On the Role of Investment in Growth

Economic growth is hard to achieve without investment, because growth rests on rising value added, which is generated by the country as a whole. To raise value added, a country must increase domestic earnings, which are effectively the sum of all profits and wages. Profits and wages grow only through expansion and higher labor productivity in the sale of goods, works and services (hereinafter, GWS).

The economy is structured so that all GWS are divided into those that are tradable on external markets and those that are not. For example, a haircut is hard to export, whereas uranium is a tradable product. As a rule, all services (other than tourism and transport), perishable goods and goods that are difficult to transport are non-tradable. These types of GWS compete only within a country, city or town, and all the value added they create is generated domestically. From a macroeconomic standpoint, therefore, there is no justification for supporting such industries, since the support will go not to the best players but to those able to obtain state preferences. As a result, it is not the best that develop, which harms those industries overall. That is why I am generally opposed to state support for non-tradable industries.

Tradable industries face two kinds of competition: competition at home with imports, and competition abroad as exporters. For a country's development it is crucial to develop precisely the tradable industries, because their growth will automatically drive growth in the non-tradable ones. Tradable industries cannot develop without higher labor productivity and expansion, and that requires investment in the country. Rising investment in such industries leads to rising value added in the economy. Support in the form of tax breaks and preferences alone does not raise labor productivity, and therefore does not raise competitiveness either. Preferences can be granted at an early stage, but without a clear understanding that a given industry will not be able to compete with global companies in the future, there is no point in granting them.

The most effective way to achieve sustained economic growth is therefore to increase investment. Investment comes in many forms, but the following can be identified as the basic ones:

• foreign direct investment (FDI),

• bank debt financing,

• debt portfolio investment through the stock market,

• equity portfolio investment through the stock market,

• direct domestic investment.

Each type of investment plays an enormous role in a country's development, but each has its own limitations and difficulties. The state's task is to unblock each of these channels.

For FDI, the institutional environment and returns are critically important, and any improvement in the institutional environment will lead to higher FDI. The higher the returns, the less investors demand of the institutional environment. That is why money used to flow into Kazakhstan mainly for subsoil use: returns on capital in those industries were enough to offset institutional risks. Returns in subsoil use have now fallen sharply, because a proper taxation system has been put in place, while the number of explored deposits is dwindling and geological exploration carries high risks. To sustain FDI growth in subsoil use, reforms must continue, and there is still a great deal that needs improvement. For less profitable industries, including manufacturing, improving the investment climate is especially important.

Bank lending in the form of debt capital is one of the main drivers of investment. Yet lending to the real sector faces many problems, about which I have written extensively. First, banks have stopped raising foreign borrowed funds, because foreign-currency lending has practically disappeared in Kazakhstan, for many reasons that I have repeatedly discussed. While the high base rate is a temporary phenomenon, the rights of secured creditors in Kazakhstan remain an extremely difficult issue. Over the past ten years, the rules have only grown tougher for those seeking to recover problem debt. This is a serious barrier to lending to the real sector. It should also be mentioned that existing regulatory arbitrage and the lack of competition are likewise major constraints on the growth of real-sector lending.

Raising capital through the stock market is almost undeveloped in Kazakhstan, because very few companies meet exchange requirements. This reflects not only the immaturity of the market but also regulatory factors that encourage the fragmentation of businesses and opacity. Fragmentation and opacity are largely a consequence of tax optimization, itself a result of imperfect tax legislation and loopholes. The government is taking steps in the new Tax Code, but I now see more and more attempts to roll back very sound and necessary reforms. On foreign stock markets, only the banking sector can raise substantial investment, but, as I wrote above, banks then simply cannot put the foreign currency to use inside the country.

Raising capital by placing shares on the stock market is also hard to achieve in Kazakhstan for the same reasons: an underdeveloped market and a shortage of proper companies. Here, privatization of state-owned companies through IPOs could partly solve the problem, but work in this area has slowed considerably, and no major IPOs are expected for now. The private sector, for its part, has gone far backward over the past ten years, with several Kazakhstani companies delisting. The state is a minority shareholder in several large companies, and, in my view, now is a good time to bring them to the stock market and make them the first truly public companies.

Direct domestic investment currently relies largely on state initiatives. However, it is very difficult to systematically increase corporate investment without developing bank financing and improving the domestic investment climate. State investment is very much needed, especially now. In my view, we have enormous potential to raise external public debt, which could be channeled into large-scale infrastructure projects. We often rely on the past, but I would look to the future and base decisions on future cash flows.

After all, besides the institutional environment, it is very important to build an infrastructure environment, which is an integral part of attracting global investment. Infrastructure here means not only roads and power plants but everything needed for the development of large cities: schools, hospitals, social facilities, public transport and so on. Investment is always easier to attract to large, developed cities than to rural areas, because as a city grows, so does labor productivity. To that end, conditions must be created for housing construction, with a particular emphasis on developing integrated neighborhood-scale housing projects, in order to encourage migration to cities and generate domestic demand through higher labor productivity.

Therefore, to achieve sustainable growth, I believe a well-developed roadmap for attracting investment is needed, including measures for each channel that would help to attract it. The subject is very broad and touches virtually every ministry and agency.