Stepping up the pace of private sector activity brings many benefits, more jobs, higher household incomes, and greater fiscal resources for governments.  Most developing country governments are keen to boost private sector activity.  But a range of obstacles lie in the way.

Many of these obstacles concern the 'investment climate'.  The investment climate is the set of factors that influence firms' day-to-day decisions.  These factors include the costs and risks of investing and doing business, as well as the competitive forces at work in the economy.  A supporting investment climate lead to more firms being set up, more firms investing, and more jobs being created – which boosts growth and reduces poverty.

Why does Investment Climate Matter?

The investment climate can be defined by three broad sets of variables. These include macroeconomic policies such as fiscal, monetary and trade policies; governance and institutions; and infrastructure.  Firms and entrepreneurs making decisions about the investment of limited resources and efforts will base their decisions on perceptions of the overall business climate and the risks and returns associated with that business climate.  Creating a business climate that encourages the types of investments and economic activity that leads to the development of a dynamic private sector is key to sustained growth and poverty reduction.

Small and Medium Enterprise (SME) Development

The experiences of successful developing countries have shown the importance of small and medium enterprises, including micro enterprises, in overall growth and development. SMEs play an important role in promoting growth in rural areas, particularly in agricultural activities.  In urban areas, SMEs are a source of jobs as urban areas expand.  Research shows that SMEs are impacted more severely by a hostile investment climate than larger firms and that SMEs have particular problems not associated with larger firms. The investment climate framework therefore places emphasis on micro and small and medium enterprises and the particular obstacles they face. However, reforms that improve the investment climate for SMEs also help larger firms and foreign firms.