KLEIN:  Yes, we are doing a survey--thank you--and we're asking for volunteers.

On the question on Latin America, what to do, let me make a general statement.  A lot of discussion about Latin America is we have done reforms, we have done all this market stuff, and we have had enough of neo-liberal, Anglo-Saxon recipes, so what is the other recipe.

One set of countries to look to that would be useful for many of the Latin Americans but also for others if they don't like Anglo-Saxons is to look to Scandinavia.  Norway, Denmark, Holland--well, Holland is not in Scandinavia, but it is part of that Northern European group of countries with big safety nets, et cetera--they all have, following certain crises in the early nineties or in the early eighties, depending on which country it was, they have pursued very prudent macroeconomic policies, have brought inflation down and created some of the most simple and flexible regulation of the business environment that we find in the world, so that people actually get jobs, they create income, and they pay taxes, which then allows them to maintain a social safety net.

So I would go to Scandinavia to have a look.

MR. NEAL:  The lady in the back corner.

QUESTION:  I am with Latvia National Daily, and my question goes to Mr. Smith.

You mentioned the Baltic States in your introduction, and you said that frequent governmental changes can have a negative impact on investment climate.  I wanted your comment on the issue--or, probably it could be a ticking bomb for development in the future, because we really face frequent governmental changes in Latvia and Estonia.

MR. SMITH:  I think the point we make in the report is the impact of changes in government really depend on whether or not there is a social consensus for a particular direction.

In fact, we discuss both Estonia and Latvia in the Report, that notwithstanding a high level of changes of governments--was it 40 new administrations in Latvia; I have lost track, frankly--because basically, my understanding is that governments are all committed to participating fully in the EU, creating a market-friendly business environment.  There is a large consensus about many of the policies that impact on the opportunities and incentives facing firms.

So when you have that consensus, you can have many, many changes of government, and the general contours of policy remain quite predictable.  It is not as though--and again, I can't speak to the current conditions in Latvia--but it is not where, as in some countries in Latin America, for example, where there have been quite dramatic reversals of policy--a government may be leading a very strong market-oriented approach, and then there is a change of government, and they are speaking with sentimentality about the former Soviet Union, and another government is thinking of something else--so if you have that change in the direction of government and the general policies of government, that can be very destabilizing and really cripple incentives to invest.

But whereas when governments have been able to build a consensus, there is much less concern.  For example, people tell me the United States is about to have an election, but I don't think firms have stopped investing or hiring people just in case the new government will take some totally different direction.  Surely there will be changes of policies if there is a change of government in any country, but as long as the basic principles and the basic protection of property rights, commitment to growth and productivity improvement, I think governments can go through quite substantial and even frequent changes without necessarily handicapping their investment climate.

MR. NEAL:  This lady here.

QUESTION:  [Inaudible] from Romania.

I would like to know if you see a better investment climate in Romania in the near future, considering the high level of corruption in the region, and if you think that we have credibility gaps in Eastern Europe.

MR. SMITH:  The Report doesn't speak to the circumstances of any particular country, but I think we can make some general points, and that is, it is quite clear that corruption is not good for the business environment.  Not only is it a direct cost on firms, but we think that actually the larger concern is that it can distort policies with the creation of monopolies when there shouldn't be monopolies, things of that kind.

So insofar as there are issues here in a country, we think attending to them is important, and then we see and we discuss in the Report a lot of encouraging progress on this.  Many governments are taking this agenda far moro seriously; they are being far more transparent in their relationships between governments and firms.  I think free media plays a very important role in keeping governments accountable.  There is a range of things like that--and I think there is actually a close tie-in with the regulatory reform agenda we discuss in this Report and in the Doing Business Report.  There is actually, a close association between high levels  of government intervention in the economy and corruption, because ultimately, bribes need a leverage point, and that is often the need for a regulatory approval or a permit.  So governments who actually reduce the burden of regulation, reduce the number of intervention points, actually reduce corruption as well.

So unfortunately, I can't speak more to the circumstances in Romania.

MR. KLEIN:  Just one little remark on Romania.  Romania, as you well know, tries to become a member of the European Union by 2007, and the experience with the other accession countries to the EU has been that they have some of the strongest reform experience in recent years.  So while Romania still has lots of problems, we hope that it will follow on the path of those who heave acceded to the EU and will actually reform strongly.

MR. NEAL:  We have time for about three more questions and fairly short answers, please.

This gentleman in the center here has been very patient.

QUESTION:  Thank you.

Pedro Alonso, from Mexico City [inaudible] Communicaciones.

Do you have any comment on the capital flows or money flows from immigrating workers or immigrants, because as you know, in my country, this is bigger than all the foreign investment, and I think it is a very interesting phenomenon.  Second, it is very effective to fight poverty beyond the official or international programs.

MR. SMITH:  We discuss briefly in the Report the role of foreign remittances as a source of investment, drawing on other research in the Bank.  And certainly it is becoming increasingly important, and another tie between the investment climate and immigration flows as well.

One of the things we discuss in the Report is that a good investment climate doesn't only influence the location of firms, it influences the location of people, and people travel around the world to countries with better investment climates.

I think there is quite a bit of work done in the Development Economics Vice Presidency of the Bank on the remittances issue, and I'm sure we could furnish you with some more details, if that's useful, after the event.

MR. BOURGUIGNON:  One word on the remittances.  I think that we should avoid confusion over the various flows between North and South, because remittances are not really comparable to foreign direct investment.  Remittances are the income of some individuals, the migrants, being sent to other individuals, households, and as far as I know, there is not necessarily a productive goal behind that transfer.

Now, we might say that because those flows are in foreign exchange, they have an impact on the overall development of the economy, and this is fine, and this may be the reason why we may want to have more remittance flows, bigger remittance flows.  And it is also true that a good investment climate is probably an incentive for  migrants to remit more of their earnings to their home country rather than to stay in the host country.

But again, we should refrain from the analogy between remittances and foreign direct investments.

MR. NEAL:  The gentleman here in front.

QUESTION:  Antonio Rodriguez, working for the EFP News Agency [phonetic].

You said that growth is one of the best ways to fight against poverty in the world.  In the nineties, Argentina had wonderful growth--better than the Scandinavian countries, probably--but at the same time, the poverty increased.

How do you explain that?

MR. BOURGUIGNON:  Maybe I'll take this question, which is not directly related to investment climate, although probably investment climate has something to do with it, too.

Now, when we say that in general, growth is producing some poverty reduction, this is assuming that growth is taking place in a rather neutral way with respect to the distribution of economic resources in the economy.  If growth is taking place with some big changes in the way in which total income is distributed, then it is possible for growth to take place and for poverty not to be reduced, and it is even possible for growth to take place and for poverty to increase.

So the only thing we know is that without growth, it will be very difficult to eliminate poverty.  Now, this means that growth is a necessary condition for poverty reduction; it is not a sufficient condition.  And I believe that the case of Argentina in the nineties is a very good case to illustrate that.

MR. NEAL:  One last question from this lady right here.

QUESTION:  Julie Zigler from Bloomberg.

Keeping with Argentina, why wasn't Argentina included in this study?  It seems that its investment climate could stand a review.

And with regard to your comments about the international community needing to deal with trade barriers, are you talking about continuing to proceed with the Doha Round?

MR. KLEIN:  Just a quick comment on Argentina.  One of the interesting features of the Argentina economy--some studies have been recently done trying to break down the performance of the Argentine economy over the nineties, and when you look at actually the performance by breaking down the manufacturing sector, service sector, financial sector and infrastructure, you see, following some of the initial reforms in the early nineties, that in the financial sector and in the infrastructure sector, you had productivity increases and growth coming out of those sectors in the early half of the nineties; and then, the initial reforms had no further major effect, and productivity increases in those sectors petered out.

But the big thing in Argentina when you look at the growth experience is that in manufacturing and services throughout the nineties, throughout all the reform period, there has been very little productivity growth.  And one question is why.  And the most detailed study that has been done on that is by McKenzie's Global Institute, and they look sector-by-sector at some of the details, and it is the regulatory obstacles in the Argentine economy that seem to be the main explanatory factor for that.

So macroeconomic stabilization had initially some effect on bringing inflation rates down, et cetera.  Then, of course, there are all the problems associated with the fixed exchange rate regime that Argentina had.  But underlying it all, Argentina is one of the clear cases where  in manufacturing and services, no attention has been paid, including by us, on the micro foundations of growth.  And this is why this World Development Report represents something important for the World Bank, because it puts the focus on these things that, including ourselves, we have not paid sufficient attention to.  And privatization, for example, only works when you have--which we have also sometimes taken on board a bit too late--when you have an environment in which other challengers can come in, challenge the privatized companies so that you don't make a private monopoly out of a public monopoly.

QUESTION:  You have other countries--why isn't Argentina in the survey, then?

MR. SMITH:  Eventually, we will be covering all countries; we do a number every year, and we are going back and doing some a second time. So I don't know offhand when Argentina is scheduled, but I'm sure it's on the list.

We have so far done 53 countries out of the larger sample, and eventually, we'll get to all.  We're trying to get a reasonable coverage across Regions and moving forward on that basis.

Just to say a couple brief points on the links between poverty and investment climate improvements--we argue quite strongly in this Report that looking at growth in aggregate numbers is deeply misleading, that just as we are arguing that you need to go to the micro foundations of growth and look at what is going on in the incentives and firms, you need to understand who is benefitting from the growth.  And the investment climate really influences who benefits in terms of job creation and opportunities.

So it is clear that the kind of growth we are advocating and the investment climate reforms that we are looking at expand opportunities for everyone in the economy, not just large and connected firms.  So it makes it easier for small micro entrepreneurs to increase their incomes; it makes it easier for people and creates stronger incentives for firms to create more jobs, and that is the number one way of helping people climb out of poverty.

So I think that's a really important point to bring out is that we don't see growth and poverty as different subjects--they are intimately related.  Ultimately, of course, the growth recorded in national statistics is just the accretion of lots of little increases of income, including higher income by individual entrepreneurs.

On the international trade subject, yes, we are suggesting that the Doha Round is very important--you are not the first to say that--for the developing countries, and I think we are encouraged by at least the most recent news I have heard on that.

MR. NEAL:  That's all we have time for, so thank you very much for coming. 

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