For foreign investments, the govts need to go beyond Adam Smith’s maxim of peace, easy taxes and justice

Prof Ricardo Hausmann in this piece says governments need to do three more things than Adam Smith’s maxim.

First why Doing Business Rankings does not translate into foreign investments:

The scenario is all too familiar. A reformist government wants to boost economic growth and employment by implementing market-friendly reforms designed to make the country more attractive to (often foreign) investors. Policymakers understand that these investors possess the technological prowess, organizational capability, and market reach that the country desperately needs. Committees are created to improve the country’s performance in the World Bank’s Doing Business index, the World Economic Forum’s Global Competitiveness Report, or other beauty contests promoted by a sprawling array of international rankings.

The reformist government overcomes grueling fights with legislators and civil society, who accuse it of putting investors’ interest ahead of those of its own people. But with perseverance, it successfully adopts reforms that improve the country’s rankings and gets glowing coverage in the international press. The learned world’s impression of the country (and even that of money managers) changes significantly for the better. And then the government waits for foreign investment to arrive. And waits. And, as in Samuel Beckett’s famous play, the anticipated inflows, like Godot, never show up.

This problem stems in part from assuming that what needs fixing is captured in international rankings. Too often it is not: worldwide, there is zero correlation between improvements in the Doing Business and Competitiveness indexes and growth or investment performance.

Often, the focus of such rankings is on reducing red tape, which assumes that investors stay away because of some sin of commission, which, if stopped, would release the floodgates. But the world is more complicated than that. Most people who could potentially do well by investing in your country know a lot about their business but probably know very little about your country – particularly the things about your country that matter for their business, including the ones you just reformed. More important, their business usually depends on things you should be doing but aren’t – your sins of omission.

Three things to be done:

To avoid this predicament, governments need organizational capabilities that go beyond Adam Smith’s maxim that they must do no more than ensure “peace, easy taxes, and a tolerable administration of justice.” They need to do at least three additional things.

First, the government needs to engage with existing economic activities to identify what it can do to improve their productivity, whether by changing rules, infrastructure, or other publicly provided goods and services. 

Second, the government should mobilize society and domestic and foreign firms to explore the “adjacent possible”: activities that do not exist but for which the requisite ecosystem is almost in place. This requires people in and out of government to imagine what is not yet there, figure out what is needed to establish it, and determine whether it would be both feasible and valuable to society. This exploratory process is both costly and risky, although recent advances such as the Atlas of Economic Complexity make it less of a crapshoot, by revealing relevant information for assessing the feasibility and the attractiveness of potential new industries. 

Third, and most controversially, governments often need a corporation to facilitate investment in new strategic areas and manage the activities generated by previous strategic investments. These corporations may be set up as holding companies for already existing state-owned enterprises that currently report to their respective line ministries. The ministries should focus on their regulatory functions, leaving the holding company to provide close financial and operational oversight and exercise shareholder rights on behalf of society. The holding company can also be capitalized with assets that the government already owns.

How some of this policy advisory has changed over the years!

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