Robust methodology for investment climate assessment on productivity: application to investment climate surveys from Central America

Developing countries are increasingly concerned about improving country competitiveness and productivity, as they face the increasing pressures of globalization and attempt to improve economic growth and reduce poverty. Among such countries, Investment Climate Assessments (ICA) surveys at the firm level, have become the standard way for the World Bank to identify key obstacles to country competitiveness, in order to prioritize policy reforms for enhancing competitiveness. Given the surveys objectives and the nature and limitations of the data collected, this paper discusses the advantages and disadvantages of using different productivity measures. The main objective is to develop a methodology to estimate, in a consistent manner, the productivity impact of the investment climate variables. The paper applies it to the data collected for ICAs in four countries: Costa Rica, Guatemala, Honduras and Nicaragua. Observations on logarithms (logs) of the variables are pooled across three countries (Guatemala, Honduras and Nicaragua). Endogeneity of the production function inputs and of the investment climate variables is addressed by using a variant of the control function approach, based on individual firm information, and by aggregating investment climate variables by industry and region. It is shown that it is possible to get robust results for 10 different productivity measures. The estimates for the four countries show how relevant the investment climate variables are to explain the average level of productivity. IC variables in several categories (red tape, corruption and crime, infrastructure and, quality and innovation) account for over 30 percent of average productivity. The policy implications are clear: investment climate matters and the relative impact of the various investment climate variables indicate where reform efforts should be directed in each country. It is argued that this methodology can be used as a benchmark to assess productivity effects in other ICA surveys. This is important because ICA surveys are available now for more than 65 developing countries.