friendly regulations have tended to have greater economic inclusiveness and smaller informal sectors, and have grown faster (Djankov, McLiesh, and Ramalho 2006; World Bank 2014). Conversely, trade restrictions have been associated with lower firm-level productivity, especially when accompanied by intrusive domestic industrial policy (Topalova and Khandelwal 2011). Weak business environments have also diminished complementarities between public, foreign direct, and domestic investment (Kose et al. 2017). Major improvements in business environments have been associated with increased output growth (Divanbeigi and Ramalho 2015; Kirkpatrick 2014).

A number of factors have affected the impact and success of institutional reforms, including the country’s stage of development and distance to the technological frontier (Dabla-Norris, Ho, and Kyobe 2016). Thus investment in physical and human capital has often been associated with stronger long-term outcomes when the quality of institutions exceeded certain thresholds (Hall, Sobel, and Crowley 2010; Jude and Levieuge 2017). EMDEs with stronger institutions and better regulations may have achieved greater output gains from financial liberalization and trade openness (Atkin and Khandelwal 2020; Slesman, Baharumshah, and Azman-Saini 2019; Williams 2019).

The ability of governments to maintain the pace of institutional reforms has often been uneven, in part because the growth dividends from reforms have often materialized with substantial lags and reforms may have initially been unpopular and politically costly, including at election times (Alesina et al. 2020). Major growth downturns have sometimes been associated with subsequent reform accelerations; conversely, growth-enhancing reforms have often been delayed or even reversed during times of economic stress and in economies with high debt burdens (Gokmen et al. 2020; Muller, Storesletten, and Zilibotti 2019). Even during more tranquil times, meaningful reforms have often been postponed or abandoned because of their redistributive effects, including their costs to vested interests. (Gradstein 2007).

# Reforms to institutions and business climates: Empirical estimation

A local projection approach is used to estimate the impact of major, sustained institutional reform advances and setbacks on the growth of TFP and investment in EMDEs. Sustained institutional advances (or setbacks) are defined as increases (or decreases) in the unweighted average of four indicators from the International Country Risk Guide (ICRG)—bureaucracy quality, law and order, corruption, and investment profile— provided the increase (or decrease) is not unwound for at least three consecutive years. The local projection model estimates the effect of the reform event on the cumulative growth of investment and TFP over horizons of two and four years after the start of the event (annex B).

The estimates suggest that reform advances were associated with significant and, in some cases, lasting increases in the growth of TFP and investment whereas the impacts of setbacks were highly heterogeneous. TFP was, on average, about 1.9 percent above the baseline two years after reform advances (figure 11). Over time, this impact became more heterogeneous and more difficult to estimate precisely. By contrast, the impact on