Excerpt from / Fragmento del

GLOBAL COMPETITIVENESS REPORT 2004/2005

By / Por World Economic Forum

in collaboration with / con la colaboración de

IESE Business School

and the support of / y el apoyo de Nissan Chair of Corporate Strategy and International Business

Anselmo Rubiralta Center for Globalization and Business Strategy

Including/Incluye:

- Executive Summary - Chapter 1.2: Building the Microeconomic Foundations of Prosperity

- Competitiveness Spain

You can search for the full text at / Puede buscar el texto completo en:

http://www.weforum.org/site/homepublic.nsf/Content/Global+Competitiveness+Programme%5CGlobal+Competitiveness+Report

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Executive SummaryAUGUSTO LOPEZ-CLAROS, World Economic Forum

For well over two decades the World Economic Forumhas been trying to shed light on the question of why somecountries are able to grow on a sustained basis for pro-longed periods of time, in the process pulling large seg-ments of the population out of poverty, while othersremain stagnant or, worse, actually see an erosion of livingstandards.Through its flagship publication, The GlobalCompetitiveness Report, the World Economic Forum has led the way in assessing the competitiveness of nations.

The Forum may be in a singularly advantageous posi-tion, for at least two reasons, to contribute meaningfully to the debate on the key building blocks of successful economic development and improved competitiveness.First, it brings key representatives from the private sectorand the corporate world together with a broad spectrumof senior policymakers in government, creating opportuni-ties for the thoughtful exchange of ideas and experienceson best practices.This exchange may be an important catalyst in identifying the most critical factors in thedevelopment process.The role of corruption in delayingthe development process, the central importance ofwomen’s education for boosting per capita incomes, theinterplay between political and civil rights and the will-ingness of the public to engage in economic activity, therole of a free press, and the type of safety net arrangementsthat governments put in place to enhance the ability ofeconomic agents to participate in the life of the nation,are but some of the topics that have been at the centre ofthe agenda in many of the summits and other interactionsorganized by the World Economic Forum.

Second, the Forum has developed a vehicle, theExecutive Opinion Survey (EOS), which annually conveysa wealth of information about the obstacles to growth inmore than 100 countries, accounting for the lion’s share ofglobal GNP.Through the Survey, business executives inthese countries assess the importance of a broad range offactors central to creating a healthy business environmentin support of successful and productive economic activity.The tax and regulatory environment, labor market legisla-tion, the overall macroeconomic environment, the preva-lence of corruption and other irregular practices in theeconomy at large, the quality of the country’s infrastruc-ture and education are but a few of the areas covered bythe EOS. Over the years, the Survey has continued todeliver a treasure trove of information about both coun-try-specific strengths and weaknesses, and the challengesfaced by the business community. On the basis of theinformation provided by the EOS, the Country Profilesprepared by the Forum offer extremely valuable informa-tion for policymakers, aid agencies and others, working to improve economic performance and the quality of people’s lives.

The methodology used by the Forum to assessnational competitiveness has evolved over time, taking intoaccount the latest thinking on the factors driving compet-itiveness and growth.The Forum first introduced theGrowth Competitiveness Index (GCI) three years ago, in col-laboration with Professors Jeffrey Sachs and JohnMcArthur, in the Global Competitiveness Report2001–2002.The GCI aims specifically to gauge the abilityof the world’s economies to achieve sustained economicgrowth over the medium to long term. It primarily assess-es the impact of those factors that economic theory andthe accumulated experience of policymakers in a broadrange of countries have shown to be critical for growth,whether narrowly focused on elements of the macroeco-nomic environment or, reflecting the latest insights in theeconomics literature, institutional and other factors.

Professor Michael Porter’s Business CompetitivenessIndex, presented in Chapter 1.2 in this volume, is an espe-cially useful complement to the GCI, with its specialemphasis on a range of company-specific factors con-ducive to improved efficiency and productivity at themicro level.

The Growth Competitiveness IndexThe GCI is composed of three “pillars,” all of which arewidely accepted as being critical to economic growth: thequality of the macroeconomic environment, the state of acountry’s public institutions, and, given the increasingimportance of technology in the development process, acountry’s technological readiness. Using a combination ofpublicly available hard data, and information provided inthe Forum’s Executive Opinion Survey—which providesmore textured qualitative information on difficult-to-measure concepts—these three pillars are brought togetherin the three indexes of the GCI: the macroeconomic envi-ronment index, the public institutions index, and the tech-nology index.

Sachs and McArthur strongly emphasized that therole of technology in the growth process differs for coun-tries, depending on their particular stage of development.It is widely understood that technological innovation isrelatively more important for growth in countries close tothe technological frontier. Innovation will be key inSweden, but the adoption of foreign technologies, or thekind of technology transfer frequently associated with for-eign direct investment will be relatively more important ina country such as the Czech Republic. For this reason, inestimating the GCI, economies are separated into twogroups: the core economies, i.e. those for which technolog-ical innovation is critical for growth, and non-coreeconomies, i.e. those which can still grow by adoptingtechnologies developed abroad.

The critical importance of technological innovationfor core economies is taken into account in the technolo-gy index. Specifically, more weight is given to innovation,by means of the innovation subindex, for the coreeconomies, than for the non-core.To make a further dis-tinction, an additional measure is used of the ability ofnon-core economies to adopt technology from abroad:the technology transfer subindex. Finally, since the deter-minants of economic competitiveness vary for core andnon-core economies, the weighting of the three indexes inthe overall GCI differs between the two groups. For thenon-core economies, more weight is given to the qualityof institutions and the macroeconomic environment, sincethese countries can still make progress in achieving highergrowth by getting their fundamentals in order.

On the other hand, for the core economies that arecloser to the technological frontier, more weight is placedon technology. It is, of course, important for these coun-tries to have a sound macroeconomic environment andstrong institutions, but these economies will typically havelong ago entered a period characterized by “institutionalstability.” For these countries to continue to grow theymust innovate.This is why more weight is placed, for thecore innovators, on technology, than on the other two pil-lars. Chapter 1.1, by Jennifer Blanke and Augusto Lopez-Claros provides specific details on the composition andconstruction of the GCI, which this year covers a total of104 countries.

The Competitiveness Rankings for 2004Table 1 presents the rankings from this year’s GCI. For the third time during the last four years Finland tops therankings.The country is extremely well managed at themacroeconomic level, and scores very high in those measures which assess the quality of its public institutions.Moreover, Finland has very low levels of corruption andits firms operate in a legal environment in which there iswidespread respect for contracts and the rule of law.Finland’s private sector shows a proclivity for adoptingnew technologies, and nurtures a culture of innovation.Especially noteworthy is the fact that, for several years,Finland has been running budget surpluses, in anticipationof future claims on the budget associated with the agingof its population.The United States is ranked second, withoverall technological supremacy, and especially high scoresfor such indicators as companies’ spending on R&D, thecreativity of its scientific community, personal computerand internet penetration rates. However, these are partlyoffset by a weaker performance in those areas which cap-ture the quality of the macroeconomic environment andits public institutions.

As compared to the results of 2003, nine out of ten ofthe top performers remain in this category.Among these

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GCI GCI GCI Country 2004 rank 2004 score 2003 rank*

Finland 1 5.95 1United States 2 5.82 2Sweden 3 5.72 3Taiwan 4 5.69 5Denmark 5 5.66 4Norway 6 5.56 9Singapore 7 5.56 6Switzerland 8 5.49 7Japan 9 5.48 11Iceland 10 5.44 8United Kingdom 11 5.30 15Netherlands 12 5.30 12Germany 13 5.28 13Australia 14 5.25 10Canada 15 5.23 16United Arab Emirates 16 5.21 —Austria 17 5.20 17New Zealand 18 5.18 14Israel 19 5.09 20Estonia 20 5.08 22Hong Kong SAR 21 5.06 24Chile 22 5.01 28Spain 23 5.00 23Portugal 24 4.96 25Belgium 25 4.95 27Luxembourg 26 4.95 21France 27 4.92 26Bahrain 28 4.91 —Korea 29 4.90 18Ireland 30 4.90 30Malaysia 31 4.88 29Malta 32 4.79 19Slovenia 33 4.75 31Thailand 34 4.58 32Jordan 35 4.58 34Lithuania 36 4.57 40Greece 37 4.56 35Cyprus 38 4.56 —Hungary 39 4.56 33Czech Republic 40 4.55 39South Africa 41 4.53 42Tunisia 42 4.51 38Slovak Republic 43 4.43 43Latvia 44 4.43 37Botswana 45 4.30 36China 46 4.29 44Italy 47 4.27 41Mexico 48 4.17 47Mauritius 49 4.14 46Costa Rica 50 4.12 51Trinidad and Tobago 51 4.12 49Namibia 52 4.11 52El Salvador 53 4.10 48Uruguay 54 4.08 50India 55 4.07 56Morocco 56 4.06 61Brazil 57 4.05 54Panama 58 4.01 59Bulgaria 59 3.98 64Poland 60 3.98 45Croatia 61 3.94 53Egypt 62 3.88 58

(cont’d.)

GCI GCI GCI Country 2004 rank 2004 score 2003 rank*

Romania 63 3.86 75Colombia 64 3.84 63Jamaica 65 3.82 67Turkey 66 3.82 65Peru 67 3.78 57Ghana 68 3.78 71Indonesia 69 3.72 72Russian Federation 70 3.68 70Algeria 71 3.67 74Dominican Republic 72 3.63 62Sri Lanka 73 3.57 68Argentina 74 3.54 78Gambia 75 3.52 55Philippines 76 3.51 66Vietnam 77 3.47 60Kenya 78 3.45 83Uganda 79 3.41 80Guatemala 80 3.38 89Bosnia and Hercegovina 81 3.38 —Tanzania 82 3.38 69Zambia 83 3.36 88Macedonia, FYR 84 3.34 81Venezuela 85 3.30 82Ukraine 86 3.27 84Malawi 87 3.24 76Mali 88 3.24 99Serbia and Montenegro 89 3.23 77Ecuador 90 3.18 86Pakistan 91 3.17 73Mozambique 92 3.17 93Nigeria 93 3.16 87Georgia 94 3.14 —Nicaragua 95 3.12 90Madagascar 96 3.11 96Honduras 97 3.10 94Bolivia 98 3.09 85Zimbabwe 99 3.03 97Paraguay 100 2.99 95Ethiopia 101 2.93 92Bangladesh 102 2.84 98Angola 103 2.72 100Chad 104 2.50 101

* Note that these are the published rankings from 2003. The three countries notcovered this year (Cameroon, Haiti, and Senegal) are not shown.

Table 1: Growth Competitiveness Index rankings and 2003 comparisons

leaders, the largest improvement has been registered byNorway, which has moved up from ninth to sixth placesince 2003. Norway improved in all three areas of theIndex, most particularly with regard to its public institu-tions, driven by a much better score in the area of con-tracts and law. Indeed, the Nordic countries all occupyprivileged positions in the GCI ranking.

The GCI does a reasonably good job not only ofranking countries vis-à-vis each other, but also of trackingshifts in rank over time.This is perhaps not surprising inthe case of the macroeconomic environment index, whichis made up overwhelmingly of hard data variables—Norway, Estonia, and New Zealand get credit for runningbudget surpluses, while Turkey, India, and Japan are penal-ized for running large deficits—but applies to other com-ponents of the GCI as well.

Those countries showing the largest drops in rankingsin 2004—Bolivia, the Dominican Republic, Pakistan,Peru, Philippines, Poland,Vietnam, to name some—are allcountries that have witnessed significant deteriorations inone or more areas tracked by the Index. Others, such asVenezuela and Zimbabwe, already low last year, havedropped even further. Indeed, all of these countries havebeen prominent in the pages of the international press.Highly visible instances of official corruption, a crack-down on press freedoms and other civil liberties whichcontribute to capital outflows and harden the mood of thebusiness community, political instability linked to domesticinfighting in some cases leading to civil unrest, a weaken-ing in the rule of law have, to a greater or lesser degree,been prominent in some of the above cases.

The reverse is also true: countries may move up inthe rankings, when they show not only improvements inthe macroeconomic environment—e.g.Argentina in 2003,following the country’s harrowing experiences the previ-ous year—but some other factors, directly or indirectlyreflected in those variables tracked by the index.We arenot puzzled by the significant improvement in the rank-ings of Bulgaria and Romania, for instance.These coun-tries have an appointment to keep with the EU in 2007,and are gradually gearing up to meet EU accession crite-ria. In Latin America, we note that Chile improved itsperformance significantly, moving up from 28th to 22ndplace in the overall rankings. Chile not only has the high-est ranking in Latin America, but the gap with respect toits nearest rival (Mexico) is a full 26 places; there is noother continent in the world where we can observe thissymbolic “migration” from the region, in terms of per-formance. Chile’s case is featured separately in Chapter 2.3of this Report.

In Asia, the rankings are quite stable, with some smallimprovements—notably Indonesia and, more significantly,Japan, the latter by two places—and some small drops inthe rankings, as with Malaysia and Thailand.There are

two countries in the region, which stand out for their significant drop in the rankings: Korea and Vietnam, thelatter noted above. Korea’s drop is linked to a significantdecline in the macroeconomic environment subindex,falling from 23rd last year to 35th this year; moreover,Korea also experienced declines in the other two areasmeasured by the GCI.Vietnam’s decline is linked to significant drops in all three areas, particularly with regardto public institutions and technology.

Countries in sub-Saharan Africa continue to holdplaces primarily at the bottom of the rankings, with a fewbright exceptions. South Africa improved its performancesomewhat, continuing to lead the region in competitive-ness, with an overall rank of 41, incidentally, well ahead of all countries in Latin America, except Chile. Likewise,while it did slip somewhat in the rankings, Botswana continues to outperform most of the other sub-SaharanAfrican countries, with a relatively strong performance,particularly in its public institutions, and a relativelyhealthy macroeconomic environment. Still, three of the five bottom-ranked countries are from this region,including Angola and Chad, which take the last two places in the ranking. It is clear that much work remainsto be done to improve competitiveness in Africa.Table 2provides more detailed information on the components of each of the three subindexes of the GCI for all 104countries in 2004.

The Business Competitiveness IndexThe Business Competitiveness Index (BCI) is a comple-ment to the medium-term, macroeconomic approach ofthe Growth Competitiveness Index. It evaluates theunderlying microeconomic conditions defining the currentsustainable level of productivity in each of the countriescovered, the underlying concept being that, while macro-economic and institutional factors are critical for nationalcompetitiveness, these are necessary but not sufficient fac-tors for creating wealth.Wealth is actually created at themicroeconomic level by the companies operating in eacheconomy.The BCI evaluates two specific areas, critical tothe business environment in each country: the sophistica-tion of the operating practices and strategies of companies,and the quality of the microeconomic business environ-ment in which a nation’s companies compete.The idea isthat, without these microeconomic capabilities, macroeco-nomic and institutional reforms will not bear full fruit.

This year’s BCI rankings are shown in Table 3.Thefirst column shows the overall rankings, while the secondand third columns show the two interrelated subindexes:company operations and strategy, and the quality of thenational business environment.

The table shows that the United States has taken over the leading position from Finland, after dropping to

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second place last year.The United States benefited fromimprovements in the sophistication of marketing, the avail-ability of venture capital, the intensity of local competi-tion, local supplier quality, and local supplier quantity.Other advanced economies improving their rankingsinclude Hong Kong, by reflecting more sophisticatedfinancial markets and improvements in management prac-tices, Japan, by improving financial market sophisticationand improving quality of administrative services, andPortugal, by improving cluster strength. Japan registeredthe highest absolute improvement of its BCI score, fol-lowed by Hong Kong and Norway.

Advanced countries, which dropped in the rankingsinclude Italy, Malta, and Iceland. Italy dropped by a disap-pointing nine ranks, almost entirely driven by a deteriorat-ing business environment, now evaluated on a par withthat of Portugal and the Czech Republic. Italy deteriorat-ed especially in areas related to innovative capacity, such asuniversity-industry research collaboration, foreign technol-ogy licensing, government procurement of advanced tech-nology, company R&D spending, and venture capitalavailability.

Middle-income nations improving their business com-petitiveness rankings this year include Romania, Lithuania,the Slovak Republic, Russia, Namibia, and the Ukraine.Romania jumped by a remarkable 22 ranks, driven bystrong across-the-board improvements, especially in thearea of company sophistication. Romania’s improvementcomes after repeated slippage in the ranking since thecountry became part of The Global Competitiveness Reportin 2001.

Middle-income countries which have experienced afall in ranking include Latvia, the Dominican Republic,Poland, and Mauritius. Other countries with significantabsolute drops in BCI scores include Thailand andMexico. Latvia has moved back to a level consistent withits longer-term trajectory; last year’s strong improvementproved to be unsustainable optimism.The DominicanRepublic, down 13 places, continues the trend set by alarge drop last year, driven particularly by a decline inopenness to imports, and in the sophistication of its finan-cial market.

Among low-income countries, Indonesia made thegreatest improvement, jumping a remarkable 18 ranks.After years of turmoil, the country is now back to its 2000business competitiveness level.While improvements wereregistered in areas across the board, they were strongest inmeasures of company sophistication.Another low-incomecountry with large improvements is India, up 8 ranks,showing the benefits of increased company sophisticationand strengthened clusters.Vietnam slipped significantly,down 23 places, after a number of years of steadyimprovement. Conditions worsened most in areas relatedto technology and government administration.

As explained above, the GCI and the BCI measurecomplementary dimensions of competitiveness. Figure 1compares the two rankings for 2004, revealing their highcorrelation.

A look ahead—the new Global Competitiveness IndexOver the last several years the Growth Competitiveness Indexhas been a useful tool in thinking about key macroeco-nomic and institutional elements, critical to the growthprocess.The present rankings continue to provide policy-makers, businesses and organizations of civil society withvaluable insights into areas where further progress is calledfor, in order to improve the environment for private sectoreconomic activity, and generate sustainable growth.

The considerable utility of the GCI notwithstanding,the vertiginous pace of change of the global economy hasbrought into sharper focus the increasing role played by anumber of other factors in enhancing the ability of coun-tries to grow.The swift pace of innovation in informationand communications technology, and the concomitant fallin the costs of communication is leading to an accelera-tion in the pace of integration of the world economy.Theincreasingly global perspective of businesses in formulatingtheir strategies and decision making—already manifestinga global reach in the search for new markets and sourcesof supply—has now extended to the location of produc-tion, and resulted in the increasing internationalization ofthe labor force of the typical multinational corporation.Innovations in transportation, which have reduced the costof freight, mean that location is less of a factor than in thepast, and businesses are now looking for the right combi-nation of labor costs—coupled, ideally, with flexible labormarkets—skills, infrastructure, and the support provided bya good macroeconomic and institutional environment toreduce production costs.

Against the backdrop of these changes, countries arebeing forced to be increasingly creative, in order to main-tain their competitive edge.The role of multi-countryalliances in bringing together better combinations of capi-tal, labor, skills and regulatory frameworks for particularprojects is becoming more important. Countries with thenimbleness demanded for such cross-border arrangementsare reaping the benefits of higher economic growth ratesand improvements in living standards. Countries which arenot allocating sufficient resources to improve the qualityof their educational systems or to address major publichealth concerns, or which are otherwise engulfed in inter-nal conflicts and instability, are rapidly falling behind.Thenet effect of these trends is the growing complexity in the economic, social and political underpinnings of theenvironment faced by policymakers and business leaderseverywhere.This is not only putting enormous stress onthe institutions that sustain and support the global economy,

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Table 2: Growth Competitiveness Index components

GCI GCI2004 2004

Country rank score

Finland 1 5.95United States 2 5.82Sweden 3 5.72Taiwan 4 5.69Denmark 5 5.66Norway 6 5.56Singapore 7 5.56Switzerland 8 5.49Japan 9 5.48Iceland 10 5.44United Kingdom 11 5.30Netherlands 12 5.30Germany 13 5.28Australia 14 5.25Canada 15 5.23United Arab Emirates 16 5.21Austria 17 5.20New Zealand 18 5.18Israel 19 5.09Estonia 20 5.08Hong Kong SAR 21 5.06Chile 22 5.01Spain 23 5.00Portugal 24 4.96Belgium 25 4.95Luxembourg 26 4.95France 27 4.92Bahrain 28 4.91Korea 29 4.90Ireland 30 4.90Malaysia 31 4.88Malta 32 4.79Slovenia 33 4.75Thailand 34 4.58Jordan 35 4.58Lithuania 36 4.57Greece 37 4.56Cyprus 38 4.56Hungary 39 4.56Czech Republic 40 4.55South Africa 41 4.53Tunisia 42 4.51Slovak Republic 43 4.43Latvia 44 4.43Botswana 45 4.30China 46 4.29Italy 47 4.27Mexico 48 4.17Mauritius 49 4.14Costa Rica 50 4.12Trinidad and Tobago 51 4.12Namibia 52 4.11El Salvador 53 4.10Uruguay 54 4.08India 55 4.07Morocco 56 4.06Brazil 57 4.05Panama 58 4.01

(cont’d.)

GCI GCI2004 2004

Country rank score

Bulgaria 59 3.98Poland 60 3.98Croatia 61 3.94Egypt 62 3.88Romania 63 3.86Colombia 64 3.84Jamaica 65 3.82Turkey 66 3.82Peru 67 3.78Ghana 68 3.78Indonesia 69 3.72Russian Federation 70 3.68Algeria 71 3.67Dominican Republic 72 3.63Sri Lanka 73 3.57Argentina 74 3.54Gambia 75 3.52Philippines 76 3.51Vietnam 77 3.47Kenya 78 3.45Uganda 79 3.41Guatemala 80 3.38Bosnia and Hercegovina 81 3.38Tanzania 82 3.38Zambia 83 3.36Macedonia, FYR 84 3.34Venezuela 85 3.30Ukraine 86 3.27Malawi 87 3.24Mali 88 3.24Serbia and Montenegro 89 3.23Ecuador 90 3.18Pakistan 91 3.17Mozambique 92 3.17Nigeria 93 3.16Georgia 94 3.14Nicaragua 95 3.12Madagascar 96 3.11Honduras 97 3.10Bolivia 98 3.09Zimbabwe 99 3.03Paraguay 100 2.99Ethiopia 101 2.93Bangladesh 102 2.84Angola 103 2.72Chad 104 2.50

Country Rank Score

United States 1 6.24Taiwan 2 6.04Finland 3 5.92Sweden 4 5.80Japan 5 5.68Denmark 6 5.34Switzerland 7 5.25Israel 8 5.25Korea 9 5.18Norway 10 5.17Singapore 11 5.11Germany 12 5.08Canada 13 5.05Iceland 14 5.05Estonia 15 5.01Netherlands 16 4.98Australia 17 4.93United Kingdom 18 4.92Czech Republic 19 4.88Spain 20 4.86Malta 21 4.85Austria 22 4.85Portugal 23 4.78New Zealand 24 4.76United Arab Emirates 25 4.71Slovenia 26 4.71Malaysia 27 4.67Slovak Republic 28 4.67Hungary 29 4.66France 30 4.65Belgium 31 4.59Chile 32 4.55Lithuania 33 4.51Hong Kong SAR 34 4.49Bahrain 35 4.47Latvia 36 4.46Ireland 37 4.43Greece 38 4.42Cyprus 39 4.36South Africa 40 4.33Luxembourg 41 4.28Brazil 42 4.24Thailand 43 4.24Mauritius 44 4.19Poland 45 4.19Croatia 46 4.15Romania 47 4.13Mexico 48 4.13Jamaica 49 4.12Italy 50 4.08Jordan 51 4.02Turkey 52 4.01Panama 53 4.00Trinidad and Tobago 54 3.98Costa Rica 55 3.97Uruguay 56 3.92Argentina 57 3.87Tunisia 58 3.87

(cont’d.)

Country Rank Score

Bulgaria 59 3.82Dominican Republic 60 3.80Philippines 61 3.72China 62 3.72India 63 3.72Botswana 64 3.70Egypt 65 3.68Namibia 66 3.66Russian Federation 67 3.65Colombia 68 3.60El Salvador 69 3.60Venezuela 70 3.60Peru 71 3.45Kenya 72 3.31Indonesia 73 3.31Morocco 74 3.30Serbia and Montenegro 75 3.30Macedonia, FYR 76 3.26Uganda 77 3.22Ghana 78 3.21Guatemala 79 3.18Georgia 80 3.18Sri Lanka 81 3.17Bosnia and Hercegovina 82 3.15Ukraine 83 3.15Tanzania 84 3.12Gambia 85 3.12Zimbabwe 86 3.04Pakistan 87 3.02Ecuador 88 3.01Nigeria 89 2.99Zambia 90 2.98Paraguay 91 2.94Vietnam 92 2.92Honduras 93 2.89Mozambique 94 2.89Bolivia 95 2.81Nicaragua 96 2.78Malawi 97 2.74Algeria 98 2.67Madagascar 99 2.64Bangladesh 100 2.62Mali 101 2.52Angola 102 2.30Ethiopia 103 2.17Chad 104 1.81

Growth Competitiveness Index (GCI) Technology Index

Source: World Economic Forum

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Country Rank Score

Denmark 1 6.59Iceland 2 6.58Finland 3 6.48New Zealand 4 6.41Norway 5 6.35Sweden 6 6.31United Kingdom 7 6.23Switzerland 8 6.22Hong Kong SAR 9 6.22Singapore 10 6.21Germany 11 6.21Australia 12 6.10Netherlands 13 6.08Luxembourg 14 5.99Austria 15 5.99Japan 16 5.88Ireland 17 5.87Canada 18 5.84United Arab Emirates 19 5.82Chile 20 5.77United States 21 5.74Belgium 22 5.71Portugal 23 5.69Israel 24 5.64France 25 5.62Estonia 26 5.59Taiwan 27 5.56Bahrain 28 5.56Jordan 29 5.43Malta 30 5.39Slovenia 31 5.28Uruguay 32 5.23Cyprus 33 5.18Spain 34 5.16South Africa 35 5.15Tunisia 36 5.14Hungary 37 5.07Malaysia 38 5.06Botswana 39 4.98Namibia 40 4.92Korea 41 4.81Morocco 42 4.75Lithuania 43 4.75Greece 44 4.74Thailand 45 4.71El Salvador 46 4.71Costa Rica 47 4.69Italy 48 4.64Slovak Republic 49 4.64Brazil 50 4.62Czech Republic 51 4.56Latvia 52 4.55India 53 4.45Ghana 54 4.44China 55 4.39Bulgaria 56 4.36Gambia 57 4.30Peru 58 4.28

(cont’d.)

Country Rank Score

Mexico 59 4.28Panama 60 4.26Colombia 61 4.25Turkey 62 4.22Malawi 63 4.20Trinidad and Tobago 64 4.18Mauritius 65 4.16Zambia 66 4.16Algeria 67 4.13Indonesia 68 4.12Jamaica 69 4.11Egypt 70 4.10Dominican Republic 71 4.08Sri Lanka 72 4.08Zimbabwe 73 3.99Romania 74 3.94Kenya 75 3.87Croatia 76 3.86Ethiopia 77 3.80Bosnia and Hercegovina 78 3.80Argentina 79 3.77Poland 80 3.70Nicaragua 81 3.68Vietnam 82 3.66Mali 83 3.66Guatemala 84 3.61Serbia andMontenegro 85 3.61Uganda 86 3.61Bolivia 87 3.55Tanzania 88 3.54Russian Federation 89 3.54Ecuador 90 3.42Venezuela 91 3.41Macedonia, FYR 92 3.41Angola 93 3.38Mozambique 94 3.36Madagascar 95 3.32Nigeria 96 3.31Ukraine 97 3.29Paraguay 98 3.24Philippines 99 3.21Honduras 100 3.19Georgia 101 3.17Pakistan 102 2.87Chad 103 2.61Bangladesh 104 2.47

Country Rank Score

Singapore 1 5.79Norway 2 5.54Finland 3 5.47Denmark 4 5.36Switzerland 5 5.24Luxembourg 6 5.23Netherlands 7 5.13United Kingdom 8 5.11Taiwan 9 5.11Austria 10 5.11United Arab Emirates 11 5.09Iceland 12 5.09Hong Kong SAR 13 5.05Australia 14 5.04United States 15 5.04Spain 16 4.99Sweden 17 4.99Canada 18 4.97Belgium 19 4.92Malaysia 20 4.91Ireland 21 4.85New Zealand 22 4.80Thailand 23 4.79China 24 4.78France 25 4.78Germany 26 4.77Chile 27 4.71Bahrain 28 4.70Japan 29 4.67Estonia 30 4.65Greece 31 4.52Tunisia 32 4.52Lithuania 33 4.46Portugal 34 4.42Korea 35 4.41Jordan 36 4.29Latvia 37 4.27Italy 38 4.27Slovenia 39 4.26Algeria 40 4.23Czech Republic 41 4.22Botswana 42 4.21Israel 43 4.20Trinidad and Tobago 44 4.20Cyprus 45 4.14Morocco 46 4.13Malta 47 4.11South Africa 48 4.11Mexico 49 4.09Mauritius 50 4.08Poland 51 4.05India 52 4.05El Salvador 53 3.99Slovak Republic 54 3.98Hungary 55 3.95Russian Federation 56 3.87Egypt 57 3.86Vietnam 58 3.82

(cont’d.)

Country Rank Score

Croatia 59 3.81Bulgaria 60 3.77Panama 61 3.76Namibia 62 3.76Indonesia 63 3.74Costa Rica 64 3.72Ghana 65 3.68Colombia 66 3.67Pakistan 67 3.63Peru 68 3.60Philippines 69 3.59Mali 70 3.55Romania 71 3.50Tanzania 72 3.47Sri Lanka 73 3.46Bangladesh 74 3.42Uganda 75 3.41Ukraine 76 3.39Macedonia, FYR 77 3.37Madagascar 78 3.36Guatemala 79 3.36Brazil 80 3.28Mozambique 81 3.26Honduras 82 3.23Jamaica 83 3.23Turkey 84 3.22Bosnia and Hercegovina 85 3.19Kenya 86 3.18Nigeria 87 3.17Gambia 88 3.13Ecuador 89 3.10Uruguay 90 3.10Chad 91 3.08Georgia 92 3.07Dominican Republic 93 3.00Argentina 94 2.96Zambia 95 2.96Bolivia 96 2.90Nicaragua 97 2.90Venezuela 98 2.89Ethiopia 99 2.81Malawi 100 2.79Paraguay 101 2.77Serbia and Montenegro 102 2.77Angola 103 2.46Zimbabwe 104 2.07

Table 2: Growth Competitiveness Index components (cont’d.)

Public Institutions Index Macroeconomic Environment Index

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Country

United States 1 2 2Finland 2 7 1Germany 3 1 5Sweden 4 5 6Switzerland 5 4 7United Kingdom 6 8 4Denmark 7 9 3Japan 8 3 11Netherlands 9 6 9Singapore 10 13 8Hong Kong SAR 11 15 10France 12 10 16Australia 13 19 12Belgium 14 11 19Canada 15 16 13Austria 16 14 17Taiwan 17 12 20New Zealand 18 20 15Iceland 19 17 18Norway 20 23 14Israel 21 18 21Ireland 22 22 22Malaysia 23 28 23Korea 24 21 28South Africa 25 24 25Spain 26 25 27Estonia 27 34 24United Arab Emirates* 28 32 26Chile 29 33 29India 30 30 32Slovenia 31 27 33Tunisia 32 43 30Portugal 33 42 31Italy 34 26 43Czech Republic 35 31 37Lithuania 36 37 35Thailand 37 36 36Brazil 38 29 44Slovak Republic 39 41 39Bahrain* 40 53 34Greece 41 40 42Hungary 42 48 38Jordan 43 54 40Indonesia 44 38 46Cyprus 45 59 41Morocco 46 45 45China 47 39 47Costa Rica 48 35 50Latvia 49 51 48Malta 50 60 49Namibia 51 63 51Turkey 52 44 55Mauritius 53 49 54Jamaica 54 52 53Mexico 55 46 56Romania 56 61 57Poland 57 47 64Colombia 58 58 61Trinidad and Tobago 59 55 62Panama 60 66 58Russian Federation 61 62 60Botswana 62 73 52Kenya 63 56 63Ghana 64 71 59El Salvador 65 65 65Egypt* 66 57 68Gambia* 67 70 66Sri Lanka 68 69 67

(cont’d.)

Country

Ukraine 69 64 71Philippines 70 50 77Uganda* 71 75 69Croatia 72 72 70Pakistan 73 67 75Argentina 74 68 78Bulgaria 75 86 72Peru 76 77 74Uruguay 77 80 76Zambia* 78 85 73Vietnam 79 81 79Dominican Republic 80 74 83Nigeria* 81 76 80Zimbabwe 82 79 84Macedonia, FYR 83 84 82Malawi 84 83 85Serbia and Montenegro 85 87 81Guatemala 86 78 90Madagascar 87 88 88Venezuela 88 82 91Algeria 89 93 86Tanzania 90 92 87Mali* 91 95 89Georgia 92 89 93Bosnia and Hercegovina 93 96 92Ecuador 94 90 95Bangladesh 95 97 94Mozambique 96 94 98Honduras 97 91 100Paraguay 98 98 96Ethiopia 99 101 97Nicaragua 100 100 99Bolivia 101 99 101Chad* 102 103 102Angola* 103 102 103

*Survey data for these countries have high within-country variance. Until thereliability of survey responses improves, with future educational efforts andimproved sampling in these countries, their rankings should be interpreted withcaution.

Table 3: The Business Competitiveness Index

BCI ranking

Company operations and

strategy ranking

Quality of the national business

environment rankingBCI

ranking

Company operations and

strategy ranking

Quality of the national business

environment ranking

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but is also changing our understanding of what areemerging as the key factors determining a country’sgrowth performance.

To address some of these challenges, we have beenworking with Xavier Sala-i-Martin and Elsa Artadi todevelop a more comprehensive competitiveness index.Reflecting the need to broaden our scope and look at alarger set of factors, the new index will bring into focus amuch richer set of pillars: human capital, labor and finan-cial markets efficiency, openness and market size, quality ofinfrastructure, to name a few of the new ones being incor-porated; in this spirit, it will be called the GlobalCompetitiveness Index. Chapter 1.3 of this Report is anexcellent presentation of the work that has been done todate. 2004 therefore constitutes a transition year betweenthe presentation of two indexes, the GCI and the BCI,and the subsequent consolidation of the World EconomicForum’s competitiveness work into a single index—theGlobal Competitiveness Index.

Selected issues of competitiveness and special topicsThis year’s Report contains a number of studies whichaddress different aspects of competitiveness and, more gen-erally, themes which emanate from the World EconomicForum’s deep concern with growth and development andthe state of the world. Some of these studies draw directlyfrom the Executive Opinion Survey for their analysis and

insight. Others are concerned with a broader set of issuesat the heart of the development agenda.All are businessrelevant, and highlight a range of issues which are various-ly shaping the global economic and business environment.

Selected issues of competitivenessDaniel Kaufmann’s “Corruption, Governance andSecurity: Challenges for the Rich Countries and theWorld” is an important addition to the literature in anincreasingly important field.Traditionally, governance andcorruption challenges have been seen as especially daunt-ing in poorer countries, with the richer ones viewed asgood examples, with their relative law and order, and welldeveloped institutions. Others might view them as publicsector problems, divorced from global governance or secu-rity issues. Using an empirical approach, based on thisyear’s EOS, Kaufmann challenges these notions, and showsus a more complex reality, revealing more subtle, yet costlymanifestations of misgovernance, afflicting not only poor,but rich countries as well.The traditional definition ofcorruption as the commission of an illegal act, such asoutright bribery, is here broadened to include new meas-ures of “legal corruption,” seen as the collusion of at leasttwo parties, typically from the public and private sectors,and where the rules of the game, laws and institutions areused, via influence peddling and even capture, to benefitvested interests.

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Uruguay

India

Malta

Germany

Taiwan

Norway

Algeria

Indonesia

Botswana

Pakistan

France

Iceland

United States

Finland

SwedenSwitzerland

Hong Kong SAR

Belgium

United Arab Emirates

South Africa

Bosnia and Herzegovina

UkraineKenya

Zimbabwe

Portugal Brazil

Bulgaria

Figure 1: Growth and Business Competitiveness rankings

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Growth Competitiveness ranking

By analyzing the interaction between rich countrytransnationals and the public sectors in emerging coun-tries, Kaufmann finds that ethics and corruption pose aserious challenge for many rich countries, and that theyrepresent key determinants of a country’s competitiveness,shaping its investment climate. Kaufmann ends his chapterwith an insightful analysis of the governance data from theEOS, separating the issues of national governance andglobal and domestic security, and challenging the notionthat security issues—common crime, organized crime,money laundering, and the threat of terrorism—are notsubject to measurement.The evidence suggests that somerich countries are faced not only with domestic challengesof undue influence, as regards many key public policies,laws and regulations, but with a new set of security threatsas well; even with their well-developed institutions, the G-7 and other rich countries must face the challenge ofguaranteeing level playing fields and mitigating the cost ofterrorist threats.

In his paper “The Competitive Edge in Environ-mental Responsibility,”Arthur Dahl argues that the envi-ronment has for too long been seen as an impediment tobusiness, since environmental regulations have increasedcosts.A review of global environmental problems revealsnot only challenges and risks for the private sector thatcannot be ignored, but also opportunities for businessesthat can work to their competitive advantage. Dahl high-lights the significant potential for business leadership inthe field of environment and sustainable development ateach stage of the development process. By taking a posi-tive, proactive view, the private sector can ensure suppliesof raw materials, increase efficiency, and generate newtechnologies to respond to these problems, thus openingup new markets, reducing costs, and allowing more timefor adaptation, with phased investments and reducedwrite-offs or special charges.

The 2004 Executive Opinion Survey evaluates theviews of business leaders on environmental and socialresponsibility issues, and demonstrates both the impor-tance of governmental leadership in providing an effectiveregulatory climate, and the key role of business leadershipin addressing environmental and social issues proactively.In Dahl’s analysis, countries are rated not on their presentenvironmental status, but on the efforts of both businessand government to improve that status, and to anticipateand address emerging problems. Nine countries receivedhigh ratings, another 34 were positive on balance, while24 showed progress in some areas, and 38 were making lit-tle or no effort to be environmentally responsible. Someemerging economies and developing countries scoredwell, driven perhaps by dynamic business sectors andenlightened governments, while some industrialized coun-tries were ranked far below their peers, suggesting a needfor greater efforts to remain competitive.The results

strongly suggest that combined efforts by business andgovernment to facilitate corporate social and environmen-tal responsibility do, indeed, generate a competitive edge.

In “Chile:The Next Stage of Development,”AugustoLopez-Claros notes that Chile has managed to grow fasterthan many other countries in the developing world,boosting per capita incomes, and making further progressto reduce poverty levels. It has done so against a backdropof fiscal discipline and rapidly declining public debt levels,while maintaining an admirably open trade and foreigninvestment regime, and improving to a remarkable degreethe quality of its public institutions, which have played astabilizing and pivotal role in the country’s recent evolu-tion. By a wide margin, Chile is the most competitiveeconomy in Latin America.

The author identifies a number of areas where chal-lenges remain, however, if Chile is to make a successfultransition to the next stage of its development.This phasewill require a combination of comparative advantages andthe adoption of new technologies to facilitate the emer-gence of clusters, centered mainly on the natural resourcesectors and the upstream development of supportingindustries with higher value added. Critical to this processof development will also be a substantial upgrading in thequality of Chile’s educational system, which remains sur-prisingly inefficient, given the country’s income levels.Lopez-Claros also raises the question of whether thecountry—and in particular its political leadership—havereached the right balance, as regards the role of the state inthe economy.Without doubt, the country has benefitedfrom a system that has built in a number of safeguards toprotect the public interest from the short-term interests ofpassing politicians, and from various forms of abuse. Butthis approach may need to make room for a more activerole for the state, as has been done in Finland, with regardto the support for new ventures, aimed at enhancing thecountry’s potential for innovation.

Chile aside, in “The Future of Competitiveness-Enhancing Reforms in Latin America,” Mario Blejerargues that despite a recent pickup in growth, the regioncontinues to confront important challenges and faces seri-ous struggles ahead.The difficulties concern the uncer-tainty regarding the sustainability of macroeconomicrecovery and, more importantly, the capacity of the regionto address long-term structural weaknesses.A significantproblem in Latin America is the incomplete nature of thereforms, evidenced by deficiencies in institutional develop-ment, and reflected in the loss of competitiveness. Indeed,Latin America is falling behind, not only with respect tothe economies of East Asia but, more significantly, withrespect to the transition economies of central and easternEurope.

In answer to the question what explains this worri-some trend, Blejer suggests that in most cases, reforms

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have remained incomplete and their economic benefitshave not been fully realized. Some of the successes in creating a more stable macroeconomic environment havenot been complemented by more broad-based “secondgeneration” reforms. He points out that any assessment of the current political and social realities in the regionsuggests that the short term prospects for further imple-mentation of market-oriented reforms would seem bleak.Reforms have not had the anticipated effects on growthand employment and, against a groundswell of the anti-globalization movement, the entire concept of structuralreform—with the exception of Chile—has been systemat-ically maligned and discredited across Latin America. Insuch an environment, it is clear that there is a widespreadlack of enthusiasm for further reforms. In practice, thedesign and introduction of a realistic reform agenda wouldrequire two key elements: compensation for those who arebound to be negatively affected from the process, and abetter set of international incentives for governments andcountries willing to swim against the current of publicopinion, and take the necessary steps to improve theireconomy.

In “International Productivity Comparisons: theImportance of Hours of Work,”Andrew Warner challengesthe traditional measures of productivity, by highlightingthe importance of hours worked. He demonstrates thatwhile growth of GDP or GDP per capita puts the UnitedStates clearly ahead of most industrial countries during theboom years of the new economy (1995–2000), thissupremacy is not quite so obvious when data on growthof GDP per hour is used to quantify productivity growth.Warner also questions the common notion that productiv-ity has suffered a serious decline in Europe over the lastdecade. Using GDP per hour calculations, he shows theclear lead of some European countries over the UnitedStates, and implies that the European “productivity slow-down” may be more myth than reality, when we focus onper hour data.

Given uncertainties about the reliability and compara-bility of existing data on hours worked, as well as lack ofcoverage of poorer countries, questions were introducedinto the 2004 Executive Opinion Survey on the extent ofhours worked.Warner uses this unique dataset to revealinteresting differences between the trends observed inindustrial countries and those in developing nations.Wagelabor in low-income countries work particularly longhours, whereas in rich countries as a whole, there is atrend for executive workers to put in more hours thanhourly labor.

Warner also uses the Survey data to highlight differ-ences in productivity barriers and to show how these vary across countries and income levels. Four barriers to productivity are examined: labor practices, business regulations, labor skills, and poor infrastructure.While the

perception of labor practices and business regulations asbarriers to productivity does not appear to be directlyrelated to income level, lack of skilled labor appears to bea hindrance in high-income countries, while the lack ofinfrastructure is typically, but not surprisingly, perceived asa productivity barrier in most low-income countries.

Special topicsBy analyzing trends in population growth, per capitaincome, and the effects of the IT revolution, RichardCooper, in “A Glimpse of 2020,” offers an insightful perspective on what the world will look like two decadesfrom now. Cooper paints contrasting demographic scenar-ios for 2020: low-income countries will see rapid popula-tion increase, placing heavy pressures on energy demandand urban infrastructure; rich countries will experiencepopulation decline, and a much higher ratio of elderly toworking age, severely taxing governments’ abilities tomaintain the high social benefits to which their citizenshave grown accustomed.

Dramatically decreased costs of communication willincrease mobility, reduce economic and cultural differ-ences between the regions of the world, but increaseinternational cooperation, not only in areas such as finan-cial regulation, tax and law enforcement and technologyexchange, but also in the willingness of nations to inter-vene where national governments have failed. Despite thenatural attraction of familiar languages and social environ-ments, businesses are becoming “footloose,” increasinglydriven by competition to outsource offshore, with head-quarters and production centers often situated at great dis-tances from each other. NGOs as well as criminal businessand terrorism will become increasingly international inscope, and repressive governments will find it more diffi-cult to insulate their populations from access to informa-tion. Cooper points out that by 2020, while there isbound to be uncertainty following the inevitable demiseof current dictators, more “South Koreas” will arise, i.e.developing countries which grow rapidly, democratize andjoin the ranks of the rich, forming new market opportuni-ties. Particular attention is paid to China, whose GDP by2020 could make it the world’s third largest economy, andwhere, although still poor, the high ratio of wage earnersto dependents will enable the country to become a majorworld player. Forecasting the future is hazardous business,but Cooper presents a cogent, business-relevant, vision of 2020.

A number of challenges to the well-being of oursocieties—demographic, technological, climatological, andgeopolitical—are visible on the long-term horizon. In“Confronting Long-Term Fiscal Challenges:Why itMatters for the Global Economy,” Peter Heller takes up anissue raised by Cooper in his own article, and perceptivelyexplains why some of these challenges are predictable,

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while others are vague and uncertain. Even when clearlyanticipated, uncertainty still surrounds developmentswhose horizon may be measured in decades. Some, suchas aging populations, pose a threat to the financial solven-cy of national governments, raising the prospect of vastlyincreased future public outlays, whether for pensions,health care, long-term chronic care, infrastructure, or security.Accentuating these fiscal risks is the fact that thefuture resources of governments are already precommittedto an unprecedented extent. Not surprisingly, politicaleconomy factors work against efforts to address these challenges.

Heller contends that governments must do muchmore, now, to prepare for the fiscal consequences of thedevelopments that their countries face over the next sev-eral decades.The agenda for action will depend on thecountry, on the preferences and capacities of its peopleand institutions, on the extent of its existing policy com-mitments, and on the specific challenges it faces.Uncertainty does not absolve fiscal policymakers from theburden of addressing long-term issues.What they do, orfail to do, will critically influence both the welfare of cur-rent and future generations, and the role and capacity ofthe state itself. Delay in addressing these changes will onlyincrease their costs, some of which will be borne by thoseliving today.What to do? Heller suggests that no singlepolicy reform will suffice to meet long-term challenges.Reform must proceed on many fronts, utilizing additionalanalytic techniques, strengthening institutions to clarifyand monitor evolving budget trends, introducing detailedpolicy reforms, the sustained strengthening of the aggre-gate fiscal position, and working with other countries onareas where collective action is required.

In a compelling contribution to this year’s Report,entitled “Agricultural Policies in OECD Countries: anAgenda for Reform,” Stefan Tangermann makes a numberof fundamental points, which cast refreshing light on acomplex and politically charged subject.To begin with,there is an apparent inconsistency between the rapidlydeclining importance of agriculture among the 30Member countries of the OECD—whether measured interms of the sector’s contribution to total GDP or totalemployment—and the considerable attention devoted to itin the public debate.The resources transferred to farm-ers—an impressive US$257 billion in 2003, a full threequarters of which taking the form of production-linkedtransfers—seriously distort markets and competition ininternational trade.Tangermann shows that, despite long-standing discussions about the need for reforms, the levelof support during 2001–2003 is only marginally lowerthan during the period 1986–1988. However, within theOECD as a whole, there is considerable diversity acrosscountries, with New Zealand and Australia having essen-tially eliminated farm support as a result of comprehensive

reforms, and others, such as Norway and Switzerland, stillproviding levels of producer support more than twice theaverage in the EU, and hardly changed during the past 15 years.

Tangermann examines the reasons for these massivetransfers to farmers.Their motivation stems from a desireto address equity concerns in societies at large, and dealwith market failures associated with the interactionbetween agriculture and the environment. However, heprovides compelling data to show that, in fact, incomes offarm households in OECD countries are in line with, ifnot higher than, household incomes in the overall econo-my.Thus, broad-based support measures such as price andoutput support are unnecessary.Worse still, only 25 centsout of every dollar of support provided to farmers actuallyends up in farmers’ pockets, with a large share of the restgoing to large landowners.As regards the environment, theharsh effects of overproduction on the quality of farmlandand wildlife are well known. Finally, the extra output gen-erated by farm policies in OECD countries depressesprices for farm products in international trade, and hasbeen a contributing factor in the difficulties encounteredin promoting further multilateral trade liberalization.Theauthor concludes this important paper with some specificsuggestions for reform.

In his paper “Can Foreign Aid Make Poor CountriesCompetitive?”William Easterly offers insightful answers tothe question why foreign aid has not been more successfulat promoting competitiveness. In his review of the evi-dence on foreign aid and economic growth, the effective-ness of aid conditionality, and the bureaucratic nature ofaid agencies, Easterly questions and then examines theresults of the regression analysis published in 2000 byCraig Burnside and David Dollar, which investigated therelationship between foreign aid, economic policy and thegrowth of per capita GDP. Because of its conclusion, viz.that aid only works in a good policy environment, thisstudy was widely cited by media, governments and aidagencies, as a basis for increasing foreign aid. By expandingthe dataset, extending the time line and using alternativedefinitions of “aid,”“policy,” and “growth,” Easterly comesto some different and thought-provoking conclusions, tothe effect that the interaction term of aid and good policyis no longer statistically significant. Easterly also criticallyexamines the “financing gap” approach to aid, by which itis assumed that aid increases investment and investmentincreases economic growth, finding it both theoreticallyquestionable and empirically deficient, leading him toquestion why the international community has not heldagencies responsible for the failure of large flows of aid togenerate growth.

After discussing the detailed findings, Easterly analyzeshow aid agencies actually function, citing the excessive,dysfunctional bureaucracy of agencies, the fact that they

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are answerable to the rich donors, rather than their voiceless recipients, the assumption of capital projectswithout maintaining them, and the pernicious tendency toovermeet, overextend and overstate. He saves particularlytrenchant criticism for the failure of aid agencies, despitethe presence of obviously well-intentioned and capableminds, to understand the deeper implications of and trulypractice “grassroots” development.The result of this fail-ure, he concludes, has been not only the continued pres-ence of unalleviated misery, but the loss of support for aidon the part of the rich countries most able to provide it.He ends in a positive tone, pointing to a successful projectin Ethiopia, by making a number of serious and realisticproposals for aid agencies, governments and developmentpractitioners, to assist them in revising expectations, meth-ods, and, hopefully, outcomes.

The Report ends with a section containing detailedcountry profiles for each of the 104 economies covered inour competitiveness indexes, as well as data tables for thevariables that are used as inputs in their construction.Abrief Annex, explaining how best to interpret the infor-mation contained in the country profiles and the datatables, is an essential companion to this section, as aretechnical notes clarifying the meaning of many variables,and listing relevant data sources.

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CHAPTER 1.2

Building the MicroeconomicFoundations of Prosperity:Findings from the BusinessCompetitiveness Index1

MICHAEL E. PORTER, Harvard University

Competitiveness has become a central preoccupation ofboth advanced and developing countries in an increasinglyopen and integrated world economy. Despite its acknowl-edged importance, the concept of competitiveness is oftenmisunderstood. Here, we define competitiveness concretely,show its relationship to a nation’s standard of living, andoutline a conceptual framework for understanding itscauses.

The Business Competitiveness Index (BCI), based onthis conceptual framework, provides a data-rich approachto measuring and analyzing the fundamental competitive-ness of a large number of countries in a comparative con-text.This year’s BCI includes 103 countries, up one fromlast year. Our aim is to rank country competitivenessacross countries, identify individual countries’ competitivestrengths and weaknesses, reveal the trends in competitive-ness in the global economy, and extend our basic knowl-edge about the sources of competitiveness and the processof economic development.

Most discussion of competitiveness and economicdevelopment is still focused on the macroeconomic, politi-cal, legal, and social circumstances that underpin a success-ful economy. It is well understood that sound fiscal andmonetary policies, a trusted and efficient legal system, astable set of democratic institutions, and progress on socialconditions contribute greatly to a healthy economy.However, these broader conditions are necessary but notsufficient.They provide the opportunity to create wealthbut do not themselves create wealth.Wealth is actuallycreated in the microeconomic level of the economy, root-ed in the sophistication of the operating practices andstrategies of companies as well as in the quality of themicroeconomic business environment in which a nation’scompanies compete. Unless these microeconomic capabili-ties improve, macroeconomic, political, legal, and socialreforms will not bear full fruit.

Beginning in 1998, we began an effort to examinestatistically the microeconomic foundations of competi-tiveness and prosperity across a wide array of countries.This is a daunting task, given the need to measure andcompare the complex array of national circumstances thatsupport a high and sustainable level of productivity.Theeffort aims to move beyond the examination of broad,aggregate variables typical of most economic growthanalyses to provide a framework for countries and compa-nies to understand their detailed competitive strengths andweaknesses. It also aims to be as rigorous as possible, veri-fying the importance of each measure statistically andusing statistical techniques to weight the contribution ofindividual variables. Finally, we know that improvement incompetitiveness is not a simple linear process but onewhere nations at different levels of development face dif-ferent challenges and priorities.This effort aims to high-light these differences.

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The Business Competitiveness Index seeks to explorethe underpinnings of a nation’s prosperity, measured by itslevel of GDP per capita.The focus is on whether currentprosperity is sustainable, and on the specific areas that mustbe addressed if GDP per capita is to achieve higher levelsin the future.A separate Growth Competitiveness Index(GCI), discussed in the previous chapter of this Report,examines the sources of GDP per capita growth, which ismore dependent on investment rates and other macroeco-nomic policies.The sustainable level of current GDP percapita and its rate of growth will be related in the longterm, but each area requires its own distinctive policyagenda.The conceptual framework and statistical approachfollow that of the previous reports and the findings arefully comparable with previous MicroeconomicCompetitiveness Index results.

The analysis here is pragmatic, making use of the bestavailable data and econometric methods even though bothare far from perfect.We also confront the challenge ofestablishing the direction of causality given limited time-series data. However, even if definitive tests of causality arenot possible, understanding the microeconomic correlatesof prosperity remains crucial.There may be a natural ten-dency for some microeconomic conditions to improve asGDP per capita increases.Yet the large observed differ-ences across countries, even those at similar income levels,reveal that this improvement is far from automatic.

Despite the statistical challenges, the statistical findingsoverall are remarkably stable and robust compared withthe Global Competitiveness Report 2003–2004 (GCR) andearlier Reports.We expand this year’s analysis to include ananalysis of natural resource endowments and their role incompetitiveness, a crucial issue especially for developingcountries.The results again provide strong support for theimportance of microeconomic competitiveness for eco-nomic development and prosperity. Our findings also veri-fy the striking and regular pattern of microeconomicchanges that accompany economic development.

The Business Competitiveness Index (BCI) accountsfor 81 percent of the variation across countries in the levelGDP per capita.2 This level is remarkably high given thepresence of so many low- income countries and theinherent imperfections of national income data.Thesefindings highlight the pressing need to better incorporatemicroeconomic competitiveness agenda into efforts tostimulate economic growth. In advanced countries, whichhave largely gotten their macro policies right, it is microreform that holds the key to reversing unemploymentproblems, to growing exports, and to translating economicgrowth into a rising standard of living.

In developing countries, microeconomic failures nul-lify macroeconomic and social programs again and again.By accessing global capital markets, countries can engineerspurts of growth through macroeconomic stabilization and

financial reforms that bring in floods of capital and createthe illusion of progress as construction cranes dot the sky-line.Without microeconomic reforms, however, growthwill be snuffed out as exports and jobs fail to materialize,wages stagnate, and the return on investments proves dis-appointing.This disappointment, and the austerity thatresults from such cycles, is at the heart of the backlashagainst globalization.

Successful economic development requires progresson multiple fronts simultaneously. Reform efforts need tobe tightly connected to the country’s current stage ofdevelopment.As an economy progresses, the constraints toits continued advancement shift.At strategic points in thedevelopment process, the whole basis of national competi-tiveness must be transformed. Many aspects of companystrategy must be shifted and new requirements in thenational business environment must be met. Our analysisprovides the conceptual framework and comparative datato define such national agendas, and to measure progress.

Competitiveness and its causesMeasuring and ranking competitiveness requires a clearconceptual framework, drawing on the accumulatedknowledge about competitiveness and its sources.We sum-marize the framework here, drawing on previous years’chapters while extending it to incorporate recent learning.

What is competitiveness?Competitiveness remains a concept that is not well under-stood, despite widespread acceptance of its importance.The most intuitive definition of competitiveness is a coun-try’s share of world markets for its products.This makescompetitiveness a zero-sum game, because one country’sgain comes at the expense of others.This view of compet-itiveness is used to justify intervention to skew marketoutcomes in a nation’s favor (so-called industrial policy). Italso underpins policies intended to provide subsidies, holddown local wages, and devalue the nation’s currency, allaimed at expanding exports. In fact, it is still often saidthat lower wages or devaluation “make a nation morecompetitive.” Business leaders are drawn to the market-share view because these policies seem to address theirimmediate competitive concerns.

Unfortunately, the most intuitive view of competi-tiveness is deeply flawed, and acting on it works againstnational economic progress.The need for low wagesreveals a lack of competitiveness and holds down prosperi-ty. Subsidies drain national income and bias choices awayfrom the most productive use of the nation’s resources.Devaluation results in a collective national pay cut by dis-counting the products and services sold in world marketswhile raising the cost of the goods and services purchased

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abroad. Exports based on low wages or a cheap currency,then, do not support an attractive standard of living.

To understand competitiveness, the starting pointmust be the underlying sources of prosperity.A nation’sstandard of living is determined by the productivity of itseconomy, which is measured by the value of goods andservices produced per unit of the nation’s human, capital,and natural resources. Productivity depends both on thevalue of a nation’s products and services, measured by theprices they can command in open markets and the effi-ciency with which they can be produced. Productivityalso depends on the ability of an economy to mobilize theavailable human resources. Some European economiesreport high levels of productivity per hour worked, buthigh unemployment, sick leave, and limited working hoursdepress national income per capita.3 Much of this is notvoluntary but reflects a lack of employment alternatives.4

True competitiveness, then, is measured by productiv-ity. Productivity allows a nation to support high wages, astrong currency, and attractive returns to capital—and withthem a high standard of living. Productivity is the goal,not exports per se. Only if a nation increases exports ofproducts or services that it can produce more productivelythan the average industry will national productivity rise.Also, productivity is the goal, not whether firms operatingin the country are domestic or foreign owned.What mat-ters most is not ownership, but the nature and productivityof the business activities taking place in a particular country.Finally, purely local industries also matter for competitive-ness because their productivity not only sets the wages inthese industries but also has a major influence on the costof living and the cost of doing business in the country.The productivity of the entire economy matters for thestandard of living, not just the traded sector.

The world economy is not a zero-sum game. Manynations can improve their prosperity if they can improveproductivity.The central challenge in economic develop-ment, then, is how to create the conditions for rapid andsustained productivity growth.

Microeconomic foundations of productivityStable political, legal, and social institutions and soundmacroeconomic policies create the potential for improvingnational prosperity. But wealth is actually created at themicroeconomic level—in the ability of firms to createvaluable goods and services using efficient methods. Onlyin this way can a nation support high wages and theattractive returns to capital necessary to support sustainedinvestment (see Figure 1).

The microeconomic foundations of productivity reston two interrelated areas: (1) the sophistication withwhich domestic companies or foreign subsidiaries com-pete in the country, and (2) the quality of the microeco-nomic business environment in which they operate.

The productivity of a country is ultimately set by theproductivity of its companies.An economy cannot becompetitive unless companies operating there are compet-itive, whether they are domestic firms or subsidiaries offoreign companies. However, the sophistication and pro-ductivity of companies is inextricably intertwined withthe quality of the national business environment. Moreproductive company operating practices and strategiesrequire more highly skilled people, better information, moreefficient government processes, improved infrastructure,better suppliers, more advanced research institutions, andmore intense competitive pressure, among other things.

Companies in a nation must upgrade their ways ofcompeting if successful economic development is tooccur. Broadly, companies must shift from competing oninherited endowments (comparative advantages such aslow-cost labor or natural resources) to competing oncompetitive advantages arising from efficient and distinc-tive products and processes. Companies must move fromtapping foreign distribution channels to building theirown channels.These and other transitions in corporatestrategies and operating practices required for successfuleconomic development are shown in Figure 2.

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Macroeconomic, Political, Legal, and Social Context for Development

Sophistication of Company

Operations andStrategy

Quality of theMicroeconomic

Business Environment

Microeconomic Foundations of Development

Figure 1: Determinants of productivity and productivitygrowth

Low-Income Countries

• Competitive advantages beyondcheap inputs

• Production processsophistication

• Broad value chainpresence

• Reliance on profes-sional management

Middle-IncomeCountries

• Extent of regionalsales

• Control of internation-al distribution

• Extent of branding

• Company spendingon R&D

• Prevalence of foreigntechnology licensing

• Extent of staff training

High-Income Countries

• Capacity for innovation

• Breadth of interna-tional markets

• Extent of incentivecompensation

• Willingness to delegate authority

Figure 2: Company sophistication and economic development

What were strengths in competing at earlier stages ofdevelopment become weaknesses at more advanced levelsof development. Extensive technology licensing works forlower- and middle-income countries, but must give wayto indigenous technology development. Necessary changesare often resisted by the corporate sector because pastapproaches were profitable and because old habits aredeeply ingrained.

Moving to more sophisticated ways of competingdepends on parallel changes in the microeconomic busi-ness environment.The business environment can beunderstood in terms of four interrelated areas: the qualityof factor (input) conditions, the context for firm strategyand rivalry, the quality of local demand conditions, and thepresence of the related and supporting industries. Becauseof their graphical representation (see Figure 3), the fourareas have collectively become referred to as the diamond.

As the diamond framework reveals, almost everythingmatters for competitiveness.The schools matter, the roadsmatter, the financial markets matter, and customer sophis-tication matters, among many other aspects of a nation’scircumstances, many of which are deeply rooted in anation’s institutions, people, and culture.This makesimproving competitiveness a special challenge, becausethere is no single policy or grand step that can createcompetitiveness, only many improvements in individualareas that inevitably take time to accomplish. Improving

competitiveness is a marathon, not a sprint. How to sus-tain momentum in competitiveness improvements overtime is among the greatest challenges facing countries.

There are distinct influences on competitiveness atmultiple geographic levels: national, state, and local.5 In manycountries, we observe striking differences in economicperformance among subnational regions. In countries suchas China, India, and the United States, the benefits ofdecentralization of economic policy and strong initiativein individual regions is evident.The crucial need for eco-nomic strategies for sub-national units such as states orregions is among the most important new directions incompetitiveness thinking and practice.

National productivity can also be enhanced throughcoordinating policies among neighboring countries.Aconcerted effort to improve the business environment isneeded both within countries and across countries.

Government plays an inevitable role in economicdevelopment because it affects many aspects of the busi-ness environment. Government shapes factor conditions,for example, through its training and infrastructure poli-cies.The sophistication of home demand derives in partfrom regulatory standards, consumer protection laws, gov-ernment purchasing practices, and openness to imports.Similar policy influences are present in all four parts of thediamond. Many government departments and agenciesimpinge on competitiveness, as do government entities at

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Factor (Input) ConditionsPresence of high quality, specialized inputs available to firms

• Human resources• Capital resources• Physical infrastructure• Administrative infrastructure• Information infrastructure• Scientific and technological

infrastructure• Natural resources

Related and Supporting Industries• Access to capable, locally

based suppliers and firms in related fields

• Presence of clusters instead of isolated industries

Demand Conditions• Sophisticated and demanding

local customer(s)

• Local customer needs that anticipate those elsewhere

• Unusual local demand in special-ized segments that can be servednationally and globally

Figure 3: The microeconomic business environment

Context for Firm Strategy and Rivalry• A local context and rules that

encourage investment and sustained upgrading (e.g.,Intellectual property protection)

• Meritocratic incentive systemsacross institutions

• Open and vigorous competitionamong locally based rivals

the provincial, state, and city levels.The question is notwhether government has a role, but what that role shouldbe and how to coordinate policies across parts of govern-ment. Many countries have sought to limit the inappro-priate roles of government while ignoring its positiveroles. Government must set the right rules and incentivesand make the public investments needed for a productiveeconomy.

National endowments such as natural resources play adeclining role in competitiveness as the resource intensityof the economy falls and as technology substitutes forresources or opens up new resource locations.The realprices of most resources or resource-intensive goods havebeen falling over the decades. It is the productivity withwhich natural resources can be utilized, not the resourcesthemselves, that normally have the strongest influence onprosperity.Abundant natural resources also carry a risk. Incountries where natural resources are abundant or domi-nate economic activity, forces are set in motion that limitthe development of policies, skills, and attitudes thatenhance competitiveness. Exploiting and redistributingresource spoils can become the dominant orientation notenhancing productivities.We explore the relationshipbetween natural resource endowments and competitive-ness in a later section.

Clusters and economic developmentAn improving business environment gives rise to the for-mation of clusters. Clusters are geographically proximategroups of interconnected companies, suppliers, service

providers, and associated institutions in a particular field,linked by commonalities and complementarities. Clusterssuch as software in India or high-performance cars inGermany are often concentrated in a particular regionwithin a larger nation, and sometimes in a single town.

Clusters affect competitiveness in three broad ways:first, by increasing the productivity of constituent firms orindustries. Firms with a cluster have more efficient accessto specialized suppliers, employees, information, and train-ing than isolated firms.The presence of a wide range ofavailable inputs, machinery, skills, and knowledge promotesgreater efficiency and flexibility than vertical integrationor relationships with distant suppliers. Second, clustersincrease the capacity for innovation and productivitygrowth. Opportunities for innovation are often perceivedmore easily within clusters, and the assets, skills, and capitalare more available to pursue them.Third, clusters stimulateand enable new business formation that supports innovationand expands the cluster.The local presence of experiencedworkers and access to all the needed inputs and specializedservices, for example, reduces the barriers to entry.

The benefits of clusters apply to virtually all parts ofan economy, not only to knowledge-intensive industriessuch as life sciences or information technology as is some-times assumed.A good example is tourism: in the Cairnstourism cluster of northwestern Australia, natural attrac-tions such as proximity to the Great Barrier Reef and atropical rainforest alone would provide little advantage forthe location versus competing tourism destinations.6 Onlythe combination of high-quality transportation services,

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Figure 4: The Cairns Tourism Cluster

Source: Research by HBS Student Team, 2003

Public Relations and MarketResearch Services

Restaurants

Attractions and Activities

e.g., James CookUniversity, CairnsCollege of TAFE

Airlines, Cruise ShipsHotels

Food Suppliers

Property Services

Maintenance Services

Government AgenciesHarvard University, MIT,

e.g., Australian Tourism Commission, Great Barrier Reef Authority

Educational Institutionse.g., James Cook University,

Cairns College of TAFE

Industry Groupse.g., Queensland Tourism

Industry Council

Local Transportation

Souvenirs, Duty Free

Banks, Foreign Exchange

Local retail, health care, and other services

Travel Agents Tour Operators

accommodation, restaurants, travel guides, and the manysupporting activities required to operate them creates thehigh level of value which tourists are looking for. Eventhe best hotel and the most unique tourist attractionwould loose greatly in value if local transportation serviceswere weak.

National economies tend to specialize in particularclusters, which account for a disproportionate share oftheir output and exports.This specialization is even moreevident in sub-national regions.The nature and depth ofclusters varies with the state of development of the econo-my. In developing countries, clusters are normally shallowor underdeveloped. Firms compete based on cheap laboror local natural resources, and they depend heavily onimported components, machinery, and technology.Specialized local infrastructure and institutions are absentor inefficient, which limits local processing of productsand limits quality.As economies advance, clusters developand deepen to include suppliers of specialized inputs,components, machinery, and services; specialized infra-structure; and institutions providing specialized training,education, information, research, and technical support.

It is rare for there to be only a single cluster in theworld in a given field; usually there is an array of clustersin different locations with different levels of sophisticationand specialization. In a given field, only a small number ofclusters tend to be true innovation centers, such as SiliconValley and Japan in semiconductors.These innovation cen-ters sometimes specialize in particular market segments—the Silicon Valley cluster is unusually strong in micro-processors. Other locations may be manufacturing centers.Still other clusters can be regional assembly and serviceclusters.

Firms based in the most advanced clusters often seedor enhance clusters in other locations as they dispersesome activities to reduce risk, access lower cost inputs, orbetter serve particular regional markets. Intel, for example,has moved some assembly and testing and some wafer fab-rication to a number of non-US locations that havebecome regional clusters.The same development can beseen in a number of other areas: for example, the off-shoring of business services and manufacturing activitiesto locations with lower labor costs. Instead of spreadingthese activities across geography in less-advancedeconomies, companies have found it advantageous to co-locate in newly emerging clusters.This can be seen inoutsourced business services in Bangalore, India and intextile production in Timisoara, Romania.7

The challenge for an economy is to move from isolat-ed firms to an array of clusters, and to upgrade the sophis-tication of clusters to more advanced activities.

Stages of competitive developmentSuccessful economic development is a process of succes-sive upgrading, in which a nation’s business environmentevolves to support and encourage increasingly sophisticat-ed and productive ways of competing by firms basedthere. Nations at different levels of development face distinctly different challenges.

As nations develop, they progress in terms of theircompetitive advantages and modes of competing.8 In theFactor-Driven stage, basic factor conditions such as low-cost labor and unprocessed natural resources are the domi-nant sources of competitive advantage and exports. Firmsproduce commodities or relatively simple productsdesigned in other, more-advanced countries.Technology isassimilated through imports, supply agreements, foreigndirect investment, and imitation. In this stage, companiescompete on price and lack direct access to consumers.They have limited roles in the value chain, focusing onassembly, labor-intensive manufacturing, and resourceextraction.A Factor-Driven economy is highly sensitive toworld economic cycles, commodity prices, and exchangerate fluctuations.

In the Investment-Driven stage, efficiency in produc-ing standard products and services becomes the dominantsource of competitive advantage. Heavy investment in effi-cient infrastructure, business-friendly government adminis-tration, strong investment incentives, and better access tocapital allow major improvements in productivity.Theproducts and services produced become more sophisticat-ed, but technology and designs still largely come fromabroad.Technology is accessed through licensing, jointventures, foreign direct investment, and imitation.However, nations at this stage not only assimilate foreigntechnology but also begin to develop the capacity toimprove on it. Companies serve a mix of OEM customersand end users. Firms extend capabilities more widely inthe value chain.An Investment-Driven economy is con-centrated on manufacturing and on outsourced serviceexports. It is susceptible to financial crises and external,sector-specific demand shocks.

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Figure 5: Stages of competitive development

Source: Porter (1990)

Input Cost

Factor-Driven Economy

Efficiency

Investment-Driven Economy

Unique Value

Innovation-Driven Economy

In the Innovation-Driven stage, the ability to produceinnovative products and services at the global technologyfrontier using the most advanced methods becomes thedominant source of competitive advantage.The nationalbusiness environment is characterized by strengths in allareas together with the presence of deep clusters.Institutions and incentives supporting innovation are welldeveloped. Companies compete with unique strategiesthat are often global in scope.An Innovation-Driveneconomy has a high share of services in the economy andis resilient to external shocks.

Seeing economic development as a sequential processof building interdependent microeconomic capabilities,shifting company strategies, improving incentives, andincreasing rivalry exposes important pitfalls in economicpolicy.The influence of one part of the microeconomicbusiness environment depends on the state of others. Lackof improvement in any important area can lead to aplateau in productivity growth and stalled development.Worse yet, it can undermine the whole economic reformprocess.When well-trained college graduates cannot findappropriate jobs because companies are still competingbased on cheap labor, for example, a backlash against busi-ness is created.

This analysis also begins to reveal why countries findthe transition to a new stage of development so difficult.Such inflection points require wholesale transformation ofmany interdependent aspects of competition.

Institutions and roles in economic developmentWhile government is important to competitiveness, gov-ernment alone is less and less able to build a competitiveeconomy. Many other national and local institutions havea role in competitiveness and economic development.Theinfluence of universities and schools is growing as knowl-edge and technology become more and more central tocompetition. Universities and schools must not onlyimprove the educational and research capabilities, but mustalso become better connected to the private sector.

The private sector has also become a crucial actor inimproving competitiveness and in setting economic policy.The private sector is not only a consumer of the businessenvironment, but it also can and must play a role in shap-ing it. Individual firms, through steps such as establishingeducational programs, attracting suppliers, or defining stan-dards, not only benefit themselves but also improve theoverall environment for competing. Collective industrybodies, such as trade associations and chambers of com-merce, also have important roles to play in improvinginfrastructure, providing training, and developing exportmarkets that are often overlooked. Collective efforts toenhance the capabilities of individual companies, such asquality certification programs and manufacturing assistance

centers, are becoming more prominent. Engagement ofthe private sector in competitiveness is also important toprovide the continuity of attention necessary to sustainprogress through changes of government and to counter-act the relatively short attention span of political leaders.

Finally, a whole class of institutions, which we termInstitutions for Collaboration (IFCs), play an importantrole in competitiveness though they have been largelyignored in economic development thinking.9 Neithergovernment agencies, educational institutions, nor firms,these organizations—trade associations, entrepreneur net-works, standard-setting agencies, quality centers, technolo-gy networks, and many others—are common.They areespecially prevalent in the most advanced economies, butalso have crucial roles in developing countries. IFCs playan essential role in connecting the parts of the diamondand fostering efficient collective activities in bothadvanced and developing countries.10

The importance of institutions for economic develop-ment has been widely recognized in recent years.Whileinstitutions are important, they are only one of the factorsthat determine competitiveness and, maybe even moreimportantly, the ability of a country to sustain andupgrade competitiveness over time. Institutions are neithera strictly necessary nor a sufficient factor for competitive-ness.This view, consistent with the conceptual frameworkoutlined here, has recently been supported by new empir-ical analyses.11 Institutions are often used in a very widesense, incorporating a broad set of organizations, rules, andbehavioral patterns in many different parts of the econo-my and society.This way the term becomes too wide tobe a useful guide for policy. It has encouraged a focus onlarge public institutions, while the role of private and pub-lic-private institutions such as IFCs is much less wellunderstood.

The relationship between macroeconomic and microeconomic policyOur analysis makes it clear why the traditional focus onmacroeconomic stabilization and market opening is insuf-ficient. Macroeconomic policies fostering high rates ofcapital investment, for example, will not translate into rising productivity unless the forms of investment areappropriate, the company skills and supporting industriesare present to make the investments efficient, and strongcompetitive pressures and adequate corporate governanceprovide the needed market discipline. Sound monetaryand fiscal policies and the removal of distortions inexchange rates and other prices will eliminate impedi-ments to productivity, but microeconomic foundationsmust be in place if productivity is actually to increase.

Appropriate levels of foreign debt depend on micro-economic circumstances.The prudence of foreign debtlevels depends on exactly where the foreign capital is

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invested, together with the microeconomic fundamentalssurrounding its deployment and governance. Regulatingoverall debt levels is less important, in many ways, thanimproving the microeconomic foundations.

High rates of public investment in human capital willnot pay off unless a nation’s microeconomic circumstancescreate the demand for skills in companies. Privatizationwill not boost prosperity unless companies can improveefficiency and are pressured by local competition. Forsound policies at the macroeconomic level to translateinto an increasingly productive economy, then, parallelmicroeconomic improvements must take place.

The effects of trade agreements and other marketopening measures, a major focus in today’s internationaleconomic policymaking, also depends on microeconomicpolicies. Market opening is good, but its benefits in termsof prosperity depend on microeconomic progress. If thelocal business environment does not become more effi-cient and local companies do not improve their productiv-ity and sophistication, market opening will boost importsbut growth in exports and the attraction of foreign invest-ment will be painfully slow. Improvement in the micro-economic business environment begins before marketopening measures are complete.

A greater focus on microeconomic reforms will payanother essential dividend.While macro reforms almostinevitability inflict hardship in the short and medium runthrough raising interest rates and prices while cutting pub-lic expenditures, micro reforms can produce tangible andvisible benefits for citizens. Breaking up local cartels andmonopolies, for example, lowers the cost of food, housing,electricity, telephone service, and other costs of living.Regulatory reform can rapidly begin to ease inefficiencies,reduce pollution, improve product quality, and end unsafepractices. Bold steps to improve the quality of educationand training are particularly important, because they offerthe hope of a better life for children. If citizens see busi-nesses reforming themselves and having to confront toughcompetitive challenges, they themselves will be more will-ing to live with personal sacrifices and less likely to sidewith anti-reform interest groups.The political will andpublic support to make real economic change is elevated.

Ranking competitiveness

Measures of competitivenessThe Business Competitiveness Index (BCI) is constructedfrom measures drawn primarily from the survey of 8,695senior business leaders in 103 countries.12 Compared withlast year five countries were added (Bahrain, Bosnia-Hercegovina, Cyprus, Georgia, and the United ArabEmirates) but three countries (Cameroon, Haiti, Senegal)

had to be dropped.We are working with our partners inthese countries to reenter them next year.

Measuring competitiveness is challenging because ofthe sheer number and variety of influences that shapenational productivity. Only through a detailed survey cantextured measures of the competitive environment andcompany practices be assembled across many countries.The Survey questions aim to capture the circumstances ina nation, but they do so in way that is meaningful forSurvey respondents. For example, we get at the stock ofbasic human capital with a question on the quality ofpublic schools because this is something that respondentscan compare more readily across countries.The quality ofschools, a flow measure, will be highly correlated with thestock of basic skills.

The World Bank has recently started a new effort tosystematically collect comparable data on regulatory con-ditions, an important element of the microeconomicfoundations for competitiveness, across a wide number ofcountries.13 In three of the areas covered by the WorldBank effort—the administrative procedures of starting abusiness, the availability of effective credit registers toenable loans to businesses, and the organization of bank-ruptcy procedures—our Survey contains questions thatcover related aspects.The analysis reveals low levels of cor-relation between our data (assessments of the overall effec-tiveness of procedures made by business leaders) and theWorld Bank data (quantifications of specific aspects ofprocedures made by technical specialists).These differencescould indicate that the technical dimensions measured inthe World Bank effort (e.g., number of steps needed toregister a new business) give a skewed description of thereal impact these regulations have on business.They couldalso be a sign of weaknesses in the Survey data, related tomisinformed respondents or other reasons. More researchwill be necessary to evaluate the relative advantages ofboth types of data.

Quantitative measures are utilized for patenting rates,Internet penetration, and cellular phone penetration. Forall of the other dimensions we measure, however, quantita-tive data are simply unavailable, especially for so manycountries.The Survey not only offers many unique meas-ures, but also captures the informed judgments of thou-sands of actual participants in the economies examined.The Survey responses are important in their own right,because they reflect the attitudes of the decision makersthat ultimately determine economic activity.

As with last year, we examined the consistency of theSurvey data to ensure that the sample used for statisticalestimation is as valid as possible and to identify particularcountries whose rankings may be less reliable. For eachSurvey question we compared the standard deviation ofanswers within a country with the standard deviation of

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answers across all countries.This is a weak statistical testthat the vast majority of countries easily meet. In thosecountries with high within-country variance of responseson many survey questions, however, it is hard to interpretthe country averages, independently of the possible reasonsfor the variances.14 In addition to examining all responsesfor each country, we further analyzed within-countryconsensus in the subset of responses from executives fromforeign companies operating in the country.We expectthese respondents to have the best perspective on how thecountry compared to others.

Of the 103 countries surveyed this year, the 93 coun-tries shown in Table 1 passed our data consistency test,15

of at least 50 Survey questions out of the 67 with a lowerwithin-country variance than cross-country variance.Countries that have more heterogeneous responses in thesample include some low-income countries only added tothe survey process last year (for example Gambia, Ghana,and Uganda), but also some Arab countries included thisyear for the first time (Bahrain, UAE).

We calculated Index rankings for all 103 countriesshown in Table 2, with those marked with an asterisk sub-ject to concerns about the Survey data.16 Until the relia-bility of Survey responses improves with future education-al efforts and improved sampling in these countries, theirrankings should be interpreted with caution.

For the 93-country sample used in the regressionsand for computing the Index model, there is an average ofmore than 80 respondents per country.The degree ofwithin-country consensus is striking. For all measures, theproportion of variation due to country differences is statis-tically significant. For most measures, between one-thirdand one-half of the overall variation in the responses isdriven by country-specific differences for that measure.Asexpected, the within-country consensus is higher forcross-cutting business environment indicators, such asoverall infrastructure quality, and lower for measures wherethere would be variation within the country across com-panies and clusters, such as state of cluster development.The country averages, then, capture meaningful differencesacross countries in competitive circumstances while limit-ing idiosyncratic biases that would result if there wereonly a handful of responses per country.

The dependent variable used to develop the BCI isthe level of GDP per capita in 2003, adjusted for purchas-ing power parity (PPP). GDP per capita is the broadestmeasure of national productivity and is strongly linkedover time to a nation’s standard of living.17 It is the bestsingle, summary measure of microeconomic competitive-ness available across all countries.18 GDP per capita willreflect a country’s structural fundamentals over the medi-um and long term. However, it is also influenced by awide array of short-term and idiosyncratic factors such as natural disasters, macroeconomic shocks, and price

movements in particular export industries.The proportionof the variation in GDP per capita across all countries that can be explained by microeconomic fundamentals isinteresting in its own right.

To explore differences in the sources of competitive-ness across countries at different levels of development, wedivided countries into three groups based on income.There is no accepted division among low-, middle-, andhigh-income countries, and efforts to define income cut-offs statistically face data limitations. Instead, we proceedpragmatically, dividing countries based on two criteria.First, we use income cutoffs that yield logical divisions ofcountries in terms of aspirations and competitive position.Second, we ensure that there are enough countries in eachgroup to allow meaningful statistical tests. Ideally, the cut-offs are also stable.Applying these criteria, we maintainedthe cutoff points at US$4,000 GDP per capita (PPP) forlow to middle income and US$17,000 GDP per capita(PPP) for middle to high income.

There were 20 low-income countries with a purchas-ing power-adjusted US-dollar GDP per capita in 2003below $4,000; 43 middle-income countries with GDP percapita between $4,000 and $17,000; and 30 high-incomecountries with a GDP per capita above $17,000.As willbe reported, these groups exhibited quite different patternsof influence among variables as we would expect.

Sources of competitivenessTo construct an overall index of competitiveness, we firstvalidated the statistical relationship of each of a wide arrayof measures of microeconomic competitiveness that aresuggested by our conceptual framework with GDP percapita.Variables are drawn from Survey responses andavailable quantitative measures, and are broadly groupedinto those measuring the sophistication of company oper-ations and strategy and those measuring the quality of thenational business environment.A full list of Survey ques-tions and available quantitative measures is given inAppendix A.

Table 3 gives bivariate regressions on GDP per capitathat include those variables that proved to be the most sta-tistically significant. Included in the table is the meanresponse across all countries or groups of countries, theslope of the regression relationship, a measure of the statis-tical significance of the relationship, and the adjusted R2

(or proportion of variation in GDP per capita explainedby the variable, adjusted for statistical degrees offreedom).19 While the bivariate regressions are not meantto represent a fully specified model, they provide a basictest of whether the variables have a meaningful relation-ship with the level of GDP per capita across countries.Allthe reported variables are highly statistically significant inthe full sample of countries.A wide range of company

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Country 2004 2003 2002 2001 2000 1999 1998 2004 2003 2002 2001 2000 1999 1998 2004 2003 2002 2001 2000 1999 1998

United States 1 2 1 2 2 1 1 2 2 1 1 2 1 2 2 2 1 2 2 1 1 37,352Finland 2 1 2 1 1 2 2 7 4 4 2 3 7 8 1 1 2 1 1 2 2 27,252Germany 3 5 4 4 3 6 4 1 1 2 4 1 5 1 5 9 4 4 6 5 8 27,609Sweden 4 3 6 6 7 4 7 5 3 6 6 6 3 4 6 5 8 6 11 7 9 26,656Switzerland 5 7 5 5 5 5 9 4 5 5 5 5 2 3 7 8 6 5 10 9 10 30,186United Kingdom 6 6 3 7 8 10 5 8 8 3 7 11 13 9 4 6 3 8 9 8 5 27,106Denmark 7 4 8 8 6 7 8 9 7 9 9 8 9 10 3 3 9 10 4 6 7 30,588Japan 8 13 11 10 14 14 18 3 6 7 8 4 4 7 11 20 17 16 19 19 19 28,162Netherlands 9 9 7 3 4 3 3 6 10 8 3 7 8 5 9 11 10 3 3 3 4 29,412Singapore 10 8 9 9 9 12 10 13 12 14 15 15 14 12 8 4 5 9 5 12 6 24,480Hong Kong SAR 11 19 19 18 16 21 12 15 22 24 21 23 24 17 10 15 16 17 14 18 11 28,027France 12 10 15 13 15 9 11 10 9 10 10 9 6 6 16 14 21 13 15 11 13 27,327Australia 13 11 14 14 10 13 15 19 18 19 24 20 19 22 12 7 11 7 7 10 12 29,143Belgium 14 15 13 15 12 15 19 11 11 11 12 10 11 13 19 17 15 14 13 15 18 28,396Canada 15 12 10 12 11 8 6 16 14 13 14 16 12 15 13 10 7 11 8 4 3 30,463Austria 16 17 12 11 13 11 16 14 13 12 11 12 10 11 17 18 12 12 12 13 17 29,972Taiwan 17 16 16 21 21 19 20 12 16 16 20 18 17 16 20 16 13 21 21 22 21 24,560New Zealand 18 18 22 20 19 16 17 20 23 25 19 22 16 19 15 13 20 20 17 14 16 21,177Iceland 19 14 17 16 17 22 24 17 15 17 16 14 21 28 18 12 14 15 16 21 23 30,658Norway 20 22 21 19 20 18 14 23 21 23 23 21 23 14 14 21 19 19 18 16 15 37,063Israel 21 20 18 17 18 20 21 18 20 20 18 13 18 21 21 19 18 18 20 20 20 19,678Ireland 22 21 20 22 22 17 13 22 17 15 17 19 20 18 22 22 22 22 22 17 14 29,907Malaysia 23 26 26 37 30 27 27 28 26 27 37 30 25 34 23 24 26 37 30 31 26 9,696Korea 24 23 23 26 27 28 28 21 19 21 26 25 27 24 27 25 23 29 28 30 28 17,908South Africa 25 27 29 25 25 26 25 24 28 31 25 26 28 33 25 28 33 27 25 25 25 10,492Spain 26 25 25 24 23 23 22 25 25 22 22 24 22 23 26 26 25 23 23 23 22 22,264Estonia 27 28 30 28 — — — 33 36 36 32 — — — 24 27 28 26 — — — 13,348Chile 28 32 31 29 26 24 23 32 34 35 30 27 26 25 28 30 31 30 24 24 24 10,206India 29 37 37 36 37 42 44 30 40 40 43 40 48 50 31 36 37 34 37 43 42 2,909Slovenia 30 30 27 32 — — — 27 27 26 28 — — — 32 34 27 35 — — — 19,300Tunisia 31 33 32 — — — — 42 38 37 — — — — 29 29 30 — — — — 7,083Portugal 32 36 36 33 28 29 33 41 46 41 38 35 37 48 30 33 32 28 27 26 30 18,444Italy 33 24 24 23 24 25 26 26 24 18 13 17 15 20 41 23 24 24 26 27 27 27,050Czech Republic 34 35 34 34 34 41 30 31 33 34 41 41 55 31 35 38 34 31 34 36 33 16,448Lithuania 35 40 40 50 — — — 36 41 39 47 — — — 33 41 39 47 — — — 11,250Thailand 36 31 35 38 40 39 37 35 31 33 42 47 43 37 34 32 35 39 40 39 36 7,580Brazil 37 34 33 30 31 35 35 29 30 28 29 29 32 27 42 39 36 32 32 37 39 7,767Slovak Republic 38 43 42 40 36 48 36 40 44 43 57 31 51 40 37 43 40 36 36 47 37 13,469Greece 39 39 43 46 33 36 38 39 39 47 51 32 45 32 40 40 41 43 33 34 38 19,973Hungary 40 38 28 27 32 33 31 47 45 29 33 34 36 39 36 37 29 25 31 33 31 14,572Jordan 41 41 53 47 35 32 32 52 59 59 56 46 44 42 38 35 48 41 35 28 32 4,319Indonesia 42 60 64 55 47 53 51 37 62 55 50 51 47 52 44 61 65 58 47 52 51 3,364Cyprus 43 — — — — — — 56 — — — — — — 39 — — — — — — 19,155Morocco 44 49 48 — — — — 44 49 50 — — — — 43 49 46 — — — — 4,012China 45 46 38 43 44 49 42 38 42 38 39 38 31 35 45 44 38 46 45 50 44 4,995Costa Rica 46 45 39 48 43 38 — 34 32 32 34 39 35 — 48 47 47 51 42 41 — 9,490Latvia 47 29 45 41 — — — 50 29 48 35 — — — 46 31 42 42 — — — 9,981Malta 48 42 — — — — — 57 47 — — — — — 47 42 — — — — — 18,203Namibia 49 55 51 — — — — 60 64 58 — — — — 49 52 49 — — — — 6,375Turkey 50 52 54 35 29 31 29 43 51 56 44 28 33 26 53 55 55 33 29 32 29 6,749Mauritius 51 44 49 51 38 30 — 48 35 42 49 37 29 — 52 46 50 50 38 29 — 11,258Jamaica 52 56 59 39 — — — 51 56 60 31 — — — 51 56 59 44 — — — 4,184Mexico 53 48 55 52 42 34 39 45 37 45 46 42 30 29 54 51 60 52 43 35 41 9,136Romania 54 76 67 61 — — — 58 84 69 63 — — — 55 71 64 60 — — — 7,222Poland 55 47 46 42 41 37 41 46 43 46 55 36 38 38 62 45 45 40 41 38 40 11,623Colombia 56 51 56 57 48 52 49 55 50 51 52 48 40 43 59 54 57 59 48 53 49 6,784Trinidad and Tobago 57 53 44 31 — — — 53 54 44 27 — — — 60 53 44 38 — — — 9,975Panama 58 59 50 49 — — — 63 60 54 40 — — — 56 60 52 49 — — — 6,475Russian Federation 59 66 58 56 52 55 46 59 69 62 54 33 42 45 58 64 56 55 53 55 47 9,195Botswana 60 54 57 — — — — 69 67 64 — — — — 50 50 51 — — — — 8,359Kenya 61 67 — — — — — 54 61 — — — — — 61 72 — — — — — 1,035Ghana 62 63 — — — — — 67 66 — — — — — 57 57 — — — — — 2,234El Salvador 63 64 63 64 51 47 — 62 58 61 66 57 46 — 63 65 62 64 50 48 —— 4,994Sri Lanka 64 57 47 58 — — — 66 52 52 58 — — — 64 59 43 56 — — — 3,776Ukraine 65 73 69 59 56 56 52 61 72 66 62 52 50 51 66 77 69 57 56 56 52 5,472Philippines 66 65 61 53 46 44 45 49 48 49 45 43 34 41 71 74 67 54 46 46 45 4,321Croatia 67 62 52 — — — — 68 65 53 — — — — 65 58 54 — — — — 11,139Pakistan 68 75 — — — — — 64 81 — — — — — 69 70 — — — — — 1,971Argentina 69 69 65 54 45 40 34 65 63 57 53 45 39 30 72 73 68 53 44 40 34 11,586Bulgaria 70 77 68 68 55 54 — 79 85 72 70 54 52 — 67 75 63 65 54 54 — 7,807

(cont’d)

BCI rankingCompany operations and strategy ranking

Quality of the national business environment ranking

2003 GDP per capita

(PPP-adjusted)*

Table 1: The Business Competitiveness Index, sample of 93 countries

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Country 2004 2003 2002 2001 2000 1999 1998 2004 2003 2002 2001 2000 1999 1998 2004 2003 2002 2001 2000 1999 1998

Peru 71 81 66 63 49 46 47 71 83 65 65 53 56 49 68 78 66 63 51 44 46 5,267Uruguay 72 71 62 45 — — — 74 77 63 48 — — — 70 68 61 45 — — — 8,280Vietnam 73 50 60 62 53 50 43 75 53 67 64 50 41 36 73 48 58 62 52 49 43 2,490Dominican Republic 74 61 41 60 — — — 70 57 30 59 — — — 76 63 53 61 — — — 6,703Zimbabwe 75 78 70 65 50 45 48 73 70 68 60 56 54 46 77 81 70 67 49 45 48 1,892Macedonia, FYR 76 82 — — — — — 78 79 — — — — — 75 83 — — — — — 6,762Malawi 77 72 — — — — — 77 71 — — — — — 78 76 — — — — — 618Serbia and Montenegro 78 79 — — — — — 80 75 — — — — — 74 79 — — — — — 3,970Guatemala 79 86 73 69 — — — 72 76 70 69 — — — 82 88 73 69 — — — 4,122Madagascar 80 90 — — — — — 81 88 — — — — — 81 90 — — — — — 808Venezuela 81 85 72 67 54 51 50 76 74 73 67 49 53 44 83 87 72 66 55 51 50 4,909Algeria 82 88 — — — — — 86 93 — — — — — 79 86 — — — — — 6,248Tanzania 83 68 — — — — — 85 68 — — — — — 80 67 — — — — — 611Georgia 84 — — — — — — 82 — — — — — — 85 — — — — — — 2,569Bosnia and Hercegovina 85 — — — — — — 88 — — — — — — 84 — — — — — — 6,029Ecuador 86 89 77 72 57 57 — 83 87 74 71 55 57 — 87 92 77 72 58 57 — 3,684Bangladesh 87 91 74 73 — — — 89 91 76 72 — — — 86 91 74 73 — — — 1,786Mozambique 88 93 — — — — — 87 90 — — — — — 90 95 — — — — — 1,133Honduras 89 95 78 74 — — — 84 89 78 74 — — — 92 96 79 75 — — — 2,658Paraguay 90 97 76 70 — — — 90 95 77 68 — — — 88 98 75 71 — — — 4,724Ethiopia 91 96 — — — — — 93 96 — — — — — 89 94 — — — — — 716Nicaragua 92 94 75 71 — — — 92 92 75 73 — — — 91 93 76 70 — — — 2,523Bolivia 93 98 79 75 58 58 — 91 97 79 75 58 58 — 93 97 78 74 57 58 — 2,546

Note: GNI per capita is used for Ireland

BCI rankingCompany operations and strategy ranking

Quality of the national business environment ranking

2003 GDP per capita

(PPP-adjusted)*

Table 1: The Business Competitiveness Index, sample of 93 countries (cont’d.)

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Country

United States 1 2 2 37,352Finland 2 7 1 27,252Germany 3 1 5 27,609Sweden 4 5 6 26,656Switzerland 5 4 7 30,186United Kingdom 6 8 4 27,106Denmark 7 9 3 30,588Japan 8 3 11 28,162Netherlands 9 6 9 29,412Singapore 10 13 8 24,480Hong Kong SAR 11 15 10 28,027France 12 10 16 27,327Australia 13 19 12 29,143Belgium 14 11 19 28,396Canada 15 16 13 30,463Austria 16 14 17 29,972Taiwan 17 12 20 24,560New Zealand 18 20 15 21,177Iceland 19 17 18 30,658Norway 20 23 14 37,063Israel 21 18 21 19,678Ireland 22 22 22 29,907Malaysia 23 28 23 9,696Korea 24 21 28 17,908South Africa 25 24 25 10,492Spain 26 25 27 22,264Estonia 27 34 24 13,348United Arab Emirates* 28 32 26 17,520Chile 29 33 29 10,206India 30 30 32 2,909Slovenia 31 27 33 19,300Tunisia 32 43 30 7,083Portugal 33 42 31 18,444Italy 34 26 43 27,050Czech Republic 35 31 37 16,448Lithuania 36 37 35 11,250Thailand 37 36 36 7,580Brazil 38 29 44 7,767Slovak Republic 39 41 39 13,469Bahrain* 40 53 34 17,789Greece 41 40 42 19,973Hungary 42 48 38 14,572Jordan 43 54 40 4,319Indonesia 44 38 46 3,364Cyprus 45 59 41 19,155Morocco 46 45 45 4,012China 47 39 47 4,995Costa Rica 48 35 50 9,490Latvia 49 51 48 9,981Malta 50 60 49 18,203Namibia 51 63 51 6,375Turkey 52 44 55 6,749Mauritius 53 49 54 11,258Jamaica 54 52 53 4,184Mexico 55 46 56 9,136Romania 56 61 57 7,222Poland 57 47 64 11,623Colombia 58 58 61 6,784Trinidad and Tobago 59 55 62 9,975Panama 60 66 58 6,475Russian Federation 61 62 60 9,195Botswana 62 73 52 8,359Kenya 63 56 63 1,035Ghana 64 71 59 2,234El Salvador 65 65 65 4,994Egypt* 66 57 68 3,950

(cont’d.)

Table 2: The Business Competitiveness Index, full sample of 103 countries

BCI ranking,

2004

Company operations

and strategyranking,

2004

Quality of the national

businessenvironmentranking, 2004

2003GDP per capita (PPP

adjusted)

BCI ranking,

2004

Company operations

and strategyranking,

2004

Quality of the national

businessenvironmentranking, 2004

2003GDP per capita (PPP

adjusted)Country

Gambia* 67 70 66 1,714Sri Lanka 68 69 67 3,776Ukraine 69 64 71 5,472Philippines 70 50 77 4,321Uganda* 71 75 69 1,471Croatia 72 72 70 11,139Pakistan 73 67 75 1,971Argentina 74 68 78 11,586Bulgaria 75 86 72 7,807Peru 76 77 74 5,267Uruguay 77 80 76 8,280Zambia* 78 85 73 883Vietnam 79 81 79 2,490Dominican Republic 80 74 83 6,703Nigeria* 81 76 80 1,024Zimbabwe 82 79 84 1,892Macedonia, FYR 83 84 82 6,762Malawi 84 83 85 618Serbia and Montenegro 85 87 81 3,970Guatemala 86 78 90 4,122Madagascar 87 88 88 808Venezuela 88 82 91 4,909Algeria 89 93 86 6,248Tanzania 90 92 87 611Mali* 91 95 89 994Georgia 92 89 93 2,569Bosnia and Hercegovina 93 96 92 6,029Ecuador 94 90 95 3,684Bangladesh 95 97 94 1,786Mozambique 96 94 98 1,133Honduras 97 91 100 2,658Paraguay 98 98 96 4,724Ethiopia 99 101 97 716Nicaragua 100 100 99 2,523Bolivia 101 99 101 2,546Chad* 102 103 102 1,206Angola* 103 102 103 2,319

Note: GNI per capita is used for Ireland

* Survey data for these countries have high within-country variance. Until the reliability of Survey responses improves with future educational efforts andimproved sampling in these countries, their rankings should be interpreted with caution.

Mean Slope Adj. R 2 Mean Slope Adj. R 2 Mean Slope Adj. R 2 Mean Slope Adj. R 2

I. COMPANY OPERATIONS & STRATEGY

Production process sophistication 3.95 7964.0** 0.805 2.79 657.8* 0.119 3.54 3137.5** 0.216 5.33 4762.4** 0.417Nature of competitive advantage 3.68 7590.5** 0.699 2.83 311.4 –0.032 3.13 531.8 –0.019 5.03 2786.7** 0.219Extent of staff training 3.93 8652.0** 0.687 3.02 321.3 –0.017 3.61 1796.8** 0.078 5.00 4664.3** 0.392Extent of marketing 4.48 8647.8** 0.659 3.46 659.4 0.089 4.26 1437.3* 0.060 5.47 5526.2** 0.425Willingness to delegate authority 3.78 8851.1** 0.667 3.06 365.1 –0.019 3.41 2041.1** 0.079 4.78 4168.4** 0.482Capacity for innovation 3.59 7820.3** 0.685 2.74 630.9 0.080 3.14 3070.5** 0.192 4.80 2725.7** 0.229Company spending on research

and development 3.42 8330.5** 0.584 2.78 310.1 –0.028 3.05 2445.9** 0.104 4.38 2716.8** 0.222Value chain presence 3.95 6678.5** 0.627 2.90 591.9 0.069 3.49 1542.3** 0.086 5.29 1414.1 0.037Breadth of international markets 3.93 6469.1** 0.615 2.89 605.3* 0.097 3.52 1533.3** 0.152 5.22 2380.9** 0.175Degree of customer orientation 4.62 11011.8** 0.672 3.85 58.7 –0.055 4.40 1750.8* 0.048 5.46 6530.2** 0.314Control of international distribution 4.00 11595.8** 0.600 3.37 117.6 –0.052 3.78 285.1 –0.023 4.73 4647.3** 0.195Extent of branding 3.70 7136.5** 0.689 2.66 902.0* 0.150 3.24 1778.0** 0.076 5.05 2290.6** 0.173Reliance on professional management 4.64 8086.5** 0.506 4.06 –104.3 –0.050 4.36 2241.5** 0.170 5.44 3936.1** 0.415Extent of incentive compensation 4.20 8594.5** 0.521 3.49 567.9 0.075 3.97 1902.6** 0.144 4.99 3748.6** 0.183Extent of regional sales 4.68 6752.6** 0.488 3.74 388.7 0.018 4.47 1481.4** 0.145 5.59 2843.0** 0.191Prevalence of foreign technology licensing 4.48 8134.0** 0.380 3.71 –111.3 –0.049 4.41 1604.3** 0.091 5.09 3510.3 0.049

II. NATIONAL BUSINESS ENVIRONMENT

A. FACTOR (INPUT) CONDITIONS1. Physical Infrastructure

Overall infrastructure quality 4.07 6155.9** 0.687 2.64 417.1 –0.008 3.69 1130.4** 0.086 5.55 3168.4** 0.314Railroad infrastructure development 3.23 4507.1** 0.487 2.15 262.2 –0.004 2.75 1174.4** 0.186 4.65 1449.9** 0.152Port infrastructure quality 3.99 5659.2** 0.585 2.71 599.8* 0.152 3.58 496.3 0.001 5.45 2240.0** 0.125Air transport infrastructure quality 4.70 6655.0** 0.532 3.69 67.5 –0.054 4.39 343.5 –0.014 5.82 3936.1** 0.230Quality of electricity supply 4.85 6011.6** 0.668 2.96 924.1** 0.256 4.76 1497.3** 0.162 6.24 4806.2** 0.355Telephone/fax infrastructure quality 5.55 5777.8** 0.445 4.07 264.4 0.027 5.53 547.8 –0.001 6.57 4839.8 0.060Cell phones per 100 people (2003) 42.91 269.4** 0.749 6.51 85.6** 0.378 32.49 111.3** 0.520 82.10 –34.9 –0.026Internet users per 10,000 people (2003) 2006 4.9** 0.805 215 3.7** 0.448 1264 2.0** 0.422 4262 1.9** 0.186

2. Administrative Infrastructure

Reliability of police services 4.31 6360.0** 0.528 3.45 508.3 0.077 3.86 –291.1 –0.017 5.52 4053.0** 0.326Judicial independence 4.08 5434.5** 0.553 2.96 –137.0 –0.038 3.61 949.8** 0.096 5.50 3158.9** 0.210Efficiency of legal framework 3.95 5972.3** 0.559 3.04 –172.6 –0.037 3.47 767.2 0.035 5.25 3336.7** 0.341Administrative burden for startups 3.99 6682.3** 0.348 3.49 335.5 –0.014 3.71 861.9 0.024 4.72 2121.1* 0.085Extent of bureaucratic red tape 5.55 15689.0** 0.260 5.34 1723.7** 0.158 5.50 1894.2 0.025 5.76 10469.4** 0.163

3. Human Resources

Quality of management schools 4.33 7756.5** 0.554 3.39 330.4 0.001 4.14 1255.8* 0.059 5.23 4869.8** 0.466Quality of public schools 3.97 6306.1** 0.702 2.54 821.5** 0.242 3.63 1892.1** 0.377 5.41 4299.2** 0.300Quality of the educational system 3.66 7158.8** 0.595 2.71 197.2 –0.035 3.33 1788.9** 0.196 4.76 3441.8** 0.248Quality of math and science education 4.19 5902.0** 0.387 3.36 466.4* 0.099 3.98 1405.6** 0.208 5.03 1906.4 0.026

4. Technology Infrastructure

Patents per million population (2003) 29.59 116.0** 0.486 0.07 5108.2** 0.179 0.92 1620.5** 0.481 90.35 25.8** 0.133Availability of scientists and engineers 4.73 7334.0** 0.396 4.20 382.4 0.055 4.47 1555.8** 0.129 5.45 4599.3** 0.209Quality of scientific research institutions 4.01 8145.8** 0.563 3.38 –102.3 –0.051 3.67 2721.2** 0.300 4.92 3554.0** 0.297University/industry research collaboration 3.37 8507.5** 0.626 2.58 344.2 –0.027 3.04 1768.9** 0.086 4.37 3409.6** 0.266

5. Capital Markets

Financial market sophistication 4.16 6677.0** 0.613 3.06 518.7 0.065 3.80 779.1 0.023 5.39 3770.4** 0.356Venture capital availability 3.33 8830.8** 0.599 2.68 757.6* 0.101 2.98 2220.4** 0.145 4.26 3172.6** 0.191Ease of access to loans 3.38 8013.9** 0.505 2.68 278.6 –0.024 3.13 1921.6** 0.141 4.22 2799.7** 0.151Local equity market access 4.82 4830.9** 0.302 4.28 33.6 –0.054 4.43 510.0 0.005 5.74 3478.9** 0.154

B. DEMAND CONDITIONSBuyer sophistication 4.02 8122.2** 0.699 3.06 348.3 0.009 3.62 1281.7 0.032 5.22 5352.7** 0.384Sophistication of local buyers’

products and processes 4.55 9298.3** 0.631 3.74 73.6 –0.053 4.26 1456.8* 0.042 5.50 5329.1** 0.240Government procurement of advanced

technology products 3.70 10233.6** 0.360 3.30 –271.0 –0.041 3.55 1010.2 0.006 4.20 3826.5** 0.100Presence of demanding regulatory standards 4.37 8430.4** 0.783 3.21 482.6 –0.005 4.07 3064.7** 0.385 5.58 5440.5** 0.450Laws relating to ICT 3.85 8500.3** 0.604 2.91 350.7 –0.009 3.63 1842.5** 0.135 4.79 4201.1** 0.190Stringency of environmental regulations 4.12 7218.7** 0.719 3.07 348.0 –0.022 3.70 2481.1** 0.331 5.41 3444.9** 0.396

(cont’d.)

All countries (N = 93)

Table 3: Bivariate regression results, dependent variable: 2003 GDP per capita (PPP-adjusted)

Low-income countriesGDP per capita

< $4,000 (N = 20)

Middle-income countriesGDP per capita > $4,000 and < $17,000 (N = 43)

High-income countriesGDP per capita > $17,000except Norway (N = 30)

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Mean Slope Adj. R 2 Mean Slope Adj. R 2 Mean Slope Adj. R 2 Mean Slope Adj. R 2

II. NATIONAL BUSINESS ENVIRONMENT (cont’d.)

C. RELATED AND SUPPORTING INDUSTRIESLocal supplier quality 4.47 9622.4** 0.736 3.46 622.8 0.057 4.25 3086.2** 0.213 5.47 5848.8** 0.414State of cluster development 3.43 7644.9** 0.406 3.07 46.9 –0.054 3.05 68.3 –0.024 4.22 3143.5** 0.199Local availability of process machinery 3.03 6409.1** 0.447 2.17 395.3 0.039 2.81 1005.3* 0.049 3.93 2804.3** 0.233Local availability of specialized research

and training services 4.19 8933.7** 0.696 3.29 631.4 0.042 3.90 2428.4** 0.169 5.20 4385.1** 0.399Extent of collaboration among clusters 3.76 8660.7** 0.549 3.14 35.9 –0.055 3.44 1276.4 0.038 4.63 3652.2** 0.259Local supplier quantity 4.74 10773.7** 0.590 4.00 410.9 0.003 4.60 2463.0** 0.109 5.45 6160.6** 0.337Local availability of components and parts 3.34 6495.8** 0.443 2.43 411.8 0.061 3.15 1256.0** 0.089 4.21 2603.1** 0.150

D. CONTEXT FOR FIRM STRATEGY AND RIVALRY1. Incentives

Favoritism in decisions of government officials 3.40 7483.1** 0.468 2.84 –324.1 –0.019 3.04 512.5 –0.010 4.30 3157.9** 0.213Cooperation in labor–employer relations 4.51 7898.2** 0.315 3.99 –133.8 –0.053 4.42 1074.7 0.010 5.00 2813.9** 0.198Efficacy of corporate boards 4.56 11290.8** 0.412 4.19 –530.8 0.011 4.40 2258.3* 0.066 5.03 5137.8** 0.302Intellectual property protection 3.93 6980.6** 0.731 2.79 –72.9 –0.054 3.45 1105.4* 0.051 5.37 4691.1** 0.505Protection of minority shareholders’ interests 4.51 7361.0** 0.412 4.06 –538.7 0.060 4.14 332.4 –0.018 5.34 3323.9** 0.186Regulation of securities exchanges 4.90 7812.6** 0.447 4.26 132.3 –0.047 4.64 799.7 0.012 5.69 4396.4** 0.213Effectiveness of bankruptcy law 4.52 7467.1** 0.632 3.58 –452.1 0.022 4.15 977.8 0.030 5.66 4406.5** 0.456

2. Competition

Hidden trade barrier liberalization 4.57 8493.7** 0.609 3.85 475.4 0.007 4.20 2007.7** 0.179 5.60 2368.8 0.034Intensity of local competition 4.82 10911.6** 0.466 4.24 230.0 –0.038 4.68 1636.6 0.039 5.41 3948.2 0.055Extent of locally based competitors 4.31 8307.5** 0.326 3.72 639.0* 0.120 4.23 1025.6 0.018 4.80 4058.3** 0.137Effectiveness of anti–trust policy 4.05 8375.0** 0.651 3.18 –108.8 –0.052 3.68 969.4 0.017 5.16 4514.9** 0.238Decentralization of corporate activity 3.92 8276.9** 0.558 3.28 156.3 –0.045 3.58 1318.7 0.035 4.85 3615.9** 0.288Business costs of corruption 4.79 7899.0** 0.632 3.98 –94.1 –0.054 4.35 916.2 0.021 5.95 3618.9** 0.179Tariff liberalization 5.95 13230.5** 0.603 5.38 1455.0** 0.305 5.78 2734.2** 0.154 6.59 5426.7 0.003Centralization of economic policy–making 3.00 6481.9** 0.279 2.66 350.8 –0.008 2.79 2038.3** 0.167 3.53 2354.4** 0.169Prevalence of mergers and acquisitions 3.98 9701.4** 0.515 3.35 285.0 –0.043 3.80 1577.2* 0.048 4.66 3785.1** 0.266Foreign ownership restrictions 5.03 6966.5** 0.220 4.65 –456.7 0.025 4.93 1847.0** 0.121 5.43 2463.0* 0.069

Note: * denotes p < 0.10, ** denotes p < 0.05

All countries (N = 93)

Table 3: Bivariate regression results, dependent variable: 2003 GDP per capita (PPP-adjusted) (cont’d.)

Low-income countriesGDP per capita

< $4,000 (N = 20)

Middle-income countriesGDP per capita > $4,000 and < $17,000 (N = 43)

High-income countriesGDP per capita > $17,000except Norway (N = 30)

practices and multiple dimensions of the business environ-ment prove strongly related to competitiveness.Thesefindings are highly consistent with results from earlierGlobal Competitiveness Reports.While a bilateral statisticalcorrelation to GDP per capita does not necessarily implycausation, it does refute the hypothesis that microeconom-ic variables have no important relation to prosperity.Interestingly, prominent macroeconomic variables such asthe national savings rate and the level of investment as apercentage of GDP are either not significantly related tothe level of GDP per capita in bilateral regressions or asso-ciated with only a minor share of its variation acrosscountries.20

Among the company variables, production processsophistication, the nature of competitive advantage, theextent of staff training, the extent of branding, the capacityfor innovation, and the degree of customer orientationhave the strongest bilateral association with per capitaGDP. By itself, the nature of companies’ competitiveadvantage—whether competitive advantage is based on

cheap inputs versus unique products and processes—explains a remarkable 71 percent of the variance in GDPper capita.

All four parts of the business environment proveimportant, with the influences of individual variables quitestable from previous years.Among factor conditions,telecommunication access (cell phone and Internet use),the quality of public schools, overall infrastructure quality,the quality of public schools, the quality of electricity sup-ply, university-industry research collaboration, financialmarket sophistication, and the efficiency of the legalframework have the strongest bilateral association withGDP per capita. Many of the most important influenceson GDP per capita relate to policies and institutions ratherthan fact stocks.

Measures of local demand conditions perform partic-ularly strongly.The presence of demanding regulatorystandards, stringent environmental regulations, and buyersophistication, among other measures, are strongly associat-ed with the variation in GDP per capita.These results run

counter to the perceived wisdom that local demand andlocal market conditions are not important in a globaleconomy.

Cluster linkages, especially the quality of local suppli-ers and the presence of specialized local research andtraining providers, also prove significant and highlight therole of clusters in competitiveness. Finally, the incentivesand rules governing local competition show a strong rela-tionship to national productivity. Intellectual property pro-tection, the effectiveness of antitrust policy, the prevalenceof illegal or unfair activities (corruption), the effectivenessof bankruptcy laws, and the openness to trade tariff andnon-tariff barriers are particularly potent variables.Theintensity of local competition is strongly and positivelyrelated to GDP per capita, alone explaining 47 percent ofvariations across countries in GDP per capita.The stronginfluence of local competition, supported in other recentstudies,21 is contrary to arguments made about the need tocurb local competition in favor of creating national cham-pions.This failed policy has recently resurfaced in France.

It is important to acknowledge that causality can beargued in both directions for some of the variables,though the Survey questions were worded to avoid spuri-ous reverse causality.The quality of scientists and engineersor the sophistication of buyers, for example, could be part-ly the result of high per capita GDP and not the cause.Note that the same causality issue applies to macroeco-nomic and economic growth analyses.We provide someevidence of causality from microeconomic conditions toGDP per capita later in this chapter, but more years ofsurveying will be required to establish definitive cause andeffect relationships.

Competitiveness and economic developmentAs has been discussed, the appropriate company strategiesand operating practices, as well as the influence of particu-lar elements of the business environment, will differ forcountries at different levels of development.As noted ear-lier, the transition to entirely different stages of competi-tive development is particularly challenging.

To examine these issues, we explored the impact ofmeasures of microeconomic competitiveness in the threecountry groups based on per capita GDP.Although thereported variables are statistically significant across theentire sample and strongly distinguish countries acrossgroups, individual variables, as expected, differ in theirinfluence within groups. Some variables will not yet beimportant for low-income countries. Others may act via athreshold that a country must reach, but no longer explainincome beyond this level.

The right-hand side of Table 3 presents income subgroups’ regressions.We explore the differences acrossincome groups in the mean Survey response and the

differences in slope as well as the pattern of statistical sig-nificance of each variable with the caveat that limitationson subgroup sample size and the more limited variation ofthe dependent variable within versus across subgroupsreduce statistical power.

It is notable that, for all variables, the mean Surveyresponse increases as we compare low- and high-incomecountries.This confirms the fact that economic develop-ment is associated with improvement across many aspectsof the business environment and company behavior.However, we find distinctive differences across incomegroups in the relative importance and trajectory ofimprovements of particular aspects of the process of development.

Low-income countriesFor low-income countries at the Factor-Driven stage ofdevelopment, the ability to move beyond competing solelyon cheap labor/natural resources is the essential challengeemerging from the regressions. It is revealing that for low-income countries none of the variables describing thesophistication of companies is significantly related to GDPper capita.With huge challenges in their surroundingbusiness environment, companies find it hard to reap thebenefits of more advanced operating practices.

Low-income countries score low on most measuresof the business environment, but especially on infrastruc-ture, educational quality, cluster development, capitalaccess, and measures related to technology and innovation.Priorities for improving the business environment in low-income countries revealed in the regressions begin withupgrading the quality of infrastructure (including electrici-ty, communications, and transportation networks) andschools.Another priority is the opening of competition(reducing trade barriers and increasing the number oflocal competitors).These steps create a foundation of effi-ciency and competitive pressure that supports more pro-ductive Factor-Driven competition. Other aspects of thebusiness environment, such as expanding the availability ofscientists and engineers and updating regulatory standards,are not yet priorities at this stage of development.

Middle-income countriesMoving into middle income, the task is to move beyondFactor-Driven competition to the Investment-Drivenstage.Their biggest challenge remains the nature of theirlocal competitive advantages, often still based solely onlow-cost production inputs. Other reported weaknessesconsistent with this underlying challenge are a lack ofbranding, a narrow position in the value chain, low pro-duction process sophistication, and limited innovativeactivities.

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The regressions suggest the following patterns:improving production process sophistication is the singlemost important corporate priority. But companies mustalso begin to increase the professionalism of management,create the capacity for technology absorption and intro-duction, and overcome their dependence on exports to afew, often distant, advanced foreign markets.

Middle-income countries score low on many aspectsof the business environment, but especially on infrastruc-ture, the legal and regulatory efficiency and transparency(including corruption), educational quality, cluster devel-opment, and measures related to technology and innova-tion.The regressions reveal that there is a high payoff tocontinued progress in a number of areas, especially publicschools, telecommunication quality, and Internet usage.Success as a middle-income country also raises new chal-lenges in the business environment. Improving university-industry research collaboration and the quality of researchinstitutions becomes an important differentiator of success,as does the quality of the judicial system. Improving localdemand conditions, for example through more stringentenvironmental and consumer protection laws, is needed topressure improvements in producer quality.All aspects ofcluster development become significant in differentiatingmore successful from less successful countries, especiallywidening the supplier base and improving the availabilityof specialized research and training institutions. Finally,moving to higher levels of competition and rivalry isimportant across many dimensions, including liberalizingtariff and non-tariff barriers, improving antitrust policy,and opening the market for corporate control.

High-income countriesHigh-income countries report more advanced companypractices across the board.The difference is highest interms of the nature of firm competitive advantage.Thegap in terms of management professionalism and customerorientation is smaller.

To succeed in a high-income economy, assimilatingimprovements in quality and efficiency are no longerenough.The hurdle is to move to the Innovation-Drivenstage.The regressions suggest that overcoming this hurdleis not only a matter of more R&D spending. It is alsotightly connected to the ability to transform technologicaladvances into attractive new products and services, usingflexible work organizations and the delegation of authori-ty combined with marketing and advanced productionprocesses.

High-income countries have all achieved strength inmany aspects of the business environment. Continuing toimprove infrastructure, simplicity and fairness of regula-tion, and schools remain important in distinguishing themore successful high-income countries. Other distinguish-ing factors include deep cluster development, especially

the improvement of local supplier quality and the accessto local providers of specialized research services.The regulatory environment, including the protection of intel-lectual property rights and effective bankruptcy laws, isalso important. Other distinguishing factors include thequality of management education, the sophistication ofdemand conditions (e.g., demanding regulatory standards,local buyer sophistication), the extent of decentralizationof corporate activity away from large business groups, andthe sophistication of the local financial market.

Trends in competitiveness in the global economyWith several years of consistent Survey data, we can exam-ine trends in the variables that offset competitivenessbetween 1998 and 2004.22 Table 4 identifies those vari-ables where substantial changes in company practices andthe quality of the business environment, defined aschanges greater than 10 percent positive or negative in themean Survey responses between 1998 and 2004, were reg-istered in eight more countries, or 15 percent of the sam-ple of 51 countries for which we have seven years of data.Other metrics (fixed absolute changes or different per-centage cutoffs) produce virtually identical results.

Overall, there is clear upgrading in national businessenvironments in the global economy.The bar is rising, andimprovement in the business environment is needed justto maintain position vis-à-vis other countries. In companyoperations and strategy, the average company is, in manycountries, progressing its sophistication along some dimen-sions, but there are also signs that the growing intensity ofcompetition is making it hard to keep up and that greatestinternational specialization of activity is occurring.

As shown in Table 4, professionalism of managementis rising in increasingly competitive markets, the singlemost widespread global development among companies.Also widespread are improvements in marketing and cus-tomer orientation plus moves to regionalize sales asregional trade opening continues. Companies from mid-dle-income economies have made strides in raising thesophistication of their competitive advantage. Companiesfrom high-income economies are becoming more globalthrough increasing the breath of international marketsthey serve.

Although companies are improving in some respects,however, they are struggling to cope with tough interna-tional competition. Especially in middle-income countries,companies report less presence in the value chain, accom-panied most likely by greater international specializationof activities. Companies in middle-income countries alsoare having difficulty defending brands and maintainingglobal market presence. Even in a significant minority of advanced economies, companies find it hard to keepcontrol of international distribution. Overall, these

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observations are consistent with a global marketplace thathas, in many ways, become more sophisticated and moredemanding, especially for companies that are trying tomove away from dependence on cheap inputs.

In the business environment,Table 4 shows that governments around the world are continuing to reducebureaucratic red tape, lower tariffs, improve corporate governance, upgrade financial markets, and improve infrastructure. Progress in these areas is increasinglybecoming a given if a country is to participate fully in theworld economy. For middle-income countries, improve-ments in their scientific research institutions, air transportand telecommunication infrastructure, the quality of localsuppliers, and effective police services are notable. Manyhigh-income countries have put renewed emphasis ontheir public schools and diminishing favoritism in providing public services.

While there is much progress, however, many coun-tries, especially middle-income countries, are also strug-gling to sustain the quality of their business environments.

The quality of the legal institutions and of the educationalsystem seems especially hard to defend.

Overall, we find that the gap between country groupsseems to be increasing; an observation we made in previousyears.While many countries have improved many elementsof their business environments, high-income countrieshave been able to improve more than middle-incomecountries and more than low-income countries, based onthe mean responses across all Survey questions (see Table5).This pattern raises concerns about the ability of devel-oping economies to catch up to more prosperous nations.

Ranking competitivenessTo derive an overall Business Competitiveness Index(BCI), we compute subindexes measuring the sophistica-tion of company operations and strategy and the quality ofthe national business environment. Because many of thedimensions of company sophistication and the quality ofthe business environment tend to move together, andbecause the sample of countries is relatively small and the

Table 4: Significant changes in competitive conditions in eight or more countries, 1998–2004

Sophistication of CompanyOperations and Strategy

Quality of the BusinessEnvironment

Improving international competitive conditionsNo. of countries

Total L M H51 4 20 27

Reliance on professional management...................39 3 15 21Extent of marketing .....................................................28 2 10 16Degree of customer orientation................................24 2 10 12Extent of regional sales..............................................21 2 10 9Nature of competitive advantage.............................13 2 8 3Extent of staff training ................................................13 2 3 8Prevalence of foreign technology licensing.............8 — 4 4Breadth of international markets................................8 — — 8

Extent of bureaucratic red tape................................48 4 20 24Tariff liberalization.......................................................38 4 17 17Efficacy of corporate boards.....................................36 4 14 18Financial market sophistication ................................34 4 15 15Overall infrastructure quality ....................................30 2 10 18Railroad infrastructure development .......................25 2 9 14Extent of locally based competitors.........................23 2 7 14Quality of management schools ...............................22 1 9 12Quality of scientific research institutions ...............21 3 13 5Favoritism in decisions of government officials ....21 2 6 13Air transport infrastructure quality ..........................21 2 13 6Port infrastructure quality..........................................19 2 6 11Local supplier quality..................................................18 3 11 4Reliability of police services......................................16 1 11 4Quality of public schools............................................16 1 2 13Local equity market access.......................................15 3 4 8Presence of demanding regulatory standards ......15 3 8 4Venture capital availability ........................................14 2 6 6Telephone/fax infrastructure quality........................12 1 10 1Hidden trade barrier liberalization ...........................11 2 4 5Effectiveness of anti-trust policy..............................10 2 3 5

Worsening international competitive conditionsNo. of countries

Total L M H51 4 20 27

Value chain presence.................................................26 3 17 6Extent of branding .......................................................24 2 15 7Breadth of international markets..............................23 2 15 6Capacity for innovation ..............................................13 2 7 4Prevalence of foreign technology licensing...........12 2 6 4Production process sophistication ..........................11 2 8 1Control of international distribution .........................11 1 2 8

Efficiency of legal framework ...................................22 2 12 8Quality of public schools............................................19 3 12 4Venture capital availability ........................................19 2 12 5Judicial independence ...............................................18 2 8 8Administrative burden for startups ..........................18 1 12 5Buyer sophistication ...................................................15 1 8 6University/industry research collaboration ............14 2 6 6Intellectual property protection ................................14 2 10 2Favoritism in decisions of government officials ....12 1 8 3Hidden trade barrier liberalization .............................8 — 6 2

Notes: L, M, and H refer to low-, middle-, and high-income countries, respectively.Significant change is defined as 10 percent or more change in country average score over the six- year period from the score of year 1998.

number of relevant variables is high, the impact of individ-ual variables is difficult to distinguish statistically.

The weighted average of the two subindexes isdefined as the BCI.The weights are determined from thecoefficients of a multiple regression of the subindexes onGDP per capita, using pooled data from 2002 to 2004 tosmooth year-to-year variations.This procedure results in aweight of 0.7 for national business environment and 0.3for company operations and strategy, similar to last year.When we include an interaction term in the regression on GDP per capita of the two subindexes, it proves to bepositive and significant.This means that the benefits of abetter business environment for prosperity are increasingwith the sophistication of company operations and strate-gy, and vice versa. Countries that improve both the busi-ness environment and company sophistication in tandemreap disproportionate benefits, while countries wherethere is an imbalance bear disproportionate costs.

Figure 6 plots BCI against 2003 GDP per capitaadjusted for purchasing power parity for each country inthe sample of 93 countries used in building the model.The regression line is shown, together with bands aboveand below the regression line that delineate the 95 percentconfidence forecast region.23 Only three countries,Norway, India, and Italy fall outside the forecast region.Differences in BCI account for a remarkable 80 percent of thevariation in GDP per capita across a widely disparate group ofcountries.

In the regression we allow for a non-linear relation-ship between the BCI and GDP per capita.The best fit isthe polynomial form, indicating a higher impact on GDPper capita of improvements in BCI for higher-incomeversus lower-income countries.This finding has a numberof possible interpretations: First, we would expectimprovements in microeconomic conditions to have posi-tive spill-overs, that is, an improvement in one part of thebusiness environment has more impact if other parts ofthe business environment are stronger.This interpretationis consistent with the positive interaction between compa-ny sophistication and the business environment previouslyreported. Second, lower-income countries may reap fewerproductivity benefits from microeconomic improvementsdue to weaknesses in macroeconomic, political, legal, andsocial conditions.

We use the model along with data for each countryto calculate a BCI for each country.The overall BCI rank-ings for 2004 for the 93 countries that were used for thestatistical analysis are shown in Table 1, along with therankings for the previous four years where available.Alsoincluded are the separate subindex rankings.The rankingsfor all 103 surveyed countries are shown in Table 2.24

Because changes in the ranking can result from very smalldifferences in the absolute value of the BCI score, we alsograph the relation between rank and BCI score in Figure

7. BCI scores change smoothly with ranks for most partsof the ranking. However, in some ranges—such as thosebetween rank 25 and 20 at the transition between middle-and high-income countries—the gaps in BCI scorebecome larger.We also include a new Table 5 that givesmore detailed information on the changes of BCI scoreby country.

Please refer to the Country Profiles section of theReport for detailed descriptions of the competitive advan-tages and disadvantages of each country. As noted earlier,competitiveness is not a zero-sum game. Many countriescan improve productivity and prosperity. BCI tracks boththe absolute and relative progress of countries in buildinga productive economy.

The United States has retaken the leading positionfrom Finland, after dropping to second place last year.TheUnited States benefited from improvements in the sophis-tication of marketing, the availability of venture capital, theintensity of local competition, local supplier quality, andlocal supplier quantity; in these areas the United States wasseen to have improved while its peers either improvedmuch less (local supplier quantity) or registered worseningconditions. Other advanced nations improving their rank-ings include Hong Kong SAR (reflecting more sophisti-cated financial markets and improvements in managementpractices), Japan (improving financial market sophistica-tion; improving quality of administrative services), andPortugal (improving cluster strength). Japan registered thehighest absolute improvement of its BCI score, followedby Hong Kong and Norway.

Advanced countries dropping in the rankings includeItaly, Malta, and Iceland. Italy dropped by a disappointingnine ranks,25 almost entirely driven by a deterioratingbusiness environment that is now evaluated on par withPortugal and the Czech Republic, with 32 percent and 39percent lower GDP per capitas. Italy deteriorated especial-ly in areas related to innovative capacity, such as universi-ty-industry research collaboration, foreign technologylicensing, government procurement of advanced technolo-gy, company R&D spending, and venture capital availabili-ty.Advanced countries that registered large absolutereductions in their BCI score despite relatively stable ranksinclude Spain, Korea, Singapore, and Finland.

Middle-income nations improving their competitive-ness ranking this year include Romania, Peru, Lithuania,the Slovak Republic, Russia, Namibia, and the Ukraine.Romania jumped by a remarkable 22 ranks, driven bystrong across-the-board improvements, especially in thearea of company sophistication.Whether this large jump isa temporary event reflecting positive near-term sentimentor a sustainable improvement will become evident in sub-sequent years. Romania’s improvement comes after repeat-ed slippage in the ranking since the country became partof the GCR in 2001.

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Table 5: Decomposition of rank changes

Change of Number of indicators* BCI score change of Change of Income group

Country BCI rank BCI score advancing declining Top 5 Bottom 5 COS score NBE score

High income na –0.016 20 51 0.010 –0.008 –0.003 –0.013 3Middle income na –0.070 8 63 0.003 –0.012 –0.015 –0.055 2Low income na –0.081 11 60 0.007 –0.021 –0.026 –0.054 1

Indonesia 16 0.403 66 5 0.077 –0.013 0.133 0.271 1Japan 5 0.338 59 12 0.067 –0.020 0.054 0.284 3Romania 20 0.307 51 20 0.086 –0.034 0.142 0.164 2Hong Kong SAR 8 0.264 58 13 0.075 –0.023 0.093 0.170 3Norway 2 0.231 50 21 0.075 –0.065 –0.025 0.256 3Madagascar 3 0.216 49 22 0.069 –0.023 0.051 0.165 1Morocco 3 0.145 45 26 0.058 –0.050 0.028 0.117 2India 7 0.133 42 29 0.054 –0.025 0.077 0.056 1Germany 2 0.131 50 21 0.050 –0.030 0.042 0.089 3Netherlands 0 0.128 51 20 0.029 –0.016 0.047 0.080 3Kenya 4 0.112 38 33 0.067 –0.029 0.008 0.104 1Austria 1 0.111 47 24 0.051 –0.031 0.021 0.089 3Switzerland 2 0.098 36 35 0.059 –0.018 0.047 0.050 3Russian Federation 5 0.096 41 30 0.050 –0.041 0.054 0.041 2Ukraine 4 0.096 42 29 0.064 –0.057 0.061 0.035 2Belgium 1 0.083 40 31 0.060 –0.031 0.023 0.060 3Paraguay –1 0.076 37 34 0.058 –0.035 0.000 0.076 2United Kingdom 0 0.074 44 27 0.045 –0.028 –0.002 0.075 3Algeria –1 0.068 39 32 0.061 –0.040 0.032 0.036 2Taiwan –1 0.068 40 31 0.043 –0.019 0.048 0.020 3Lithuania 4 0.066 43 28 0.037 –0.029 0.031 0.035 2Slovak Republic 4 0.063 42 29 0.053 –0.042 0.017 0.045 2South Africa 2 0.047 40 31 0.043 –0.030 0.043 0.004 2New Zealand 0 0.044 40 31 0.040 –0.026 0.025 0.019 3Estonia 1 0.041 41 30 0.042 –0.039 0.026 0.015 2Namibia 4 0.036 37 34 0.073 –0.064 –0.005 0.041 2Portugal 3 0.028 39 32 0.042 –0.050 0.015 0.013 3Peru 5 0.013 34 37 0.046 –0.043 0.027 –0.015 2United States 1 0.006 37 34 0.043 –0.030 0.006 0.000 3Turkey 0 0.006 32 39 0.061 –0.042 0.026 –0.021 2Jamaica 2 0.004 34 37 0.052 –0.041 0.005 –0.001 2Bolivia –3 0.001 33 38 0.038 –0.031 0.025 –0.025 1Pakistan 2 –0.001 30 41 0.140 –0.115 0.101 –0.102 1Mozambique –3 –0.005 36 35 0.049 –0.045 –0.014 0.008 1Malaysia 3 –0.006 35 36 0.068 –0.067 –0.042 0.037 2Chile 3 –0.013 33 38 0.043 –0.055 0.001 –0.015 2France –2 –0.014 33 38 0.035 –0.026 –0.008 –0.007 3Bulgaria 2 –0.015 31 40 0.036 –0.034 –0.006 –0.009 2Ethiopia –3 –0.017 32 39 0.043 –0.054 –0.032 0.015 1Guatemala 0 –0.022 30 41 0.067 –0.047 –0.002 –0.020 2China –1 –0.023 31 40 0.036 –0.041 0.007 –0.030 2Panama –1 –0.029 34 37 0.029 –0.048 –0.040 0.011 2Honduras –2 –0.030 32 39 0.034 –0.043 0.004 –0.034 1Ireland –1 –0.034 37 34 0.037 –0.056 –0.038 0.004 3Canada –3 –0.040 27 44 0.045 –0.040 –0.010 –0.030 3Denmark –3 –0.042 34 37 0.034 –0.053 –0.043 0.001 3Czech Republic 0 –0.043 36 35 0.040 –0.052 0.017 –0.060 2Sweden –1 –0.046 32 39 0.041 –0.054 –0.012 –0.034 3Iceland –5 –0.047 32 39 0.037 –0.054 –0.018 –0.029 3Australia –2 –0.059 27 44 0.053 –0.046 0.006 –0.065 3Slovenia –1 –0.062 29 42 0.034 –0.033 –0.006 –0.055 3Greece –2 –0.062 29 42 0.024 –0.036 –0.022 –0.040 3El Salvador –1 –0.063 30 41 0.031 –0.056 –0.044 –0.019 2Costa Rica –3 –0.066 30 41 0.039 –0.062 –0.029 –0.037 2Israel –1 –0.066 31 40 0.057 –0.060 0.039 –0.106 3Brazil –4 –0.085 29 42 0.036 –0.052 –0.007 –0.078 2Bangladesh –4 –0.093 24 47 0.027 –0.037 –0.039 –0.054 1Tunisia 1 –0.099 28 43 0.031 –0.054 –0.040 –0.059 2Hungary –4 –0.100 22 49 0.025 –0.036 –0.034 –0.066 2Ecuador –5 –0.103 16 55 0.032 –0.028 –0.034 –0.069 1Finland –1 –0.105 21 50 0.026 –0.041 –0.052 –0.053 3Philippines –5 –0.106 24 47 0.024 –0.044 –0.014 –0.091 2Venezuela –3 –0.113 29 42 0.055 –0.068 –0.031 –0.082 2Colombia –7 –0.114 19 52 0.034 –0.044 –0.040 –0.074 2

(cont’d.)*The count of advancing/declining is based on the normalized values for 2003 and 2004 data.

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Middle-income countries losing rank in competitive-ness include Latvia, the Dominican Republic, Poland, andMauritius. Other countries with significant absolute dropsin BCI score include Thailand and Mexico. Latvia hasmoved back to a level consistent with its longer-term trajectory; last year’s strong improvement proved to beunsustainable optimism. Dominican Republic (down 13places) continues the trend set by a large drop last year.Dominican Republic was hurt by declining openness toimports and regressing financial market sophistication.

Among low-income countries, Indonesia made thelargest improvement, jumping a remarkable 18 ranks.Thecountry registered the highest increase in absolute BCIscore of all the countries included in our sample.Afteryears of turmoil the country is now back to its 2000 com-petitiveness level.While improvements were registeredareas across the board, they were strongest in measures ofcompany sophistication.Another low-income countrywith large improvements is India (up 8 ranks; profitingfrom increasing company sophistication and strengtheningclusters).Vietnam slipped significantly (down 23 places)after a number of years with steady improvements.Conditions worsened most in areas related to technologyand government administration. It remains to be seenwhether Vietnam’s drop reflects short-term sentiments orsignals more fundamental problems.

For low-income countries, we also calculated the BCIincorporating only those variables with a significant rela-tionship to GDP per capita for this income group in orderto recognize the more limited set of variables that prove

significant early in development.26 The rankings using thisalternative approach are highly correlated (70 percent)with the reported rankings.

Company competitiveness versus the quality of the businessenvironmentTo gain deeper insight into the competitive position ofcountries, normalized subindexes of company sophistica-tion and the quality of the microeconomic business environment are plotted against each other in Figure 8.Countries near the 45-degree line enjoy the positiveinteraction of the two subindexes, as noted previously.Countries lying above line are those whose companies aremore advanced than the state of their business environ-ment.Those below the line are countries whose businessenvironment is more advanced than their companies.

Countries whose company development is ahead ofthe business environment include Japan, the Philippines,Germany, Korea, Italy, Switzerland, France, Sweden, andthe Netherlands.With the exception of the Philippines, allthese countries have reported a relative weakness in thebusiness environment relative to company developmentfor some years. Significant changes in public policy arenecessary in these countries to improve the platform forproductivity. Unless the business environment improves,companies will be prone to move operations or make newinvestments outside the country. Japan remains the advancedeconomy with the most glaring weaknesses in the businessenvironment relative to the sophistication of its companies.The consequences of this weakness for Japan’s economic

Table 5: Decomposition of rank changes (cont’d.)

Change of Number of indicators* BCI score change of Change of Income group

Country BCI rank BCI score advancing declining Top 5 Bottom 5 COS score NBE score

Nicaragua –6 –0.120 27 44 0.024 –0.061 –0.080 –0.040 1Trinidad and Tobago –6 –0.123 21 50 0.026 –0.037 –0.011 –0.112 2Jordan –2 –0.125 22 49 0.019 –0.045 0.006 –0.132 2Uruguay –6 –0.132 17 54 0.036 –0.054 –0.016 –0.117 2Argentina –5 –0.135 25 46 0.059 –0.051 –0.031 –0.104 2Botswana –8 –0.144 28 43 0.044 –0.071 –0.051 –0.093 2Singapore –2 –0.149 13 58 0.013 –0.041 –0.039 –0.110 3Zimbabwe –4 –0.152 23 48 0.040 –0.069 –0.056 –0.096 1Sri Lanka –11 –0.175 20 51 0.044 –0.069 –0.092 –0.082 1Serbia and Montenegro –6 –0.179 25 46 0.056 –0.070 –0.084 –0.095 1Korea –1 –0.192 19 52 0.044 –0.088 –0.005 –0.186 3Mexico –7 –0.203 13 58 0.032 –0.053 –0.077 –0.126 2Spain –1 –0.223 16 55 0.022 –0.065 –0.074 –0.150 3Croatia –10 –0.235 16 55 0.017 –0.057 –0.074 –0.161 2Thailand –6 –0.245 9 62 0.021 –0.046 –0.066 –0.179 2Malawi –12 –0.257 23 48 0.025 –0.070 –0.073 –0.184 1Malta –8 –0.288 9 62 0.031 –0.058 –0.085 –0.204 3Mauritius –9 –0.292 13 58 0.030 –0.077 –0.117 –0.175 2Poland –10 –0.380 9 62 0.031 –0.070 –0.057 –0.323 2Dominican Republic –19 –0.444 10 61 0.017 –0.099 –0.124 –0.320 2Tanzania –22 –0.555 10 61 0.046 –0.093 –0.201 –0.354 1Latvia –20 –0.597 8 63 0.039 –0.114 –0.197 –0.400 2Vietnam –29 –0.633 5 66 0.027 –0.118 –0.169 –0.464 1Italy –10 –0.649 5 66 0.015 –0.078 –0.129 –0.520 3

*The count of advancing/declining is based on the normalized values for 2003 and 2004 data.

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growth have been severe, as Japanese corporate investmenthas fled the country.27

Countries whose business environment ranks ahead ofcurrent company sophistication include Tunisia, Estonia,Cyprus, Norway, and Portugal. In these countries manyleading companies still rely on natural resource extraction(e.g., Norway), depend heavily on OEM production, orhave a high incidence of local subsidiaries of foreignmultinationals competing heavily on the basis of low laborcosts (e.g.,Tunisia, Cyprus, and Portugal). In some coun-tries, such as Estonia, part of the gap results from rapidimprovements in the business environment that have notyet been harnessed by companies who remain focused ontraditional ways of competing. Efforts to improve entre-preneurship, strategic thinking, managerial practice, andbusiness education are high priorities in these countries.

Country overperformance and underperformanceWe can gain insights into the sustainability of a country’sprosperity by looking at its level of microeconomic (business) competitiveness relative to its current per capitaincome.Table 6 lists countries in order of the divergencebetween actual GDP per capita and the expected GDPgiven microeconomic competitiveness.A level of actualGDP per capita above the expected level is termed “overperformance,” below the expected level “underper-formance.”

Reasons for sustained over- or underperformance can reflect a variety of circumstances.The political,governmental, and social situation is one of them, as ourmodel suggests.The data set on governance generated byKaufman et al. (2003) allows a better explanation of theserelationships. Many of these indicators are highly correlat-ed with GDP per capita.This is to be expected, withcausality is likely to run both ways.28 We find thatKaufmann’s measures for “voice and accountability” and“government effectiveness” are significant in explainingthe gap between actual and predicted GDP per capita in our model.“Voice and accountability” is especiallyimportant for middle-income countries, with “govern-ment effectiveness” important for high-income countries.“Political stability” is also important but less significant.Countries that, in terms of absolute GDP per capita,benefit most from good governance are Switzerland, theNetherlands, Finland, Denmark, New Zealand, the UnitedKingdom, Sweden, and Norway. Countries that suffer themost from bad governance in terms of absolute GDP percapita reduction are Zimbabwe, Ethiopia, Paraguay,Venezuela, Pakistan, and Algeria.

Another important factor is a country’s geographiclocation.We examine two aspects of location: the neigh-borhood a country is part of, and its proximity to oceantransportation.We find that the average income of neigh-boring countries is positive and significant in explaining

Table 6: GDP per capita relative to competitiveness

Competitiveness(measured by BCI)would support higher per capitaincome

Competitiveness(measured by BCI)and per capitaincome are balanced

Per capita income is high relative tocompetitiveness(measured by BCI)

Advanced Middle-income Developingcountries countries countries

UPSIDE POTENTIAL

Finland Malaysia IndiaGermany Jordan IndonesiaSweden Morocco KenyaUnited Kingdom Tunisia GhanaNew Zealand South Africa Pakistan

China MalawiThailand Sri LankaBrazil MadagascarJamaica TanzaniaChile ZimbabweEstonia VietnamNamibia EthiopiaEl Salvador MozambiqueTurkeyPhilippines

NEUTRAL

Singapore Lithuania BangladeshIsrael Panama Serbia and Japan Ukraine MontenegroSwitzerland Colombia GeorgiaTaiwan Costa Rica HondurasDenmark RomaniaNetherlands PeruKorea GuatemalaFrance LatviaHong Kong SAR MexicoBelgium Botswana

VenezuelaRussian Federation

CURRENT OVERACHIEVERS

Australia Trinidad and Tobago NicaraguaUnited States Macedonia, FYR BoliviaPortugal Bulgaria EcuadorAustria AlgeriaCanada MauritiusSlovenia ParaguaySpain UruguayIceland HungaryGreece Bosnia and Cyprus HercegovinaMalta Czech RepublicIreland PolandNorway CroatiaItaly Argentina

the gap between predicted and actual GDP per capita.This finding suggests the benefits of collaboration withneighboring countries to improve competitiveness.Second, we find that the share of a country’s populationwithin 100 km of an ocean or rivers accessible from anocean is also positive and significant in explaining the gapbetween actual and predicted GDP per capita.29 Countriesthat in terms of GDP per capita benefit most from theirgeographic location are the Dominican Republic, Canada,New Zealand, Denmark, and the United Kingdom.Countries that are most negatively affected are Malawi,Ethiopia, Kenya,Tanzania, Pakistan, and Bolivia. Overall,we find that locational factors, the size of natural resourceexports, and political conditions (voice and accountability,government effectiveness) explain more than 25 percent ofthe variation in the gap between expected and actualGDP per capita across countries.

Countries lying above the regression line in Figure 6are those whose current GDP per capita exceeds that predicted by their microeconomic competitiveness, asmeasured by the BCI index.This is a danger sign, becauseit means that a country’s per capita income may be unsus-tainable.Among high-income countries, Malta, Greece,Cyprus, Ireland, and especially Norway and, after its mas-sive drop in the BCI, Italy all enjoy a level of prosperitythat exceeds their microeconomic fundamentals.Argentina, Croatia, Poland, and the Czech Republic areamong a group of middle-income countries whose levelsof income appear unsustainable without substantial microeconomic reform. Ecuador, Bolivia, Nicaragua, andHonduras are the low-income countries in this precariousposition.

Reasons for country overperformance seem to vary, with some enduring and others more transitory.Overperformance can persist for many years if it is basedon stable political and social conditions or a favorable geo-graphic location as discussed above. It can also be sustainedby ample natural resource endowments, as in the case ofNorway, as long as the natural resources are not exhaustedand commodity price levels are maintained at highenough levels. Large, consistent foreign aid inflows cansupport otherwise unsustainable prosperity levels, too,which may explain the overperformance of countries suchas Nicaragua. Overperformance can be more transitory ifit is based on a boom in foreign investment, as in Polandand the Czech Republic, or European Structural Fundinflows, as in Ireland, Greece, and Portugal.Overperformance can also reflect a lag in the affect onincome of deteriorating microeconomic conditions, as inItaly and Argentina.We find that relatively few low-income countries are overperformers.This is consistentwith the higher incidence of macroeconomic, political,and social challenges among low-income countries that

depresses GDP per capita levels below what could beexpected given their BCI position.

Countries lying below the regression line in Figure 6are those whose microeconomic competitiveness is strongerthan current GDP per capita. Underperformance bodeswell for the future, because the platform is in place to support higher GDP per capita if macro, political, or otherconstraints can be eased.

Finland, Germany, Sweden, the United Kingdom,New Zealand, and Singapore lead the advanced countrieswith upside potential. Malaysia, Jordan, Morocco,Tunisia,South Africa, China, and Thailand are among the middle-income countries that should be able to support a higherGDP per capita given microeconomic fundamentals.India, followed by Indonesia, Kenya, Pakistan, Malawi,and Sri Lanka, continues to head the list of low-incomecountries with upside potential alongside.

Sustained underperformance can result from politicalor geographic challenges, as discussed earlier. More transi-tory underperformance can also occur in the aftermath ofa macroeconomic crisis that did not lead to a deteriora-tion of the microeconomic fundamentals, as in Thailand,Malaysia, and Singapore. Underperformance may alsoreflect a lag prosperity adjusting upward to improvingmicroeconomic conditions.This seems to be the case inFinland and the United Kingdom.

India and China are two particularly interesting cases.The underperformance measured for both on a per capitabasis may well result from the sheer number of people living at the subsistence level outside the mainstreameconomy. In these and other countries, the Survey con-firms large regional differences in business environmentquality, while Surveys tend to come from executives in the more advanced regions.The average prosperity of suchcountries will remain below measured microeconomicpotential until progress is spread throughout the country.For both countries, however, it is likely that even correct-ing for this bias, the economies would remain to register abusiness environment that should be able to sustain higherprosperity, including higher wages and more economicactivity.This imbalance makes the countries particularlyattractive for foreign investors that can tap into huge markets where costs have not yet caught up with the levelof productivity that can be reached.

Regional disparitiesAs with last year, we included a question on regional differences in a country’s business environment. Not surprisingly, countries such as Italy, Russia, Brazil, China,and India register high regional heterogeneity. For coun-tries such as China and India, this high degree of regionalheterogeneity could help explain the low level of GDPper capita relative to the reported BCI since Surveyrespondents will tend to come from companies in more

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prosperous regions and not reflect average conditions inthe economy.

There are also many other smaller, often less devel-oped, countries that register equal or even higher rates ofregional disparity. Peru, Mozambique, Georgia, Guatemala,Argentina, and Bolivia top the list of such countries, fol-lowed by Italy, the Slovak Republic, Latvia, and Mexico.These data indicate that regional disparity in both eco-nomic prosperity and competitiveness is a prominent fea-ture of developing economies. Policies in these countriessometimes accentuate the problem by biasing investmentflows toward a few regions, notably the capital city.Reducing regional disparities, especially the overconcen-tration of economic activity in a few huge metropolitanareas, is one of the critical agendas in the developmentprocess that less advanced economies need to address.

More-advanced economies tend to have policiesaimed at fostering the development of less prosperousregions.30 A good example is the system of RegionalDevelopment Agencies in the United Kingdom, a deliber-ate attempt to balance the dominance of the GreaterLondon region in the UK economy.31 But in all countries,the challenge of moving from policies focused on provid-ing social transfers to ones supporting the upgrading oflocal competitiveness is daunting.The challenge is tomobilize the economic potential of all regions, especiallywhen the demographic development will increase thescarcity of labor, and overcome the tendency the use ofmarket interventions such as subsidies and trade barriers toshelter less prosperous regions from competition.

Natural resources and developmentNatural resources have played a prominent role in think-ing about economic development. Historically, abundantresources were seen as the source of national prosperity. Inthe last decade, however, the importance of naturalresources has been called into question as the knowledgeand skill intensity of competition has risen.

As was the case in last year’s Report, we explore therelationship between resource abundance and competitive-ness. For 88 countries we were able to assemble data onthe size of minimally processed natural resources relativeto overall exports.32 The largest absolute natural resourceexporting countries remain the United States, Canada,Russia,Australia, and Norway.The countries with thehighest share of natural resources exports to total exportsare Venezuela, Jamaica, Ecuador, Malawi, and Paraguay, allwith a natural resource share of greater than 50 percent.Natural resource exports per capita as a proportion ofGDP per capita are plotted on Figure 9.

Natural resources result from endowments, not eco-nomic competitiveness.A country’s world market share ofnatural resource exports proves to be more closely relatedto its geographic size than to its share of world GDP,

while non-natural resource exports are closely correlatedto a country’s share of world GDP. Natural resourceexports per capita are, controlling for country size (we usepopulation density, the inverse of land area per capita),much less related to underlying competitiveness measuredby BCI than non-natural resource exports.We find thatthe natural resource share of a country’s exports (andGDP) is decreasing in GDP per capita, again controllingfor country size, as we might expect. Countries withlower levels of productivity are more dependent on natu-ral resource exports.

Theory suggests another effect of natural resourcesthat would counteract the positive direct effect on pros-perity: abundant natural resources might bias policiestoward rent seeking and redistribution and work againstoverall competitiveness.A crude analysis of changes inBCI supports this view: both high 1997 (initial) naturalresource exports (share of GDP) and a dummy variable forcountries with high current natural resource exports(more than 1 percent of GDP) are negatively and signifi-cantly correlated with changes in the BCI rank between1998 and 2003.33

Changing microeconomic competitiveness and prosperitygrowthWe also examined whether countries that are improvingor worsening their competitiveness ranking register corre-sponding trends in growth of GDP per capita. Changes inBCI rank should affect growth in GDP per capita as percapita income responds to a new sustainable level.Although macroeconomic adjustments and other shocksmay also affect per capita income growth, the relationshipbetween shifts in BCI ranking and prosperity growth pro-vides a tentative indication of causality in the relationshipbetween BCI and prosperity.

Regressing GDP per capita growth between 1998and 2003 on BCI rank changes between 1999 and 2004yields a statistically significant relationship that explainsabout 18 percent of the total variation in the growth inGDP per capita across countries.The relationship is highlysignificant.The coefficient of the relationship implies thatan improvement of 10 BCI ranks over the five-year timeperiod is associated with a 1.9 percent higher growth ratein GDP per capita, and vice versa.Two countries,Venezuela and Zimbabwe, fall outside the 95 percent sig-nificance interval in their relationship.Their GDP percapita has dropped even more than predicted due tofalling BCI, not surprising given the political turmoil inboth countries.34

ConclusionsNational prosperity is strongly affected by competitiveness,which is defined by the productivity with which a nation

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utilizes its human, capital, and natural resources.Competitiveness is rooted in a nation’s microeconomicfundamentals, manifested in the sophistication of its companies and the quality of its microeconomic businessenvironment.

Stable institutions, sound macroeconomic policies,market opening, and privatization have long been consid-ered the cornerstones for economic development. Ourresults here, and in previous years, suggest that these fac-tors are necessary but far from sufficient. More than 80percent of the variation of GDP per capita across coun-tries is accounted for by microeconomic fundamentals.

In this Report we have shown how other factors,including political governance, geography, and naturalresources, explain why a country’s prosperity can deviate,sometimes for long time periods, from the level supportedby its microeconomic fundamentals.We find, however, thatthe absolute impact of these factors is significantly smallerthan that of the microeconomic fundamentals.

Without micro reforms, growth in GDP induced bysound macro policies, market opening, and privatizationwill be unsustainable or will not translate into improve-ments in GDP per capita.Appropriate micro reforms,which boost productivity and productivity growth, cangreatly ease the challenge of meeting government’s fiscalobligations and reducing macroeconomic distortions.Microeconomic reforms can also reduce the political pres-sure on governments trying to defend macroeconomicstabilization and market opening against vested interests.Citizens who see monopolies loosing their grip, businessesreforming themselves, and opportunities for employmentand entrepreneurship increasing are much less likely to beseduced by the false promises of redistribution and gov-ernment intervention.

Over time, more countries are realizing that sustainedprosperity growth can be achieved only through continu-ous improvement of the microeconomic foundations ofcompetitiveness.The experience with the 2000 LisbonAgenda of the European Union, however, is an indicationof how hard it is to move from realization to meaningfulaction.The current economic climate in Europe has raisedthe danger that politicians will fall back on tried and failedmodels of industrial policy. More broadly, our results illus-trate the challenges countries face, especially low- andmiddle-income countries, in sustaining and continuouslyimproving their business environments when the bar isrising in the global economy.

Our findings confirm the view that it is unwise toview micro reforms narrowly in terms of reducing therole of government and abolishing market distortions.Such steps remain a critical challenge that many countriesstill have to master.Yet government has a range of positiveroles that are fundamental to prosperity, such as investingin human resources, stimulating sophisticated demand via

setting appropriate regulatory standards, and buildinginnovative capacity. Many nations need to move beyondfirst-stage reforms and address these agendas.

The private sector has a crucial role in improving anation’s competitive platform through dialogue with government, collective private activities, and cluster development. Second-stage micro reforms require a newperspective on the role of the private sector. Private sectorleaders are still not engaged enough in driving nationalcompetitiveness programs and initiatives, especially indeveloping countries.

The important role of clusters in competitiveness isagain validated by our results. Realizing that clusters areimportant, however, is not the same as developing policiesand process that are effective in supporting cluster devel-opment and growth.There is a pressing need to profes-sionalize the way cluster development efforts are conduct-ed, including the application of tools to track theirimpact.35 Our analysis, however, also makes it clear thatmicroeconomic reform is much more than cluster devel-opment.While numerous efforts to enhance clustersaround the world are highly encouraging, countries alsoneed to pursue improvements throughout the businessenvironment. Otherwise cluster development initiativeswill ultimately be stymied.

Our results once again highlight the need to align anation’s economic priorities with its level of development.There is strong evidence that microeconomic upgrading isa sequential process in which countries at different levelsof development face distinctly different challenges.Attempting to apply one policy model across disparatecountries is often not appropriate; a problem theEuropean Union is now facing after the accession of tenmainly central and eastern European countries.This Reportclarifies the differing policy priorities and challenges forlow-, middle-, and high-income countries, and the diffi-cult transitions between broad developmental stages.Countries that have been very successful in one mode ofcompeting need to recognize the multifaceted adjustmentsnecessary for managing the transition to the next one.

This year’s Report also sheds light on the experienceof individual countries.The strong underlying competi-tiveness of the United States, confirmed by its reclaimingthe top rank in the BCI, bodes well for the medium-termprospects of the US economy, despite the turbulences inthe international environment. India, after an erratic histo-ry, has now for a number of years registered a stable trendof improvements in competitiveness. Indonesia, a crucialcountry given its large Muslim population and role in theregion, has made heartening improvements in competi-tiveness. Italy has seen an alarming deterioration of itscompetitiveness position; part of it might be temporary,related to the sentiment of the country’s business elite inthe wake of the Parmalat accounting scandal, but our

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results indicate that the country has underlying challengesthat have become much more apparent in an environmentof slow growth and joint European currency.The data inthis Report provide detailed assessments of the strengthsand weaknesses in these and other countries.

China and India stand out as enjoying the fruits ofimprovements in competitiveness that have run ahead ofwages.Their position as underperformers—countries withcurrent prosperity and productivity levels below thepotential of their microeconomic fundamentals—helpsexplain the robust investment inflows into these countries:They are attractive not because their wages are low in anabsolute sense but because their level of wages is low rela-tive to the quality of business environment in which for-eign companies can operate.We are already observing anadjustment process that will, over time, tend to close thisgap and investment flows will reflect this.

Microeconomic competitiveness is arguably the cen-tral item on the economic policy agenda of every nation.Progress in improving the sophistication of companies andthe quality of the business environment is the only way toproduce real improvements in efficiency, product quality,and new business and job growth that support a risingstandard of living for citizens. In future years, we and theForum are committed to work toward improved data andmore advanced tools to enable leaders in government andbusiness to guide economic development.

Notes1 I would like to thank Christian Ketels and Weifeng Weng for their major

role in the analyses reported here. Lyn Pohl provided able supervi-sion of the final production of the chapter.

2 The proportion has grown modestly over the last several years as themodel has been improved.

3 See, for example, O’Mahony and van Ark (2003).

4 Accordingly, the European Union has made increasing labor participationone of the core goals of its Lisbon Agenda to improve competitive-ness. See Lisbon European Council: Presidency Conclusions, Lisbon(23/24 March 2000)

5 See the Clusters of Innovation report (Porter, Council onCompetitiveness, and Monitor Group, 2001); further reports on fiveUS regions are available at www.compete.org.

6 See the report by Harvard students Jean Hayden, Chai McConnell,Peter Tynan, and Alexandra West

7 See the report by Harvard students Mattia Adani, Adrien Couton,Marisa Joelson, and Verena Kugi.

8 The stages were first introduced in Porter (1990).

9 The notion of institutions for collaboration has been developed furtherin joint work with Willis Emmons, Georgetown University. Porter andEmmons (2003)

10 For a survey of cluster initiatives, a specific type of IFC with the explic-it purpose to mobilize and upgrade a cluster, see Sölvell, Lindqvist,and Ketels (2003)

11 Glaeser, La Porta, Lopez-de-Silanes, and Shleifer (2004).

12 One surveyed economy, Luxembourg, was not included in the calcula-tions because, given its small size, functional concentration on a fewsectors, and almost complete integration into the neighboringeconomies, it is better understood as a region within theseeconomies.

13 See World Bank (2004) and the web sitehttp://rru.worldbank.org/doingbusiness/

14 These reasons could include larger actual heterogeneity within thecountry as well as greater uncertainty by respondents about appro-priate international benchmarks.

15 Eighty-nine countries were included with all their responses; fourcountries (Ghana, Macedonia, Namibia, and Tanzania) were includedwith only the responses from their foreign-owned businesses.

16 These countries are Angola, Bahrain, Chad, Egypt, Gambia, Mali,Nigeria, Uganda, the United Arab Emirates, and Zambia.

17 GDP per worker is employed as a productivity measure in some stud-ies. We used the broader measure here because GDP per workercan be increased by high unemployment or low workforce participa-tion, which do not increase wealth. Also, holders of capital, not onlyworkers, contribute to national productivity. In comparing the UnitedStates and France, for example, the United States has absorbed ahuge influx of new workers (higher workforce participation) over thelast decade, while France has maintained high GDP per workerthrough suffering high unemployment and maintaining a large stu-dent population not counted as part of the potential workforce.

18 In the case of Ireland, we used GNP instead of GDP because of thesize of dividend outflows to foreign investors. Ireland’s GDP is about20 percent higher than its GNP.

19 Statistical significance at ** = 5 percent and * = 10 percent (all two-tailed tests) is noted in the table.

20 We conducted additional bivariate regressions (not reported here)using macroeconomic indicators collected for the GlobalCompetitiveness Report. These regressions show no statistical rela-tionship between GDP per capita and individual macroeconomic indi-cators. See also Easterly (2001), who finds similar results.

21 See Lewis (2004) and Porter and Sakakibara (2004)

22 This analysis covers the Survey questions that have been commonover five years, which comprise the great majority of questions.

23 The forecast region has wider bands than a 95 percent mean confi-dence region. The mean confidence region provides a confidenceinterval for a given level of competitiveness over repeated observa-tions. The forecast region method, in contrast, reflects a higherdegree of inherent uncertainty in predicting a single observation. Asa result, interpretation of the proximity of data points to the regres-sion line should be undertaken with appropriate caveats. Note thatthe forecast region widens slightly as it moves away from the “cen-ter” of the graph. The center is the point located at the intersectionof the mean GDP per capita level and mean factor score.

24 Our ranking has an interesting correlation with the FDI potential indexcalculated by UNCTAD (2004). The FDI potential index includes natu-ral resource deposits and a large domestic market as elements, bothfactors that motivate inward foreign direct investment but not them-selves indicators of competitiveness. The index contains fewer ele-ments of business environment quality than the BCI but includesGDP per capita, an indicator highly correlated with the BCI and manyof its constituent elements.

25 All changes refer to the sample of 93 countries included in the statisti-cal analysis.

26 For middle- and high-income countries, most of the individual variablesincluded in the BCI are significant.

27 For a more detailed examination of Japan’s competitive situation, seePorter, Takeuchi, and Sakakibara (2000).

28 This implies also a high correlation between these indicators and theBCI, providing a statistical challenge for distinguishing their inde-pendent effects.

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29 See Gallup and Sachs (1999) for a discussion of the data on geograph-ic location.

30 A good example is the discussion about policies for rural regions. Foran assessment of the current situation in the United States seePorter, Ketels, Miller, and Bryden (2004)

31 For a discussion in the context of a broader assessment of UK com-petitiveness, see Porter and Ketels (2003).

32 Data were drawn from “Trade Analysis System on Personal Computer,1997–2001, SITC Rev.3.” A list of SITC industries included can beobtained from the author.

33 The time-series data available for this analysis unfortunately stillinclude few low-income countries with high natural resource exportshare. The analysis will be expanded as more country data becomeavailable over time.

34 When Venezuela and Zimbabwe are dropped from the regression, theexplanatory power of the equation falls to 13.6 percent and the coef-ficient falls to an increase of 1.2 percent annual GDP per capitagrowth for an increase of ten ranks in the BCI over five years.

35 See, for example, the tools provided by the Foundation Cluster andCompetitiveness (www.clustercompetitiveness.org), an institutionlaunched on the initiative of the Catalan government.

Selected ReferencesAdani, M., A. Couton, M. Joelson, and V. Kugi. 2003. The Romanian

Textile & Apparel Cluster, Paper prepared for the Harvard Universitycourse “Microeconomics of Competitiveness,” Boston, MA: June2003.

Barro, R. J. 1991. “Economic Growth in a Cross Section of Countries,”Quarterly Journal of Economics 106 (2): 407–443.

Baumol, W. J. 2002. The Free-Market Innovation Machine: Analyzing theGrowth Miracle of Capitalism. Princeton, NJ: Princeton UniversityPress.

Department of Trade and Industry. 2003. UK Productivity andCompetitiveness Indicators 2003, London: Department of Trade andIndustry.

Easterly, W. 2001.The Elusive Quest for Growth: Economists’ Adventuresand Misadventures in the Tropics. Cambridge, MA: MIT Press.

Easterly, W. and R. Levine. 2002. “Tropics, Germs, and Crops: HowEndowments Influence Economic Development,” NBER WorkingPaper No. 9106. Cambridge, MA: National Bureau of EconomicResearch.

European Commission. 2003. European Competitiveness Report 2003.Brussels: European Commission.

European Council. 2000. Presidency Conclusions of the Lisbon EuropeanCouncil. March 23/34, 2000.

Enright, M. J., A. Francés, and E. S. Saavadra. 1994. Venezuela: El Reto dela Competitividad. Caracas, Venezuela: Ediciones IESA.

Fairbanks, M. and S. Lindsay. 1997. Plowing the Sea: The Challenge ofCompetitiveness in the Developing World Boston: Harvard BusinessSchool Press.

Gallup, J. L. and J. D. Sachs. 1999. Geography and EconomicDevelopment. Center for International Development (CID) WorkingPaper no. 1, Cambridge, MA: March 1999.

Glaeser, E., R. La Porta, F. Lopez-de-Silanes, and A Shleifer. 2004. “DoInstitutions Cause Growth?” NBER Working Paper No. 10568,Cambridge, MA: National Bureau of Economic Research.

Hall, R. E. and C. I. Jones. 1999. “Why Do Some Countries Produce SoMuch More Output per Worker than Others?” Quarterly Journal ofEconomics 114 (1): 83 –116.

Hayden, J., C. McConnell, P. Tynan, and A. West. 2003. The CairnsTourism Clusterl, Paper prepared for the Harvard University course“Microeconomics of Competitiveness,” Boston, MA: June 2003.

Hirschman, A. O. 1958. The Strategy of Economic Development NewHaven, CT: Yale University Press.

Kaufmann, D., A. Kraay, and M. Mastruzzi. 2003. “Governance Matters III:Governance Indicators for 1996–2002, Washington, DC: World BankPolicy Research Working Paper 3106

Lewis, W. W. 2004. The Power of Productivity Chicago, IL: The Universityof Chicago Press.

Lucas, R. E., Jr. 1988. “On the Mechanics of Economic Development,”Journal of Monetary Economics 22 (July 1988): 3–42.

Mankiw, N. G. 1995. “The Growth of Nations,” Brookings Papers onEconomic Activity 1 (1): 275–310.

Mankiw, N. G., D. Romer, and D. N. Weil. 1992. “A Contribution to theEmpirics of Economic Growth,” Quarterly Journal of Economics107(2): 407–437.

Nickell, S. 1996. “Competition and Corporate Performance,” Journal ofPolitical Economy 104 (1996): 724-746.

Nordhaus, W. D. 1994. “Climate and Economic Development.” InProceedings of the World Bank Annual Conference on DevelopmentEconomics 1993. Washington, DC: The International Bank forReconstruction and Development/The World Bank.

North, D. C. 1990. Institutions, Institutional Change and EconomicPerformance: Political Economy of Institutions and Decisions.Cambridge: Cambridge University Press.

O’Mahony, M., B. van Ark (eds.). 2003. EU productivity and competitive-ness: an industry perspective. Brussels: European Commission.

Porter, M. E. 2003. “The Economic Performance of Regions,” RegionalStudies 37(6&7): 549–678.

———. 2000. “Attitudes, Values, Beliefs, and the Microeconomic ofProsperity,” in L. E. Harrison, S. P. Huntington (eds.), CultureMatters, New York: Basic Books, 2000: 14–28.

———. 2000. “Locations, Clusters, and Company Strategy,” in G. L. Clark,M. P. Feldman, and M. S. Gertler (eds.), The Oxford Handbook ofEconomic Geography, New York: Oxford University Press, 2000:253–274.

———. 1998a. “Introduction.” In The Competitive Advantage of Nations:With a New Introduction. New York: The Free Press.

———. 1998b. “Clusters and Competition: New Agendas for Companies,Governments, and Institutions.” In On Competition. Boston: HarvardBusiness School Press.

———. 1996. “What Is Strategy?” Harvard Business Review 74 (6):61–78.

———. 1995. “Comment on ‘Interaction Between Regional and IndustrialPolicies: Evidence From Four Countries,’ by J. Markusen. ”InProceedings of The World Bank Annual Conference on DevelopmentEconomics 1994. Washington, DC: The International Bank forReconstruction and Development/The World Bank.

———. 1990. The Competitive Advantage of Nations. New York: The FreePress.

Porter, M. E., Council on Competitiveness, and Monitor Group. 2001.Clusters of Innovation Initiative: Regional Foundations of U.S.Competitiveness. Washington, DC: Council on Competitiveness.

Porter, M.E., and W. Emmons. 2003. “Institutions for Collaboration:Overview.” Harvard Business School case 9-703-436.

Porter, M. E. and C. Ketels. 2003. UK Competitiveness: Moving to theNext Stage, DTI Economics Paper No.3.

Porter, M.E., C. Ketels, K. Miller, and R. Bryden. 2004. Competitiveness inRural U.S. Regions: Learning and Research Agenda, Washington,DC: US Economic Development Administration (EDA).

Porter, M. E. and M. Sakakibara. 2004. Competition in Japan, Journal ofEconomic Perspectives, Winter Issue, forthcoming 2004.

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Porter, M. E. and H. Takeuchi with M. Sakakibara. 2000. Can JapanCompete? Basingstoke, England, and New York: Macmillan andBasic Books.

Porter, M. E. and C. van der Linde. 1995. “Toward a New Conception ofthe Environment-Competitiveness Relationship,” Journal ofEconomic Perspectives 9(4): 97–118.

Romer, P. M. 1990. “Endogenous Technological Change,” Journal ofPolitical Economy 98(5): S71–S102.

Sachs, J. D. and A. Warner. 1995. “Economic Reform and the Process ofGlobal Integration,” Brookings Papers on Economic Activity 1(1):1–118.

Sakakibara, M. and M. E. Porter. 1998. “Competing at Home to WinAbroad: Evidence from Japanese Industry,” Harvard BusinessSchool Working Paper No. 99-036. Cambridge, MA: HarvardBusiness School Press.

Solow, R. M. 1956. “A Contribution to the Theory of Economic Growth,”Quarterly Journal of Economics 70(1): 65–94.

Sölvell, Ö., G. Lindqvist, and C. Ketels. 2003. “The Cluster InitiativeGreenbook,” Stockholm: November 2003.

UNCTAD. 2004. World Investment Report 2004 Geneva: UNCTAD.

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I. COMPANY OPERATIONS & STRATEGY R 2

Production process sophistication. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.422Nature of competitive advantage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.358Extent of staff training. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.342Extent of marketing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.339Willingness to delegate authority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.278Capacity for innovation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.382Company spending on research and development . . . . . . . . . . . . . . . 0.322Value chain presence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.392Breadth of international markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.412Degree of customer orientation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.227Control of international distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.178Extent of branding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.396Reliance on professional management . . . . . . . . . . . . . . . . . . . . . . . . . 0.297Extent of incentive compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.263Extent of regional sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.366Prevalence of foreign technology licensing . . . . . . . . . . . . . . . . . . . . . 0.221

II. NATIONAL BUSINESS ENVIRONMENT R 2

A. FACTOR (INPUT) CONDITIONS1. Physical Infrastructure

Overall infrastructure quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.553Railroad infrastructure development . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.608Port infrastructure quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.500Air transport infrastructure quality. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.408Quality of electricity supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.487Telephone/fax infrastructure quality . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.438

2. Administrative Infrastructure

Reliability of police services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.355Judicial independence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.426Efficiency of legal framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.408Administrative burden for startups. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.222Extent of bureaucratic red tape . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.081

3. Human Resources

Quality of management schools . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.352Quality of public schools . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.480Quality of the educational system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.347Quality of math and science education . . . . . . . . . . . . . . . . . . . . . . . . . 0.387

4. Technology Infrastructure

Availability of scientists and engineers . . . . . . . . . . . . . . . . . . . . . . . . . 0.274Quality of scientific research institutions . . . . . . . . . . . . . . . . . . . . . . . 0.327University/industry research collaboration. . . . . . . . . . . . . . . . . . . . . . 0.299

5. Capital Markets

Financial market sophistication . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.432Ease of access to loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.226Local equity market access . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.343

II. NATIONAL BUSINESS ENVIRONMENT (Cont’d.) R 2

B. DEMAND CONDITIONSBuyer sophistication . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.334Sophistication of local buyers' products and processes . . . . . . . . . . 0.269Government procurement of advanced technology products. . . . . . 0.170Presence of demanding regulatory standards . . . . . . . . . . . . . . . . . . . 0.426Laws relating to ICT. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.305Stringency of environmental regulations . . . . . . . . . . . . . . . . . . . . . . . 0.411

C. RELATED AND SUPPORTING INDUSTRIESLocal supplier quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.314State of cluster development. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.220Local availability of process machinery . . . . . . . . . . . . . . . . . . . . . . . . 0.341Local availability of specialized research and training services . . . 0.278Extent of collaboration among clusters . . . . . . . . . . . . . . . . . . . . . . . . . 0.263Local supplier quantity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.216Local availability of components and parts . . . . . . . . . . . . . . . . . . . . . 0.323

D. CONTEXT FOR FIRM STRATEGY AND RIVALRY1. Incentives

Favoritism in decisions of government officials. . . . . . . . . . . . . . . . . . 0.272Cooperation in labor-employer relations . . . . . . . . . . . . . . . . . . . . . . . . 0.218Efficacy of corporate boards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.148Intellectual property protection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.418Protection of minority shareholders’ interests . . . . . . . . . . . . . . . . . . . 0.259Regulation of securities exchanges . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.338Effectiveness of bankruptcy law. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.359

2. Competition

Hidden trade barrier liberalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.267Intensity of local competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.163Extent of locally based competitors . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.174Effectiveness of anti-trust policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.315Decentralization of corporate activity . . . . . . . . . . . . . . . . . . . . . . . . . . 0.261Business costs of corruption. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.254Tariff liberalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.225Centralization of economic policy-making . . . . . . . . . . . . . . . . . . . . . . 0.207Prevalence of mergers and acquisitions. . . . . . . . . . . . . . . . . . . . . . . . 0.181Foreign ownership restrictions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.216

Appendix A: ANOVA Analysis for Survey Responses

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Competitiveness Rankings

Growth Competitiveness Index Rank 23

Macroeconomic Environment Index Rank .....................16Macroeconomic Stability Subindex Rank .............34Government Waste Rank .....................................17Country Credit Rating Rank..................................16

Public Institutions Index Rank..........................................34Contracts and Law Subindex Rank ......................42Corruption Subindex Rank....................................32

Technology Index Rank ......................................................20Innovation Subindex Rank ....................................24ICT Subindex Rank ...............................................30Technology Transfer Subindex Rank

(out of 79 non-core innovators)........................11

Business Competitiveness Index Rank 26

Sophistication of Company Operations and Strategy Rank ............................................................25

Quality of the National Business Environment Rank ............................................................26

The Most Problematic Factors for Doing Business

FACTOR

Restrictive labor regulations ..............................Access to financing .............................................Inefficient bureaucracy.......................................Tax regulations......................................................Tax rates.................................................................Inadequate infrastructure...................................Inadequately educated workforce....................Policy instability....................................................Inflation ..................................................................Poor work ethic ....................................................Crime and theft .....................................................Corruption ..............................................................Government instability/coups ............................Foreign currency regulations.............................

0 5 10 15 20 25 30

Percent of responses

Note: From a list of 14 factors, respondents were asked to select the five most problematic for doing business in their coun-try and to rank them between 1 (most problematic) and 5. The bars in the figure show the responses weighted according totheir rankings.

Source: World Economic Forum, Executive Opinion Survey (2004)

National competitiveness balance sheetNOTABLE COMPETITIVE ADVANTAGES

Growth Competitiveness Index Rank/104

Macroeconomic Environment2.26 Interest rate spread, 2003.................................................22.30 Country credit rating, 2004 .............................................162.22 Government surplus/deficit, 2003...................................176.06 Wastefulness of government spending..........................17

Technology3.18 Cellular telephones, 2003..................................................84.22 Tertiary enrollment ..........................................................14

Business Competitiveness Index Rank/93

Sophistication of Company Operations and Strategy9.14 Extent of incentive compensation ..................................189.09 Control of international distribution.................................189.02 Value chain presence ......................................................21

Quality of the National Business Environment6.15 Centralization of economic policymaking..........................43.18 Cellular telephones, 2003..................................................79.16 Quality of management schools .......................................8

Other Indicators Rank/1044.07 Present business impact of HIV/AIDS ..............................72.04 Soundness of banks........................................................149.05 Ethical behavior of firms .................................................214.04 Disparity in healthcare quality .........................................22

NOTABLE COMPETITIVE DISADVANTAGES

Growth Competitiveness Index Rank/104

Macroeconomic Environment2.24 Real effective exchange rate, 2003 ................................882.07 Access to credit ..............................................................502.25 Inflation, 2003 .................................................................502.01 Recession expectations ..................................................492.23 National savings rate, 2003.............................................39

Public Institutions6.01 Judicial independence.....................................................506.22 Irregular payments in public utilities ...............................396.03 Property rights.................................................................386.18 Organized crime ..............................................................386.10 Favoritism in decisions of government officials..............366.23 Irregular payments in tax collection ................................346.21 Irregular payments in exports and imports .....................31

Technology3.15 Government success in ICT promotion ..........................693.14 Government prioritization of ICT .....................................523.02 Firm-level technology absorption ....................................523.13 Quality of competition in the ISP sector .........................463.06 Company spending on research and development ........413.16 Laws relating to ICT ........................................................393.12 Internet access in schools ..............................................383.19 Internet users, 2003........................................................363.01 Technological readiness ..................................................333.08 University/industry research collaboration ......................333.21 Personal computers, 2003 ..............................................313.03 Prevalence of foreign technology licensing ....................293.04 FDI and technology transfer............................................295.08 Telephone lines, 2003 .....................................................293.17 Utility patents, 2003 ........................................................283.20 Internet hosts, 2003........................................................27

Business Competitiveness Index Rank/93

Sophistication of Company Operations and Strategy9.10 Extent of regional sales...................................................439.13 Willingness to delegate authority....................................403.06 Company spending on research and development ........39

Quality of the National Business Environment6.16 Reliability of police services ............................................777.05 Administrative burden for startups .................................619.20 Cooperation in labor-employer relations..........................52

Other Indicators Rank/1044.13 Maternity laws’ impact on hiring women .......................959.18 Hiring and firing practices ...............................................897.08 Private-sector employment of women ..........................837.09 Wage equality of women in the workplace ....................832.14 Business impact of foreign trade barriers.......................809.26 Company promotion of volunteerism .............................782.17 Tax burden.......................................................................769.19 Flexibility of wage determination ....................................767.10 Regional disparities in quality of business environment .742.13 Business impact of domestic trade barriers ...................734.14 Childcare availability ........................................................72

10.07 Subsidies for energy or materials ...................................702.02 Business costs of terrorism ............................................699.25 Charitable causes involvement .......................................68

10.06 Political context of environmental gains .........................60

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Note: The Business Competitiveness Index applies different criteria for selecting a country’s competitive advantages and disadvantages. Please refer to the section “How Country Profiles Work” for further details.