EXECUTIVE SUMMARY

Investment Climate Assessment on Productivity and Wages:

Analysis Based on Firm Level Data from Selected South East
Asian Countries

by

Alvaro Escribano
Universidad Carlos III de Madrid
J. Luis Guasch
The World Bank and University of California, San Diego
Jorge Pena
Universidad Carlos III de Madrid
and
Manuel de Orte
Universidad Carlos III de Madrid

November, 14, 2005

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1. Introduction

The objective of this paper is to analyze the productivity determinants using survey
information at the plant level on the investment climate variables, from selected South East
Asian (SEA) countries. In particular, we evaluate the impact of investment climate (IC)
variables and other firm control (C) characteristics on several productivity measures.

The detailed selection of IC variables belong to five broad categories: a) infrastructure, b) red
tape, corruption and crime, c) quality, innovation and labor skills, d) finance and corporate
governance and e) other firm control characteristics. Once we have estimates of productivity
we evaluate if those productivity differences among firms have an impact on wages, after
controlling for ICA variables and other firm control (C) characteristics.

The productivity approach that we follow here is based on the robust econometric methodology
of Escribano and Guasch (2005). Productivity refers to the effects of any variable different
from the inputs --labor, intermediate materials and capital services--, affecting the production
(sales) process.

For the econometric analysis we have survey information for six South-East Asian countries;
China, Cambodia, Indonesia, Malaysia, Philippines and Thailand. However, the list of
available IC variables for China is shorter than for the other five countries. China has sufficient
number of observations in each sector and since for China we only have information about
three (Food/Beverages/Tabacco, Textiles/Apparel and Machinery/Equipment) out of the five
sectors (Food/Beverages/Tabacco, Textiles/Apparel and Machinery/Equipment, Rubber/Plastic
and Wood/Furniture), we have done a separate ICA analysis for China. For Cambodia there are
more missing observations of the capital stock (114) than available observations (12) and
therefore we have decided to drop it from the original sample keeping, in the group the other
four SEA countries, Indonesia, Malaysia, Philippines and Thailand.

Any empirical evaluation of the productivity impact of IC variables might critically depend on
the particular productivity measure considered. Therefore, to get reliable empirical results for
policy analysis, we search for robust empirical results using several productivity measures.

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 2. Robustness of the Estimated Productivity-IC Elasticities and Semi-elasticities

For policy evaluations we desire the elasticities, or semi-elasticities of IC variables on

productivity to be robust to several productivity measures. Thus in Table 1 we summarize the
ten different productivity measures (Pit ) that we use to evaluate the impact of IC variables.

Table 1. Summary of Productivity Measures and

Estimated Investment Climate (IC) Elasticities
1.1.a OLS
1.1 Restricted Coef
Two Step 1.1.b RE 2 (Pi t) measures
1. Solow´s Residual
Estimation 1.2.a OLS 4 (IC) elasticities
1.2 Unrestricted Coef
1.2.b RE
2.1.a OLS
2.1 Restricted Coef
Single Step 2.1.b RE 4 (Pi t) measures
2. Cobb-Douglas
Estimation 2.2.a OLS 4 (IC) elasticities
2.2 Unrestricted Coef
2.2.b RE
3.1.a OLS
3.1 Restricted Coef
Single Step 3.1.b RE 4 (Pi t) measures
3. Translog
Estimation 3.2.a OLS 4 (IC) elasticities
3.2 Unrestricted Coef
3.2.b RE
10 (Pi t) measures
Total 12 (IC) elasticities
Restricted Coef.= Equal input-output elasticities in all industries
Unrestricted Coef.= Different input output elasticities by industry
OLS = Pooling Ordinary Least Squares estimation (with robust standard errors)
RE = Random Effects estimation.

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The alternative productivity measures considered in this paper come from considering:

1) different functional forms of the production functions

2) different set of assumptions (technology and market conditions) to get consistent estimators
(Solow´s residuals, OLS, RE, etc.) or,

3) different levels of aggregation in measuring input-output elasticities (industry level or the

aggregate country level).

The question of interest is whether these new productivity measures yield similar elasticity and
semi-elasticity estimates for the IC effects on productivity. The empirical results that we get
are robust since the signs of all of the ICA variables are equal and the range of values of the
elasticities are reasonable, see Figure 1 and Figure 2.

3. Investment Climate Productivity Contribution to the Mean Productivity.

The Olley and Pakes (1996) decomposition of productivity is useful to do a country by country
(or industry by industry) analysis evaluating the productivity impact of IC variables. The
aggregate productivity of each industry is obtained as a weighted average of plants. The
weights indicate the share of firm over the total sales the industry of that year. Then the annual
aggregate productivity of industry can be decomposed as,

AggregateProductivity = average productivity + efficiencyterm .

The second term measures the allocative efficiency or covariance between sales shares and
productivity. If the covariance is positive, then the larger it is, the higher will be the share of
sales that goes to more productive firms, allocation efficiency is increased and industry j
productivity is enhanced. That is the most productive firms are the ones with larger market
share. The empirical results are:

• By Country

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First, we constructed a measure of aggregate productivity for each of country and decompose it
into the average productivity term and the covariance term. The results of Figure 34a and
Figure 34b show that more productive plants have higher market shares. From Olley and Pakes
decomposition, the dominant component is the average productivity in all the countries but in
Malaysia and maybe in China. Therefore we later evaluate the impact of average values of IC
variables on this average productivity component.

• By Size

Second, we construct a measure of productivity for each group of plants – small, medium and
large - in each country and we apply the Olley and Pakes decomposition. Once again in
Malaysia and China the small firms have an efficiency productivity component which
dominates aggregate productivity behavior. In all the countries, resources are efficiently
allocated for small, mediums and large plants. The most productive firms are the small and
medium ones.

• By Age

In China young firms are more productive than old ones and for the young one the efficiency
component dominates over average productivity. Only in Malaysia, old firms are more
productive than young ones and the efficient productivity component dominates the aggregate
productivity behavior.

• By Industry

We construct a measure of productivity for each industry of each country and we perform the
Olley and Pakes decomposition. In Malaysia and in China and only for the Machinery and
Equipment sector the efficiency component dominates over average productivity. In all the
sectors of all the countries the efficiency component is positive and only in Malaysia
dominates over average productivity in food, beverages and tobacco sector and in textile and
apparels sector.

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3.1. Investment Climate Contribution to the Average Productivity Component of Olley
and Pakes Decomposition

3.1.1 Indonesia, Malaysia, Philippines and Thailand.

A. Infrastructure
a. Average days to clear customs to export. The contribution to the average
productivity is negative. In Indonesia this contribution is -1.84%, in Malaysia is
-1.37%, in Philippines is -2.95 and finally -0.92 for Thailand.

B. Red Tape, Corruption and Crime

b. Losses due to criminal activity. The percentage of sales lost due to criminal
attempts has a negative impact on the average productivity being the lowest
negative impact in Indonesia -0.29; for Malaysia we have computed a negative
impact of -0.94; in Philippines we registered the greatest negative impact -1.6; and
in Thailand the impact is -0.4.

C. Quality, Innovation and Labor Skills

c. Dummy for ISO quality certification. The contribution to the average productivity
of the firm engaging in a process of ISO certification is 0.25% in Indonesia, 0.71%
in Malaysia, 0.33% in Philippines and 0.92% in Thailand.
d. External auditory. The contribution of having an external auditory of the firm’s
annual statements is 0.6% in Indonesia, 1.9% in Malaysia, 2.3% in Philippines and
2.75% in Thailand.
e. Dummy for exporter firm. The contribution of being an exporter firm is 1.58% in
Indonesia, 0.4% in Malaysia, 1.6% in Philippines and 4.4% in Thailand.
f. Dummy for improvement of an existing product. To improve an existing product
has a positive impact on the average productivity, being this impact 3.69% in
Indonesia, 6.4% in Malaysia, 8.25% in Philippines and 10.26% in Thailand.

D. Finance and Corporate Governance

g. Re-investment. The percentage of the profits reinvested in the own firm has a
positive impact in all the countries, in Indonesia this impact is 1.94%, in Malaysia
6.14%, in Philippines 6.78% and in Thailand 4.89.

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E. Other Control variables
h. Trade union. The percentage of workforce unionized has a negative impact on the
average productivity, being -4.14% in Indonesia, -8.48% in Malaysia, -15.24% in
Philippines and -11% in Thailand.
i. Losses due to strikes. The impact of the number of days of production lost due to
strikes is -0.7 in Indonesia, -0.23 in Malaysia, -0.61 in Philippines and -0.03 in
Thailand.
j. Rent buildings. Having almost all the firm’s buildings rented has a positive impact.
This variable causes the average productivity to growth a 1.4% in Indonesia, a
20.2% in Malaysia, a 8% in Philippines and a 24.1% in Thailand.
k. Trade association. The impact of this variable is 0.55% in Indonesia, 1% in
Malaysia, 1.1% in Philippines and 1.46% in Thailand.
l. Small. This dummy variable has a effect on average productivity of -3.73% in
Indonesia, -10.77 in Malaysia, -10.97 in Philippines and -7.73 in Thailand.
m. Medium. The effect is -1.23 in Indonesia, -3.7 in Malaysia, -2.29 in Philippines and
-4.43 in Thailand.

3.1.2 ICA effects on Average Productivity: China

A. Infrastructure
a. Days to clear customs to export (logs). The negative effect on average productivity is
equal to -5.1%.
b. Losses due to power outages. The negative impact on the average productivity is
equal to -5.1%.
c. E-mail or Web page. The positive impact on the average productivity of having an e-
mail or a web page in China is 6.28%.

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B. Red Tape, Corruption and Crime
d. Number of inspections and regulation related controls. The negative impact on
average productivity of the number of inspections is -14.23%.

C. Quality, Innovation and Labor Skills

e. Dummy for ISO quality certification. The impact of being engaged in a process of
ISO quality certification on the average productivity is 4.35%.
f. Dummy for external audit of the financial statements. The positive impact of this
variable on average productivity is 2.35%.
g. New product. To develop a new product line has a positive impact on average
productivity of equal to 0.23%.

D. Finance and Corporate Governance

h. Overdraft. The effect on average productivity of having an overdraft is 7.02%.

E. Other Control Variables

i. Age. The negative effect of the age on the average productivity is -7.6%.
j. Dummy for Incorporated Company. The effect on the average productivity is -1.09%
k. Competitive pressure. The effect on average productivity of the number of
competitors in the main market is -40.17%.

4. Are Productivity Gains Translated to Wages?

In order to evaluate the impact that productivity had on wages we estimate (by 2SLS) a wage
equation in terms of productivity and the investment climate variables.

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4.1.1 Empirical Results on Average Wages: Indonesia, Malaysia, Philippines and
Thailand.

Our estimated wage equations are also robust to the ten different productivity
measures, see Figure 18 and Figure 30.

Based on these wage equations we can evaluate the impact at the mean values.

A. Productivity
a. Productivity. The impact of productivity on the average wage is 15.2% in Indonesia,
14.64% in Malaysia, 14.4% in Philippines and 14.9% in Thailand.

B. Infrastructure
b. Losses due to power outages. The impact of the fraction of production lost due to
power outages is negative on the average wage; this impact is -0.44% in Indonesia, -
0.44% in Malaysia, -1.3% in Philippines and -0.27 in Thailand.
c. E-mail. The contribution of the probability of having an e-mail to the average wage
is 0.16% in Indonesia, 0.32% in Malaysia, 0.28% in Philippines and 0.32% in
Thailand.

C. Red Tape, Corruption and Crime

d. Number of inspections. The contribution of the number of inspections suffered by the
firm on the average wage is 0.08% in Indonesia, 0.48% in Malaysia, 0.48% in
Philippines and 0.8 in Thailand.

D. Quality, Innovation and Labor Skills

e. Dummy for new technology purchased. The contribution of the probability of getting
a new technology to the average wage is 1.17% in Indonesia, 2.6% in Malaysia, 4%
in Philippines and 5% in Thailand.
f. Dummy for external auditory. The contribution to the country’s average wage of the
probability that the firms engage in an external auditing of its financial statements is
0.5 % in Indonesia, 1.3% in Malaysia, 1.5% in Philippines and 1.9% in Thailand.
g. Education. The impact of the average number of years of education of the workforce
is 3.7% in Indonesia, 7.8% in Malaysia, 9% in Philippines and 8.3% in Thailand.

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E. General information and Other Control Variables
h. Trade union. The impact of the percentage of workforce unionized on average wage
is -0.7% in Indonesia, -1.17 in Malaysia, -2.16 in Philippines and -1.45 in Thailand.
i. Absenteeism. The impact of the number of days of production lost due to absenteeism
is -0.51% in Indonesia, -1.7% in Malaysia, -1.31% in Philippines and -0.08% in
Thailand.
j. Capacity utilization. The impact of the percentage of the capacity of the firm used is
3.66% in Indonesia, 6.41% in Malaysia, 6.39% in Philippines and 6.81% in Thailand.
k. Number of competitors. The effect of the competitive pressure on average wage is
2.41% in Indonesia, 3.1% in Malaysia, 4.12% in Philippines and 4.5% in Thailand.
l. Small-medium size. The impact of being a firm of small or medium size on average
productivity is 0.73% in Indonesia, 1.76% in Malaysia, 1.24% in Philippines and
2.22% in Thailand.
m. Old. The impact on the average wage is -0.65% in Indonesia, -1.04% in Malaysia, -
1.17% in Philippines and -1.08 in Thailand.

4.1.2 Empirical Results on Average Wages: China.

A. Productivity
a. Productivity. The impact of productivity on the average wage is 14.54%.

B. Infrastructure
b. Days to clear customs to export. The average number of days to clear customs has an
impact on the average wage of -4.33%.

C. Red tape, Corruption and Crime

c. Number of inspections. The impact of the number of inspections suffered on
country’s average wage is -10.3%.

D. Quality, Innovation and Labor Skills

d. Dummy for external audit. The impact of the probability of being the financial
statements engaged in a process of external audit is 3.2%.
e. ISO quality certification. The impact of the probability of being engaged in a process
of ISO quality certification on average wage is 0.19%.

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 f. Education. The impact on the average wage of the average number of years of
education is 21.6%.
g. New product development. The contribution of the probability of developing a new
product on the average wage is 1.39%.

E. General information and Other Control Variables

h. Capacity utilization. The contribution of the percentage of capacity utilization on
country’s average wage is 46.4%.
i. Incorporated company. The contribution of the probability of becoming publicly
listed on average wage is 1.1%.
j. Trade association. The contribution of the probability of being in a trade association
is 3.2%.
k. Number of competitors. The impact on the average wage of the number of
competitors is -10.7%.
l. Old. The impact on average wage of the probability of being more than 4 years old is
3.64%.
m. Small-medium size. The impact on average wages of being small or medium size
firms is 1.6%.

5. Conclusions

For the analysis of the investment climate (IC) determinants of productivity in selected south
east Asian (SEA) counties, productivity is considered the part of the production of goods
(sales) that is not explained by the main inputs labor, intermediate materials and capital. This
productivity concept is sometimes called total factor productivity (TFP) or multifactor
productivity (MFP).

Using ten different productivity measures, we show that it is possible to get consistent and
robust estimates (elasticities) of investment climate determinants of productivity. In our case,
most of the signs of the estimated coefficients are as expected. Obviously, the numerical
values of those elasticities parameters vary from one productivity measure to the next, but the
range of values is reasonable and significant in most cases.

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 The analysis is undertaken without transforming the variables into rates of growth. There are
good reasons explaining that decision: (a) the IC variables are available for only one year; (b)
the panel data is unbalanced with more observations in 2001 than in 2002 and 2003, hence
computing rates of growth for the non IC variables implies loosing observations; and (c)
measurement errors are enhanced by taking first differences. Therefore, variables in levels
are used with logarithmic (logs) transformation of output, labor, intermediate materials and
capital.

Four important categories of investment climate (IC) variables are identified for SEA
countries: (a) Infrastructure (b) Read Tape, Corruption and Crime, (c) Quality, Innovation
and Labor Skills, (d) Finance and Corporate Governance and (e) other firm control
characteristics. Within each group, most of the IC variables have the expected signs and the
estimated elasticities or semi-elasticities are always within a reasonable value range for the
ten different productivity measures considered.

The robustness of these empirical results across productivity measures allows us to obtain
consistent empirical evaluations of the IC determinants of productivity. The estimates show
consistently the high impact of investment climate on productivity.

The policy implications are clear. Investment climate matters enormously and the relative
size of the impact of the various investment climate variables indicates where the efforts of
reform should be placed.

References

Escribano Alvaro and J. Luis Guasch (2005). “Assessing the Impact of Investment Climate on
Productivity using Firm Level Data: Methodology and the Cases of Guatemala, Honduras
and Nicaragua”. The World Bank, Policy Research Working Paper # 3621. June.
Olley G. S. and A. Pakes (1996). “The Dynamics of Productivity in the Telecommunications
Equipment Industry”. Econometrica, Vol. 64, 6, 1263-1297.

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 Figure 1

Productivity Elasticities and Semielasticities with Respect to ICA Variables (Indonesia, Malaysia,
Philippines and Thailand).
Infraestructure Red tape Quality, Innovation and Labor Skills Finance General Information and other control characteristics

0.6
0.452
0.4
0.213 0.200
0.2 0.062 0.072 0.052
0.003 -0.004
0
-0.048 -0.025
-0.2
-0.250 -0.214
-0.4

-0.6 -0.552
-0.8
1.1 2.1 3.1 3.2 3.3 3.4 4.1 5.1 5.2 5.3 5.4 5.5 5.6
1.1 Days to clear customs to exports (log). 4.1 Re-investment.
2.1 Losses due to criminal activity. 5.1 Trade Association.
3.1 ISO certification. 5.2 Rent buildings
3.2 External auditory. 5.3 Trade union
3.3 Exporter. 5.4 Losses due to strikes.
3.4 Product improvement. 5.5 Small.
5.6 Medium.

*Elasticities are indicated by blue bars, and semielasticities are indicated by yellow bars.

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 Figure 2
Productivity Elasticities and Semielasticities with Respect to ICA Variables (China)
Red Tape
Quality, innovation and Labor
Infraestructure Finance Other control characteristics
Skills
1,000
0,800
0,618
0,600
0,428
0,400
0,200
0,200 0,132 0,099
-0,008
0,000
-0,200 -0,057 -0,044 -0,075 -0,072

-0,400
-0,600
-0,555
-0,800
-1,000
1,1 1,2 1,3 2,1 3,1 3,2 3,3 4,1 5,1 5,2 5,3
1.1 Days to clear customs to exports (log). 4.1 Overdraft.
1.2 Losses due to power outages. 5.1 Age.
1.3 E-mail or Web page. 5.2 Incorporated Company.
2.1 Inspections (log). 5.3 Competitors (log).
3.1 External auditory.
3.2 New product.
3.3 ISO certification.
*Elasticities are indicated by blue bars and semielasticities are indicated by
yellow bars.

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 Figure 18

Wage Elasticities and Semielasticities with Respect to ICA Variables (Indonesia, Malaysia,
Philippines and Thailand).
Productivity Infraestructure Red tape Quality, Innovation and Labor Skills General Information and other control characteristics

0.8
0.684
0.7
0.6
0.496
0.5 0.398
0.4
0.3
0.2 0.157
0.103
0.060 0.063 0.075
0.1 -0.002 0.007
0
-0.010
-0.1 -0.074
-0.087
-0.2
1.1 2.1 2.2 3.1 4.1 4.2 4.3 5.1 5.2 5.3 5.4 5.5 5.6
1.1 Productivity. 5.1 Trade union
2.1 Losses due to power outages. 5.2 Absenteeism.
2.2 E-mail. 5.3 Capacity utilization
3.1 Number of inspections. 5.4 Number of competitors
4.1 New technology. 5.5 Small-medium.
4.2 External audit. 5.6 Old.
4.3 Education

*Elasticities are indicated by blue bars, and semielasticities are indicated by yellow bars.

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 Figure 30

Wage Elasticities and Semielasticities with Respect to ICA Variables (China).

Infraes
Productivity Red tape Quality, Innovation and Labor Skills General Information and other control characteristics
tructure
1.2 1.012
1 0.808
0.8
0.6 0.489 0.485
0.368 0.361 0.326
0.4 0.219
0.2 0.051 0.056
0
-0.2
-0.4 -0.301 -0.301
-0.6
-0.8
-0.799
-1
1.1 2.1 3.1 4.1 4.2 4.3 4.4 5.1 5.2 5.3 5.4 5.5 5.6
1.1 Productivity. 5.1 Capacity utilization.
2.1 Days to clear customs to export. 5.2 Incorporated company.
3.1 Number of inspections. 5.3 trade association.
4.1 Auditory. 5.4 Number of competitors.
4.2 ISO certification. 5.5 Old.
4.3 Education. 5.6 Small-medium.
4.4 New product.

*Elasticities are indicated by blue bars, and semielasticities are indicated by yellow bars.

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 Figure 34a

Olley and Pakes Decomposition by Country of Restricted Solow Residual; Indonesia,

Malaysia, Philippines and Thailand.

4.5

3.5

2.5

1.5

0.5

0
Indonesia Malaysia Philippines Thailand

Aggregate Wage Average Wage Efficiency Term

Figure 34b

Olley and Pakes Decomposition by Country of Restricted Solow Residual; China.

2.5

1.5

0.5

0
China

Aggregate Wage Average Wage Efficiency Term

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