A number of major cities in China have created good investment climates, compared to other locations that were at similar levels of development ten years earlier and had similar good potential for access to the international market. As a result, these Chinese cities receive large amounts of foreign investment and have large numbers of firms that are selling internationally. Returning to the puzzle we started with, the evidence reviewed in this chapter supports the view that the interaction of open trade and investment policies with a sound investment climate has created especially dynamic growth in a number of Chinese cities.
Our estimates also confirm that there is some truth to the stories that emphasize natural geography and agglomeration economies. We do not find manufacturing plants randomly distributed around rural locations. That said, most of the locations we cover are large cities, and many of them are ports, with at least potential access to the international market. Locations such as Calcutta (India), Karachi (Pakistan), Chittagong (Bangladesh), and Tianjin (China) are not performing as well as Guangzhou and Shanghai in China. So, while being a big port city is an advantage, poor local governance can easily undo the advantage.
We have shown in a companion paper that a good investment climate is related to high productivity, wages, and profitability at the plant level, and that where hassles and bottlenecks are great, productivity and profitability are low (Dollar, Hallward-Driemeier, and Mengistae 2003).
The new results here complement that earlier work. We find that a sound
investment climate—as reflected in short customs clearance times, reliable infrastructure, and good financial services—attracts foreign investment. Foreign firms generally introduce superior technology and management, and hence raise the average productivity of a randomly chosen sample of firms. The same investment climate factors make it more likely that domestic firms will export, enabling the more productive among them to expand their scale and scope.
Clearly other factors, including geography and national-level policies, matter as well. But the point that we emphasize here is that, among large port cities in Asia, there are large differences in the volume of inward foreign investment and in the extent to which the cities’ firms successfully sell in international markets. There are also large differences among the cities in the investment climate indicators that we have collected. In Karachi, it is difficult to move goods through customs and difficult to get reliable power or telecom services. Similar problems—though not as extreme—hamper firms in the port cities of Calcutta and Chittagong. It is no surprise, then, that the lagging cities have relatively little foreign investment and export activity.
Clearly other factors, including geography and national-level policies, matter as well. But the point that we emphasize here is that, among large port cities in Asia, there are large differences in the volume of inward foreign investment and in the extent to which the cities’ firms successfully sell in international markets. There are also large differences among the cities in the investment climate indicators that we have collected. In Karachi, it is difficult to move goods through customs and difficult to get reliable power or telecom services. Similar problems—though not as extreme—hamper firms in the port cities of Calcutta and Chittagong. It is no surprise, then, that the lagging cities have relatively little foreign investment and export activity.
We see these results as consistent with the larger literature on the importance of institutions and policies for economic growth. Our contribution is to use data from a large number of firms in order to see how weak institutions actually affect the environment in which firms operate and to investigate the importance of local governance. Most of the existing work on the relationship between institutions and growth assumes that the important institutions are uniform throughout a country. The empirical link that we establish between investment climate indicators and firm performance is robust to the inclusion of country dummies, which reveals that there is significant variation in the investment climate across locations within countries. So local governance is important.
In this chapter we have stressed the combined significance of the investment climate indicators and the fact that together they predict performance differences across locations, of magnitudes that are both plausible and important. As more surveys are completed and the sample size grows, it will be possible to gain confidence about the importance of specific aspects of the investment climate. At present, it appears that customs clearance times, power reliability, and availability of financial services are the indicators that most consistently influence foreign investment and export status. This suggests that the government’s role in providing a good regulatory framework for infrastructure, access to the international market, and finance is particularly important.
Looking ahead, we plan to sponsor repeat surveys (rolling panels) on about a three-year cycle.8 We hope that these surveys will be a useful tool for communities that are trying to improve their investment climates, helping them to benchmark themselves against other locations and to measure their progress over time.
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