Does a country need a promotion agency to attract foreign direct investment : a small analytical model applied to 58 countries

Establishing an investment promotion agency has become a central part of most countries'development strategies. Today there are more than 150 investment promotion agencies worldwide. Yet very little is known about what these agencies have been really doing, notably in emerging countries, and whether they have been effective in influencing investors'decisions. Using data from a new survey on 58 countries, Morisset shows that greater investment promotion is associated with higher cross-country foreign direct investment (FDI) flows, on top of the influence of the country's investment climate and market size. But this result has to be qualified on several counts. First, the effectiveness of the agency depends on the country's environment in which it operates. An agency in a poor investment climate is less effective at attracting investment. Second, the scope of activities that an agency undertakes influences its performance. Morisset's empirical analysis indicates that agencies devoting more resources on policy advocacy are more effective because such activity is not only beneficial to foreign investors but also to domestic investors. In contrast, investment generation or targeting strategies appear expensive and risky, especially in countries with poor investment climates. Finally, certain internal characteristics of the agencies are associated with greater effectiveness. The agencies that have established reporting mechanisms to the country's highest policymakers (the president or prime minister) or to the private sector have been systematically more efficient at attracting foreign direct investment. Such institutional links are crucial because they contribute to strengthen the government's commitment as well as reinforce the agency's credibility and visibility in the business community.Decentralization,Economic Theory&Research,Payment Systems&Infrastructure,International Terrorism&Counterterrorism,Environmental Economics&Policies,Foreign Direct Investment,Economic Theory&Research,Environmental Economics&Policies,International Terrorism&Counterterrorism,ICT Policy and Strategies

Does financial liberalization really improve private investment in developing countries?

Assuming that liquidity constraints exist in most developing countries, the majority of analysts believe that increasing real interest rates will raise the volume of lending and hence private investment. The author, focusing on the demand for capital goods, argues that the positive effect on the domestic credit market may be offset by the negative effect of a portfolio shift from capital goods and public bonds into monetary assets. The author also demonstrates that a policy of financial liberalization could increase the public sector's demand for domestic credit, thus limiting the funds available to the private sector. This crowdingout does not result from a change in the government's behavior but from a shift in the portfolio of private agents. Higher demand for bank deposits reduces the private sector's willingness to hold government bonds, so the public sector must finance a given budget deficit with more domestic credit. Simulations for Argentina for 1961 - 1982 suggest that the low response of private investors to changes in interest rate policy in those 20 years was attributable not to the low values of interest elasticities but to the interaction of the mechanisms allowed for in the model, which tends to neutralize the impact of such policies. The author concludes that the effect of changes in interest rate policy on the demand for capital goods is weak in Argentina and might affect the quality of private investment more than its quantity.Economic Theory&Research,Environmental Economics&Policies,Banks&Banking Reform,International Terrorism&Counterterrorism,Macroeconomic Management

Foreign direct investment in Africa : policies also matter

Africa has not succeeded in attracting much foreign direct investment in the past few decades. When countries did attract multinational companies, it was principally because of their (abundant) natural resources and the size of their domestic market. Angola, Cote d'Ivoire, Nigeria, and South Africa have traditionally been the main recipients of foreign direct investment in Sub-Saharan Africa. But the author shows that a few Sub-Saharan countries have generated interest among international investors by improving their business environment. In the 1990s, Mali, Mozambique, Namibia, and Senegal attracted substantial foreign direct investment--more so than countries with bigger domestic markets (Cameroon, Republic of Congo, and Kenya) and greater natural resources (Republic of Congo and Zimbabwe). Mali and Mozambique, which improved their business climate spectacularly in the 1990s, did so with a few strategic actions: liberalizing trade, launching an attractive privatization program, modernizing mining and investment codes, adopting international agreements on foreign direct investment, developing a few priority projects that had multiplier effects on other investment projects, and mounting an image-building effort in which political figures such as the nation's president participated. These actions are similar to those associated with the success of other small countries with limited natural resources, such as Ireland and Singapore about 20 years ago.Environmental Economics&Policies,Economic Theory&Research,Governance Indicators,International Terrorism&Counterterrorism,Foreign Direct Investment

Unfair trade? Empirical evidence in world commodity markets over te past 25 years

Since the 1970s, commodity prices have fallen in international markets at the same time that consumer pries have risen. The price of coffee declined 18 percent on world markets between 1975 and 1993, for example, but the consumer price for it increased 240 percent in the United States. Explanations for such diverging patterns remain largely unexplored in current economic literature. The author examines the spreads between international and domestic commodity prices, explains why they have increased, and analyzes their implications for commodity-exporting countries. He finds that the spreads have increased dramatically because of the asymmetric response of domestic consumer prices to movements in world prices. In all major consumer markets, decreases in world commodity prices have systematically been transmitted to domestic consumer prices much less than have increases. This may have cost commodity-exporting countries more than $100 billion a year because it has limited the expansion of demand for commodities in these markets. The asymmetric response, which has been attributed to trade restrictions and rising processing costs, appears to be caused largely by the behavior of international trading companies. Many of these companies are large enough to dominate most commodity markets. Surprisingly, although mainstream economists have suggested imperfect competition in international trade at both the producer and the consumer levels, they have not yet pointed it out at the intermediary level. Free trade requires that all players sing the same tune : competition. The author recommends a special effort to understand the determinants of consumer prices and the role of intermediaries at both wholesale and retail levels -starting with the collection of information about the activities of international trading companies. This effort would require the involvement of the World Bank and the World Trade Organization, because they have the resources to undertake such an operation worldwide. Only a better understanding of how these companies operate will remove the suspicion of unfair trade in international commodity markets.Markets and Market Access,Environmental Economics&Policies,Economic Theory&Research,Payment Systems&Infrastructure,Labor Policies,Markets and Market Access,Access to Markets,Environmental Economics&Policies,Economic Theory&Research,Consumption

Can debt-reduction policies restore investment and economic growth in highly indebted countries? A macroeconomic framework applied to Argentina

The author devised an analytical framework to examine the implications of debt-reduction operations for the economy of a typical middle-income, heavily indebted country. A major finding is that debt-reduction policies can succeed in restoring investment and, consequently, growth in debtor countries. Such policies combine a liquidity effect resulting from the reduction in debt service payments and an incentive effect resulting from debt relief. A simulation designed to analyze the effects of debt-reduction policies in Argentina showed that a 30 percent reduction in debt had a 2.4 percent positive effect on the level of GDP in the first year and a 5.4 percent effect in the fifth year. The model identifies various channels through which a reduction in foreign debt influences investment. The analysis includes a calculation of the debt-reduction and liquidity combination that maximizes Argentina's GDP. The purpose was to determine the best use of a potential loan to the country from international financial institutions. The empirical results suggest the tentative conclusion that a Brady Initiative debt and debt service reduction operation could establish the basis for sustainable growth in Argentina, if combined with appropriate domestic policies.Banks&Banking Reform,Settlement of Investment Disputes,Economic Theory&Research,Environmental Economics&Policies,Financial Intermediation

Unstable inflation and seignorage revenues in Latin America : How many times can the government fool people?

In the past 20 years, high and extremely volatile inflation rates in Latin America have generally been associated with unstable monetary policies and the (temporary) use of inflationary revenues to finance fiscal deficits. There seems to be a consensus that high inflation is bad for economic development and growth, so it is unclear why governments have adopted unstable monetary policies they have known to be unsustainable in the long run. This paper argues that Latin America governments have followed unstable monetary policies principally to maximize their inflationary revenues. Explanations based on irrationality or on institutional and political shock are only partially convincing. A government maximizes inflationary revenues by adopting temporary unstable monetary policies because people tend to revise their expectations (slower) faster in periods of (dec-) accelerating inflation as the cost of collecting information (rises) falls compared with other welfare losses. When the rate of inflation is relatively high, a restrictive monetary policy is implemented so people can reconstitute monetary balances. When the inflation rate is low, an expansive monetary policy is adopted to confiscate existing real balances. Governments may appear for some time to succeed in fooling people, by adopting temporary reforms and restoring confidence, but their reputation is damaged when they repeatedly do so. Utlimately, private agents react so quickly and with such sophistication that even small fiscal gaps produce precipitous declines in money demand. Over time, private agents learn to anticipate the relationship between unstable inflation and monetary policy and progressively reduce their real monetary balance. In the end, the optimal inflation rate tends toward its steady-state value, as Friedman found 20 years ago. The author develops a small dynamic model to stylize these facts and applies it to Argentina.Economic Theory&Research,Environmental Economics&Policies,Public Sector Economics&Finance,Inflation,Banks&Banking Reform

In search of price rigidities : recent sector evidence from Argentina

The hypothesis that the price adjustment to nominal shocks is instantaneous has been part of the monetarist approach explaining the inflationary process in Argentina. But the authors argue that monetary and exchange rate policies have had different effects on relative prices and thus have a significant influence on the real side of the economy. The existence of rigidities has prevented full and instantaneous price adjustments. Recent work on inflation in imperfectly competitive markets explain rigidities as a consequence of firms'strategic responses to nominal shocks, which in turn depend on the market structure and demand elasticities faced by firms. Price rigidities emerge when firms facing changes in aggregate demand behave collusively, and there are costs for customers to switch between suppliers. In contrast, when the costs for customers to switch between suppliers are low, firms are obliged to adjust their prices to new demand conditions, otherwise they will lose their customers. Changes in foreign prices affect domestic prices depending on the degree of foreign competition and the price formation mechanism in each sector. As expected, price rigidities are minimal in tradable sectors where firms react to these changes by changing their prices almost instantaneously. The response in nontradable activities depends on indirect effects and whether prices are indexed to a foreign currency. Because understanding this is essential for effective policymaking, the authors analyze price behavior of four economic sectors - agriculture, industry, (retail) commerce, and services - in Argentina from 1981-94. The econometric analysis show large differences in the price behavior across sectors. Firms do not respond uniformly to changes in production costs, foreign prices, and demand conditions. The response of individual prices reflects the distribution of adjustment costs across sectors in the case of nominal shocks. To maintain social and political stability, the government's challenge is to minimize divergence across sectors. Increasing competition appears to be a crucial element of this strategy since monopolistic power is frequently associated with the existence of price rigidities.Economic Theory&Research,Markets and Market Access,Environmental Economics&Policies,Payment Systems&Infrastructure,Settlement of Investment Disputes,Economic Theory&Research,Markets and Market Access,Access to Markets,Environmental Economics&Policies,Settlement of Investment Disputes

Effects of tax reform on Argentina's revenues

Too often, a good tax policy proposal is considered sufficient to improve the tax system - too little consideration is given to weaknesses in tax administration, perhaps because of measurement problems. Analyzing legal and administrative measures and quantitatively evaluating their impact on tax revenues is generally arduous. The authors develop a simple approach to assessing how tax effort affects tax revenues (performance). By"tax effort"they mean changes in tax legislation (except changes in nominal taxes), tax administration, and individual taxpayers attitudes toward tax evasion. Changes in tax administration include increasing tax penalties, new technologies, and administrative reform. They measure tax effort as a residual: the variations in tax revenues that cannot be explained by changes in economic variables and tax structures. Using this approach, one can easily identify factors that influence tax revenues over time, and understand the behavior of tax revenues in developing countries, particularly where macroeconomic conditions are volatile. The authors apply this approach to Argentina; it can easily be applied to other countries. Their main conclusions in this application follow. The administrative dimension of tax reform is at the heart of Argentina's recent fiscal adjustment. Since 1991, tax effort is an average 80 percent higher than during the preceding (temporary) successful adjustment period (under the Austral Plan). An efficient tax administration and an improvement in taxpayer compliance levels appear to precede rather than follow increases in tax revenues. Tax effort is influenced significantly by such macrovariables as GDP growth and inflation, as well as by political (in)stability. It is influenced less by such fiscal variables as alternative sources of financing. In Argentina, the sequence of the tax effort was, first, to broaden the potential value added tax base, and then to reduce tax evasion through higher tax penalties and improvements in the basic functions of tax administration (inspection, audits, tax management, and personnel policy).Public Sector Economics&Finance,Tax Policy and Administration,National Governance,Taxation&Subsidies,Environmental Economics&Policies

Measuring the risk of default in six highly indebted countries

The price of debt on the secondary market reflects the risk that the debtor country might default on its external debt. Using the option-pricing theory, the authors identify the factors that influenced the risk of default in six highly indebted countries (Argentina, Brazil, Chile, Mexico, Venezuela, and Poland) from 1986 to 1990. In particular, they provide a measure of the debtor countries'willingness to pay. They identify the parameters of the stochastic process followed by this variable, so this approach can be used to predict the future price of debt. Their model also emphasizes that a debt-reduction operation may lead to a significant increase in the price of debt on the secondary market. This effect appears to be linked to the initial stock of external debt, as suggested by the debt overhang hypothesis. Finally, the authors show empirically that a country's willingness to pay is significantly influenced by changes in indicators of thecountry's ability to pay (for example, by an increase in reserves or in GDP growth), and by exogenous events such as the increase in commercial banks'loan reserves in mid-1987 or the Brady Plan announcement in 1989.Economic Theory&Research,Housing Finance,Environmental Economics&Policies,Banks&Banking Reform,Strategic Debt Management

Savings and education: a life-cycle model applied to a panel of 74 countries

The authors analyze how education contributes to savings. There are many reasons to believe that education and savings may be linked, either positively or negatively. It is generally expected that people with higher education will earn greater income, thereby leading to higher savings, even if the positive relationships between education and income andbetween income and savings take time to be completely realized. The relationship between education and income can be negative at first because education expenses initially increase consumption and reduce current disposable income. Another argument for a negative link concerns precautionary savings. If there is a precautionary motive for savings, education should reduce income volatility because educated people are less likely to be unemployed, or, if unemployed, they are covered by unemployment insurance. With less need for precautionay savings among the more educated, education and savings would be negatively correlated. The author's major findings for a panel of 74 countries over the period 1960-90 include the following views. Education positively influences savings in the long run. For each percentage point increase in education stock, the savings rate increases 0.37 percent. But it takes more than five years for the positive effect, through income, to compensate for the initial negative impact on savings. The lagged effect (five years) of a change in the stock of education appears positive in all regions except Latin America. The negative correlation in this region can be explained by the worsening quality of education, which reduces the ability to implement new technologies, and by the traditional focus on university education instead of primary and secondary education. Moreover, well-educated people in Latin America seem to have a lower precautionary motive for saving than in other regions. People are more productive, invest more, or are a better complement to physical capital in an environment where many people are well-educated. Accordingly, the positive effect of education on savings appears higher in industrial countries, given their higher initial stock of human capital, than in developing countries. The effects of primary and secondary education on savings are positive and significant in all regions, while the effects of university education is positive only in industrial countries. One explanation might be that industrial countries tend to invest in new projects rather than to adopt existing technology. The authors derive several policy recommendations from their conclusions. First, the positive effect of education on savings is enhanced by a reduction in the cost of education which automatically increases disposable income. In many countries, the unit cost of education may be reduced by exploiting economies of scale and by developing incentives for greater cost-consciousness among consumers and providers. Many education systems may need to upgrade their internal efficiency. Second, a focus on primary education should be encouraged, specifically in developing countries. The empirical results indicate that the positive long-run effect associated with primary education is twice as large as that for secondary and tertiary eduation. Latin America's traditional neglect of primary education contrasts sharply with the policy of Asian countries. Finally, it is important to increase the coverage of education, not only for equity but also for efficiency reasons. Indeed, how much a child learns is influenced by the nature of the learning environment, as supported by the role played by externalities and the intial level of education in the realtionship between eduation and savings.Curriculum&Instruction,Decentralization,Economic Theory&Research,Public Health Promotion,Health Monitoring&Evaluation,Gender and Education,Teaching and Learning,Economic Theory&Research,Curriculum&Instruction,Health Monitoring&Evaluation