21 corresponding to the degree to which it is an obstacle to firm performance.<sup>45</sup> High mean reported values for particular dimensions of the investment climate are then interpreted as evidence of the severity of obstacles to growth.

However, this may not be the case. Perceptions of the degree to which some investment climate variables differ from the actual effect of these variables on firm productivity, business performance, or firm growth. Despite their intimate knowledge of their business processes and operating environment, firms may not fully recognize the true origin of their main problems and mistakenly identify as a constraint something which is in fact a symptom of another less obvious problem. Because of these shortcomings, investment climate constraints are increasingly complemented by the World Bank “Doing Business” indicators, which are based on expert surveys (not just firm-level perceptions) and provide a more comparable cross-country perspective across a detailed range of regulation.

The problem remains, as survey results often vary depending on whether respondents are asked to rate their most important constraints, or to rank them. While ranking appears to be favored by researchers who have examined different methodologies, as it forces stronger expression and relationships (Alvin and Krosnick 1985), it may not be entirely reliable: firms or experts who are asked to rank constraints may not have a good basis for determining whether their top-ranked constraint is serious or not. Ranking without a solid and meaningful benchmark against which local firms in a given country can rate the severity of a particular constraint may not provide useful information. In addition, there are instances where picking any single quantitative criterion could be misleading, as firms often face several constraints simultaneously. Ranking all of them as important may not be very helpful for policymaking. In order to account for the major role of firm heterogeneity in growth analysis, one must go beyond extracting means of investment climate variables from firm-level surveys. Careful econometric modeling of firm performance is therefore needed to identify which particular variable has the biggest effect on growth. In other words, the policy variables with the greatest economic impact can be quite different from the policy variables with the highest perceived values.<sup>46</sup> Investment climate surveys have two more limitations: they do not provide information about industries that do not yet exist, but in which a country has latent comparative advantage. Moreover, the existing industries that are surveyed may not be consistent with the country’s comparative advantage, either because they are too advanced (as a legacy of a development strategy that defied comparative advantage), or because they have become fundamentally uncompetitive (as a result of a general wage increase that accompanied the country’s development). These two additional limitations make it highly desirable for investment climate

> 45 Ayyagari et al. (2005) present the mean reported values for a number of investment climate variables in a sample of over 6,000 firms in 80 countries. In the overall sample, taxes and regulation, political instability, inflation, and financing are reported as being the greatest obstacles to firm growth.

> 46 Bourguignon (2006) observes: “‘Extracting means’ is the way I would characterize the Investment Climate Assessment exercises that the Bank is now carrying out. Like the ‘Doing Business’ indicators, these are undoubtedly useful. However, what they give us is essentially new and better right hand side variables in cross-country regressions, not necessarily better data for country-specific analysis. The goal should be to use investment climate surveys to measure the sensitivity of firms of different types to investment climate variables, as another way of determining exactly which variable corresponds to a major obstacle to growth.”