Strengthening Rural Investment Climate

Important elements in the regulatory framework are free entry for new enterprises; freedom to operate without the need for difficulty to obtain permits and without heavy administrative burdens; freedom to trade domestically and internationally without serious administrative obstacles; and functional competition laws, auditing requirements, industrial standards, and market regulations. Policies should enable, but not distort markets. Good governance should also be evident, including transparent policymaking and absence of corruption among and harassment by public servants.

Also of importance are the quality and availability of public services;

availability of a healthy, educated, and skilled labor force; availability of financial services; and availability of infrastructure-based services such as transport, telecommunications, post-office, power, water, and sanitation.

opportunities to make profitable. World Bank (2005, p.19) describes that “a good investment climate fosters productive private investment, the engine for growth and poverty reduction”. Stern (2002a) defines that a more attractive investment climate could enhance market prospects for the rural non-farm incomes and employment that could help to reduce rural poverty.

Several researchers highlight the importance of the investment climate for economic growth and economic stability. World Bank (2004) mentions that quality of investment climate affects the performance of regional and national economies, and industrial growth. Although “growth with a poor investment climate is possible, but unlikely to be sustained” (World Bank, 2005, p. 29). Mohammed and Hasan (2010) also mention that the investment climate has a close link with the economic development of a country. It affects productivity, creates job opportunities, and quickens the pace of economic growth.

In general, strengthening investment climate benefits the whole society, not only to maintain and consolidate macroeconomic stability but also to reduce corruption (World Bank, 2005). Dollar, Hallward-Driemeier, and Mengistae (2003b) explain that improvements in investment climate, such as strengthening of property rights, legal system, and reducing level of corruption are also well correlated with growth. Therefore, an enabling investment climate contributes greatly to promote growth and poverty reduction.

According to Operations Evaluation Department - OED (2004), a country’s investment climate is its environment for private sector activity that is characterized by the legal and regulatory framework, barriers to entry and exit, and conditions in markets for labor, finance, information, infrastructure services, and other productive inputs. The OED’s report highlighted that investment climate can be healthy through government’s policies, institutions, and their relationship with the private sector. Moreover, private sector activity is believed to play a major role on growth and employment and an enabling rural investment climate has important impact to poverty reduction.

Improvement of infrastructure could be promoted by a good investment climate (Bergara et al., 1998; Henisz, 2002; Henisz & Bennet, 2001; Weder & Schiffer, 2000;

Zhang et al., 2002; and Mendes et al., 2009). World Bank (2005) suggests that public investment in infrastructure is an important source of financing in order to improve the investment climate, but in the context of international integration, the international development community is also a necessary source of external financing for these investments.

The above-mentioned evidences emphasize the role of the investment climate for social benefits, such as growth, poverty reduction, creating jobs, and strengthening infrastructure. However, it is important to find “a consistent pattern of relationships between the investment climate on one hand and firm productivity, factor prices, and growth rates, on the other” Dollar et al. (2003, p.13). Several researches using different ways have verified the relationship between the investment climate and business activities of enterprise.

According to the World Bank (2005, p.1), “a good investment climate provides opportunities and incentives for firms, from micro enterprises to multinationals, to invest productively, create jobs, and expand”. Furthermore, asound investment climate ensures higher productivity of manufacturing firms anddetermines firms’ decisions(Mohammed

& Khan, 2010; Cuong et al., 2009). Dollar, Hallward-Driemeier, and Mengistae (2003) show that firms in better investment climate can be highly productive as compared to those in weaker environment. World Bank (2004) finds that labor productivity and total factor productivity are much higher in a better investment climate. Therefore, a good investment climate not only generate profits for firms but also minimize costs and risks (World Bank, 2005). Improving investment climate lead to higher productivity, factor returns, and growth (Dollar et al., 2003). In addition, domestic firms are also more likely to export where the investment climate is good (Dollar et al., 2003b). However, some authors have found that improving investment climate conditions would disproportionately benefit the smallest firms (Hallward-Driemeier & Stone, 2004; Josef

& Lane, 2007).

Wages and returns to capital would be higher in a better investment environment (Dollar et al., 2003). At the firm level, the study show that investment climate has significant influences on the level of productivity, wages, profit rates, growth rates of output, employment, and capital stock. In addition, a good investment climate for firms to

invest and operate is established by an interaction of openness and sound investment climate (Dollar et al., 2003b).

Some research works emphasize the importance of corporate governance for improvements of investment climate. In a study, reform in governance affected profoundly both investment climate and social inclusion (Stern, 2002a). Also emphasized was the role of a country’s general governance structure and business government interactions as important components of the investment climate (Dollar et al., 2003c).

Hung (2006) suggests that corporate governance would contribute an important role in the attraction of foreign direct investment in Vietnam. Likewise, improving taxation and regulation not only plays a key role in creating an enabling investment climate but also contributes to protect broader social interests (Smith & Hallward-Driemeie, 2005).

Conversely, poor infrastructure as well as the weakness of the government factors can deplete the attractiveness of the investment climate (Stern, 2003).

In terms of its implication on rural agenda, World Bank (2006) states that many of these facets of the investment climate are absent, defective, or at least in need of improvement in most rural areas. However, this does not mean that a healthy investment will ensure more stable enterprises and fewer enterprise deaths (Mead & Liedholm, 1998). At a certain aspect, a good investment climate implies a healthier economy, one in which the more efficient enterprises will gain the advantage of existence and force the less efficient ones on going out of business. A better rural investment climate, of course, is reflected by good economic environment, the economic health of rural entrepreneurs, and the dynamics in the rural economy.

Many researchers mention improving rural investment climate and realize its role in rural sector development. World Bank (2008b, p.3) argues on the importance of rural investment climate as follows:

Improving the rural investment climate will likely involve a differing set of remedial actions, consisting of a tableau of nuanced priorities for the kinds of public sector support needed for rural non-farm enterprises, distinct from and in contrast to intervention geared toward stimulating investment by the more formal urban-based enterprise sector.

Targeting the rural investment climate is consistent with a rural development policy that stresses the importance of a thriving private sector in rural areas as the best means of achieving growth, creating employment, and reducing poverty.

Generally, the mainstream of improving rural investment climate and rural

development programs will ultimately lead to more operations that support rural enterprise development. It also severs as significant bases for policy makers and researchers in understanding profoundly the structure and role of rural economics generally, and provides insight into agricultural and rural economics and their position in the global economy.

According to World Bank's study (2011b), entitled "India: Priorities for Agriculture and Rural Development", rural investment climate plays an important role in strengthening rural non-farm sector growth. It also suggests that the government should create the enabling rural investment climate for private sector participation and competition for agribusiness by shifting its role from direct intervention and overregulation. This means that improving rural investment climate implies removing obstacles which can be barriers for firms to operate more efficient, such as trade controls, regulations and permits, tax regime, access to credit and key infrastructure, etc.

Agriculture play an important role in rural investment climate because benefits from agricultural productivity result to reduced poverty by lowering food prices, raising farmers’ incomes (despite market adjustment from increasing output) and creating employment opportunities (DFID, 2005). There is little evidence that other sectors can replace agriculture in its primary growth role in rural area that remains at a low level of development. Thus, creating a healthy rural investment climate for agro-enterprises and other rural entrepreneurs to perform is central to supporting growth and poverty reduction, particularly in developing countries.

Usually, agriculture as the dominant economic activity in rural areas has many potentials because synergies exist in rural space between farming and private enterprises and between consumers and enterprises. Also important is the role of the government in maintaining synergy and business development through the removal of obstacles and provision of public goods. However, the direct interventions may be not enough for the governments to do this important task as it needs“a much broader agenda” (World Bank, 2006).

Nevertheless, improving the investment climate for agricultural producers remains a challenging problem. According to Lauren (2006), low productivity in

agricultural sector that leads to state of slow growth and poverty still persist in many parts of rural area. Therefore, improvements of the investment climate in rural and agricultural producing regions have significant influences on agricultural growth and poverty reduction, levels of inequality in society and between sub-regions and management of natural resources, etc.

In Vietnam, several studies have proved that improving investment climate is imperative, especially in rural areas. World Bank and International Financial Corporation (2012) indicate that the ease of doing business in Vietnam had significant progress but also highlight that the constraints such as business regulations, tax system and administrative process are still severe for firms to operate. In general, the legal system is still inefficient despite improvements of legal system (Alain, 2005). In a more related study, Dzung et.al (2005) show that difficulties in access to land and finance and considerable distinction between state-owned enterprises and private enterprises are major constraints of rural investment climate in Vietnam. Thanh (2010), on the analysis of the situation of infrastructure in Vietnam, concluded that rural infrastructure is poor, particularly electricity and roads and this situation has negative effects on firm’s business activities.

2.2.3.2 Lessons Learned in Strengthening Investment Climate from Countries in the World

In developing countries, the most important priority is economic growth and poverty reduction. One of the path ways to achieve this goal is to improve the investment climate (World Bank, 2005). In fact, many developing countries have impressively achieved economic growth through efforts in improving investment climate. In this study, we refer to the cases of China, Singapore, Thailand, Malaysia, and Indonesia which were considered to have many similarities with Vietnam in economic development.

China was cited as the successful country in attracting foreign direct investment (FDI) and developing economics that depended largely on the achievements in improving the investment climate (Dollar et al., 2003c). The lessons learned from the case of China in improving the investment climate are initially to establish the special economic zones

to attract investment, transfer of technology and advanced management experience (Huong, 2007). Accordingly, the priorities in creating an enabling investment climate in the special economic zone include improving infrastructure (e.g. transport, electricity, telecommunication, and water), applying administrative autonomy in planning, and controlling, and preferential policies to encourage investment (e.g. tax, finance and construction). Based on the lessons learned from the cases of special economic zones, China has gradually replicated the improvements of investment climate in whole country.

Consequently, achievement of developing economics in China is very impressive.

Singapore is now the country with the largest level of foreign direct investment in Southeast Asia, accounting for 54.7% of total FDI in Southeast Asia in 2011 (VietnamPlus, 2012). Unlike many countries when conducting industrialization at that time, Singapore has focused on creating a favorable investment climate to encourage foreign capitalists to invest directly instead of lending to address capital needs.

Accordingly, the regulation of “the industry pioneers” exempting corporate income tax from 5 to 10 years was applied for the areas of metallurgy, mechanics, aerospace, shipbuilding, transportation equipment, optical devices, electronics, chemicals and petrochemicals. Additionally, foreign firms were free to transfer capital and dividends to foreign countries where they have headquarters and investor's property rights were guaranteed by the government.

In Thailand, the achievements in improving investment climate have also contributed greatly to economic growth (World Bank, 2008c). The lessons learned from Thailand may be mentioned that the priority in creating “one stop shop” to simplify the administrative processes such as business registrations, licenses and permits, incentivizing export tax and value added tax for products exported, providing trade services such as consulting (e.g. finance, legal, investment incentives), banking, and vocational training.

Similarly to Thailand in improving investment climate, Indonesia initially succeeded in creating an attractive investment environment through the creation of “one stop shop”for simplifying administrative processes. In addition, the government has also given the priorities to the maintenance of macro stability (e.g. macroeconomic, transparency, anti-corruption), improvements of capacity of local governments and poor

infrastructure system such as power outages, transport failures, and inadequate water supply (ADB, 2005b). Recently, the government has stipulated that foreigner's entry and exit taxes must be deducted from his/her personal income tax (VietnamPlus, 2012).

In Malaysia, the government attaches much the role of multinational companies, especially those having benefits associated with the country's interests. In addition, Malaysia adopted a policy of training employees following the request of the investor (World Bank, 2009a).

2.3. Role of Agro-enterprises in Development of Agriculture and Rural Economy