Relationship between Rural Investment Climate and Firm’s Investment 1 Defining Firm’s Investment

(Hung, 2006).

By measuring the effects of public infrastructure on firm’s productivity in the rural areas of India, Zhang and Fan (2004) found that infrastructure development is productive. This finding reverses the trend of declining investment in rural infrastructure.

In a more recent empirical research, Waleerat and Warr (2010) show that the following factors such as public investment in agricultural research, international research spillovers, rural roads and case-specific factors have significant influences on total factor productivity in agricultural sector in Thailand.

Furthermore, Trung and Cuong (2010) conducted an analysis at firm level to measure the influence of investment climate factors on total factor productivity in the agricultural sector in Vietnam. They found that the time for administrative clearance has significant negative effects on total factor productivity by 1.7 - 5.7% among various business lines. Whereas, some factors in investment climate such as time of land rent, certification of clean production, and level of market competition have positive effects on total factor productivity within different levels among various business lines. In the model, two internal variables, including age of the firm and educational level of labor also positively influence the firm’s productivity.

Nevertheless, none of the above-mentioned studies rightly emphasizes the impacts of the factors of rural investment climate on agro-enterprise productivity. In general, the effective performance of agro-enterprises is linked to better rural investment climate which may also lead to the government’s efforts in prioritizing the development of agriculture and rural economics. It is therefore important to examine the effects of the factors of rural investment climate on agro-enterprise performance because these factors can explain the variation in performance across agro-enterprises.

2.4.3. Relationship between Rural Investment Climate and Firm’s Investment

investment. However, the analysis with some more other definitions of investment is helpful to make precise the subject matter that we will be studying.

In terms of finance, InvestorWords defines investment as the use money in the hope of making more money. It means that the investor purchases a financial product or other item of value with an expectation of favorable future return. On the other hand, in terms of business, investment means the purchase by a producer of a physical good, such as durable equipment or inventory, with the hope of improving future business. More relevant to the definition of investment in terms of business, World Bank (2005, p.2) emphasizes as “investment underpins economic growth by bringing more inputs to the production process”.

Cuong, Nga, Trung, Huong, Anh and Loan (2009) conducted an economic analysis of investments in the agricultural sector based on the two types of investment division: new investment and upgrading investment. Irish National Farm Survey (as cited in Hennessy & Brien, 2008, p.4) defines net new investment asan “investment (including both purchase and repair) in buildings, land improvements, machinery, and production quotas, less all sales, grants and subsidies”. Hennessy and Brien (2008) note that net new investment measure of a farm exclude investment in land purchases which means that it does not include any potentially speculative investment, such as farmers purchasing the land with the intention of re-selling it for a profit. Similarly, it is important for an investment to based its operation on a detailed analysis that guarantees safety of amount invested and gives an adequate return for an investment operation, otherwise it is speculative (Graham & Qadd, as cited in Vijay, 2012).

Looking more closely, investment is involved in many areas of the economy, such as business management and finance whether for individual economic units or for governments. Moreover, investment can be divided into two types. The first is investment which refers to the purchase of financial products such as stocks and bonds. Second is real investment which pertains to the purchase of physical capital such as equipment, land and inventory as employed in the production process and which will earn increased profit. In this study, the definition of investment meaning “real investment” is closer relation to the research problem. Furthermore, the term "net new investment" will be used in the analyses in the different sections of the following chapters.

2.4.3.2 Behavioral Decision Making

Principle of profit maximization is initiated and underpinned under the orthodox neoclassical economics. The proponents of the theory assume that an investor has perfect information of his surroundings and he makes the decisions on the basis of this principle.

Conversely, the neoclassical economic theory proposes that every investor has limited access to the information and his decision making is influenced by external constraints and his own behavior. Therefore, bounded rationality is normally considered in investigating behavioral decision making (Bruin & Dupuis, 2000; Simon, 1992).

According to Thaler (1997), behavior decision making represents what actually happens when investors make decisions. Investors normally overreact to current information and display excessive optimism because they may fail to consider long-term investment prospects in terms of short-term forecasts. That is why they appreciate information received through personal contacts rather than from the general market information. Somil (2007) argues that investors are normally mindful of past performance and they make investment decision based on the analysis of current circumstances in reference to what has been performed in the past. Ehrbeck and Waldmann (1996) have strengthened this viewpoint by concluding that investors tend to relate past incidents in making their decision despite the economic forecasters’ overreaction in response to recent information. According to Olsen (1997), investor’s suspicion about the reliability of economic forecasts is partially explained by the forecasters exhibited wishful thinking when forecasting economic events either without or with less reference to normative investment model. Somil (2007) argues that these reasons have reduced an investor’s adherence to a strictly normative investment model and suggest the importance of behavioral investment model.

2.4.3.3 Relationship between Rural Investment Climate and Firm’sInvestment Decisions

Firms invest mainly to grow and make profits. As such, capital investments are natural needs for enterprise to expand the scale of production and competitiveness. The two sources of capital which can satisfy investment demand are internal finance which is derived from firms’ profits for reinvesting and/or from the entrepreneurs and external

finance which is derived from formal and informal credits, third-party equity, and quasi debt instruments (World Bank, 2005; Sinha & Fiestas, 2011).

In a firm’s decision-making to invest, Sinha and Fiestas (2011) mentioned that it is a pre-requisite that the risk adjusted rate of return on capital (after tax) must be greater than the cost of borrowing (for capital funded by loans) or the opportunity cost of using equity. A poor investment climate normally exhibits obstacles that increase the risk and costs of investment, reduce returns or impede the firms from capturing these returns. This is particularly true for developing countries. Thus, creating an enabling investment climate will certainly attract more investors to invest.

Following earlier literature, we capture the evidences that indicated the positive link between the investment climate and private investment. The improvements of investment climate during the 1980s and 1990s paved the way to increased private investment as the share of GDP nearly doubled in India and more than doubled in Uganda (World Bank, 2009). In Ghana, the significant impacts on private investments resulted to reducing macroeconomic instability, growing real credit, and improving infrastructure (Asante, 2000). However, more severe constraints have discouraged private investment in developing countries (Kinda, 2010; Tokuoka, 2012).

The combination of related literature review and the assessment of rural investment climate in Vietnam, has led to the development of a rural investment framework as a basis for the analysis of rural investment. Accordingly, the components of rural investment climate affecting rural investment include demand for output of rural enterprise, local endowments, capital availability and costs, land tenure security, rules and regulations, taxation, infrastructure, and competition. The characteristics of the individual firm are also included in the framework, together with entrepreneurship and management skills, knowledge of market opportunities, and manager’s characteristics.

Analysis of the results led to the conclusion that rural firms are profitable but this seems to be not enough for the growth of investment. Furthermore, corruption has its shares in the already thin margins of profits as evident in dealing with regulations and officials, poor rural infrastructure, and low level playing field. In sum, these have significant negative impacts on rural investment (Dzung et al., 2005).

Several empirical researches emphasize the significance of the relationship between investment climate factors and investment in agriculture. Li, Rozelle, and Brandt (1998) show that associated property rights in rural China have significantly influenced the behavior of farmers in investments. Several studies prove the influences of household characteristics and access to bank credit on farmer investment (Ghorbani & Darijani, 2009; Thong et al., 2008; Hennessy & Brien, 2008; Liu et al., 2002). In Kenya and Tanzania, access to financial services has strong impact of on level of investment by the household (Ellis et al., 2010). On the other hand, Lin (2010) shows that rising in level of competition between crops and policies towards support to ethanol plant have deterred local investors from investing on food crops.

Thanh (2008) discusses the theoretical models of investment in agricultural sector and suggests that investors in agriculture need access to agricultural and rural markets, tenure and property rights, infrastructure, access to credit markets, development research (private sector), and tax system. Recently, Cuong and Nga (2011) conclude that agricultural firms have enhanced higher economic efficiency from investing on farm production as compared to their agri-business activities. They also found significant impact of the factors of investment climate such as land rights, agricultural policy, infrastructure, market competitiveness, and management capacity of the local government on the level of investment in agriculture.

Nonetheless, none of the studies mentioned above focus on the influence of rural investment climate factors on agro-enterprise’s investments. Most of the available literature that link investment climate and firm’s investment mainly studied the impact of the factors of investment climate on investments made by farmers or on non-farm enterprises, rather than on the influences of the factors of rural investment climate on agro-enterprise’s investment. A healthy rural investment climate is generally linked to a dynamic rural economy that triggers development of agriculture and rural economics through the government’s efforts. It is therefore important to examine the effects of the factors in rural investment climate on agro-enterprise’s investments in order to explain the variation in growth of agro-enterprises –an important motivation to the development of agriculture and rural economy.