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Does the investment climate matter?

Editor's note: Dorsati Madani is a Senior Economist with the Strategy and Analysis Unit of the World Bank Group's Investment Climate Advisory department.

Well, according to the 2009 book Does the Investment Climate Matter? Microeconomic Foundations of Growth in Latin America, the answer is a resounding "yes." The book, a compendium of seven interesting chapters by different authors, focuses on the recent growth in Latin America and finds it could be based on better microeconomic foundations. 

While Latin America's growth rates are at a three-decade high, it is losing ground compared to the world at large and in comparison to reference groups such as middle-income countries and East Asia. Specifically, the book suggests that the region needs to implement important reforms in investment climate to achieve higher and more sustainable growth. These reforms should focus on governance and institutions, physical infrastructure, the development of the financial sector, the improvement of the education of the labor force, and innovation within the private sector.

A chapter I found especially noteworthy is Chapter 3, where the authors assess the potential gains in labor productivity and wages related to reforms in the 5 aforementioned areas. Progress in the regulatory framework and the rule of law would generate the most gains for countries. For instance, average wage gains in Latin America and Caribbean driven by regulatory compliance (firms moving to the 75th percentile of the entire sample) is over 13 percent. For Nicaragua this average wage gain reaches 75 percent, while Chilean average wage gains will reach 9 percent. The gains from reforms in other areas are smaller and apparently more country specific.

Finally, small firms would gain relatively more from these reforms than medium and large firms, especially from improvements in the regulatory framework: for small producers (firms with less than 19 employees)  improving regulatory compliance to the 75 percentile within the same industry (and firm size group) will improve aggregate productivity gains by 25 percent. Further results are reported in detail in the chapter. 

The findings of this chapter and indeed this book provide microeconomic and practical arguments for Latin American reformers, helping to gather national stake-holders for reforms that are difficult to launch from a political economy perspective.

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