Catalog

Conclusion

Real equity prices, EIU risk indicators, and KK governance indicators all point in the same broad direction, and suggest that firms and investors may now be more circumspect than a decade ago. Elevated precautionary behavior is also suggested by rapidly falling debt-equity ratios and slow growth of real credit to the private sector. And at least until 2004, there would also appear to have been more dissonance about the macroeconomic outlook than before.

But the crisis countries show significant differences in circumstances. The decline in Korea's investment rate and a lower growth trajectory is consistent with the maturation that occurs as income levels approach those of the richest countries in the world. Controlling for per capita income, Korea's postcrisis investment rates and growth may not be unusual.

In the case of Malaysia and Thailand, postcrisis growth and investment rates are possibly "too low. "Although the evidence suggests that the overall business climate in both countries compares favorably internationally, increased uncertainty may have led investors to sit on the sidelines to wait for clearer direction. It is also possible that bottlenecks in the supply of complementary factors, particularly skilled technical and scientific workers, may have clipped growth.

The picture for Indonesia and the Philippines is somewhat different. Although performance on macroeconomic management has improved, their investment climate ratings and governance performance generally compare unfavorably in a wide international setting. There is also evidence of regression on a number of indicators, especially those related to economic regulation. It may be that earlier reforms need more time to gain traction, but the presence of deeply embedded institutional constraints, including high levels of corruption, may slow progress even then.

Looking ahead, Indonesia, Malaysia, Philippines, and Thailand all have ambitions to lift their growth rates, but not quite to the lofty heights that were envisaged a decade ago. Indonesia's Medium-Term Development Plan aims to rack growth up to 7.6% by 2009 and anticipates a steady rise in the ratio of investment to GDP. Malaysia's Ninth Five-Year Plan sets a target of 6% growth over 2006-2010, an acceleration of 1.5% a year relative to the outcome during the Eighth Plan. In the Philippines, the National Economic Development Authority has set its sights on a GDP growth rate of 7-8% by 2009. By that time, investment in fixed capital is expected to be growing at a much faster clip of around 14-15% a year. Thailand, too, anticipates an acceleration of growth to around 6% which, it is anticipated, will be accompanied by strong investment growth.

But what needs to be done to encourage investment, and accelerate growth on a sustainable basis?

Macroeconomic policy appears to offer little maneuver for stimulating investment. Policy interest rates are now more firmly set with inflation prospects in sight in Indonesia, Philippines, and Thailand. Even in Malaysia, which has no formal adherence to "inflation targeting," prospects for inflation are a significant concern in charting monetary policy. If the inflationary pressures were to retreat further, allowing policy rates to come down, this could stimulate investment, but real interest rates are already low by historical standards (Figure 1.4.10).

Fiscal options are also somewhat constrained. Infrastructure spending plans, particularly in Malaysia and Thailand, will have to be assessed in the context of other priorities and domestic debt levels that are still quite high. One possibility might be to deploy some portion of low-yielding foreign exchange reserves to help finance the import content of investment projects. Because a critical element in any assessment of country risk and uncertainty is the macroeconomic environment, continued adherence to prudent policies is what will help investment most.

Improvements in the investment climate are clearly needed, but priorities differ by country. The successful migration to higher-productivity industrial and services activities depends critically on having a pool of versatile workers with the right skills. In both Malaysia and Thailand businesses complain loudly of bottlenecks in the supply of workers with relevant skills. In Malaysia, the presence of a growing number of unemployed graduates alongside increasing vacancies for technical and managerial workers suggests that there is a mismatch between what is being taught at upper-secondary and tertiary levels and what firms need. Investment in quality and relevance, including high-quality business-oriented vocational training, is what is needed. Success in building a modern knowledge economy will depend critically on better educated teachers and relevant curricula. Thailand performs poorly on various infrastructure indicators.

Malaysia and Thailand also need to improve their regulatory environments. Labor market regulations, customs procedures, and ordinary bureaucratic requirements are widely cited as sources of uncertainty. In Malaysia, these burdens fall disproportionately on the largest and best performing firms, and the growth of the services sector is hobbled by lack of competition. In Thailand, tax, customs, labor, and ownership regulations are regarded as problematic by the business community. Improvement in these areas and in the quality of enforcing laws would reduce the risks and costs for business investors.

For Indonesia and the Philippines, where improvements have already taken place in the macroeconomic policy environment, the key to sustaining growth is likely to lie in improving the quality and performance of key institutions that influence investor perceptions about uncertainties, risks, and the costs of doing business. Clearly, useful advice needs refinement and has to be tailored to the country context, though in both countries (outside the financial sector) lighter regulation-but with much improved implementation-is required.

The Investment Climate report for Indonesia identifies "risks" as the leading concern among investors. Policy and regulatory risks are singled out. Although clarity on policy has improved, regulatory risks remain a problem. A second significant concern is the costs of doing business, which include the costs of corruption, as well as poor contract enforcement and regulation. Indonesia ranks poorly by international standards, and has seen no improvement in the past decade. Poor infrastructure also raises business costs in the country.

In the Philippines, too, governance issues are to the fore. Contract enforcement, corruption, and crime and security are of particular concern. The Investment Climate report suggests that added and avoidable costs in the Philippines place it at a disadvantage to the PRC. Poor infrastructure, particularly in power and transportation, add most to costs. Generally, the institutions of government are weak and this has slowed the pace of progress. Complex rules and regulations do not adequately address competition issues and continue to create fertile ground for rent seeking. In a variety of dimensions, prospects for raising investment and accelerated growth will depend on the capacity of institutions to move ahead and implement the changes that are required to reduce uncertainty and risk.

Finally in all countries, although a pickup in investment may not be sufficient for faster growth, it will help growth to accelerate if new investments raise aggregate productivity. Fundamental to this will be the ability of financial systems to direct resources to the best projects. This will not only require continuing improvements in banking regulation and supervision, but also the expansion of capital markets that price risks efficiently, improve information flows, and enhance liquidity. The opening of sectors that are still sheltered from competition (especially in services) could also help lift investment and growth. Lying at the intersection of these difficult challenges will be more effective institutions and improved governance.

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