# **Introduction**

This is a survey paper of the literature discussing the impact of the business climate on productivity and growth in developing countries. In recent years, an unprecedented data collection effort has yielded a set of comparable enterprise surveys covering close to 70,000 firms from over 100 countries in all continents. As a result, a number of studies have started to analyze the impact of the business climate variables contained in these surveys on different dimensions of firm performance. The general aim of this literature is to generate policy prescriptions based on the identification of the main constraints facing firms. Although many of these studies identify relevant constraints, contradictory or fragile results are also found, pointing to some weaknesses in the methodology applied in some papers as well as in the original survey questionnaire design itself.

The objectives of this paper are to review the literature, take stock of the lessons learned, highlight strengths and shortcomings, and propose potential improvements. To do so, we start by providing a theoretical framework to think about the impact of the business climate on productivity and growth in developing countries (Section 1). We then survey the existing empirical literature that is based on investment climate survey data. We discuss the empirical macro literature in order to put the firm level investment climate studies into context. The main findings of the micro literature are then outlined, and the robustness of the results considered (Section 2). Finally, we highlight the main econometric issues raised by the current literature, put forward a number of ideas to advance research on the investment climate and suggest possible improvements in survey design (Section 3).

# **Section 1. Economic Growth and the Business Climate**

This first section describes the general theory of the business climate and outlines a theoretical model linking critical variables with economic performance and growth. A number of structural, institutional, and behavioral variables shape and drive economic growth. The critical variables that collectively define the so-called business or investment climate are, broadly speaking, (1) infrastructure, (2) access to finance, (3) security (absence of corruption and crime) and (4) the regulatory framework, including competition policies and the protection of property rights. The main hypothesis of the investment climate literature is that the business climate affects activity throughout the economy—particularly incentives to invest. An improvement in the business climate increases returns to current lines of activity and so increases investment in these. It also creates new opportunities – for example, through trade or access to new technology. It influences the psychology of entrepreneurs – the Keynesian ‘animal spirits – affecting their assessment of whether innovation will pay off. It puts competitive pressure on firms that have enjoyed privileged positions as a result of import or other protection, or special access to government officials. As a result of greater competition, it may cause some firms, perhaps those closer to technological frontiers, to shine—even as others fail.

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