WHAT makes countries tick and sustain high growth rates? Conventional wisdom and experience could never have predicted an economy with a heavy footprint of government (China) to grow at double-digit rates for such a long period.

So, what combination of factors stimulates investor sentiment and growth? Is it easy to identify such a set and then put it in place in any socio-political system?

Do factors like the size of economy, the stock of natural, physical and human resources and low interest rates have more than a marginal influence on investor behaviour? If some of these factors had been critical it would be difficult to explain the cases of Dubai, Singapore and Hong Kong.

Some would then argue that a combination of political stability and a business-friendly political, administrative and policy environment is probably more decisive in creating the feel-good factor that kindles investor sentiment. But then the control freak bureaucracy of the Indian variety did not impede the sterling performance of its private sector over the last two decades. Therefore, it is not that obvious what makes countries tick and what drives the ‘animal spirit’ of the private sector, although there would have to be attractive opportunities to make money to fuel private enterprise.

What is it about the feel-good factor which gets translated into optimism? How do policies and practices for implementing them influence this sentiment?

Can the feel-good factor be based merely on abstract numbers? The importance of this factor in generating investment is well illustrated by the cases of India and Dubai. It is the feel-good factor that largely explains why barren soil in Dubai is selling at developed country prices. Resultantly, investor confidence is high, attracting multinationals to shift their regional offices from centres like Singapore, transforming Dubai into a new business hub connecting the east and west.

In Pakistan, some of the factors that have hindered the development of the feel-good sentiment include: persistent issues with law and order; lack of an environment promoting competitiveness instead of patronage and protection to inefficient entrepreneurs through concessions and ‘subsidies’; weak implementation of policies and the unpleasant experiences of investors with unpredictable changes in government policy.

Examples of the latter include the 1970s’ nationalisation, the freezing of foreign currency accounts, withdrawal of incentives, tax and other concessions without adequate notice etc.

Casual surveys of potential investors suggest that factors contributing to the weak sentiment in Pakistan include the high cost of doing business, resulting from the nature and degree of corruption, policy unpredictability, an inhospitable regulatory environment and lack of transparency in government procedures and decision-making.

The unfamiliarity with regulatory systems, mechanisms and procedures encourages the misuse of discretionary powers, in an environment in which institutional arrangements for redressing grievances are limited. Moreover, the power of veto is so liberally distributed in the system that subordinate staff can scuttle the process at any stage. Senior officials are left almost helpless to even check, let alone reverse, the attempt to put a spanner in the works, especially out of fear of NAB and the media and judiciary. These problems are exacerbated by widespread political and bureaucratic interference.

In addition, there’s the general mindset of the bureaucracy. It believes that private entrepreneurs make money simply by exploiting others. Thinking which stems partly from the value system and social ethos of both bureaucrats and an uninformed civil society leads both to distrust market forces. These factors are instrumental in creating a low-trust culture and in providing a regulatory role for the government even in areas where it is not required, thus constraining the development of a robust private sector.

Enterprises that are able to function in such an environment are generally those that have managed to reach some understanding with the relevant government departments, mandated to enforce these laws, on how these laws are to be implemented. This arrangement, in many cases bilateral in nature, can be disrupted with the change of government or key department personnel.

Since legal and judicial systems in Pakistan have not been successful in enforcing contracts, they have failed to resolve disputes in an efficient and timely manner.

The high cost of contract repudiation increases costs for investors in two ways. First, it increases the risk of larger-scale investments. Secondly, it forces firms to diversify their manufacturing operations into activities in which they do not have a comparative advantage, thereby lowering the efficiency of investment.

Since it takes years to get disputes resolved through courts, contract violators have much to gain by getting a case stuck in the court queue. Weak enforcement of property rights and contracts adds to the atmosphere of low trust that prevails in the economy.

Perceptions take time to change since views shaped over a long period have a deep-seated impact, especially if the scale of the shock and the losses incurred are large. Since the feel-good factor is critical in shaping sentiment, nasty experiences of the past reduce the time horizon of investment payback and lower the threshold of losses that investors are willing to bear in Pakistan, compared with the limit that they would place in the case of another country similarly placed economically but with a more credible history.

Contrary to the widely held belief in Pakistan, foreign investors do not create a boom, they follow a boom created by domestic conditions and the success, and resulting buoyed sentiments, of local investors. Foreign investment tends to supplement/complement domestic investment. And lest we forget, foreign investors need domestic investors as partners, if only to navigate local laws, regulations, procedures and administrative structures.

However, with the public sector slowly adopting a more transparent and merit-based system, better governance and active promotion of a competitive environment will begin to be accepted as the more important factors underlying prosperity, thereby gradually changing perceptions, the socio-political culture and work ethics. But then with even the rest of South Asia hurtling past us, how long should we wait?

The writer is a former governor of the State Bank of Pakistan.

http://www.dawn.com/news/1058591/the-feel-good-factor