Putting it to Work in Developing Countries - Nathan Associates

But, in addition to these commercial-economic
factors, multinationals pay close attention to
political, institutional, and regulatory characteristics
that together define a host country’s
“investment climate.”
BACK TO BASICS—THE
RIGHT INVESTMENT
CLIMATE
A country’s investment climate is the sum of its
public policy and institutional characteristics
and conditions that affect the attractiveness and
profitability of establishing and operating a business.
As the World Bank has said, “Governments
influence the investment climate through the
impact of their policies and behaviors on the
costs, risks, and barriers to competition facing
firms.” 3 A healthy economy requires getting the
investment climate right. Doing so benefits all
investors—foreign and domestic alike. A sound
investment climate attracts not only foreign
direct investment, but also figures heavily in
domestic investors’ decisions to establish or
expand their businesses. 4 Moreover, there is
ample empirical evidence that differences in productivity
in both FDI and domestic investment
can be explained by differences in investment
climate, including good governance, institutions,
and government policies. 5 With distortions and
inefficiencies that erode productivity removed, a
sound climate boosts the quality of all investment
in addition to encouraging capital accumulation.
This is especially valuable in making
the most of FDI.
WHAT IS “RIGHT”
An investment climate has three elements: conditions
of macroeconomic stability, including
institutional and policy predictability; the
microeconomic enabling environment; and the
infrastructure base. A multinational takes all
three into account, although the relative weights
given to one element or another in FDI decisions
may vary. 6 But because all elements are
important, getting the investment climate
“right” means making policy and institutional
reforms in each area. 7
For example, a sound investment climate first
requires macroeconomic stability and institutional
and policy predictability. The famed
“Washington Consensus” set forth reform prescriptions
for ensuring this result. Such reforms
establish competitive exchange rates and marketdetermined
interest rates; fiscal discipline, efficient
tax systems and prudent public expenditure
and debt management; privatization, deregulation,
and general recognition of property
rights. Liberalization of trade and FDI policy is
also part of the reform package. 8 But while
macroeconomic stability and institutional predictability
are necessary to attract FDI and are
achievable through such reforms, many experts
now agree that they are not sufficient.
This is why the right investment climate also
stresses a proper enabling environment at the
microeconomic level. Microeconomic factors
affect the way individuals or firms operate in the
macroeconomic environment. These factors are
key to project profitability and thus to attracting
FDI. 9 A positive enabling environment is characterized
by
• Good governance, maximized through transparency
and the rule of law, including a range
of specific investor protections to secure and
safeguard private property and preserve the
sanctity of contracts, as well as measures to
minimize crime;
• Openness to trade, achieved by liberalizing
foreign trade policy, but also by removing
administrative barriers to entry and exit in
domestic markets, ending state monopolies,
and generally promoting competitive
conditions;
• Minimal distortions, created by lowering tax
rates and eliminating arbitrary regulation and
overregulation, and especially by reducing the
administrative “red-tape factor” in doing business.
This allows and encourages individuals
such as upstream suppliers for foreign affiliates
to start their own businesses, and to use their
land and property as collateral to raise cash
and obtain credit. Embracing the principle of
nondiscrimination between foreign investors
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