Business Environment Sabina Silajdzic, PhD

(prezentacije) Leila L.
Business and its Environment
CONTENTS
1. Business and its environment- the main characterisitcs
2. Conceptualisation of BE differing concepts and contextualisation of BE
3. BE- framework of analysis
4. BE differing approaches to BE analysis
5. Conclusion?

What is Business?
the organised effort by individuals to produce goods and services, to sell these
goods and services in a market place and to reap some reward for this effort.
those human activities which involves production or purchase of goods with the
object of selling them at a profit margin.
What is Business Environment?
All those factors external to business that either inhibit or favour their
development no unanimity about what exactly should be included in the definition of the
term.

Business Climate/Investment Climate/Enabling Environment

I Business and its Environment: main characteristics

Diversity Business is a diverse category. It does not refer only to private sector, privately
owned profit making companies. Businesses vary in a number of ways, such as legal structure,
industry, size and market power, or geographical reach. Public org. may also be regarded as
business.
External/Internal BE mainly focuses on the external environment the surrounding conditions
outside the organisation. It is however useful to think of the environment as also having internal
dimension organisation as a highly differentiated and complex system.
Complexity economic conditions are of primary importance (competitors customers), but
business operates in more complex environment incl. political-legal, social-cultural,
environmental and technological aspects.
Spatial Levels refers to the geogprahical or territorial unit of anylsis that we use to
conceptualise business environment, local-national-reg.-intl.
I Business and its Environment:
main characteristics-2
Dynamic a fast changing environment. Dynamics of changes is directly in relation to
globalsation forces incl. tehnological progress and innovation. In the context of TE it is directly in
relation to the pace, scale and scope of economic restructuring and social transformation.
Interaction there is a two way interaction b/w business org. and their environment. Business
org. are not passive entities but seek to affect BE
Stakeholder public and business decisions are incresingly made in a context of multiple
stakeholder interests and demands- public trust is at stake. Stakeholder is an individual/group that
is affected by the decision.
Values there are competing perspectives and values concerning the nature and purpose of
business, public sector or the government. These debates mostly relate to power, responsibilities,
performance and ethics.

II Business Environment conceptualisation

BE usually refers to.. all those factors external to businesses that either inhibit or favour their
development. (Simon White)

According to Barry M. Richman and Melvyn Copen
Environment factors of constraints are largely if not totally external and beyond the control of
individual industrial enterprises and their arrangements. These are essentially the givers within
which firms and their managements must operate in a specific country and they vary, often greatly
from country to country.

II Business Environment conceptualisation

External Business Environment determines the LOCATIONAL QUALITY

Locational advantage may derive from factors such as:
1. The availability of skilled labour
2. The cost of labour
3. Favourable tax or regulatory environment
4. The quality of infrastructure
5. the proximity of suppliers/consumers, technological availability

What do we mean by locational quality?
Simply LQ refers to the range of factors that make location attractive or otherwise for busines:
tangible and intangible

Why study BE? .. All businesses operate in a changng and in some way unique environment that
affects its performance. The environment can be regarded as the source of both threats and
opportunities. Business decisions are concerned with countering threats and exploiting
opportunities.
Examples? (change in market conditions affecting demand, bahaviour of competitors, change in
govt policy affecting level of taxes, interest rates...)

BE context free market economy is characterised by a continutal pressure of economic entities
to increase efficiency. Profit motive and competittion work out in this direction ending up in
greater product diversity, lower costs of production, higher quality and chaper products. Firms
that fall behind in the efficiency race end up pricing them selves out of the market. The BE
context, however, goes well beyond simple free market logic!!!!

BE is characterised with increasing Complexity - The BE context goes well beyond simple free
market logic.
a) In reality there is no such a thing as a FREE MARKET in the sense of business being left
entirely free to make decisions for them selves.
b) In all market systems the law is used extensively to regulate various aspects of business
decisions and behaviour. This law constitutes a key element of regulatory and/or political
environment of business.

BE is not only characterisited with complexity but also with contraversy. The contraversial
context of BE mostly has to do with questions related to debate:
Free market vs. Regulation





The rationale behind government intervention/regulation:
First market efficiency and the profit motive may well be, and it often are at odds with other
wider societal interests:
a) Profit motive may result in a poor quality or even harmeful products, discrimination, child
labour, exploatation, environmental degradation, overpricing ..........
i.e. Competition vs. market power the importance of distinctive market structures
b) Persuasive advertising may be at odds with coustomer wants and needs.
i.e. Proft vs. Social responsibility business ethics & Corporate Social Responsibility
Second, and in view of the assigned greater responsibility of business in todays world, BE is
getting more complex such that govtt regulation not only attempts to protect wider social
interests and provide incentives, but also government regulation often attempts to direct bussiness
perspectives and development prospects.

III BE- Framework of analysis

ENVIRONMENTAL INFLUENCES ON BUSINESS
The term Environmental analysis may be defined as the process by which strategists monitor
the economic, governmental, legal, market, competitive, supplier, technological, geographic, and
social cultural settings to determine opportunities
Environment has a far reaching impact on business
Environment impact presents an essential focus of strategist who analyse and study changes
within a business environment with an aim to take appropriate decisions at appropriate time. If
strategist neglect to or fail to adequatly respond to these changes at the right time this may have
far-reaching implications on the organisations survival, stability, growth, profitability. The
development of organisation depends critically on micro and macro factors of the business
environment which reflect threats and opportunities to their firms/company/organisation.

In the process of Environmental analysis a successful business enterprise has to identify,
appraise and respond to the new dimensions of changing business environment, the process which
requires to identify threats in its internal and external environment and search for various
opportunities in the market.
It involves continuous monitoring and accumulation of adaptation capabilities related to the
changes in the environment (think for instance about the impact of environmental regulation on
businesses)
BE analysis presents a helpful tool to survival and prosper of the business activities. Environment
diagnosis principally consists of managerial decisions which attempt to foresee and identify
strategic competitive forces of their business related to external factors of influences. Having said
this, however, internal environment of the organisation related to its organisational, managerial
and technological capabilities is a quite essential and important from the point of view of the
environment analysis. It is the cornerstone of the new and exiting business opportunity analysis
too.

III BE- Framework of analysis- Business analysis and interrelatedness b/w business and environment





Relationship b/w organisation and its environment

A. Exchange of Information-It refers to data or information is exchanged with business
enterprise and its interna and external environment . Exchange of information occurs in the
following ways:
Business organisation scans the external environment and internal environment components and
their behavior, changes and thereby generates important information and valuable uses for
business and make proper planning, decision making and control of environment variables in the
organisation.
Business organisation structure and functions are adjusted towards the external environment
information.
Generation of external environment information is complex and it is one of the major problem and
it involves uncertainty to business organisation.
A business project look for current information and future information which are relating to
demography, competition, technical, legal, political and government policies and procedures.

B. Exchange of Resource- Exchange resource is the second and dominate relationship with the
business enterprise and its environment. Exchange of resources occures in the following ways:
Business enterprise receives inputs like finance, materials, manpower, equipment and labor force
from the external and internal environment via contractual and other arrangements.
Availability and disposal of resources, products and services are influenced by the forces of
external environment, and assume the interaction process with the external environment for
perceiving the needs of business as well as the external environment, in this way satisfying the
expectations and demands of clients, customers, employees, shareholders, creditors, suppliers,
local community.

THE IMPORTANCE OF ENVIRONMENTAL ANALYSIS

..... processes of analysing and evaluating micro (immediate) and macro (general)
environment of business to determine opportunities and threats.....
Need to constantly engage in auditing and screening the environment that influence business;
concern over effective utilization of scarce resources and capabilities, survival and competition,
business performance improvements.
Anticipate future developments and firm/organisation prospects strategic planning, interest
grouping, lobbying, collective bargaining, advocacy and negotiation.......





III BE- Framework of analysis -3




Components of Business Environment and its analysis

Economic environment- economic conditions, economic polices, and the economic system
Political and legal political system, stability and ideology, legal aspects of business regulation
legal extensiveness and efficiency the rule of law, business regulation
Socio-economic: Cultural- social values, customs and tradition, Demographic population size,
structure, growth, education
Natural Environment geographical and ecological factors
Technological the level of technological development and technological circumstances including
technological availability, complementarities/interdependencies, changing patterns.

Framework of analysis BE from the intl institutions (donors) perspective

Although generally perceived as important and reflecting locational quality of a particular
destination, BE still suffers from serious not only terminological but also conceptual disarray,
particularly among international institutions. Principally, there are number of key factors that, for
instance, donor agencies include in their definitions.
These are governance, policy frameworks, macroeconomic policies and strategies, legal and
regulatory frameworks, organisational frameworks, organisational capacity, access to
infrastructure, cost of infrastructure, access to finance, cost of finance, social conditions &
services, cultural & attitudinal influences and support services.
It is also useful to reflect on conceptual differences in terms of different approaches to BE among
international institutions, and specifically the issues they cover, and elements these conceptual
frameworks include.

BE in the context of emerging market economies

Donors and govts in developing and transition countries (TE) have been paying growing attention
to improving the environment for business as a means of promoting enterprise development,
economic growth, increasing employment, improving welfare and reducing poverty.
The focus on the business environment (BE) is a response to disappointing experiences with direct
support measures to firms, including finance and business development services (BDS), and the
finding that the positive effects of direct support measures, where they occur, are undermined if
the wider environment is characterised by burdensome regulations, poor service delivery,
corruption and a weak entrepreneurial culture.


IV Differing approaches to BE

The concept of business climate, as used by donor agencies, refers to the laws and regulations
that directly impact companies. A Business Climate Survey (BCS) primarily looks at laws and
regulations and the extent to which they do or do not discourage business activities.
In RIA, the term regulationover time acquired a broader meaning- an RIA would take a close
look at, for instance, how the particular market or industry is regulated, and what impact does it
have on business.
An Investment Climate Survey (ICS) takes a yet wider perspective and also investigates service
provision from government in areas like physical infrastructure.

So what then is the business environment? BCS, RIA and ICS or something else.....each give
a different answer. The common denominator, though, is their focus on government. They are all
based on the assumption that government intervention is the problem, not the solution, and that the
most promising approach to creating a favourable business environment is to get government out
of the way as far as possible.
Note that government service delivery in developmental activities is not addressed by any of the
intl agency approaches mentioned so far. According to the orthodox view in donor agencies, this
is the world of business development services (BDS), i.e. an area where government should not
directly deliver services to companies in the first place.

Conclusion

So what then is the business environment? BCS, RIA and ICS or something else.....Looking
more closely at the BE Framework of analysis by international institution we may conclude that
each give a different answer as to what factors constitute BE, or which of those are of importance
in understanding their influences on business, and private sector growth in particular.
The aim of the lectures to follow is to disentangle the meaning, the scope and the pace of BE
analysis.
To debunk to myths associated with the controversial aspects of business environment.
To learn about important and specific components of BE, how they interact with business and why
it is important to study those.



Economic environment refers to all those economic factors which have a bearing on the
functioning of a business unit. It is difficult to be precise about the factors which constitute the
economic environment of a country.
Still there are conventional factors which have considerable influence.

The economic environment is generally divided into the
microeconomic environment, which affects business decision-making such as individual actions
of firms and consumers, and the
macroeconomic environment, which affects an entire economy and all of its participants,
while the primary conceptualization of economic environment reveals the following components:

economic systems,
economic conditions,
and economic policy.






Content part 1
The Conceptual framework of EEB explores the conceptual nature of the macroeconomic
environment in which business operates. What are the key macro-economic determinants of
business performance.
The Mechanism of influence: how macroeconomic policy instruments influence business
operations and business performance?
Empirical study? The effect of economic recession on companies in the UK.

What is economic environment of business and why is it important?

Outside influences that can impact a business include various external factors, among which
economic factors are of predominant importance as these can impact the ability of a business or
investment to achieve its strategic goals and objectives.

EE refers to all those economic factors, which have a bearing on the functioning of a business.
Business depends on the economic environment for all the needed inputs. It also depends on the
economic environment to sell the finished goods.
Naturally, the dependence of business on the economic environment is total and is not surprising
because, as it is rightly said, business is one unit of the total economy.
Many economic factors act as external constraints or opportunities on business entities, over
which they have little, if any, control or infulence.

As noted earlier, the economic environment consists of external factors in a business' market and
the broader economy that can influence a business.

Generally, EE refers to all those economic factors which affect the functioning of a business unit.
It refers to the totality of economic factors, such as employment, income, inflation, interest rates,
productivity, and wealth, that influence the buying behavior of consumers, access to factor
resources and production factors and institutions.

Principally, EE is composed of:
economic system,
economic policy,
economic conditions, and
other specific economic factors.

Importantly, these features of EE are interdependent and interrelated and determine the character
and the nature of economic environment of business.
Lets focus more closely on these features and their interdependence.

i) Economic systems, what are they? The way a society decides to use and distribute its resources
within the economy.
There are three principal questions of relevance here:
Who determines the prices and the quantities produced in this system? (i.e. government
authorities vs. free markets)
Who controls resource allocation and the distribution of resources in this system? (i.e.
Government authorities vs. Businesses, or both)
Who can own property in this system? (i.e. anyone or govt solely, or ?)

Theoretically there are three basic economic systems:
captalism (assuming private ownership, free-market and competition mechanism
underpinned by profit maximisation motive to determine the prices and resource allocation
within the economy),
communism/socialism (assuming command economy revealing prevasive govt role in
production and distribution of economic resources and control of resource distribution,
prohibits/restricts private ownership),
mixed economy/welfare economies (capitalist systems in principle, implying also public
ownership where appropriate (i.e. provision of essential/merit public goods, ensuring
equity and welllbeing of society).

BE CAUTIOUSS in interpreting economic systems
However, in today's world it is quite difficult to draw definite boundaries between these basic
economic systems, think of China for instance, or try to point at a single strictly capitalist
economic system as defined ???
Unlike rigorous definitions of economic systems as such, most capitalist societies reveal mixed
economic systems, principally in line with the objectives of the welfare state. These states
function based on essential capitalist premises related to economic principles of efficient and
perfect markets, private ownership and incentives... However, they also resume public ownership
and management in particular instances (e.g. provision of public goods and services), active
government role in promoting positive externalities, correcting market failures, as well as rely on
extensive regulatory role of govt attempting to promote not only economic efficiency but also
equity and societal wellbeing.

HENCE REMEBER that the context of the topic examined in this course focuses on market-based
economies or economic systems, so features and specificities of business environment associated
with command/socialist economies is of no principal interest to us.

Given the problems related to the common rigid clasification of econimic systems, it seems more
appropriate to clasiffy economic systems into:

capitalism - also known as free enterprise economy and market economy. Where two
types of capitalism may be distinguished:
The old, laissez-fair capitalism, where government intervention in the economy is
absent or negligible; and
The modern, regulated or mixed capitalism, where there is a substantial amount of
government intervention.
socialism/communism where the tools of production are to be organized, managed and
owned by the government, with the benefits occurring to the public. Socialism does not
involve an equal division of existing wealth among the people, but advocates the
egalitarian principle.

ii) Economic conditions is generally referred to as the state of the economy in a country related
to economic and business cycles.
In other words, economic conditions change depending on whether the economy is expanding
positively affecting businesses or contracting which is adversely affecting economic activities
over time.
A country's economic conditions are influenced by numerous macroeconomic and microeconomic
factors, including monetary and fiscal policy, the state of the global economy, unemployment
levels, productivity, exchange rates and inflation.

iii) Economic policy generally refers to the actions that governments take in the economic field,
with an attempt to promote wellbeing of the society.
Economic policy alter economic system and conditions, determine and influence economic factors
(e.g. Interest rate, taxes) and attempt to create an environment conducive to growth and
development.

Notwithstanding the importance of understanding the aforementioned essential components
encompassing economic environment, it is useful to divide the economic environment into:

a) the macroeconomic environment, which affects an entire economy and all of its participants.
These factors include among others, Interest rates,Taxes, Inflation, Currency exchange rates,
Consumer discretionary income, Savings rates , Consumer confidence levels, Unemployment rate,
Recession, Depression.

b) the microeconomic environment, which affects business decision-making such as individual
actions of firms and consumers. Unlike macroeconomic factors, these factors are far less broad in
scope and do not necessarily affect the entire economy as a whole. Microeconomic factors
influencing a business include: Market size, Demand, Supply, Competitors, Suppliers,
Distribution chain.

Let's examine the mechanisms of influence associated with macroeconomic environment while
referring to few examples:
If interest rates are too high, the cost of borrowing may not permit a business to expand, or may
even adversely affect ongoing investments.
On the other hand, if unemployment rate is high, businesses can obtain labor at cheaper costs.
However, if unemployment is too high, this may result in a recession and less discretionary
consumer spending resulting in insufficient sales to keep the business going.
Tax rates will take a chunk of your income; labour-related taxes will influence companys labour
costs, employment levels and policy.
Currency exchange rates can either help or hurt the exporting of your products to specific foreign
markets, hence high exchange rate volatility impose a great risk to viability and sustainability of
intl ecc. transactions.
Now, let's turn our attention to microeconomic factors and consider the mechanism of influence
on business, similalry refering to few examples:
Market size may determine the viability of entering into a new market. If a market is too small,
there may not be sufficient demand and profit potential. This leads us to the concept of demand
and supply. If your product is in high demand but there is a low supply of it, you are going to
make a tidy profit, but if your product is in low demand and the market is flooded with similar
products, you may be facing bankruptcy.
The quality and quantity of your competition will affect how well you do in winning customers in
the marketplace.
Suppliers are the arteries pumping vital supplies and resources to you for production. If you have
problems with suppliers, it can clog up those arteries and cause serious problems.
Likewise, the type of relationship you have with your distributors, such as retail stores, may
influence how quickly your products leave their shelves.

The role of Economic policy

Beginning with macro-economic factors, we examine the importanc of macroeconomic policy in
shaping the business environment.
Economic expansion is of outmost importance in that it infulences businesses growth prospects. It
can be seen that there is a clear conceptual link between macro economic policy reform and
economic growth.

Let us first consider the following question:
What are the targets of macroeconomic policy?
Macroeconomic stability, Economic growth, Control of inflation, Full employment, External
balanceLet us now examine more closely individual macroeconomic policy targets.
1. What is macroeconomic stability and why is it important?

The logic is simple: most investors seek relative stability and predictability in making an
investment. In the absence of such stability investors face risk associated with business strategic
decesions and forecasts, most investors will withhold their investment or seek other opportunities
in more stable environments.
Econometric studies show that macroeconomic stability is essential for economic growth. For
example, Easterly and Kraay (1999) using cross-country analysis show that growth is positively
related to macro economic stability.

2. Why is economic growth important?

Growth is condicio sin e qua non for the improvements of living standards of the population.
While some capital accumulation can be contributed to the public sector, it is mostly the private
sector that drives capital accumulation and therefore growth. It accounts for most increases in
employment and improvements in living standards.
This is why economic or macroeconomic reforms are targeted to benefit and spur private sector
growth and development.

3. What govt policies are there to achieve the Policy Targets?

A Fiscal Policy decisions and policy options related to taxation and public expenditures.
B Monetary Policy -decisions and policy options related to the rate of interest and the supply of
money to the economy.
C Exchange Rate Policy decision on exchange rate regime
D Competition and Industrial Policy decisions and policy options that attempt to ensure fair
market competition; policies to promote growth of selective industrial sectors.
Conflict and disarray of government policies trade policy, distributional policies income
distribution, disposable income

What are key Fiscal policy instruments and actions?
Fiscal approaches (balanced budget, budget deficit/surplus)
STOP & THINK key questions to be explored
What effect will a Budget Deficit and a Budget Surplus have on the Growth of an Economy?
What effect will a Budget Deficit and a Budget Surplus have on Inflation?
What effect will a Budget Deficit and a Budget Surplus have on Employment?
What effect will a Budget Deficit and a Budget Surplus have on the Balance of Payments?
What are key Monetary policy instruments and actions?
Monetary approches (expansionary, restrictive/ austerity)
STOP & THINK key questions to be explored
What effect will lowering interest rates have on the economy?
How can Government increase or decrease the money supply in the economy?
What relationship is there between the interest rates and the money supply?
What relationship is there between the interest rates and the inflation?
What are key Exchange rate policies? Fixed ERR (Currency Board, Currency Pag); Floating ERR (Free
float, Managed float)

What do we mean by Competition policy policy objectives?
To ensure that there are no monopoly providers who tend to maximise profits by charging prices
that are higher than a competitive market and do not respond to consumers preferences
To ensure that the competitive forces operate to optimise the allocation of resources and a
responsiveness to the choice of the consumer
To ensure that the full social costs of productions and distribution are reflected in the price
charged to consumers (e.g. environmental tax)

What do we mean by Industrial policy? In principle these are policies which excercise
selectivity principle (non-neutrality) with an aim to promote growth and build competitive
advantage of selected industires.

How do macroeconomic policies affect business?
Economic growth (supply & demand, business cycle)
In principle the fundamental mechanism of influence is through economic growth patterns. If
Government policies increase the economic growth then it is likely the companys sales will grow.
Supply and demand impacts a nation's GDP. If Government policies increase the level of demand
in the economy then it is very likely that the companys product will sell.
At what stage of the business cycle is the economy? If the economy is going through a recession it
is obvious that businesses generally will not be doing well due to low aggregate demand in the
economy. On the other hand, a boom period will lead to higher business profits and revenue for
most of the businesses in the economy.

How do macroeconomic policies affect business-continued?
Inflation mechanism
If the level of inflation rises because of Government policies this would make it easier for the
company to raise its prices but the costs will also increase. If wages don't rise at the same rate of
inflation, people actually lose money- this affect the demand pattern. When inflation rises, the
value of the local currency decreases which affects imports.

How do macroeconomic policies affect business-continued?
Interest rate mechanism
Interest rates increasing make borrowing expensive thus pushing up the cost of any overdrafts and
also the cost of borrowing for major investments which affects supply-side capacities. Also,
Fluctuation in interest rates can have an impact on consumer purchasing; when interest rates are
high, consumers may be less inclined to borrow money to buy a new home or car- whihc affects
demand pattern.
People who have adjustable-rate home mortgages can face financial hardship or even lose their
homes when interest rates spike.

How do macroeconomic policies affect business-continued?
Exchange rate policy
Transactions between different countries around the world create a need for money exchange.
Each country has its own currency system. As a result, companies need to convert currencies by
buying or selling the currency of one country to another.
These transactions are associated risks of ERR fluctuations. If the foreign currency exchange rate
is increasing local companies will struggle to compete overseas because their overseas prices will
be high.
At this stage, the success of an international company is relative to the currency of the country
where it operates ERR directly affects countries levels of imports and exports ( J-curve?)
These risks are usually mitigated by using the exchange rate of different available markets such as
the spot market, forward market and the future market depending on the ultimate goals. If the
currency of that country is soft which means it is not easily convertible, this may present a
problem.

How do macroeconomic policies affect business-continued?
Unemployment level
The rate of unemployment can have a major effect on the economy. An economy that is near to
full employment will pose a problem for companies because good workers will be hard to find and
expensive to employ.
The more people who are out of work, the less money that is circulated into the economy through
the purchase of goods and services. Even the threat of unemployment has an impact, as workers
who fear losing their jobs are less inclined to spend or invest their money.

Interaction pause BE Analysis in Practice
Consider and Discuss
(Macro)-economic business environment analysis:
an example of UNICREDIT-GROUP
Given the precedant importance of the economic environment the business operates in Economic
analysits supply business entities with the Macro economic forecast and research considered of
relevance
These BE analysis are found not only in major companies in manufacturing, commerce and
finance, but all accountable business entities.
These confirm the importance of economic environment in business.
III Empirical Study- Example of how economic environment affects business
Research Study: The impact of economic recession on business strategy planning in UK
companies (CIMA, 2012)
The key findings from this research were:
There is very little optimism about the prospects for the UK economy in the short to medium-
term.
There is quite a degree of optimism from companies about their own commercial future based on a
combination of factors such as: accessing overseas markets, improving the way they do things,
better customer relations, product innovation etc.
Businesses recognise the importance of having a robust business strategy to guide them through a
recessionary period. However, what was done in response to the recession largely conforms to the
emergent theory of strategy formulation.

Content part 2
The Importance of Investment Climate for Business growth and development: associated with
Private sector Development Policy which is a multidimensional approach to improve BE.
The meaning and the scope of Business Enabeling Environment (BEE) from international donnor
community perspective
The intersection between economic and other aspects of business environment within BEE
approach
Cross-cutting issues and the key economic factors within BEE apporach
Financial markets as key economic factor of doing business, characterists within emerging market
economies and developed market economies.

I The concept of Business Enabling Environment

The business enabling environment (BEE) is now widely recognised within major intl institutions
and donor community as a mechanism through which greater development outcomes can be
achieved.
The World Development Report (WDR) 2005, which is based on an extensive array of data
sources including Investment Climate Surveys and the Banks Doing Business reports, defines a
sound enabling environment for private sector led growth as critical.
The WDR 2005 establishes that, while private firms are at the heart of the development process,
their contribution to these processes is largely determined by the investment climate.
The investment climate shapes the costs and risks of doing business, as well as barriers to
competition, all of which strongly influence the role of the private sector in social and economic
development.
Empirical evidence in support of the hypothesis are numerous and growing- in case of India, for
instance, improvments in BEE can incrase GDP by up to 2% per annum (ceteris paribus).
According to the OECD Development Assistance Comitte, effective BEE requires the creation of:
strong incentives for domestic and foreign private investment; the fostering of international
economic linkages; access to new assets and markets; and the need for competition to spur
innovation and raise productivity.
Research into the enabling environment and country investment climate assessments have
invariably found that developing countries are challenged by poor public governance, weak
infrastructure, and policy and legal frameworks that are inconsistent, unstable, and unpredictable.
The cross-cutting nature of the enabling environment has led to an increasing awareness of the
interrelationships between different aspects of BE; private sector development generally; financial
services; the provision and maintenance of infrastructure; trade and investment; and agriculture
and rural development.
I Differing approaches to BEE policy area focus

Private sector development work is increasingly adopting a multidisciplinary approach involving
enterprise, economic, governance, livelihoods and infrastructure perspectives
Key policy area supported by intl community include:
Support to productive dialogue and the development of trust between government and
business.
Support to Legal and regulatory reform: because over-regulation of business stifles
enterprises, reducing incentives to invest and grow, the simplification and improvement of
business laws and regulations and the development of more accessible commercial justice
systems is key priority.
Support to Privatisation: reform and privatisation of state-owned enterprise and banks to
reduce the fiscal pressure on govts and to facilitate private sector development by
unblocking sectors of economy dominated by inefficient public enterprise.
Making markets work for the poor; and (v) Competition policy

I Creating an enabling environment for investment: Economic factors

Donors implement a range of activities and programmes at both central and country levels aimed
at promoting a more conducive enabling environment for both domestic and foreign investment,
highlighting the policies, regulatory frameworks and institutions that businesses need to grow, for
instance, we extract those strictly related to economic policy:
Identify and remove barriers to foreign and domestic investment, especially promote effective
FDI-related policies and institutions,
Identify the barriers related to the taxation policy (indirect taxes, direct taxes e.g. labour
taxation), assess the impact of country credit ratings and taxation regimes on private investment
Creating an enabling environment for financial services has traditionally focused on the design,
creation and development of specialised institutions (e.g., microfinance institutions) to deliver
financial services. The emphasis now is on how improvements to the policy, legal and institutional
framework for financial systems development can widen and deepen access to financial markets
generally.

Economic factors of business: financial markets and access to finances in emerging economies
Access to financing presents one of major constraints for business growth in emerging market
economies
The reasons are multiple, but the predominant are often found to be amongst the following:
Underdeveloped financial markets and instruments
Poor supply side capacity inefficient enterprises, lack of FM knowledge and capacity,
structure of private sector with dominant SME.
Cost of capital too high, mostly has to do with low levels of domestic capital accumulation
and savings


Example A: Survey Results WB (2004) Country-Level: Reported Constraints and
Impediments to financing
Unprofitable projects (e.g., too risky, insufficient profitability & scale, high upfront expense)
Inadequate legal and regulatory frameworks (especially at regional and subsovereign levels;
issue with local banking provisions for guarantees)
Unacceptable cross-border risk & insufficient access to local funding (government crowding
out, pension funds restrictions, government fiscal constraints)
Weak local partners (e.g., operators, government)
Difficulty/expense coordinating with multiple official donors
Example B: Survey Results from the Study by Ayyagari et al. (2006)
The tittle of the study: How Important Are Financing Constraints? The role of finance in the
business environment
The principal question of the study: What role does the business environment play in
promoting and restraining firm growth? Recent literature points to a number of factors as
obstacles to growth. Inefficient functioning of financial markets, inadequate security and
enforcement of property rights, poor provision of infrastructure, inefficient regulation and
taxation, and broader governance features such as corruption and macroeconomic stability.
The study uses firm level survey data to present evidence on the relative importance of
different features of the business environment. They find that only obstacles related to finance,
crime and political instability directly affect the growth rate of firms, with obstacles to
financing exhibiting greatest adverse impact on firms growth performance.
Examining the Financing obstacle in more detail, they find that although firms perceive many
specific financing obstacles, such as lack of access to long-term capital and collateral
requirements, only the cost of borrowing (i.e. interst rates) directly affects firm growth.
The study hilights the importance of access to finances as key economic factor of BE


Economic policies to promote financial market development in DC

Most common policy solutions to foster financial market development in DC:
Financial and capital market liberalisation lifiting of capital movement controls
Privatisation of banking sector principally associated with attracking foreign banks
Establish prudent financial supervisory regulation and institutions, with an explict aim to
secure individual depositors, and promote prudent and stable banking sector

BEE: financial services as key economic factor for business growht in industrialised countries

Developed financial markets are prerequisite of business development and growth.
However, access to favorable financing is of key importance and is not guaranteed per se by
the mere existence of developed financial markets due to prevalent market failures inherent in
financial sector:
Even in industrialized countries, characterized by the developed financial markets there are
pervasive market failures related to financing (e.g. innovation)
Growth in modern economies is based on efforts to increase productivity through innovation,
and innovation is an essential precondition for technological and structural changes, as well as
a contributor to growth and competitiveness.
A fundamental component of strategic innovation management is the long-term decision to
innovate, which is accompanied by the need to establish structures and resources for the
acquisition of technology.
Financing restrictions hamper innovation The latest Community Innovation Survey shows
that in the EU27, 52% of enterprises in industry and services reported innovation activity
(between 2006 and 2008). The highest levels of reported innovation were in Germany (80%)
and Luxembourg (65%), and the lowest in Latvia (24%) and Poland (28%). Often, firms
reported having ideas for technically feasible and customer-demanded innovation but that they
lacked the resources to implement them; hence, financing restrictions are reducing
innovation activities at the firm level.
This is also confirmed by empirical studies. For example, the European Commission (EC) in
2009 consulted more than 1,000 enterprises and 430 innovation intermediaries with the result
that two main factors were seen as hampering innovation activities in enterprises: (1) lack of
access to financing (70%); and (2) innovation costs that are too high (65%). As a consequence,
many firms have to rely on internal funding.
What explains the presence of financing restrictions, or generally access to financing related
to innovation and technological progress.
J-curve cash flow and business risk require seed-stage firms to rely on internal funds or
venture capital investing in innovation and new technology typically follows a negative
cash flows during the seed and startup stages, with cash flows becoming positive at the early
growth stage. Debt financing, which requires guaranteed regular repayments, is often not
suitable for small or even medium sized firms let alone young, innovate enterprises.
Instead, such enterprises, at least in their early, seed stage, have tended to rely on financing
from the founders own funds, and funds from family and friend
This tends to be provided in the form of venture capital (VC) either formally by seed funds
or venture capital funds, or informally by business angels.



Responsive and accountable govt attempts to intervene to restore or remove market failures.
In this specific context EU govts provide excessive and special financing instruments to
compensate for lack of financing of technological and innovative activities.
Public funds in EU for instance have assumed increased importance in the early-stage sector
during the current economic climate. Government agencies (including the European
Investment Fund) provided more than 30% of the funds raised by VC funds (from identifiable
sources in Europe) during 2009 and 2010.
The overall increase is partly the result of declining overall fundraising; however, the absolute
contribution of government agencies has increased by almost 80% over the past three years .
EC provides comprehensive financial assistance for innovation-collaboration and green
investment activities.

Concluding remarks
STOP & THINK
What are the obvious implications for business related to the differencies in the development
of financial markets and instruments between developing and developed countries?
a) what are the implications for local companies being fully exposed to intl competition on
domestic markets assuming presistent constraints to access (favourable) finances by local
companies in DC?