Excerpt from / Fragmento del

GLOBAL COMPETITIVENESS REPORT

2004/2005

By / Por
World Economic Forum

in collaboration with / con la colaboracin 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

Executive Summary
AUGUSTO LOPEZ-CLAROS, World Economic Forum
Executive Summary
For well over two decades the World Economic Forum
has been trying to shed light on the question of why some
countries 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 others
remain stagnant or, worse, actually see an erosion of living
standards.Through its flagship publication, The Global
Competitiveness 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 sector
and the corporate world together with a broad spectrum
of senior policymakers in government, creating opportuni-
ties for the thoughtful exchange of ideas and experiences
on best practices.This exchange may be an important
catalyst in identifying the most critical factors in the
development process.The role of corruption in delaying
the development process, the central importance of
womens education for boosting per capita incomes, the
interplay between political and civil rights and the will-
ingness of the public to engage in economic activity, the
role of a free press, and the type of safety net arrangements
that governments put in place to enhance the ability of
economic agents to participate in the life of the nation, xi
are but some of the topics that have been at the centre of
the agenda in many of the summits and other interactions
organized by the World Economic Forum.
Second, the Forum has developed a vehicle, the
Executive Opinion Survey (EOS), which annually conveys
a wealth of information about the obstacles to growth in
more than 100 countries, accounting for the lions share of
global GNP.Through the Survey, business executives in
these countries assess the importance of a broad range of
factors central to creating a healthy business environment
in 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 the
economy at large, the quality of the countrys infrastruc-
ture and education are but a few of the areas covered by
the EOS. Over the years, the Survey has continued to
deliver a treasure trove of information about both coun-
try-specific strengths and weaknesses, and the challenges
faced by the business community. On the basis of the
information provided by the EOS, the Country Profiles
prepared by the Forum offer extremely valuable informa-
tion for policymakers, aid agencies and others, working
to improve economic performance and the quality of
peoples lives.
 Executive Summary
The methodology used by the Forum to assess
national competitiveness has evolved over time, taking into
account the latest thinking on the factors driving compet-
itiveness and growth.The Forum first introduced the
Growth Competitiveness Index (GCI) three years ago, in col-
laboration with Professors Jeffrey Sachs and John
McArthur, in the Global Competitiveness Report
20012002.The GCI aims specifically to gauge the ability
of the worlds economies to achieve sustained economic
growth over the medium to long term. It primarily assess-
es the impact of those factors that economic theory and
the accumulated experience of policymakers in a broad
range 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 the
economics literature, institutional and other factors.
Professor Michael Porters Business Competitiveness
Index, presented in Chapter 1.2 in this volume, is an espe-
cially useful complement to the GCI, with its special
emphasis on a range of company-specific factors con-
ducive to improved efficiency and productivity at the
micro level.
The Growth Competitiveness Index
The GCI is composed of three pillars, all of which are
xii widely accepted as being critical to economic growth: the
quality of the macroeconomic environment, the state of a
countrys public institutions, and, given the increasing
importance of technology in the development process, a
countrys technological readiness. Using a combination of
publicly available hard data, and information provided in
the Forums Executive Opinion Surveywhich provides
more textured qualitative information on difficult-to-
measure conceptsthese three pillars are brought together
in 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 the
role of technology in the growth process differs for coun-
tries, depending on their particular stage of development.
It is widely understood that technological innovation is
relatively more important for growth in countries close to
the technological frontier. Innovation will be key in
Sweden, but the adoption of foreign technologies, or the
kind of technology transfer frequently associated with for-
eign direct investment will be relatively more important in
a country such as the Czech Republic. For this reason, in
estimating the GCI, economies are separated into two
groups: the core economies, i.e. those for which technolog-
ical innovation is critical for growth, and non-core
economies, i.e. those which can still grow by adopting
technologies developed abroad.
The critical importance of technological innovation
for 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 core
economies, than for the non-core.To make a further dis-
tinction, an additional measure is used of the ability of
non-core economies to adopt technology from abroad:
the technology transfer subindex. Finally, since the deter-
minants of economic competitiveness vary for core and
non-core economies, the weighting of the three indexes in
the overall GCI differs between the two groups. For the
non-core economies, more weight is given to the quality
of institutions and the macroeconomic environment, since
these countries can still make progress in achieving higher
growth by getting their fundamentals in order.
On the other hand, for the core economies that are
closer to the technological frontier, more weight is placed
on technology. It is, of course, important for these coun-
tries to have a sound macroeconomic environment and
strong institutions, but these economies will typically have
long ago entered a period characterized by institutional
stability. For these countries to continue to grow they
must innovate.This is why more weight is placed, for the
core 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 and
construction of the GCI, which this year covers a total of
104 countries.
The Competitiveness Rankings for 2004
Table 1 presents the rankings from this years GCI. For
the third time during the last four years Finland tops the
rankings.The country is extremely well managed at the
macroeconomic level, and scores very high in those
measures which assess the quality of its public institutions.
Moreover, Finland has very low levels of corruption and
its firms operate in a legal environment in which there is
widespread respect for contracts and the rule of law.
Finlands private sector shows a proclivity for adopting
new technologies, and nurtures a culture of innovation.
Especially noteworthy is the fact that, for several years,
Finland has been running budget surpluses, in anticipation
of future claims on the budget associated with the aging
of its population.The United States is ranked second, with
overall technological supremacy, and especially high scores
for such indicators as companies spending on R&D, the
creativity of its scientific community, personal computer
and internet penetration rates. However, these are partly
offset by a weaker performance in those areas which cap-
ture the quality of the macroeconomic environment and
its public institutions.
As compared to the results of 2003, nine out of ten of
the top performers remain in this category. Among these
 Executive Summary
Table 1: Growth Competitiveness Index rankings and 2003 comparisons

GCI GCI GCI GCI GCI GCI

Country 2004 rank 2004 score 2003 rank* Country 2004 rank 2004 score 2003 rank*

Finland 1 5.95 1 Romania 63 3.86 75

United States 2 5.82 2 Colombia 64 3.84 63
Sweden 3 5.72 3 Jamaica 65 3.82 67
Taiwan 4 5.69 5 Turkey 66 3.82 65
Denmark 5 5.66 4 Peru 67 3.78 57
Norway 6 5.56 9 Ghana 68 3.78 71
Singapore 7 5.56 6 Indonesia 69 3.72 72
Switzerland 8 5.49 7 Russian Federation 70 3.68 70
Japan 9 5.48 11 Algeria 71 3.67 74
Iceland 10 5.44 8 Dominican Republic 72 3.63 62
United Kingdom 11 5.30 15 Sri Lanka 73 3.57 68
Netherlands 12 5.30 12 Argentina 74 3.54 78
Germany 13 5.28 13 Gambia 75 3.52 55
Australia 14 5.25 10 Philippines 76 3.51 66
Canada 15 5.23 16 Vietnam 77 3.47 60
United Arab Emirates 16 5.21 Kenya 78 3.45 83
Austria 17 5.20 17 Uganda 79 3.41 80
New Zealand 18 5.18 14 Guatemala 80 3.38 89
Israel 19 5.09 20 Bosnia and Hercegovina 81 3.38
Estonia 20 5.08 22 Tanzania 82 3.38 69
Hong Kong SAR 21 5.06 24 Zambia 83 3.36 88
Chile 22 5.01 28 Macedonia, FYR 84 3.34 81
Spain 23 5.00 23 Venezuela 85 3.30 82
Portugal 24 4.96 25 Ukraine 86 3.27 84
Belgium 25 4.95 27 Malawi 87 3.24 76
Luxembourg 26 4.95 21 Mali 88 3.24 99
France 27 4.92 26 Serbia and Montenegro 89 3.23 77
Bahrain 28 4.91 Ecuador 90 3.18 86
Korea 29 4.90 18 Pakistan 91 3.17 73
Ireland 30 4.90 30 Mozambique 92 3.17 93 xiii
Malaysia 31 4.88 29 Nigeria 93 3.16 87
Malta 32 4.79 19 Georgia 94 3.14
Slovenia 33 4.75 31 Nicaragua 95 3.12 90
Thailand 34 4.58 32 Madagascar 96 3.11 96
Jordan 35 4.58 34 Honduras 97 3.10 94
Lithuania 36 4.57 40 Bolivia 98 3.09 85
Greece 37 4.56 35 Zimbabwe 99 3.03 97
Cyprus 38 4.56 Paraguay 100 2.99 95
Hungary 39 4.56 33 Ethiopia 101 2.93 92
Czech Republic 40 4.55 39 Bangladesh 102 2.84 98
South Africa 41 4.53 42 Angola 103 2.72 100
Tunisia 42 4.51 38 Chad 104 2.50 101
Slovak Republic 43 4.43 43
* Note that these are the published rankings from 2003. The three countries not
Latvia 44 4.43 37
covered this year (Cameroon, Haiti, and Senegal) are not shown.
Botswana 45 4.30 36
China 46 4.29 44
Italy 47 4.27 41
Mexico 48 4.17 47
Mauritius 49 4.14 46
Costa Rica 50 4.12 51
Trinidad and Tobago 51 4.12 49
Namibia 52 4.11 52
El Salvador 53 4.10 48
Uruguay 54 4.08 50
India 55 4.07 56
Morocco 56 4.06 61
Brazil 57 4.05 54
Panama 58 4.01 59
Bulgaria 59 3.98 64
Poland 60 3.98 45
Croatia 61 3.94 53
Egypt 62 3.88 58
(contd.)
 Executive Summary
leaders, the largest improvement has been registered by
Norway, which has moved up from ninth to sixth place
since 2003. Norway improved in all three areas of the
Index, 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 occupy
privileged positions in the GCI ranking.
The GCI does a reasonably good job not only of
ranking countries vis--vis each other, but also of tracking
shifts in rank over time.This is perhaps not surprising in
the case of the macroeconomic environment index, which
is made up overwhelmingly of hard data variables
Norway, Estonia, and New Zealand get credit for running
budget surpluses, while Turkey, India, and Japan are penal-
ized for running large deficitsbut applies to other com-
ponents of the GCI as well.
Those countries showing the largest drops in rankings
in 2004Bolivia, the Dominican Republic, Pakistan,
Peru, Philippines, Poland,Vietnam, to name someare all
countries that have witnessed significant deteriorations in
one or more areas tracked by the Index. Others, such as
Venezuela and Zimbabwe, already low last year, have
dropped even further. Indeed, all of these countries have
been prominent in the pages of the international press.
Highly visible instances of official corruption, a crack-
down on press freedoms and other civil liberties which
xiv contribute to capital outflows and harden the mood of the
business community, political instability linked to domestic
infighting 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 in
the rankings, when they show not only improvements in
the macroeconomic environmente.g. Argentina in 2003,
following the countrys harrowing experiences the previ-
ous yearbut some other factors, directly or indirectly
reflected in those variables tracked by the index.We are
not 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 its
performance significantly, moving up from 28th to 22nd
place in the overall rankings. Chile not only has the high-
est ranking in Latin America, but the gap with respect to
its nearest rival (Mexico) is a full 26 places; there is no
other continent in the world where we can observe this
symbolic migration from the region, in terms of per-
formance. Chiles case is featured separately in Chapter 2.3
of this Report.
In Asia, the rankings are quite stable, with some small
improvementsnotably Indonesia and, more significantly,
Japan, the latter by two placesand some small drops in
the 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, the
latter noted above. Koreas drop is linked to a significant
decline in the macroeconomic environment subindex,
falling from 23rd last year to 35th this year; moreover,
Korea also experienced declines in the other two areas
measured by the GCI.Vietnams decline is linked to
significant drops in all three areas, particularly with regard
to public institutions and technology.
Countries in sub-Saharan Africa continue to hold
places primarily at the bottom of the rankings, with a few
bright exceptions. South Africa improved its performance
somewhat, 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-Saharan
African countries, with a relatively strong performance,
particularly in its public institutions, and a relatively
healthy 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 remains
to be done to improve competitiveness in Africa.Table 2
provides more detailed information on the components
of each of the three subindexes of the GCI for all 104
countries in 2004.
The Business Competitiveness Index
The Business Competitiveness Index (BCI) is a comple-
ment to the medium-term, macroeconomic approach of
the Growth Competitiveness Index. It evaluates the
underlying microeconomic conditions defining the current
sustainable level of productivity in each of the countries
covered, the underlying concept being that, while macro-
economic and institutional factors are critical for national
competitiveness, these are necessary but not sufficient fac-
tors for creating wealth.Wealth is actually created at the
microeconomic level by the companies operating in each
economy.The BCI evaluates two specific areas, critical to
the 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 nations companies compete.The idea is
that, without these microeconomic capabilities, macroeco-
nomic and institutional reforms will not bear full fruit.
This years BCI rankings are shown in Table 3.The
first column shows the overall rankings, while the second
and third columns show the two interrelated subindexes:
company operations and strategy, and the quality of the
national business environment.
The table shows that the United States has taken
over the leading position from Finland, after dropping to

second place last year.The United States benefited from
improvements 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 rankings
include Hong Kong, by reflecting more sophisticated
financial markets and improvements in management prac-
tices, Japan, by improving financial market sophistication
and improving quality of administrative services, and
Portugal, by improving cluster strength. Japan registered
the highest absolute improvement of its BCI score, fol-
lowed by Hong Kong and Norway.
Advanced countries, which dropped in the rankings
include 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 with
that of Portugal and the Czech Republic. Italy deteriorat-
ed especially in areas related to innovative capacity, such as
university-industry research collaboration, foreign technol-
ogy licensing, government procurement of advanced tech-
nology, company R&D spending, and venture capital
availability.
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 by
strong across-the-board improvements, especially in the
area of company sophistication. Romanias improvement
comes after repeated slippage in the ranking since the
country became part of The Global Competitiveness Report
in 2001.
Middle-income countries which have experienced a
fall in ranking include Latvia, the Dominican Republic,
Poland, and Mauritius. Other countries with significant
absolute drops in BCI scores include Thailand and
Mexico. Latvia has moved back to a level consistent with
its longer-term trajectory; last years strong improvement
proved to be unsustainable optimism.The Dominican
Republic, down 13 places, continues the trend set by a
large drop last year, driven particularly by a decline in
openness to imports, and in the sophistication of its finan-
cial market.
Among low-income countries, Indonesia made the
greatest improvement, jumping a remarkable 18 ranks.
After years of turmoil, the country is now back to its 2000
business competitiveness level.While improvements were
registered in areas across the board, they were strongest in
measures of company sophistication. Another low-income
country with large improvements is India, up 8 ranks,
showing the benefits of increased company sophistication
and strengthened clusters.Vietnam slipped significantly,
down 23 places, after a number of years of steady
improvement. Conditions worsened most in areas related
to technology and government administration.
Executive Summary
As explained above, the GCI and the BCI measure
complementary dimensions of competitiveness. Figure 1
compares the two rankings for 2004, revealing their high
correlation.
A look aheadthe new Global Competitiveness Index
Over the last several years the Growth Competitiveness Index
has been a useful tool in thinking about key macroeco-
nomic and institutional elements, critical to the growth
process.The present rankings continue to provide policy-
makers, businesses and organizations of civil society with
valuable insights into areas where further progress is called
for, in order to improve the environment for private sector
economic activity, and generate sustainable growth.
The considerable utility of the GCI notwithstanding,
the vertiginous pace of change of the global economy has
brought into sharper focus the increasing role played by a
number of other factors in enhancing the ability of coun-
tries to grow.The swift pace of innovation in information
and communications technology, and the concomitant fall
in the costs of communication is leading to an accelera-
tion in the pace of integration of the world economy.The
increasingly global perspective of businesses in formulating
their strategies and decision makingalready manifesting
a global reach in the search for new markets and sources
of supplyhas now extended to the location of produc- xv
tion, and resulted in the increasing internationalization of
the labor force of the typical multinational corporation.
Innovations in transportation, which have reduced the cost
of freight, mean that location is less of a factor than in the
past, and businesses are now looking for the right combi-
nation of labor costscoupled, ideally, with flexible labor
marketsskills, infrastructure, and the support provided by
a good macroeconomic and institutional environment to
reduce production costs.
Against the backdrop of these changes, countries are
being forced to be increasingly creative, in order to main-
tain their competitive edge.The role of multi-country
alliances in bringing together better combinations of capi-
tal, labor, skills and regulatory frameworks for particular
projects is becoming more important. Countries with the
nimbleness demanded for such cross-border arrangements
are reaping the benefits of higher economic growth rates
and improvements in living standards. Countries which are
not allocating sufficient resources to improve the quality
of their educational systems or to address major public
health concerns, or which are otherwise engulfed in inter-
nal conflicts and instability, are rapidly falling behind.The
net effect of these trends is the growing complexity in
the economic, social and political underpinnings of the
environment faced by policymakers and business leaders
everywhere.This is not only putting enormous stress on
the institutions that sustain and support the global economy,
 Executive Summary

Table 2: Growth Competitiveness Index components

Growth Competitiveness Index (GCI) Technology Index

GCI GCI GCI GCI
2004 2004 2004 2004
Country rank score Country rank score Country Rank Score Country Rank Score

Finland 1 5.95 Bulgaria 59 3.98 United States 1 6.24 Bulgaria 59 3.82

United States 2 5.82 Poland 60 3.98 Taiwan 2 6.04 Dominican Republic 60 3.80
Sweden 3 5.72 Croatia 61 3.94 Finland 3 5.92 Philippines 61 3.72
Taiwan 4 5.69 Egypt 62 3.88 Sweden 4 5.80 China 62 3.72
Denmark 5 5.66 Romania 63 3.86 Japan 5 5.68 India 63 3.72
Norway 6 5.56 Colombia 64 3.84 Denmark 6 5.34 Botswana 64 3.70
Singapore 7 5.56 Jamaica 65 3.82 Switzerland 7 5.25 Egypt 65 3.68
Switzerland 8 5.49 Turkey 66 3.82 Israel 8 5.25 Namibia 66 3.66
Japan 9 5.48 Peru 67 3.78 Korea 9 5.18 Russian Federation 67 3.65
Iceland 10 5.44 Ghana 68 3.78 Norway 10 5.17 Colombia 68 3.60
United Kingdom 11 5.30 Indonesia 69 3.72 Singapore 11 5.11 El Salvador 69 3.60
Netherlands 12 5.30 Russian Federation 70 3.68 Germany 12 5.08 Venezuela 70 3.60
Germany 13 5.28 Algeria 71 3.67 Canada 13 5.05 Peru 71 3.45
Australia 14 5.25 Dominican Republic 72 3.63 Iceland 14 5.05 Kenya 72 3.31
Canada 15 5.23 Sri Lanka 73 3.57 Estonia 15 5.01 Indonesia 73 3.31
United Arab Emirates 16 5.21 Argentina 74 3.54 Netherlands 16 4.98 Morocco 74 3.30
Austria 17 5.20 Gambia 75 3.52 Australia 17 4.93 Serbia and Montenegro 75 3.30
New Zealand 18 5.18 Philippines 76 3.51 United Kingdom 18 4.92 Macedonia, FYR 76 3.26
Israel 19 5.09 Vietnam 77 3.47 Czech Republic 19 4.88 Uganda 77 3.22
Estonia 20 5.08 Kenya 78 3.45 Spain 20 4.86 Ghana 78 3.21
Hong Kong SAR 21 5.06 Uganda 79 3.41 Malta 21 4.85 Guatemala 79 3.18
Chile 22 5.01 Guatemala 80 3.38 Austria 22 4.85 Georgia 80 3.18
Spain 23 5.00 Bosnia and Hercegovina 81 3.38 Portugal 23 4.78 Sri Lanka 81 3.17
Portugal 24 4.96 Tanzania 82 3.38 New Zealand 24 4.76 Bosnia and Hercegovina 82 3.15
Belgium 25 4.95 Zambia 83 3.36 United Arab Emirates 25 4.71 Ukraine 83 3.15
Luxembourg 26 4.95 Macedonia, FYR 84 3.34 Slovenia 26 4.71 Tanzania 84 3.12
France 27 4.92 Venezuela 85 3.30 Malaysia 27 4.67 Gambia 85 3.12
Bahrain 28 4.91 Ukraine 86 3.27 Slovak Republic 28 4.67 Zimbabwe 86 3.04
xvi Korea 29 4.90 Malawi 87 3.24 Hungary 29 4.66 Pakistan 87 3.02
Ireland 30 4.90 Mali 88 3.24 France 30 4.65 Ecuador 88 3.01
Malaysia 31 4.88 Serbia and Montenegro 89 3.23 Belgium 31 4.59 Nigeria 89 2.99
Malta 32 4.79 Ecuador 90 3.18 Chile 32 4.55 Zambia 90 2.98
Slovenia 33 4.75 Pakistan 91 3.17 Lithuania 33 4.51 Paraguay 91 2.94
Thailand 34 4.58 Mozambique 92 3.17 Hong Kong SAR 34 4.49 Vietnam 92 2.92
Jordan 35 4.58 Nigeria 93 3.16 Bahrain 35 4.47 Honduras 93 2.89
Lithuania 36 4.57 Georgia 94 3.14 Latvia 36 4.46 Mozambique 94 2.89
Greece 37 4.56 Nicaragua 95 3.12 Ireland 37 4.43 Bolivia 95 2.81
Cyprus 38 4.56 Madagascar 96 3.11 Greece 38 4.42 Nicaragua 96 2.78
Hungary 39 4.56 Honduras 97 3.10 Cyprus 39 4.36 Malawi 97 2.74
Czech Republic 40 4.55 Bolivia 98 3.09 South Africa 40 4.33 Algeria 98 2.67
South Africa 41 4.53 Zimbabwe 99 3.03 Luxembourg 41 4.28 Madagascar 99 2.64
Tunisia 42 4.51 Paraguay 100 2.99 Brazil 42 4.24 Bangladesh 100 2.62
Slovak Republic 43 4.43 Ethiopia 101 2.93 Thailand 43 4.24 Mali 101 2.52
Latvia 44 4.43 Bangladesh 102 2.84 Mauritius 44 4.19 Angola 102 2.30
Botswana 45 4.30 Angola 103 2.72 Poland 45 4.19 Ethiopia 103 2.17
China 46 4.29 Chad 104 2.50 Croatia 46 4.15 Chad 104 1.81
Italy 47 4.27 Romania 47 4.13
Mexico 48 4.17 Mexico 48 4.13
Mauritius 49 4.14 Jamaica 49 4.12
Costa Rica 50 4.12 Italy 50 4.08
Trinidad and Tobago 51 4.12 Jordan 51 4.02
Namibia 52 4.11 Turkey 52 4.01
El Salvador 53 4.10 Panama 53 4.00
Uruguay 54 4.08 Trinidad and Tobago 54 3.98
India 55 4.07 Costa Rica 55 3.97
Morocco 56 4.06 Uruguay 56 3.92
Brazil 57 4.05 Argentina 57 3.87
Panama 58 4.01 Tunisia 58 3.87
(contd.) (contd.)

Source: World Economic Forum

 Executive Summary
Table 2: Growth Competitiveness Index components (contd.)

Public Institutions Index Macroeconomic Environment Index

Country Rank Score Country Rank Score Country Rank Score Country Rank Score

Denmark 1 6.59 Mexico 59 4.28 Singapore 1 5.79 Croatia 59 3.81

Iceland 2 6.58 Panama 60 4.26 Norway 2 5.54 Bulgaria 60 3.77
Finland 3 6.48 Colombia 61 4.25 Finland 3 5.47 Panama 61 3.76
New Zealand 4 6.41 Turkey 62 4.22 Denmark 4 5.36 Namibia 62 3.76
Norway 5 6.35 Malawi 63 4.20 Switzerland 5 5.24 Indonesia 63 3.74
Sweden 6 6.31 Trinidad and Tobago 64 4.18 Luxembourg 6 5.23 Costa Rica 64 3.72
United Kingdom 7 6.23 Mauritius 65 4.16 Netherlands 7 5.13 Ghana 65 3.68
Switzerland 8 6.22 Zambia 66 4.16 United Kingdom 8 5.11 Colombia 66 3.67
Hong Kong SAR 9 6.22 Algeria 67 4.13 Taiwan 9 5.11 Pakistan 67 3.63
Singapore 10 6.21 Indonesia 68 4.12 Austria 10 5.11 Peru 68 3.60
Germany 11 6.21 Jamaica 69 4.11 United Arab Emirates 11 5.09 Philippines 69 3.59
Australia 12 6.10 Egypt 70 4.10 Iceland 12 5.09 Mali 70 3.55
Netherlands 13 6.08 Dominican Republic 71 4.08 Hong Kong SAR 13 5.05 Romania 71 3.50
Luxembourg 14 5.99 Sri Lanka 72 4.08 Australia 14 5.04 Tanzania 72 3.47
Austria 15 5.99 Zimbabwe 73 3.99 United States 15 5.04 Sri Lanka 73 3.46
Japan 16 5.88 Romania 74 3.94 Spain 16 4.99 Bangladesh 74 3.42
Ireland 17 5.87 Kenya 75 3.87 Sweden 17 4.99 Uganda 75 3.41
Canada 18 5.84 Croatia 76 3.86 Canada 18 4.97 Ukraine 76 3.39
United Arab Emirates 19 5.82 Ethiopia 77 3.80 Belgium 19 4.92 Macedonia, FYR 77 3.37
Chile 20 5.77 Bosnia and Hercegovina 78 3.80 Malaysia 20 4.91 Madagascar 78 3.36
United States 21 5.74 Argentina 79 3.77 Ireland 21 4.85 Guatemala 79 3.36
Belgium 22 5.71 Poland 80 3.70 New Zealand 22 4.80 Brazil 80 3.28
Portugal 23 5.69 Nicaragua 81 3.68 Thailand 23 4.79 Mozambique 81 3.26
Israel 24 5.64 Vietnam 82 3.66 China 24 4.78 Honduras 82 3.23
France 25 5.62 Mali 83 3.66 France 25 4.78 Jamaica 83 3.23
Estonia 26 5.59 Guatemala 84 3.61 Germany 26 4.77 Turkey 84 3.22
Taiwan 27 5.56 Serbia andMontenegro 85 3.61 Chile 27 4.71 Bosnia and Hercegovina 85 3.19
Bahrain 28 5.56 Uganda 86 3.61 Bahrain 28 4.70 Kenya 86 3.18
Jordan 29 5.43 Bolivia 87 3.55 Japan 29 4.67 Nigeria 87 3.17 xvii
Malta 30 5.39 Tanzania 88 3.54 Estonia 30 4.65 Gambia 88 3.13
Slovenia 31 5.28 Russian Federation 89 3.54 Greece 31 4.52 Ecuador 89 3.10
Uruguay 32 5.23 Ecuador 90 3.42 Tunisia 32 4.52 Uruguay 90 3.10
Cyprus 33 5.18 Venezuela 91 3.41 Lithuania 33 4.46 Chad 91 3.08
Spain 34 5.16 Macedonia, FYR 92 3.41 Portugal 34 4.42 Georgia 92 3.07
South Africa 35 5.15 Angola 93 3.38 Korea 35 4.41 Dominican Republic 93 3.00
Tunisia 36 5.14 Mozambique 94 3.36 Jordan 36 4.29 Argentina 94 2.96
Hungary 37 5.07 Madagascar 95 3.32 Latvia 37 4.27 Zambia 95 2.96
Malaysia 38 5.06 Nigeria 96 3.31 Italy 38 4.27 Bolivia 96 2.90
Botswana 39 4.98 Ukraine 97 3.29 Slovenia 39 4.26 Nicaragua 97 2.90
Namibia 40 4.92 Paraguay 98 3.24 Algeria 40 4.23 Venezuela 98 2.89
Korea 41 4.81 Philippines 99 3.21 Czech Republic 41 4.22 Ethiopia 99 2.81
Morocco 42 4.75 Honduras 100 3.19 Botswana 42 4.21 Malawi 100 2.79
Lithuania 43 4.75 Georgia 101 3.17 Israel 43 4.20 Paraguay 101 2.77
Greece 44 4.74 Pakistan 102 2.87 Trinidad and Tobago 44 4.20 Serbia and Montenegro 102 2.77
Thailand 45 4.71 Chad 103 2.61 Cyprus 45 4.14 Angola 103 2.46
El Salvador 46 4.71 Bangladesh 104 2.47 Morocco 46 4.13 Zimbabwe 104 2.07
Costa Rica 47 4.69 Malta 47 4.11
Italy 48 4.64 South Africa 48 4.11
Slovak Republic 49 4.64 Mexico 49 4.09
Brazil 50 4.62 Mauritius 50 4.08
Czech Republic 51 4.56 Poland 51 4.05
Latvia 52 4.55 India 52 4.05
India 53 4.45 El Salvador 53 3.99
Ghana 54 4.44 Slovak Republic 54 3.98
China 55 4.39 Hungary 55 3.95
Bulgaria 56 4.36 Russian Federation 56 3.87
Gambia 57 4.30 Egypt 57 3.86
Peru 58 4.28 Vietnam 58 3.82
(contd.) (contd.)
 Executive Summary

Table 3: The Business Competitiveness Index

Company Quality of the Company Quality of the

BCI operations and national business BCI operations and national business
Country ranking strategy ranking environment ranking Country ranking strategy ranking environment ranking

United States 1 2 2 Ukraine 69 64 71

Finland 2 7 1 Philippines 70 50 77
Germany 3 1 5 Uganda* 71 75 69
Sweden 4 5 6 Croatia 72 72 70
Switzerland 5 4 7 Pakistan 73 67 75
United Kingdom 6 8 4 Argentina 74 68 78
Denmark 7 9 3 Bulgaria 75 86 72
Japan 8 3 11 Peru 76 77 74
Netherlands 9 6 9 Uruguay 77 80 76
Singapore 10 13 8 Zambia* 78 85 73
Hong Kong SAR 11 15 10 Vietnam 79 81 79
France 12 10 16 Dominican Republic 80 74 83
Australia 13 19 12 Nigeria* 81 76 80
Belgium 14 11 19 Zimbabwe 82 79 84
Canada 15 16 13 Macedonia, FYR 83 84 82
Austria 16 14 17 Malawi 84 83 85
Taiwan 17 12 20 Serbia and Montenegro 85 87 81
New Zealand 18 20 15 Guatemala 86 78 90
Iceland 19 17 18 Madagascar 87 88 88
Norway 20 23 14 Venezuela 88 82 91
Israel 21 18 21 Algeria 89 93 86
Ireland 22 22 22 Tanzania 90 92 87
Malaysia 23 28 23 Mali* 91 95 89
Korea 24 21 28 Georgia 92 89 93
South Africa 25 24 25 Bosnia and Hercegovina 93 96 92
Spain 26 25 27 Ecuador 94 90 95
Estonia 27 34 24 Bangladesh 95 97 94
United Arab Emirates* 28 32 26 Mozambique 96 94 98
Chile 29 33 29 Honduras 97 91 100
India 30 30 32 Paraguay 98 98 96
Slovenia 31 27 33 Ethiopia 99 101 97
Tunisia 32 43 30 Nicaragua 100 100 99
xviii
Portugal 33 42 31 Bolivia 101 99 101
Italy 34 26 43 Chad* 102 103 102
Czech Republic 35 31 37 Angola* 103 102 103
Lithuania 36 37 35
Thailand 37 36 36 *Survey data for these countries have high within-country variance. Until the
Brazil 38 29 44 reliability of survey responses improves, with future educational efforts and
improved sampling in these countries, their rankings should be interpreted with
Slovak Republic 39 41 39
caution.
Bahrain* 40 53 34
Greece 41 40 42
Hungary 42 48 38
Jordan 43 54 40
Indonesia 44 38 46
Cyprus 45 59 41
Morocco 46 45 45
China 47 39 47
Costa Rica 48 35 50
Latvia 49 51 48
Malta 50 60 49
Namibia 51 63 51
Turkey 52 44 55
Mauritius 53 49 54
Jamaica 54 52 53
Mexico 55 46 56
Romania 56 61 57
Poland 57 47 64
Colombia 58 58 61
Trinidad and Tobago 59 55 62
Panama 60 66 58
Russian Federation 61 62 60
Botswana 62 73 52
Kenya 63 56 63
Ghana 64 71 59
El Salvador 65 65 65
Egypt* 66 57 68
Gambia* 67 70 66
Sri Lanka 68 69 67
(contd.)
 Executive Summary
Figure 1: Growth and Business Competitiveness rankings

100
Bosnia and Herzegovina
90 Algeria
Zimbabwe
80 Bulgaria
Uruguay
Business Competitiveness ranking

Pakistan
70
Ukraine
Botswana Kenya
60

50 Malta
Indonesia
40 Brazil
Portugal
United Arab Emirates
30 India
Norway South Africa
Iceland
20 Belgium
Taiwan
France
10
Hong Kong SAR
Finland Germany
0
0 Switzerland 20 40 60 80 100
United States Sweden
Growth Competitiveness ranking

but is also changing our understanding of what are insight. Others are concerned with a broader set of issues xix
emerging as the key factors determining a countrys at the heart of the development agenda. All are business
growth performance. relevant, and highlight a range of issues which are various-
To address some of these challenges, we have been ly shaping the global economic and business environment.
working with Xavier Sala-i-Martin and Elsa Artadi to
develop a more comprehensive competitiveness index. Selected issues of competitiveness
Reflecting the need to broaden our scope and look at a Daniel Kaufmanns Corruption, Governance and
larger set of factors, the new index will bring into focus a Security: Challenges for the Rich Countries and the
much richer set of pillars: human capital, labor and finan- World is an important addition to the literature in an
cial markets efficiency, openness and market size, quality of increasingly important field.Traditionally, governance and
infrastructure, to name a few of the new ones being incor- corruption challenges have been seen as especially daunt-
porated; in this spirit, it will be called the Global ing in poorer countries, with the richer ones viewed as
Competitiveness Index. Chapter 1.3 of this Report is an good examples, with their relative law and order, and well
excellent presentation of the work that has been done to developed institutions. Others might view them as public
date. 2004 therefore constitutes a transition year between sector problems, divorced from global governance or secu-
the presentation of two indexes, the GCI and the BCI, rity issues. Using an empirical approach, based on this
and the subsequent consolidation of the World Economic years EOS, Kaufmann challenges these notions, and shows
Forums competitiveness work into a single indexthe us a more complex reality, revealing more subtle, yet costly
Global Competitiveness Index. manifestations of misgovernance, afflicting not only poor,
but rich countries as well.The traditional definition of
corruption as the commission of an illegal act, such as
Selected issues of competitiveness and special topics outright bribery, is here broadened to include new meas-
This years Report contains a number of studies which ures of legal corruption, seen as the collusion of at least
address different aspects of competitiveness and, more gen- two parties, typically from the public and private sectors,
erally, themes which emanate from the World Economic and where the rules of the game, laws and institutions are
Forums deep concern with growth and development and used, via influence peddling and even capture, to benefit
the state of the world. Some of these studies draw directly vested interests.
from the Executive Opinion Survey for their analysis and
Executive Summary
By analyzing the interaction between rich country
transnationals and the public sectors in emerging coun-
tries, Kaufmann finds that ethics and corruption pose a
serious challenge for many rich countries, and that they
represent key determinants of a countrys competitiveness,
shaping its investment climate. Kaufmann ends his chapter
with an insightful analysis of the governance data from the
EOS, separating the issues of national governance and
global and domestic security, and challenging the notion
that security issuescommon crime, organized crime,
money laundering, and the threat of terrorismare not
subject to measurement.The evidence suggests that some
rich countries are faced not only with domestic challenges
of undue influence, as regards many key public policies,
laws and regulations, but with a new set of security threats
as well; even with their well-developed institutions, the
G-7 and other rich countries must face the challenge of
guaranteeing level playing fields and mitigating the cost of
terrorist 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 to
business, since environmental regulations have increased
costs. A review of global environmental problems reveals
not only challenges and risks for the private sector that
cannot be ignored, but also opportunities for businesses
xx that can work to their competitive advantage. Dahl high-
lights the significant potential for business leadership in
the field of environment and sustainable development at
each stage of the development process. By taking a posi-
tive, proactive view, the private sector can ensure supplies
of raw materials, increase efficiency, and generate new
technologies to respond to these problems, thus opening
up new markets, reducing costs, and allowing more time
for adaptation, with phased investments and reduced
write-offs or special charges.
The 2004 Executive Opinion Survey evaluates the
views of business leaders on environmental and social
responsibility issues, and demonstrates both the impor-
tance of governmental leadership in providing an effective
regulatory climate, and the key role of business leadership
in addressing environmental and social issues proactively.
In Dahls analysis, countries are rated not on their present
environmental status, but on the efforts of both business
and government to improve that status, and to anticipate
and address emerging problems. Nine countries received
high ratings, another 34 were positive on balance, while
24 showed progress in some areas, and 38 were making lit-
tle or no effort to be environmentally responsible. Some
emerging economies and developing countries scored
well, driven perhaps by dynamic business sectors and
enlightened governments, while some industrialized coun-
tries were ranked far below their peers, suggesting a need
for greater efforts to remain competitive.The results
strongly suggest that combined efforts by business and
government to facilitate corporate social and environmen-
tal responsibility do, indeed, generate a competitive edge.
In Chile:The Next Stage of Development, Augusto
Lopez-Claros notes that Chile has managed to grow faster
than many other countries in the developing world,
boosting per capita incomes, and making further progress
to reduce poverty levels. It has done so against a backdrop
of fiscal discipline and rapidly declining public debt levels,
while maintaining an admirably open trade and foreign
investment regime, and improving to a remarkable degree
the quality of its public institutions, which have played a
stabilizing and pivotal role in the countrys recent evolu-
tion. By a wide margin, Chile is the most competitive
economy in Latin America.
The author identifies a number of areas where chal-
lenges remain, however, if Chile is to make a successful
transition to the next stage of its development.This phase
will require a combination of comparative advantages and
the adoption of new technologies to facilitate the emer-
gence of clusters, centered mainly on the natural resource
sectors and the upstream development of supporting
industries with higher value added. Critical to this process
of development will also be a substantial upgrading in the
quality of Chiles educational system, which remains sur-
prisingly inefficient, given the countrys income levels.
Lopez-Claros also raises the question of whether the
countryand in particular its political leadershiphave
reached the right balance, as regards the role of the state in
the economy.Without doubt, the country has benefited
from a system that has built in a number of safeguards to
protect the public interest from the short-term interests of
passing politicians, and from various forms of abuse. But
this approach may need to make room for a more active
role for the state, as has been done in Finland, with regard
to the support for new ventures, aimed at enhancing the
countrys potential for innovation.
Chile aside, in The Future of Competitiveness-
Enhancing Reforms in Latin America, Mario Blejer
argues that despite a recent pickup in growth, the region
continues to confront important challenges and faces seri-
ous struggles ahead.The difficulties concern the uncer-
tainty regarding the sustainability of macroeconomic
recovery and, more importantly, the capacity of the region
to address long-term structural weaknesses. A significant
problem in Latin America is the incomplete nature of the
reforms, evidenced by deficiencies in institutional develop-
ment, and reflected in the loss of competitiveness. Indeed,
Latin America is falling behind, not only with respect to
the economies of East Asia but, more significantly, with
respect to the transition economies of central and eastern
Europe.
In answer to the question what explains this worri-
some trend, Blejer suggests that in most cases, reforms

have remained incomplete and their economic benefits
have not been fully realized. Some of the successes in
creating a more stable macroeconomic environment have
not been complemented by more broad-based second
generation reforms. He points out that any assessment
of the current political and social realities in the region
suggests that the short term prospects for further imple-
mentation of market-oriented reforms would seem bleak.
Reforms have not had the anticipated effects on growth
and employment and, against a groundswell of the anti-
globalization movement, the entire concept of structural
reformwith the exception of Chilehas been systemat-
ically maligned and discredited across Latin America. In
such an environment, it is clear that there is a widespread
lack of enthusiasm for further reforms. In practice, the
design and introduction of a realistic reform agenda would
require two key elements: compensation for those who are
bound to be negatively affected from the process, and a
better set of international incentives for governments and
countries willing to swim against the current of public
opinion, and take the necessary steps to improve their
economy.
In International Productivity Comparisons: the
Importance of Hours of Work, Andrew Warner challenges
the traditional measures of productivity, by highlighting
the importance of hours worked. He demonstrates that
while growth of GDP or GDP per capita puts the United
States clearly ahead of most industrial countries during the
boom years of the new economy (19952000), this
supremacy is not quite so obvious when data on growth
of 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 last
decade. Using GDP per hour calculations, he shows the
clear lead of some European countries over the United
States, and implies that the European productivity slow-
down may be more myth than reality, when we focus on
per hour data.
Given uncertainties about the reliability and compara-
bility of existing data on hours worked, as well as lack of
coverage of poorer countries, questions were introduced
into the 2004 Executive Opinion Survey on the extent of
hours worked.Warner uses this unique dataset to reveal
interesting differences between the trends observed in
industrial countries and those in developing nations.Wage
labor in low-income countries work particularly long
hours, whereas in rich countries as a whole, there is a
trend for executive workers to put in more hours than
hourly 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
Executive Summary
perception of labor practices and business regulations as
barriers to productivity does not appear to be directly
related to income level, lack of skilled labor appears to be
a hindrance in high-income countries, while the lack of
infrastructure is typically, but not surprisingly, perceived as
a productivity barrier in most low-income countries.
Special topics
By analyzing trends in population growth, per capita
income, and the effects of the IT revolution, Richard
Cooper, in A Glimpse of 2020, offers an insightful
perspective on what the world will look like two decades
from now. Cooper paints contrasting demographic scenar-
ios for 2020: low-income countries will see rapid popula-
tion increase, placing heavy pressures on energy demand
and urban infrastructure; rich countries will experience
population decline, and a much higher ratio of elderly to
working age, severely taxing governments abilities to
maintain the high social benefits to which their citizens
have grown accustomed.
Dramatically decreased costs of communication will
increase mobility, reduce economic and cultural differ-
ences between the regions of the world, but increase
international cooperation, not only in areas such as finan-
cial regulation, tax and law enforcement and technology
exchange, but also in the willingness of nations to inter-
vene where national governments have failed. Despite the xxi
natural attraction of familiar languages and social environ-
ments, businesses are becoming footloose, increasingly
driven 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 business
and terrorism will become increasingly international in
scope, 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 is
bound to be uncertainty following the inevitable demise
of current dictators, more South Koreas will arise, i.e.
developing countries which grow rapidly, democratize and
join the ranks of the rich, forming new market opportuni-
ties. Particular attention is paid to China, whose GDP by
2020 could make it the worlds third largest economy, and
where, although still poor, the high ratio of wage earners
to dependents will enable the country to become a major
world 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 our
societiesdemographic, technological, climatological, and
geopoliticalare visible on the long-term horizon. In
Confronting Long-Term Fiscal Challenges:Why it
Matters for the Global Economy, Peter Heller takes up an
issue raised by Cooper in his own article, and perceptively
explains why some of these challenges are predictable,
 Executive Summary
while others are vague and uncertain. Even when clearly
anticipated, uncertainty still surrounds developments
whose horizon may be measured in decades. Some, such
as aging populations, pose a threat to the financial solven-
cy of national governments, raising the prospect of vastly
increased future public outlays, whether for pensions,
health care, long-term chronic care, infrastructure, or
security. Accentuating these fiscal risks is the fact that the
future resources of governments are already precommitted
to an unprecedented extent. Not surprisingly, political
economy factors work against efforts to address these
challenges.
Heller contends that governments must do much
more, now, to prepare for the fiscal consequences of the
developments that their countries face over the next sev-
eral decades.The agenda for action will depend on the
country, on the preferences and capacities of its people
and institutions, on the extent of its existing policy com-
mitments, and on the specific challenges it faces.
Uncertainty does not absolve fiscal policymakers from the
burden of addressing long-term issues.What they do, or
fail to do, will critically influence both the welfare of cur-
rent and future generations, and the role and capacity of
the state itself. Delay in addressing these changes will only
increase their costs, some of which will be borne by those
living today.What to do? Heller suggests that no single
xxii policy reform will suffice to meet long-term challenges.
Reform must proceed on many fronts, utilizing additional
analytic techniques, strengthening institutions to clarify
and monitor evolving budget trends, introducing detailed
policy reforms, the sustained strengthening of the aggre-
gate fiscal position, and working with other countries on
areas where collective action is required.
In a compelling contribution to this years Report,
entitled Agricultural Policies in OECD Countries: an
Agenda for Reform, Stefan Tangermann makes a number
of fundamental points, which cast refreshing light on a
complex and politically charged subject.To begin with,
there is an apparent inconsistency between the rapidly
declining importance of agriculture among the 30
Member countries of the OECDwhether measured in
terms of the sectors contribution to total GDP or total
employmentand the considerable attention devoted to it
in the public debate.The resources transferred to farm-
ersan impressive US$257 billion in 2003, a full three
quarters of which taking the form of production-linked
transfersseriously distort markets and competition in
international trade.Tangermann shows that, despite long-
standing discussions about the need for reforms, the level
of support during 20012003 is only marginally lower
than during the period 19861988. However, within the
OECD as a whole, there is considerable diversity across
countries, with New Zealand and Australia having essen-
tially eliminated farm support as a result of comprehensive
reforms, and others, such as Norway and Switzerland, still
providing levels of producer support more than twice the
average in the EU, and hardly changed during the past
15 years.
Tangermann examines the reasons for these massive
transfers to farmers.Their motivation stems from a desire
to address equity concerns in societies at large, and deal
with market failures associated with the interaction
between agriculture and the environment. However, he
provides compelling data to show that, in fact, incomes of
farm households in OECD countries are in line with, if
not higher than, household incomes in the overall econo-
my.Thus, broad-based support measures such as price and
output support are unnecessary.Worse still, only 25 cents
out of every dollar of support provided to farmers actually
ends up in farmers pockets, with a large share of the rest
going to large landowners. As regards the environment, the
harsh effects of overproduction on the quality of farmland
and wildlife are well known. Finally, the extra output gen-
erated by farm policies in OECD countries depresses
prices for farm products in international trade, and has
been a contributing factor in the difficulties encountered
in promoting further multilateral trade liberalization.The
author concludes this important paper with some specific
suggestions for reform.
In his paper Can Foreign Aid Make Poor Countries
Competitive?William Easterly offers insightful answers to
the question why foreign aid has not been more successful
at 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 of
aid agencies, Easterly questions and then examines the
results of the regression analysis published in 2000 by
Craig Burnside and David Dollar, which investigated the
relationship between foreign aid, economic policy and the
growth of per capita GDP. Because of its conclusion, viz.
that aid only works in a good policy environment, this
study was widely cited by media, governments and aid
agencies, as a basis for increasing foreign aid. By expanding
the dataset, extending the time line and using alternative
definitions of aid, policy, and growth, Easterly comes
to some different and thought-provoking conclusions, to
the effect that the interaction term of aid and good policy
is no longer statistically significant. Easterly also critically
examines the financing gap approach to aid, by which it
is assumed that aid increases investment and investment
increases economic growth, finding it both theoretically
questionable and empirically deficient, leading him to
question why the international community has not held
agencies responsible for the failure of large flows of aid to
generate growth.
After discussing the detailed findings, Easterly analyzes
how aid agencies actually function, citing the excessive,
dysfunctional bureaucracy of agencies, the fact that they
 Executive Summary
are answerable to the rich donors, rather than their
voiceless recipients, the assumption of capital projects
without maintaining them, and the pernicious tendency to
overmeet, overextend and overstate. He saves particularly
trenchant criticism for the failure of aid agencies, despite
the presence of obviously well-intentioned and capable
minds, to understand the deeper implications of and truly
practice 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 aid
on the part of the rich countries most able to provide it.
He ends in a positive tone, pointing to a successful project
in Ethiopia, by making a number of serious and realistic
proposals for aid agencies, governments and development
practitioners, to assist them in revising expectations, meth-
ods, and, hopefully, outcomes.
The Report ends with a section containing detailed
country profiles for each of the 104 economies covered in
our competitiveness indexes, as well as data tables for the
variables that are used as inputs in their construction. A
brief Annex, explaining how best to interpret the infor-
mation contained in the country profiles and the data
tables, is an essential companion to this section, as are
technical notes clarifying the meaning of many variables,
and listing relevant data sources.

xxiii

CHAPTER 1.2
Building the Microeconomic
Foundations of Prosperity:
Findings from the Business
Competitiveness Index1
MICHAEL E. PORTER, Harvard University
1.2: Building the Microeconomic Foundations of Prosperity
Competitiveness has become a central preoccupation of
both advanced and developing countries in an increasingly
open and integrated world economy. Despite its acknowl-
edged importance, the concept of competitiveness is often
misunderstood. Here, we define competitiveness concretely,
show its relationship to a nations standard of living, and
outline a conceptual framework for understanding its
causes.
The Business Competitiveness Index (BCI), based on
this conceptual framework, provides a data-rich approach
to measuring and analyzing the fundamental competitive-
ness of a large number of countries in a comparative con-
text.This years BCI includes 103 countries, up one from
last year. Our aim is to rank country competitiveness
across countries, identify individual countries competitive
strengths 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 process
of economic development.
Most discussion of competitiveness and economic
development 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 and
monetary policies, a trusted and efficient legal system, a
stable set of democratic institutions, and progress on social
conditions contribute greatly to a healthy economy.
However, these broader conditions are necessary but not 19
sufficient.They provide the opportunity to create wealth
but do not themselves create wealth.Wealth is actually
created in the microeconomic level of the economy, root-
ed in the sophistication of the operating practices and
strategies of companies as well as in the quality of the
microeconomic business environment in which a nations
companies compete. Unless these microeconomic capabili-
ties improve, macroeconomic, political, legal, and social
reforms will not bear full fruit.
Beginning in 1998, we began an effort to examine
statistically the microeconomic foundations of competi-
tiveness and prosperity across a wide array of countries.
This is a daunting task, given the need to measure and
compare the complex array of national circumstances that
support a high and sustainable level of productivity.The
effort aims to move beyond the examination of broad,
aggregate variables typical of most economic growth
analyses to provide a framework for countries and compa-
nies to understand their detailed competitive strengths and
weaknesses. It also aims to be as rigorous as possible, veri-
fying the importance of each measure statistically and
using statistical techniques to weight the contribution of
individual variables. Finally, we know that improvement in
competitiveness is not a simple linear process but one
where nations at different levels of development face dif-
ferent challenges and priorities.This effort aims to high-
light these differences.
1.2: Building the Microeconomic Foundations of Prosperity
The Business Competitiveness Index seeks to explore
the underpinnings of a nations prosperity, measured by its
level of GDP per capita.The focus is on whether current
prosperity is sustainable, and on the specific areas that must
be addressed if GDP per capita is to achieve higher levels
in 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 is
more dependent on investment rates and other macroeco-
nomic policies.The sustainable level of current GDP per
capita and its rate of growth will be related in the long
term, but each area requires its own distinctive policy
agenda.The conceptual framework and statistical approach
follow that of the previous reports and the findings are
fully comparable with previous Microeconomic
Competitiveness Index results.
The analysis here is pragmatic, making use of the best
available data and econometric methods even though both
are far from perfect.We also confront the challenge of
establishing the direction of causality given limited time-
series data. However, even if definitive tests of causality are
not possible, understanding the microeconomic correlates
of prosperity remains crucial.There may be a natural ten-
dency for some microeconomic conditions to improve as
GDP per capita increases.Yet the large observed differ-
ences across countries, even those at similar income levels,
20 reveal that this improvement is far from automatic.
Despite the statistical challenges, the statistical findings
overall are remarkably stable and robust compared with
the Global Competitiveness Report 20032004 (GCR) and
earlier Reports.We expand this years analysis to include an
analysis of natural resource endowments and their role in
competitiveness, a crucial issue especially for developing
countries.The results again provide strong support for the
importance of microeconomic competitiveness for eco-
nomic development and prosperity. Our findings also veri-
fy the striking and regular pattern of microeconomic
changes that accompany economic development.
The Business Competitiveness Index (BCI) accounts
for 81 percent of the variation across countries in the level
GDP per capita.2 This level is remarkably high given the
presence of so many low- income countries and the
inherent imperfections of national income data.These
findings highlight the pressing need to better incorporate
microeconomic competitiveness agenda into efforts to
stimulate economic growth. In advanced countries, which
have largely gotten their macro policies right, it is micro
reform that holds the key to reversing unemployment
problems, to growing exports, and to translating economic
growth 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 engineer
spurts of growth through macroeconomic stabilization and
financial reforms that bring in floods of capital and create
the illusion of progress as construction cranes dot the sky-
line.Without microeconomic reforms, however, growth
will 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 that
results from such cycles, is at the heart of the backlash
against globalization.
Successful economic development requires progress
on multiple fronts simultaneously. Reform efforts need to
be tightly connected to the countrys current stage of
development. As an economy progresses, the constraints to
its continued advancement shift. At strategic points in the
development process, the whole basis of national competi-
tiveness must be transformed. Many aspects of company
strategy must be shifted and new requirements in the
national business environment must be met. Our analysis
provides the conceptual framework and comparative data
to define such national agendas, and to measure progress.
Competitiveness and its causes
Measuring and ranking competitiveness requires a clear
conceptual framework, drawing on the accumulated
knowledge 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-
trys share of world markets for its products.This makes
competitiveness a zero-sum game, because one countrys
gain comes at the expense of others.This view of compet-
itiveness is used to justify intervention to skew market
outcomes in a nations favor (so-called industrial policy). It
also underpins policies intended to provide subsidies, hold
down local wages, and devalue the nations currency, all
aimed at expanding exports. In fact, it is still often said
that lower wages or devaluation make a nation more
competitive. Business leaders are drawn to the market-
share view because these policies seem to address their
immediate competitive concerns.
Unfortunately, the most intuitive view of competi-
tiveness is deeply flawed, and acting on it works against
national economic progress.The need for low wages
reveals a lack of competitiveness and holds down prosperi-
ty. Subsidies drain national income and bias choices away
from the most productive use of the nations resources.
Devaluation results in a collective national pay cut by dis-
counting the products and services sold in world markets
while raising the cost of the goods and services purchased
 1.2: Building the Microeconomic Foundations of Prosperity
abroad. Exports based on low wages or a cheap currency, Figure 1: Determinants of productivity and productivity
then, do not support an attractive standard of living. growth
To understand competitiveness, the starting point
must be the underlying sources of prosperity. A nations
Macroeconomic, Political, Legal, and Social Context for Development
standard of living is determined by the productivity of its
economy, which is measured by the value of goods and
Sophistication Quality of the
services produced per unit of the nations human, capital, of Company Microeconomic
and natural resources. Productivity depends both on the Operations and Business
Strategy Environment
value of a nations products and services, measured by the
prices they can command in open markets and the effi- Microeconomic Foundations of Development
ciency with which they can be produced. Productivity
also depends on the ability of an economy to mobilize the
available human resources. Some European economies
report high levels of productivity per hour worked, but
high unemployment, sick leave, and limited working hours The productivity of a country is ultimately set by the
depress national income per capita.3 Much of this is not productivity of its companies. An economy cannot be
voluntary but reflects a lack of employment alternatives.4 competitive unless companies operating there are compet-
True competitiveness, then, is measured by productiv- itive, whether they are domestic firms or subsidiaries of
ity. Productivity allows a nation to support high wages, a foreign companies. However, the sophistication and pro-
strong currency, and attractive returns to capitaland with ductivity of companies is inextricably intertwined with
them a high standard of living. Productivity is the goal, the quality of the national business environment. More
not exports per se. Only if a nation increases exports of productive company operating practices and strategies
products or services that it can produce more productively require more highly skilled people, better information, more
than the average industry will national productivity rise. efficient government processes, improved infrastructure,
Also, productivity is the goal, not whether firms operating better suppliers, more advanced research institutions, and
in the country are domestic or foreign owned.What mat- more intense competitive pressure, among other things.
ters most is not ownership, but the nature and productivity Companies in a nation must upgrade their ways of 21
of the business activities taking place in a particular country. competing if successful economic development is to
Finally, purely local industries also matter for competitive- occur. Broadly, companies must shift from competing on
ness because their productivity not only sets the wages in inherited endowments (comparative advantages such as
these industries but also has a major influence on the cost low-cost labor or natural resources) to competing on
of living and the cost of doing business in the country. competitive advantages arising from efficient and distinc-
The productivity of the entire economy matters for the tive products and processes. Companies must move from
standard of living, not just the traded sector. tapping foreign distribution channels to building their
The world economy is not a zero-sum game. Many own channels.These and other transitions in corporate
nations can improve their prosperity if they can improve strategies and operating practices required for successful
productivity.The central challenge in economic develop- economic development are shown in Figure 2.
ment, then, is how to create the conditions for rapid and
sustained productivity growth.
Figure 2: Company sophistication and economic
Microeconomic foundations of productivity development
Stable political, legal, and social institutions and sound
macroeconomic policies create the potential for improving Low-Income Middle-Income High-Income
Countries Countries Countries
national prosperity. But wealth is actually created at the
microeconomic levelin the ability of firms to create Competitive Extent of regional Capacity for
advantages beyond sales innovation
valuable goods and services using efficient methods. Only cheap inputs Control of internation- Breadth of interna-
in this way can a nation support high wages and the Production process al distribution tional markets
attractive returns to capital necessary to support sustained sophistication Extent of branding Extent of incentive
Broad value chain compensation
investment (see Figure 1). presence
Company spending
on R&D Willingness to
The microeconomic foundations of productivity rest Reliance on profes- Prevalence of foreign delegate authority
sional management
on two interrelated areas: (1) the sophistication with technology licensing

which domestic companies or foreign subsidiaries com- Extent of staff

training
pete in the country, and (2) the quality of the microeco-
nomic business environment in which they operate.
1.2: Building the Microeconomic Foundations of Prosperity

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 systems
across institutions
Factor (Input) Conditions
Open and vigorous competition Demand Conditions
Presence of high quality, specialized
among locally based rivals Sophisticated and demanding
inputs available to firms
local customer(s)
Human resources
Local customer needs that
Capital resources
anticipate those elsewhere
Physical infrastructure
Administrative infrastructure Unusual local demand in special-
Information infrastructure ized segments that can be served
Scientific and technological nationally and globally
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

22 What were strengths in competing at earlier stages of
development become weaknesses at more advanced levels
of development. Extensive technology licensing works for
lower- and middle-income countries, but must give way
to indigenous technology development. Necessary changes
are often resisted by the corporate sector because past
approaches were profitable and because old habits are
deeply ingrained.
Moving to more sophisticated ways of competing
depends on parallel changes in the microeconomic busi-
ness environment.The business environment can be
understood in terms of four interrelated areas: the quality
of factor (input) conditions, the context for firm strategy
and rivalry, the quality of local demand conditions, and the
presence of the related and supporting industries. Because
of their graphical representation (see Figure 3), the four
areas have collectively become referred to as the diamond.
As the diamond framework reveals, almost everything
matters for competitiveness.The schools matter, the roads
matter, the financial markets matter, and customer sophis-
tication matters, among many other aspects of a nations
circumstances, many of which are deeply rooted in a
nations institutions, people, and culture.This makes
improving competitiveness a special challenge, because
there is no single policy or grand step that can create
competitiveness, only many improvements in individual
areas that inevitably take time to accomplish. Improving
competitiveness is a marathon, not a sprint. How to sus-
tain momentum in competitiveness improvements over
time is among the greatest challenges facing countries.
There are distinct influences on competitiveness at
multiple geographic levels: national, state, and local.5 In many
countries, we observe striking differences in economic
performance among subnational regions. In countries such
as China, India, and the United States, the benefits of
decentralization of economic policy and strong initiative
in individual regions is evident.The crucial need for eco-
nomic strategies for sub-national units such as states or
regions is among the most important new directions in
competitiveness thinking and practice.
National productivity can also be enhanced through
coordinating policies among neighboring countries. A
concerted effort to improve the business environment is
needed both within countries and across countries.
Government plays an inevitable role in economic
development 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 part
from regulatory standards, consumer protection laws, gov-
ernment purchasing practices, and openness to imports.
Similar policy influences are present in all four parts of the
diamond. Many government departments and agencies
impinge on competitiveness, as do government entities at

the provincial, state, and city levels.The question is not
whether government has a role, but what that role should
be 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 positive
roles. Government must set the right rules and incentives
and make the public investments needed for a productive
economy.
National endowments such as natural resources play a
declining role in competitiveness as the resource intensity
of the economy falls and as technology substitutes for
resources or opens up new resource locations.The real
prices of most resources or resource-intensive goods have
been falling over the decades. It is the productivity with
which natural resources can be utilized, not the resources
themselves, that normally have the strongest influence on
prosperity. Abundant natural resources also carry a risk. In
countries where natural resources are abundant or domi-
nate economic activity, forces are set in motion that limit
the development of policies, skills, and attitudes that
enhance competitiveness. Exploiting and redistributing
resource spoils can become the dominant orientation not
enhancing productivities.We explore the relationship
between natural resource endowments and competitive-
ness in a later section.
Clusters and economic development
An improving business environment gives rise to the for-
mation of clusters. Clusters are geographically proximate
groups of interconnected companies, suppliers, service
Figure 4: The Cairns Tourism Cluster
Travel Agents
Public Relations and Market
Research Services
Food Suppliers Restaurants
Property Services
Maintenance Services
Hotels
Government Agencies
Harvard University, MIT,
e.g., Australian Tourism Commission,
Great Barrier Reef Authority
Source: Research by HBS Student Team, 2003
1.2: Building the Microeconomic Foundations of Prosperity
providers, and associated institutions in a particular field,
linked by commonalities and complementarities. Clusters
such as software in India or high-performance cars in
Germany are often concentrated in a particular region
within a larger nation, and sometimes in a single town.
Clusters affect competitiveness in three broad ways:
first, by increasing the productivity of constituent firms or
industries. Firms with a cluster have more efficient access
to specialized suppliers, employees, information, and train-
ing than isolated firms.The presence of a wide range of
available inputs, machinery, skills, and knowledge promotes
greater efficiency and flexibility than vertical integration
or relationships with distant suppliers. Second, clusters
increase the capacity for innovation and productivity
growth. Opportunities for innovation are often perceived
more easily within clusters, and the assets, skills, and capital
are more available to pursue them.Third, clusters stimulate
and enable new business formation that supports innovation
and expands the cluster.The local presence of experienced
workers and access to all the needed inputs and specialized
services, for example, reduces the barriers to entry.
The benefits of clusters apply to virtually all parts of
an economy, not only to knowledge-intensive industries
such as life sciences or information technology as is some-
times assumed. A good example is tourism: in the Cairns
tourism cluster of northwestern Australia, natural attrac-
tions such as proximity to the Great Barrier Reef and a 23
tropical rainforest alone would provide little advantage for
the location versus competing tourism destinations.6 Only
the combination of high-quality transportation services,
Tour Operators Local retail, health care,
and other services
Attractions
and Activities Local Transportation
e.g., James Cook
University, Cairns
College of TAFE Souvenirs, Duty Free
Airlines, Banks, Foreign Exchange
Cruise Ships
Educational Institutions Industry Groups
e.g., James Cook University, e.g., Queensland Tourism
Cairns College of TAFE Industry Council
1.2: Building the Microeconomic Foundations of Prosperity
accommodation, restaurants, travel guides, and the many
supporting activities required to operate them creates the
high level of value which tourists are looking for. Even
the best hotel and the most unique tourist attraction
would loose greatly in value if local transportation services
were weak.
National economies tend to specialize in particular
clusters, which account for a disproportionate share of
their output and exports.This specialization is even more
evident in sub-national regions.The nature and depth of
clusters varies with the state of development of the econo-
my. In developing countries, clusters are normally shallow
or underdeveloped. Firms compete based on cheap labor
or local natural resources, and they depend heavily on
imported components, machinery, and technology.
Specialized local infrastructure and institutions are absent
or inefficient, which limits local processing of products
and limits quality. As economies advance, clusters develop
and 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 the
world in a given field; usually there is an array of clusters
in different locations with different levels of sophistication
and specialization. In a given field, only a small number of
24 clusters tend to be true innovation centers, such as Silicon
Valley 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 service
clusters.
Firms based in the most advanced clusters often seed
or enhance clusters in other locations as they disperse
some activities to reduce risk, access lower cost inputs, or
better 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 have
become regional clusters.The same development can be
seen in a number of other areas: for example, the off-
shoring of business services and manufacturing activities
to locations with lower labor costs. Instead of spreading
these activities across geography in less-advanced
economies, companies have found it advantageous to co-
locate in newly emerging clusters.This can be seen in
outsourced business services in Bangalore, India and in
textile 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 development
Successful economic development is a process of succes-
sive upgrading, in which a nations business environment
evolves to support and encourage increasingly sophisticat-
ed and productive ways of competing by firms based
there. Nations at different levels of development face
distinctly different challenges.
Figure 5: Stages of competitive development
Factor-Driven Investment-Driven Innovation-Driven
Economy Economy Economy
Input Cost Efficiency Unique Value
Source: Porter (1990)
As nations develop, they progress in terms of their
competitive advantages and modes of competing.8 In the
Factor-Driven stage, basic factor conditions such as low-
cost labor and unprocessed natural resources are the domi-
nant sources of competitive advantage and exports. Firms
produce commodities or relatively simple products
designed in other, more-advanced countries.Technology is
assimilated through imports, supply agreements, foreign
direct investment, and imitation. In this stage, companies
compete on price and lack direct access to consumers.
They have limited roles in the value chain, focusing on
assembly, labor-intensive manufacturing, and resource
extraction. A Factor-Driven economy is highly sensitive to
world economic cycles, commodity prices, and exchange
rate fluctuations.
In the Investment-Driven stage, efficiency in produc-
ing standard products and services becomes the dominant
source of competitive advantage. Heavy investment in effi-
cient infrastructure, business-friendly government adminis-
tration, strong investment incentives, and better access to
capital allow major improvements in productivity.The
products and services produced become more sophisticat-
ed, but technology and designs still largely come from
abroad.Technology is accessed through licensing, joint
ventures, foreign direct investment, and imitation.
However, nations at this stage not only assimilate foreign
technology but also begin to develop the capacity to
improve on it. Companies serve a mix of OEM customers
and end users. Firms extend capabilities more widely in
the value chain. An Investment-Driven economy is con-
centrated on manufacturing and on outsourced service
exports. It is susceptible to financial crises and external,
sector-specific demand shocks.

In the Innovation-Driven stage, the ability to produce
innovative products and services at the global technology
frontier using the most advanced methods becomes the
dominant source of competitive advantage.The national
business environment is characterized by strengths in all
areas together with the presence of deep clusters.
Institutions and incentives supporting innovation are well
developed. Companies compete with unique strategies
that are often global in scope. An Innovation-Driven
economy has a high share of services in the economy and
is resilient to external shocks.
Seeing economic development as a sequential process
of building interdependent microeconomic capabilities,
shifting company strategies, improving incentives, and
increasing rivalry exposes important pitfalls in economic
policy.The influence of one part of the microeconomic
business environment depends on the state of others. Lack
of improvement in any important area can lead to a
plateau in productivity growth and stalled development.
Worse yet, it can undermine the whole economic reform
process.When well-trained college graduates cannot find
appropriate jobs because companies are still competing
based on cheap labor, for example, a backlash against busi-
ness is created.
This analysis also begins to reveal why countries find
the transition to a new stage of development so difficult.
Such inflection points require wholesale transformation of
many interdependent aspects of competition.
Institutions and roles in economic development
While government is important to competitiveness, gov-
ernment alone is less and less able to build a competitive
economy. Many other national and local institutions have
a role in competitiveness and economic development.The
influence of universities and schools is growing as knowl-
edge and technology become more and more central to
competition. Universities and schools must not only
improve the educational and research capabilities, but must
also become better connected to the private sector.
The private sector has also become a crucial actor in
improving competitiveness and in setting economic policy.
The private sector is not only a consumer of the business
environment, but it also can and must play a role in shap-
ing it. Individual firms, through steps such as establishing
educational programs, attracting suppliers, or defining stan-
dards, not only benefit themselves but also improve the
overall environment for competing. Collective industry
bodies, such as trade associations and chambers of com-
merce, also have important roles to play in improving
infrastructure, providing training, and developing export
markets that are often overlooked. Collective efforts to
enhance the capabilities of individual companies, such as
quality certification programs and manufacturing assistance
1.2: Building the Microeconomic Foundations of Prosperity
centers, are becoming more prominent. Engagement of
the private sector in competitiveness is also important to
provide the continuity of attention necessary to sustain
progress through changes of government and to counter-
act the relatively short attention span of political leaders.
Finally, a whole class of institutions, which we term
Institutions for Collaboration (IFCs), play an important
role in competitiveness though they have been largely
ignored in economic development thinking.9 Neither
government agencies, educational institutions, nor firms,
these organizationstrade associations, entrepreneur net-
works, standard-setting agencies, quality centers, technolo-
gy networks, and many othersare common.They are
especially prevalent in the most advanced economies, but
also have crucial roles in developing countries. IFCs play
an essential role in connecting the parts of the diamond
and fostering efficient collective activities in both
advanced and developing countries.10
The importance of institutions for economic develop-
ment has been widely recognized in recent years.While
institutions are important, they are only one of the factors
that determine competitiveness and, maybe even more
importantly, the ability of a country to sustain and
upgrade competitiveness over time. Institutions are neither
a strictly necessary nor a sufficient factor for competitive-
ness.This view, consistent with the conceptual framework
outlined here, has recently been supported by new empir- 25
ical analyses.11 Institutions are often used in a very wide
sense, incorporating a broad set of organizations, rules, and
behavioral patterns in many different parts of the econo-
my and society.This way the term becomes too wide to
be a useful guide for policy. It has encouraged a focus on
large public institutions, while the role of private and pub-
lic-private institutions such as IFCs is much less well
understood.
The relationship between macroeconomic and
microeconomic policy
Our analysis makes it clear why the traditional focus on
macroeconomic stabilization and market opening is insuf-
ficient. Macroeconomic policies fostering high rates of
capital investment, for example, will not translate into
rising productivity unless the forms of investment are
appropriate, the company skills and supporting industries
are present to make the investments efficient, and strong
competitive pressures and adequate corporate governance
provide the needed market discipline. Sound monetary
and fiscal policies and the removal of distortions in
exchange rates and other prices will eliminate impedi-
ments to productivity, but microeconomic foundations
must be in place if productivity is actually to increase.
Appropriate levels of foreign debt depend on micro-
economic circumstances.The prudence of foreign debt
levels depends on exactly where the foreign capital is
1.2: Building the Microeconomic Foundations of Prosperity
invested, together with the microeconomic fundamentals
surrounding its deployment and governance. Regulating
overall debt levels is less important, in many ways, than
improving the microeconomic foundations.
High rates of public investment in human capital will
not pay off unless a nations microeconomic circumstances
create the demand for skills in companies. Privatization
will not boost prosperity unless companies can improve
efficiency and are pressured by local competition. For
sound policies at the macroeconomic level to translate
into an increasingly productive economy, then, parallel
microeconomic improvements must take place.
The effects of trade agreements and other market
opening measures, a major focus in todays international
economic policymaking, also depends on microeconomic
policies. Market opening is good, but its benefits in terms
of prosperity depend on microeconomic progress. If the
local business environment does not become more effi-
cient and local companies do not improve their productiv-
ity and sophistication, market opening will boost imports
but growth in exports and the attraction of foreign invest-
ment will be painfully slow. Improvement in the micro-
economic business environment begins before market
opening measures are complete.
A greater focus on microeconomic reforms will pay
another essential dividend.While macro reforms almost
26 inevitability inflict hardship in the short and medium run
through raising interest rates and prices while cutting pub-
lic expenditures, micro reforms can produce tangible and
visible benefits for citizens. Breaking up local cartels and
monopolies, 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 unsafe
practices. Bold steps to improve the quality of education
and training are particularly important, because they offer
the hope of a better life for children. If citizens see busi-
nesses reforming themselves and having to confront tough
competitive challenges, they themselves will be more will-
ing to live with personal sacrifices and less likely to side
with anti-reform interest groups.The political will and
public support to make real economic change is elevated.
Ranking competitiveness
Measures of competitiveness
The Business Competitiveness Index (BCI) is constructed
from measures drawn primarily from the survey of 8,695
senior business leaders in 103 countries.12 Compared with
last year five countries were added (Bahrain, Bosnia-
Hercegovina, Cyprus, Georgia, and the United Arab
Emirates) but three countries (Cameroon, Haiti, Senegal)
had to be dropped.We are working with our partners in
these countries to reenter them next year.
Measuring competitiveness is challenging because of
the sheer number and variety of influences that shape
national productivity. Only through a detailed survey can
textured measures of the competitive environment and
company practices be assembled across many countries.
The Survey questions aim to capture the circumstances in
a nation, but they do so in way that is meaningful for
Survey respondents. For example, we get at the stock of
basic human capital with a question on the quality of
public schools because this is something that respondents
can compare more readily across countries.The quality of
schools, a flow measure, will be highly correlated with the
stock of basic skills.
The World Bank has recently started a new effort to
systematically collect comparable data on regulatory con-
ditions, an important element of the microeconomic
foundations for competitiveness, across a wide number of
countries.13 In three of the areas covered by the World
Bank effortthe administrative procedures of starting a
business, the availability of effective credit registers to
enable loans to businesses, and the organization of bank-
ruptcy proceduresour Survey contains questions that
cover 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 the
World Bank data (quantifications of specific aspects of
procedures made by technical specialists).These differences
could indicate that the technical dimensions measured in
the World Bank effort (e.g., number of steps needed to
register a new business) give a skewed description of the
real impact these regulations have on business.They could
also be a sign of weaknesses in the Survey data, related to
misinformed respondents or other reasons. More research
will be necessary to evaluate the relative advantages of
both types of data.
Quantitative measures are utilized for patenting rates,
Internet penetration, and cellular phone penetration. For
all of the other dimensions we measure, however, quantita-
tive data are simply unavailable, especially for so many
countries.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 makers
that ultimately determine economic activity.
As with last year, we examined the consistency of the
Survey data to ensure that the sample used for statistical
estimation is as valid as possible and to identify particular
countries whose rankings may be less reliable. For each
Survey question we compared the standard deviation of
answers within a country with the standard deviation of

answers across all countries.This is a weak statistical test
that the vast majority of countries easily meet. In those
countries with high within-country variance of responses
on many survey questions, however, it is hard to interpret
the country averages, independently of the possible reasons
for the variances.14 In addition to examining all responses
for each country, we further analyzed within-country
consensus in the subset of responses from executives from
foreign companies operating in the country.We expect
these respondents to have the best perspective on how the
country 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 lower
within-country variance than cross-country variance.
Countries that have more heterogeneous responses in the
sample include some low-income countries only added to
the survey process last year (for example Gambia, Ghana,
and Uganda), but also some Arab countries included this
year for the first time (Bahrain, UAE).
We calculated Index rankings for all 103 countries
shown 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, their
rankings should be interpreted with caution.
For the 93-country sample used in the regressions
and for computing the Index model, there is an average of
more than 80 respondents per country.The degree of
within-country consensus is striking. For all measures, the
proportion of variation due to country differences is statis-
tically significant. For most measures, between one-third
and one-half of the overall variation in the responses is
driven by country-specific differences for that measure. As
expected, the within-country consensus is higher for
cross-cutting business environment indicators, such as
overall infrastructure quality, and lower for measures where
there would be variation within the country across com-
panies and clusters, such as state of cluster development.
The country averages, then, capture meaningful differences
across countries in competitive circumstances while limit-
ing idiosyncratic biases that would result if there were
only a handful of responses per country.
The dependent variable used to develop the BCI is
the level of GDP per capita in 2003, adjusted for purchas-
ing power parity (PPP). GDP per capita is the broadest
measure of national productivity and is strongly linked
over time to a nations standard of living.17 It is the best
single, summary measure of microeconomic competitive-
ness available across all countries.18 GDP per capita will
reflect a countrys structural fundamentals over the medi-
um and long term. However, it is also influenced by a
wide array of short-term and idiosyncratic factors such
as natural disasters, macroeconomic shocks, and price
1.2: Building the Microeconomic Foundations of Prosperity
movements in particular export industries.The proportion
of the variation in GDP per capita across all countries
that can be explained by microeconomic fundamentals is
interesting in its own right.
To explore differences in the sources of competitive-
ness across countries at different levels of development, we
divided countries into three groups based on income.
There is no accepted division among low-, middle-, and
high-income countries, and efforts to define income cut-
offs statistically face data limitations. Instead, we proceed
pragmatically, dividing countries based on two criteria.
First, we use income cutoffs that yield logical divisions of
countries in terms of aspirations and competitive position.
Second, we ensure that there are enough countries in each
group to allow meaningful statistical tests. Ideally, the cut-
offs are also stable. Applying these criteria, we maintained
the cutoff points at US$4,000 GDP per capita (PPP) for
low 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 2003
below $4,000; 43 middle-income countries with GDP per
capita between $4,000 and $17,000; and 30 high-income
countries with a GDP per capita above $17,000. As will
be reported, these groups exhibited quite different patterns
of influence among variables as we would expect.
27
Sources of competitiveness
To construct an overall index of competitiveness, we first
validated the statistical relationship of each of a wide array
of measures of microeconomic competitiveness that are
suggested by our conceptual framework with GDP per
capita.Variables are drawn from Survey responses and
available quantitative measures, and are broadly grouped
into those measuring the sophistication of company oper-
ations and strategy and those measuring the quality of the
national business environment. A full list of Survey ques-
tions and available quantitative measures is given in
Appendix A.
Table 3 gives bivariate regressions on GDP per capita
that include those variables that proved to be the most sta-
tistically significant. Included in the table is the mean
response across all countries or groups of countries, the
slope 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 explained
by the variable, adjusted for statistical degrees of
freedom).19 While the bivariate regressions are not meant
to represent a fully specified model, they provide a basic
test of whether the variables have a meaningful relation-
ship with the level of GDP per capita across countries. All
the reported variables are highly statistically significant in
the full sample of countries. A wide range of company
1.2: Building the Microeconomic Foundations of Prosperity

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

Company operations Quality of the national 2003 GDP
BCI ranking and strategy ranking business environment ranking per capita
Country 2004 2003 2002 2001 2000 1999 1998 2004 2003 2002 2001 2000 1999 1998 2004 2003 2002 2001 2000 1999 1998 (PPP-adjusted)*

United States 1 2 1 2 2 1 1 2 2 1 1 2 1 2 2 2 1 2 2 1 1 37,352

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

(contd)
 1.2: Building the Microeconomic Foundations of Prosperity
Table 1: The Business Competitiveness Index, sample of 93 countries (contd.)
Company operations Quality of the national 2003 GDP
BCI ranking and strategy ranking business environment ranking per capita
Country 2004 2003 2002 2001 2000 1999 1998 2004 2003 2002 2001 2000 1999 1998 2004 2003 2002 2001 2000 1999 1998 (PPP-adjusted)*

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

29
1.2: Building the Microeconomic Foundations of Prosperity

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

Company Quality of 2003 Company Quality of 2003

operations the national GDP per operations the national GDP per
BCI and strategy business capita BCI and strategy business capita
ranking, ranking, environment (PPP ranking, ranking, environment (PPP
Country 2004 2004 ranking, 2004 adjusted) Country 2004 2004 ranking, 2004 adjusted)

United States 1 2 2 37,352 Gambia* 67 70 66 1,714

Finland 2 7 1 27,252 Sri Lanka 68 69 67 3,776
Germany 3 1 5 27,609 Ukraine 69 64 71 5,472
Sweden 4 5 6 26,656 Philippines 70 50 77 4,321
Switzerland 5 4 7 30,186 Uganda* 71 75 69 1,471
United Kingdom 6 8 4 27,106 Croatia 72 72 70 11,139
Denmark 7 9 3 30,588 Pakistan 73 67 75 1,971
Japan 8 3 11 28,162 Argentina 74 68 78 11,586
Netherlands 9 6 9 29,412 Bulgaria 75 86 72 7,807
Singapore 10 13 8 24,480 Peru 76 77 74 5,267
Hong Kong SAR 11 15 10 28,027 Uruguay 77 80 76 8,280
France 12 10 16 27,327 Zambia* 78 85 73 883
Australia 13 19 12 29,143 Vietnam 79 81 79 2,490
Belgium 14 11 19 28,396 Dominican Republic 80 74 83 6,703
Canada 15 16 13 30,463 Nigeria* 81 76 80 1,024
Austria 16 14 17 29,972 Zimbabwe 82 79 84 1,892
Taiwan 17 12 20 24,560 Macedonia, FYR 83 84 82 6,762
New Zealand 18 20 15 21,177 Malawi 84 83 85 618
Iceland 19 17 18 30,658 Serbia and Montenegro 85 87 81 3,970
Norway 20 23 14 37,063 Guatemala 86 78 90 4,122
Israel 21 18 21 19,678 Madagascar 87 88 88 808
Ireland 22 22 22 29,907 Venezuela 88 82 91 4,909
Malaysia 23 28 23 9,696 Algeria 89 93 86 6,248
Korea 24 21 28 17,908 Tanzania 90 92 87 611
South Africa 25 24 25 10,492 Mali* 91 95 89 994
Spain 26 25 27 22,264 Georgia 92 89 93 2,569
Estonia 27 34 24 13,348 Bosnia and Hercegovina 93 96 92 6,029
United Arab Emirates* 28 32 26 17,520 Ecuador 94 90 95 3,684
Chile 29 33 29 10,206 Bangladesh 95 97 94 1,786
India 30 30 32 2,909 Mozambique 96 94 98 1,133
30 Slovenia 31 27 33 19,300 Honduras 97 91 100 2,658
Tunisia 32 43 30 7,083 Paraguay 98 98 96 4,724
Portugal 33 42 31 18,444 Ethiopia 99 101 97 716
Italy 34 26 43 27,050 Nicaragua 100 100 99 2,523
Czech Republic 35 31 37 16,448 Bolivia 101 99 101 2,546
Lithuania 36 37 35 11,250 Chad* 102 103 102 1,206
Thailand 37 36 36 7,580 Angola* 103 102 103 2,319
Brazil 38 29 44 7,767
Slovak Republic 39 41 39 13,469 Note: GNI per capita is used for Ireland
Bahrain* 40 53 34 17,789
Greece 41 40 42 19,973
Hungary 42 48 38 14,572
Jordan 43 54 40 4,319
Indonesia 44 38 46 3,364
Cyprus 45 59 41 19,155
Morocco 46 45 45 4,012
China 47 39 47 4,995
Costa Rica 48 35 50 9,490
Latvia 49 51 48 9,981
Malta 50 60 49 18,203
Namibia 51 63 51 6,375
Turkey 52 44 55 6,749
Mauritius 53 49 54 11,258
Jamaica 54 52 53 4,184
Mexico 55 46 56 9,136
Romania 56 61 57 7,222
Poland 57 47 64 11,623
Colombia 58 58 61 6,784
Trinidad and Tobago 59 55 62 9,975
Panama 60 66 58 6,475
Russian Federation 61 62 60 9,195
Botswana 62 73 52 8,359
Kenya 63 56 63 1,035
Ghana 64 71 59 2,234
El Salvador 65 65 65 4,994
Egypt* 66 57 68 3,950

(contd.)

* Survey data for these countries have high within-country variance. Until the reliability of Survey responses improves with future educational efforts and
improved sampling in these countries, their rankings should be interpreted with caution.
 1.2: Building the Microeconomic Foundations of Prosperity
Table 3: Bivariate regression results, dependent variable: 2003 GDP per capita (PPP-adjusted)

Low-income countries Middle-income countries High-income countries

GDP per capita GDP per capita > $4,000 GDP per capita > $17,000
All countries (N = 93) < $4,000 (N = 20) and < $17,000 (N = 43) except Norway (N = 30)
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** 0.417
Nature 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** 0.219
Extent 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** 0.392
Extent of marketing 4.48 8647.8** 0.659 3.46 659.4 0.089 4.26 1437.3* 0.060 5.47 5526.2** 0.425
Willingness 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** 0.482
Capacity for innovation 3.59 7820.3** 0.685 2.74 630.9 0.080 3.14 3070.5** 0.192 4.80 2725.7** 0.229
Company 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** 0.222
Value chain presence 3.95 6678.5** 0.627 2.90 591.9 0.069 3.49 1542.3** 0.086 5.29 1414.1 0.037
Breadth 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** 0.175
Degree 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** 0.314
Control 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** 0.195
Extent of branding 3.70 7136.5** 0.689 2.66 902.0* 0.150 3.24 1778.0** 0.076 5.05 2290.6** 0.173
Reliance 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** 0.415
Extent 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** 0.183
Extent 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** 0.191
Prevalence 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) CONDITIONS
1. 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** 0.314
Railroad infrastructure development 3.23 4507.1** 0.487 2.15 262.2 0.004 2.75 1174.4** 0.186 4.65 1449.9** 0.152
Port infrastructure quality 3.99 5659.2** 0.585 2.71 599.8* 0.152 3.58 496.3 0.001 5.45 2240.0** 0.125
Air 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** 0.230
Quality 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** 0.355
31
Telephone/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 0.060
Cell 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 0.026
Internet 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** 0.326
Judicial independence 4.08 5434.5** 0.553 2.96 137.0 0.038 3.61 949.8** 0.096 5.50 3158.9** 0.210
Efficiency 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** 0.341
Administrative 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* 0.085
Extent 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** 0.466
Quality 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** 0.300
Quality 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** 0.248
Quality 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** 0.133
Availability 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** 0.209
Quality 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** 0.297
University/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** 0.356
Venture capital availability 3.33 8830.8** 0.599 2.68 757.6* 0.101 2.98 2220.4** 0.145 4.26 3172.6** 0.191
Ease 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** 0.151
Local 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 CONDITIONS
Buyer sophistication 4.02 8122.2** 0.699 3.06 348.3 0.009 3.62 1281.7 0.032 5.22 5352.7** 0.384
Sophistication 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** 0.240
Government 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** 0.100
Presence 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** 0.450
Laws 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** 0.190
Stringency 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

(contd.)
1.2: Building the Microeconomic Foundations of Prosperity

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

Low-income countries Middle-income countries High-income countries

GDP per capita GDP per capita > $4,000 GDP per capita > $17,000
All countries (N = 93) < $4,000 (N = 20) and < $17,000 (N = 43) except Norway (N = 30)
Mean Slope Adj. R 2 Mean Slope Adj. R 2 Mean Slope Adj. R 2 Mean Slope Adj. R 2

II. NATIONAL BUSINESS ENVIRONMENT (contd.)

C. RELATED AND SUPPORTING INDUSTRIES
Local supplier quality 4.47 9622.4** 0.736 3.46 622.8 0.057 4.25 3086.2** 0.213 5.47 5848.8** 0.414
State 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** 0.199
Local 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** 0.233
Local 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** 0.399
Extent 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** 0.259
Local supplier quantity 4.74 10773.7** 0.590 4.00 410.9 0.003 4.60 2463.0** 0.109 5.45 6160.6** 0.337
Local 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 RIVALRY

1. 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** 0.213
Cooperation in laboremployer relations 4.51 7898.2** 0.315 3.99 133.8 0.053 4.42 1074.7 0.010 5.00 2813.9** 0.198
Efficacy 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** 0.302
Intellectual property protection 3.93 6980.6** 0.731 2.79 72.9 0.054 3.45 1105.4* 0.051 5.37 4691.1** 0.505
Protection 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** 0.186
Regulation 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** 0.213
Effectiveness 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 0.034
Intensity 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 0.055
Extent 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** 0.137
Effectiveness of antitrust policy 4.05 8375.0** 0.651 3.18 108.8 0.052 3.68 969.4 0.017 5.16 4514.9** 0.238
Decentralization 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** 0.288
Business 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** 0.179
32 Tariff liberalization 5.95 13230.5** 0.603 5.38 1455.0** 0.305 5.78 2734.2** 0.154 6.59 5426.7 0.003
Centralization of economic policymaking 3.00 6481.9** 0.279 2.66 350.8 0.008 2.79 2038.3** 0.167 3.53 2354.4** 0.169
Prevalence 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** 0.266
Foreign 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

practices and multiple dimensions of the business environ-
ment prove strongly related to competitiveness.These
findings are highly consistent with results from earlier
Global Competitiveness Reports.While a bilateral statistical
correlation to GDP per capita does not necessarily imply
causation, it does refute the hypothesis that microeconom-
ic variables have no important relation to prosperity.
Interestingly, prominent macroeconomic variables such as
the national savings rate and the level of investment as a
percentage of GDP are either not significantly related to
the level of GDP per capita in bilateral regressions or asso-
ciated with only a minor share of its variation across
countries.20
Among the company variables, production process
sophistication, the nature of competitive advantage, the
extent of staff training, the extent of branding, the capacity
for innovation, and the degree of customer orientation
have the strongest bilateral association with per capita
GDP. By itself, the nature of companies competitive
advantagewhether competitive advantage is based on
cheap inputs versus unique products and processes
explains a remarkable 71 percent of the variance in GDP
per capita.
All four parts of the business environment prove
important, with the influences of individual variables quite
stable 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, financial
market sophistication, and the efficiency of the legal
framework have the strongest bilateral association with
GDP per capita. Many of the most important influences
on GDP per capita relate to policies and institutions rather
than fact stocks.
Measures of local demand conditions perform partic-
ularly strongly.The presence of demanding regulatory
standards, stringent environmental regulations, and buyer
sophistication, 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 and
local market conditions are not important in a global
economy.
Cluster linkages, especially the quality of local suppli-
ers and the presence of specialized local research and
training providers, also prove significant and highlight the
role of clusters in competitiveness. Finally, the incentives
and rules governing local competition show a strong rela-
tionship to national productivity. Intellectual property pro-
tection, the effectiveness of antitrust policy, the prevalence
of illegal or unfair activities (corruption), the effectiveness
of bankruptcy laws, and the openness to trade tariff and
non-tariff barriers are particularly potent variables.The
intensity of local competition is strongly and positively
related to GDP per capita, alone explaining 47 percent of
variations across countries in GDP per capita.The strong
influence of local competition, supported in other recent
studies,21 is contrary to arguments made about the need to
curb 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 be
argued 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 engineers
or 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 some
evidence of causality from microeconomic conditions to
GDP per capita later in this chapter, but more years of
surveying will be required to establish definitive cause and
effect relationships.
Competitiveness and economic development
As has been discussed, the appropriate company strategies
and operating practices, as well as the influence of particu-
lar elements of the business environment, will differ for
countries 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 of
measures of microeconomic competitiveness in the three
country groups based on per capita GDP. Although the
reported variables are statistically significant across the
entire sample and strongly distinguish countries across
groups, individual variables, as expected, differ in their
influence within groups. Some variables will not yet be
important for low-income countries. Others may act via a
threshold that a country must reach, but no longer explain
income beyond this level.
The right-hand side of Table 3 presents income
subgroups regressions.We explore the differences across
income groups in the mean Survey response and the
1.2: Building the Microeconomic Foundations of Prosperity
differences in slope as well as the pattern of statistical sig-
nificance of each variable with the caveat that limitations
on subgroup sample size and the more limited variation of
the dependent variable within versus across subgroups
reduce statistical power.
It is notable that, for all variables, the mean Survey
response increases as we compare low- and high-income
countries.This confirms the fact that economic develop-
ment is associated with improvement across many aspects
of the business environment and company behavior.
However, we find distinctive differences across income
groups in the relative importance and trajectory of
improvements of particular aspects of the process of
development.
Low-income countries
For low-income countries at the Factor-Driven stage of
development, the ability to move beyond competing solely
on cheap labor/natural resources is the essential challenge
emerging from the regressions. It is revealing that for low-
income countries none of the variables describing the
sophistication of companies is significantly related to GDP
per capita.With huge challenges in their surrounding
business environment, companies find it hard to reap the
benefits of more advanced operating practices.
Low-income countries score low on most measures
of the business environment, but especially on infrastruc- 33
ture, educational quality, cluster development, capital
access, and measures related to technology and innovation.
Priorities for improving the business environment in low-
income countries revealed in the regressions begin with
upgrading the quality of infrastructure (including electrici-
ty, communications, and transportation networks) and
schools. Another priority is the opening of competition
(reducing trade barriers and increasing the number of
local competitors).These steps create a foundation of effi-
ciency and competitive pressure that supports more pro-
ductive Factor-Driven competition. Other aspects of the
business environment, such as expanding the availability of
scientists and engineers and updating regulatory standards,
are not yet priorities at this stage of development.
Middle-income countries
Moving into middle income, the task is to move beyond
Factor-Driven competition to the Investment-Driven
stage.Their biggest challenge remains the nature of their
local competitive advantages, often still based solely on
low-cost production inputs. Other reported weaknesses
consistent with this underlying challenge are a lack of
branding, a narrow position in the value chain, low pro-
duction process sophistication, and limited innovative
activities.
1.2: Building the Microeconomic Foundations of Prosperity
The regressions suggest the following patterns:
improving production process sophistication is the single
most important corporate priority. But companies must
also begin to increase the professionalism of management,
create the capacity for technology absorption and intro-
duction, and overcome their dependence on exports to a
few, often distant, advanced foreign markets.
Middle-income countries score low on many aspects
of 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 to
continued progress in a number of areas, especially public
schools, 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 research
institutions becomes an important differentiator of success,
as does the quality of the judicial system. Improving local
demand conditions, for example through more stringent
environmental and consumer protection laws, is needed to
pressure improvements in producer quality. All aspects of
cluster development become significant in differentiating
more successful from less successful countries, especially
widening the supplier base and improving the availability
34 of specialized research and training institutions. Finally,
moving to higher levels of competition and rivalry is
important across many dimensions, including liberalizing
tariff and non-tariff barriers, improving antitrust policy,
and opening the market for corporate control.
High-income countries
High-income countries report more advanced company
practices across the board.The difference is highest in
terms of the nature of firm competitive advantage.The
gap in terms of management professionalism and customer
orientation is smaller.
To succeed in a high-income economy, assimilating
improvements in quality and efficiency are no longer
enough.The hurdle is to move to the Innovation-Driven
stage.The regressions suggest that overcoming this hurdle
is not only a matter of more R&D spending. It is also
tightly connected to the ability to transform technological
advances into attractive new products and services, using
flexible work organizations and the delegation of authori-
ty combined with marketing and advanced production
processes.
High-income countries have all achieved strength in
many aspects of the business environment. Continuing to
improve infrastructure, simplicity and fairness of regula-
tion, and schools remain important in distinguishing the
more successful high-income countries. Other distinguish-
ing factors include deep cluster development, especially
the improvement of local supplier quality and the access
to local providers of specialized research services.The
regulatory environment, including the protection of intel-
lectual property rights and effective bankruptcy laws, is
also important. Other distinguishing factors include the
quality of management education, the sophistication of
demand conditions (e.g., demanding regulatory standards,
local buyer sophistication), the extent of decentralization
of corporate activity away from large business groups, and
the sophistication of the local financial market.
Trends in competitiveness in the global economy
With several years of consistent Survey data, we can exam-
ine trends in the variables that offset competitiveness
between 1998 and 2004.22 Table 4 identifies those vari-
ables where substantial changes in company practices and
the quality of the business environment, defined as
changes greater than 10 percent positive or negative in the
mean 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 business
environments in the global economy.The bar is rising, and
improvement in the business environment is needed just
to maintain position vis--vis other countries. In company
operations and strategy, the average company is, in many
countries, progressing its sophistication along some dimen-
sions, but there are also signs that the growing intensity of
competition is making it hard to keep up and that greatest
international specialization of activity is occurring.
As shown in Table 4, professionalism of management
is rising in increasingly competitive markets, the single
most widespread global development among companies.
Also widespread are improvements in marketing and cus-
tomer orientation plus moves to regionalize sales as
regional trade opening continues. Companies from mid-
dle-income economies have made strides in raising the
sophistication of their competitive advantage. Companies
from high-income economies are becoming more global
through increasing the breath of international markets
they 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 specialization
of activities. Companies in middle-income countries also
are having difficulty defending brands and maintaining
global market presence. Even in a significant minority
of advanced economies, companies find it hard to keep
control of international distribution. Overall, these
 1.2: Building the Microeconomic Foundations of Prosperity
Table 4: Significant changes in competitive conditions in eight or more countries, 19982004

Improving international competitive conditions Worsening international competitive conditions

No. of countries No. of countries
Total L M H Total L M H
51 4 20 27 51 4 20 27

Sophistication of Company Reliance on professional management...................39 3 15 21 Value chain presence.................................................26 3 17 6

Operations and Strategy Extent of marketing .....................................................28 2 10 16 Extent of branding .......................................................24 2 15 7
Degree of customer orientation................................24 2 10 12 Breadth of international markets..............................23 2 15 6
Extent of regional sales..............................................21 2 10 9 Capacity for innovation ..............................................13 2 7 4
Nature of competitive advantage.............................13 2 8 3 Prevalence of foreign technology licensing...........12 2 6 4
Extent of staff training ................................................13 2 3 8 Production process sophistication ..........................11 2 8 1
Prevalence of foreign technology licensing.............8 4 4 Control of international distribution .........................11 1 2 8
Breadth of international markets................................8 8

Quality of the Business Extent of bureaucratic red tape................................48 4 20 24 Efficiency of legal framework ...................................22 2 12 8
Environment Tariff liberalization.......................................................38 4 17 17 Quality of public schools............................................19 3 12 4
Efficacy of corporate boards.....................................36 4 14 18 Venture capital availability ........................................19 2 12 5
Financial market sophistication ................................34 4 15 15 Judicial independence ...............................................18 2 8 8
Overall infrastructure quality ....................................30 2 10 18 Administrative burden for startups ..........................18 1 12 5
Railroad infrastructure development .......................25 2 9 14 Buyer sophistication ...................................................15 1 8 6
Extent of locally based competitors.........................23 2 7 14 University/industry research collaboration ............14 2 6 6
Quality of management schools ...............................22 1 9 12 Intellectual property protection ................................14 2 10 2
Quality of scientific research institutions ...............21 3 13 5 Favoritism in decisions of government officials ....12 1 8 3
Favoritism in decisions of government officials ....21 2 6 13 Hidden trade barrier liberalization .............................8 6 2
Air transport infrastructure quality ..........................21 2 13 6
Port infrastructure quality..........................................19 2 6 11
Local supplier quality..................................................18 3 11 4
Reliability of police services......................................16 1 11 4
Quality of public schools............................................16 1 2 13
Local equity market access.......................................15 3 4 8
Presence of demanding regulatory standards ......15 3 8 4
Venture capital availability ........................................14 2 6 6
Telephone/fax infrastructure quality........................12 1 10 1
Hidden trade barrier liberalization ...........................11 2 4 5 35
Effectiveness of anti-trust policy..............................10 2 3 5

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.

observations are consistent with a global marketplace that The quality of the legal institutions and of the educational
has, in many ways, become more sophisticated and more system seems especially hard to defend.
demanding, especially for companies that are trying to Overall, we find that the gap between country groups
move away from dependence on cheap inputs. seems to be increasing; an observation we made in previous
In the business environment,Table 4 shows that years.While many countries have improved many elements
governments around the world are continuing to reduce of their business environments, high-income countries
bureaucratic red tape, lower tariffs, improve corporate have been able to improve more than middle-income
governance, upgrade financial markets, and improve countries and more than low-income countries, based on
infrastructure. Progress in these areas is increasingly the mean responses across all Survey questions (see Table
becoming a given if a country is to participate fully in the 5).This pattern raises concerns about the ability of devel-
world economy. For middle-income countries, improve- oping economies to catch up to more prosperous nations.
ments in their scientific research institutions, air transport
and telecommunication infrastructure, the quality of local
suppliers, and effective police services are notable. Many Ranking competitiveness
high-income countries have put renewed emphasis on To derive an overall Business Competitiveness Index
their public schools and diminishing favoritism in (BCI), we compute subindexes measuring the sophistica-
providing public services. tion of company operations and strategy and the quality of
While there is much progress, however, many coun- the national business environment. Because many of the
tries, especially middle-income countries, are also strug- dimensions of company sophistication and the quality of
gling to sustain the quality of their business environments. the business environment tend to move together, and
because the sample of countries is relatively small and the
1.2: Building the Microeconomic Foundations of Prosperity
number of relevant variables is high, the impact of individ-
ual variables is difficult to distinguish statistically.
The weighted average of the two subindexes is
defined as the BCI.The weights are determined from the
coefficients of a multiple regression of the subindexes on
GDP per capita, using pooled data from 2002 to 2004 to
smooth year-to-year variations.This procedure results in a
weight of 0.7 for national business environment and 0.3
for 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 be
positive and significant.This means that the benefits of a
better business environment for prosperity are increasing
with the sophistication of company operations and strate-
gy, and vice versa. Countries that improve both the busi-
ness environment and company sophistication in tandem
reap disproportionate benefits, while countries where
there is an imbalance bear disproportionate costs.
Figure 6 plots BCI against 2003 GDP per capita
adjusted for purchasing power parity for each country in
the sample of 93 countries used in building the model.
The regression line is shown, together with bands above
and below the regression line that delineate the 95 percent
confidence 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 the
36 variation in GDP per capita across a widely disparate group of
countries.
In the regression we allow for a non-linear relation-
ship between the BCI and GDP per capita.The best fit is
the polynomial form, indicating a higher impact on GDP
per capita of improvements in BCI for higher-income
versus lower-income countries.This finding has a number
of possible interpretations: First, we would expect
improvements in microeconomic conditions to have posi-
tive spill-overs, that is, an improvement in one part of the
business environment has more impact if other parts of
the business environment are stronger.This interpretation
is consistent with the positive interaction between compa-
ny sophistication and the business environment previously
reported. Second, lower-income countries may reap fewer
productivity benefits from microeconomic improvements
due to weaknesses in macroeconomic, political, legal, and
social conditions.
We use the model along with data for each country
to calculate a BCI for each country.The overall BCI rank-
ings for 2004 for the 93 countries that were used for the
statistical analysis are shown in Table 1, along with the
rankings for the previous four years where available. Also
included are the separate subindex rankings.The rankings
for all 103 surveyed countries are shown in Table 2.24
Because changes in the ranking can result from very small
differences in the absolute value of the BCI score, we also
graph the relation between rank and BCI score in Figure
7. BCI scores change smoothly with ranks for most parts
of the ranking. However, in some rangessuch as those
between rank 25 and 20 at the transition between middle-
and high-income countriesthe gaps in BCI score
become larger.We also include a new Table 5 that gives
more detailed information on the changes of BCI score
by country.
Please refer to the Country Profiles section of the
Report for detailed descriptions of the competitive advan-
tages and disadvantages of each country. As noted earlier,
competitiveness is not a zero-sum game. Many countries
can improve productivity and prosperity. BCI tracks both
the absolute and relative progress of countries in building
a productive economy.
The United States has retaken the leading position
from Finland, after dropping to second place last year.The
United States benefited from improvements in the sophis-
tication of marketing, the availability of venture capital, the
intensity of local competition, local supplier quality, and
local supplier quantity; in these areas the United States was
seen to have improved while its peers either improved
much less (local supplier quantity) or registered worsening
conditions. Other advanced nations improving their rank-
ings include Hong Kong SAR (reflecting more sophisti-
cated financial markets and improvements in management
practices), Japan (improving financial market sophistica-
tion; improving quality of administrative services), and
Portugal (improving cluster strength). Japan registered the
highest absolute improvement of its BCI score, followed
by Hong Kong and Norway.
Advanced countries dropping in the rankings include
Italy, Malta, and Iceland. Italy dropped by a disappointing
nine ranks,25 almost entirely driven by a deteriorating
business environment that is now evaluated on par with
Portugal and the Czech Republic, with 32 percent and 39
percent lower GDP per capitas. Italy deteriorated especial-
ly in areas related to innovative capacity, such as universi-
ty-industry research collaboration, foreign technology
licensing, government procurement of advanced technolo-
gy, company R&D spending, and venture capital availabili-
ty. Advanced countries that registered large absolute
reductions in their BCI score despite relatively stable ranks
include 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 by
strong across-the-board improvements, especially in the
area of company sophistication.Whether this large jump is
a temporary event reflecting positive near-term sentiment
or a sustainable improvement will become evident in sub-
sequent years. Romanias improvement comes after repeat-
ed slippage in the ranking since the country became part
of the GCR in 2001.
Figure 6: The relationship between business competitiveness and GDP per capita

40,000

Norway United States

35,000

y = 1549.9x2 + 8603.4x + 11188

R 2 = 0.8064 Iceland Denmark
Canada Switzerland
30,000 Ireland Austria
Australia Netherlands
Belgium
Japan
Hong Kong SAR Germany
Italy France United Kingdom Finland
Sweden

25,000 Taiwan Singapore

Spain
New Zealand
20,000 Greece Israel
Cyprus Slovenia
Malta Portugal
Korea

Czech Republic

15,000 Hungary
Slovak Republic Estonia

Argentina Poland
Croatia Mauritius Lithuania
South Africa
10,000 Trinidad and Tobago Latvia Chile
Russian Federation Mexico Costa Rica Malaysia
Uruguay Botswana

2003 GDP per capita (adjusted for purchasing power parity)

Brazil
Macedonia, FYR Bulgaria Thailand
Colombia Romania Tunisia
Algeria Dominican Republic Turkey
Bosnia and Hercegovina Ukraine Panama Namibia
Peru El Salvador China
5,000 Paraguay Venezuela
Guatemala Philippines Jamaica Jordan
Honduras Ecuador Serbia and Sri Lanka Morocco
Bolivia Montenegro Indonesia India
Georgia Vietnam
Nicaragua Ghana
Bangladesh Zimbabwe Pakistan
Mozambique Madagascar Kenya
Ethiopia Malawi
Tanzania
0
2.0 1.5 1.0 0.5 0.0 0.5 1.0 1.5 2.0 2.5

Business Competitiveness Index

37

1.2: Building the Microeconomic Foundations of Prosperity

 38
1.2: Building the Microeconomic Foundations of Prosperity

Figure 7: BCI rank and score by country

Finland United States

High Switzerland
Germany
Denmark Sweden
United Kingdom
Netherlands Japan
High income Middle income Low income Hong Kong SAR
Canada Australia Singapore
Taiwan France
Iceland Belgium
Norway Austria
New Zealand

Israel
Ireland

Malaysia

South Africa Korea

Estonia Spain

India
Portugal Chile
Czech Republic Slovenia
Thailand Tunisia
Slovak Republic Italy

BCI score
Indonesia Hungary Lithuania
Morocco Brazil
Jordan Greece
Costa Rica
Namibia Cyprus
Latvia China
Romania Mauritius
Malta
Columbia Mexico
Botswana Panama Turkey
Kenya Jamaica
El Salvador Poland
Ghana Trinidad and Tobago
Ukraine Russian Federation
Croatia Sri Lanka
Argentina Philippines
Pakistan
Dominican Republic Uruguay Bulgaria
Macedonia, FYR Peru
Serbia and Montenegro Vietnam
Madagascar Zimbabwe
Malawi
Algeria Guatemala
Tanzania
Bosnia and Hercegovina Venezuela
Bangladesh Georgia
Honduras
Ecuador
Paraguay
Nicaragua Mozambique
Low Bolivia Ethiopia

93 BCI rank 1
 1.2: Building the Microeconomic Foundations of Prosperity
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 3

Middle income na 0.070 8 63 0.003 0.012 0.015 0.055 2
Low 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 1

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

(contd.)
*The count of advancing/declining is based on the normalized values for 2003 and 2004 data.
1.2: Building the Microeconomic Foundations of Prosperity

Table 5: Decomposition of rank changes (contd.)

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 1

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

Middle-income countries losing rank in competitive-
ness include Latvia, the Dominican Republic, Poland, and
40 Mauritius. Other countries with significant absolute drops
in BCI score include Thailand and Mexico. Latvia has
moved back to a level consistent with its longer-term
trajectory; last years strong improvement proved to be
unsustainable optimism. Dominican Republic (down 13
places) continues the trend set by a large drop last year.
Dominican Republic was hurt by declining openness to
imports and regressing financial market sophistication.
Among low-income countries, Indonesia made the
largest improvement, jumping a remarkable 18 ranks.The
country registered the highest increase in absolute BCI
score of all the countries included in our sample. After
years of turmoil the country is now back to its 2000 com-
petitiveness level.While improvements were registered
areas across the board, they were strongest in measures of
company sophistication. Another low-income country
with large improvements is India (up 8 ranks; profiting
from increasing company sophistication and strengthening
clusters).Vietnam slipped significantly (down 23 places)
after a number of years with steady improvements.
Conditions worsened most in areas related to technology
and government administration. It remains to be seen
whether Vietnams drop reflects short-term sentiments or
signals more fundamental problems.
For low-income countries, we also calculated the BCI
incorporating only those variables with a significant rela-
tionship to GDP per capita for this income group in order
to recognize the more limited set of variables that prove
significant early in development.26 The rankings using this
alternative approach are highly correlated (70 percent)
with the reported rankings.
Company competitiveness versus the quality of the business
environment
To gain deeper insight into the competitive position of
countries, 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 positive
interaction of the two subindexes, as noted previously.
Countries lying above line are those whose companies are
more advanced than the state of their business environ-
ment.Those below the line are countries whose business
environment is more advanced than their companies.
Countries whose company development is ahead of
the business environment include Japan, the Philippines,
Germany, Korea, Italy, Switzerland, France, Sweden, and
the Netherlands.With the exception of the Philippines, all
these countries have reported a relative weakness in the
business environment relative to company development
for some years. Significant changes in public policy are
necessary in these countries to improve the platform for
productivity. Unless the business environment improves,
companies will be prone to move operations or make new
investments outside the country. Japan remains the advanced
economy with the most glaring weaknesses in the business
environment relative to the sophistication of its companies.
The consequences of this weakness for Japans economic
Figure 8: The relative development of companies and the microeconomic business environment

2.5

Germany
Switzerland United States
2.0 Japan
Sweden
Netherlands Finland
United Kingdom
y = 0.9685x + 8E-17 France Denmark

1.5 R 2 = 0.938 Belgium

Taiwan Singapore
Austria Hong Kong SAR
Iceland Canada
Israel
Australia
1.0 Korea Ireland New Zealand
Norway

South Africa
Spain
0.5 Italy Slovenia Malaysia
Brazil
Czech Republic India
Thailand Chile Estonia
Costa Rica Lithuania
Indonesia
0.0 China Greece Slovak Republic
Turkey Tunisia
Mexico Mauritius Morocco Portugal
Poland Jamaica Hungary
Philippines Latvia
Kenya Trinidad and Tobago Jordan
El Salvador Colombia
Pakistan Ukraine Romania Malta Cyprus
Argentina Namibia
0.5 Russian Federation
Dominican Republic Sri Lanka
Panama
Zimbabwe Croatia Ghana
Botswana
Guatemala Peru
Venezuela Uruguay
Malawi Vietnam
Macedonia, FYR Bulgaria
1.0

Index of the sophistication of company operations and strategy

Madagascar Serbia and Montenegro
Georgia
Honduras Ecuador Tanzania
Algeria
Mozambique
Bosnia and Hercegovina
Paraguay Bangladesh
1.5
Bolivia
Nicaragua Ethiopia

2.0
2.0 1.5 1.0 0.5 0.0 0.5 1.0 1.5 2.0 2.5

Index of the quality of the national business environment

41

1.2: Building the Microeconomic Foundations of Prosperity

1.2: Building the Microeconomic Foundations of Prosperity

growth have been severe, as Japanese corporate investment Table 6: GDP per capita relative to competitiveness
has fled the country.27
Countries whose business environment ranks ahead of
current company sophistication include Tunisia, Estonia, Advanced Middle-income Developing
countries countries countries
Cyprus, Norway, and Portugal. In these countries many
UPSIDE POTENTIAL
leading companies still rely on natural resource extraction Competitiveness
Finland Malaysia India
(e.g., Norway), depend heavily on OEM production, or (measured by BCI)
Germany Jordan Indonesia
would support
have a high incidence of local subsidiaries of foreign Sweden Morocco Kenya
higher per capita
United Kingdom Tunisia Ghana
multinationals competing heavily on the basis of low labor income
New Zealand South Africa Pakistan
costs (e.g.,Tunisia, Cyprus, and Portugal). In some coun- China Malawi
tries, such as Estonia, part of the gap results from rapid Thailand Sri Lanka
Brazil Madagascar
improvements in the business environment that have not Jamaica Tanzania
yet been harnessed by companies who remain focused on Chile Zimbabwe
traditional ways of competing. Efforts to improve entre- Estonia Vietnam
Namibia Ethiopia
preneurship, strategic thinking, managerial practice, and El Salvador Mozambique
business education are high priorities in these countries. Turkey
Philippines

Country overperformance and underperformance

We can gain insights into the sustainability of a countrys NEUTRAL
Competitiveness
prosperity by looking at its level of microeconomic Singapore Lithuania Bangladesh
(measured by BCI)
Israel Panama Serbia and
(business) competitiveness relative to its current per capita and per capita
Japan Ukraine Montenegro
income are
income.Table 6 lists countries in order of the divergence balanced
Switzerland Colombia Georgia
between actual GDP per capita and the expected GDP Taiwan Costa Rica Honduras
Denmark Romania
given microeconomic competitiveness. A level of actual Netherlands Peru
GDP per capita above the expected level is termed Korea Guatemala
France Latvia
overperformance, below the expected level underper-
Hong Kong SAR Mexico
42 formance. Belgium Botswana
Reasons for sustained over- or underperformance Venezuela
Russian Federation
can reflect a variety of circumstances.The political,
governmental, and social situation is one of them, as our
CURRENT OVERACHIEVERS
model suggests.The data set on governance generated by Per capita income
Australia Trinidad and Tobago Nicaragua
Kaufman et al. (2003) allows a better explanation of these is high relative to
United States Macedonia, FYR Bolivia
relationships. Many of these indicators are highly correlat- competitiveness
Portugal Bulgaria Ecuador
(measured by BCI)
ed with GDP per capita.This is to be expected, with Austria Algeria
Canada Mauritius
causality is likely to run both ways.28 We find that Slovenia Paraguay
Kaufmanns measures for voice and accountability and Spain Uruguay
government effectiveness are significant in explaining Iceland Hungary
Greece Bosnia and
the gap between actual and predicted GDP per capita Cyprus Hercegovina
in our model. Voice and accountability is especially Malta Czech Republic
Ireland Poland
important for middle-income countries, with govern-
Norway Croatia
ment effectiveness important for high-income countries. Italy Argentina
Political stability is also important but less significant.
Countries that, in terms of absolute GDP per capita,
benefit most from good governance are Switzerland, the
Netherlands, Finland, Denmark, New Zealand, the United
Kingdom, Sweden, and Norway. Countries that suffer the
most from bad governance in terms of absolute GDP per
capita reduction are Zimbabwe, Ethiopia, Paraguay,
Venezuela, Pakistan, and Algeria.
Another important factor is a countrys geographic
location.We examine two aspects of location: the neigh-
borhood a country is part of, and its proximity to ocean
transportation.We find that the average income of neigh-
boring countries is positive and significant in explaining

the gap between predicted and actual GDP per capita.
This finding suggests the benefits of collaboration with
neighboring countries to improve competitiveness.
Second, we find that the share of a countrys population
within 100 km of an ocean or rivers accessible from an
ocean is also positive and significant in explaining the gap
between actual and predicted GDP per capita.29 Countries
that in terms of GDP per capita benefit most from their
geographic 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 resource
exports, and political conditions (voice and accountability,
government effectiveness) explain more than 25 percent of
the variation in the gap between expected and actual
GDP per capita across countries.
Countries lying above the regression line in Figure 6
are those whose current GDP per capita exceeds that
predicted by their microeconomic competitiveness, as
measured by the BCI index.This is a danger sign, because
it means that a countrys 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 prosperity
that exceeds their microeconomic fundamentals.
Argentina, Croatia, Poland, and the Czech Republic are
among a group of middle-income countries whose levels
of income appear unsustainable without substantial
microeconomic reform. Ecuador, Bolivia, Nicaragua, and
Honduras are the low-income countries in this precarious
position.
Reasons for country overperformance seem to
vary, with some enduring and others more transitory.
Overperformance can persist for many years if it is based
on stable political and social conditions or a favorable geo-
graphic location as discussed above. It can also be sustained
by ample natural resource endowments, as in the case of
Norway, as long as the natural resources are not exhausted
and commodity price levels are maintained at high
enough levels. Large, consistent foreign aid inflows can
support otherwise unsustainable prosperity levels, too,
which may explain the overperformance of countries such
as Nicaragua. Overperformance can be more transitory if
it is based on a boom in foreign investment, as in Poland
and the Czech Republic, or European Structural Fund
inflows, as in Ireland, Greece, and Portugal.
Overperformance can also reflect a lag in the affect on
income of deteriorating microeconomic conditions, as in
Italy and Argentina.We find that relatively few low-
income countries are overperformers.This is consistent
with the higher incidence of macroeconomic, political,
and social challenges among low-income countries that
1.2: Building the Microeconomic Foundations of Prosperity
depresses GDP per capita levels below what could be
expected given their BCI position.
Countries lying below the regression line in Figure 6
are those whose microeconomic competitiveness is stronger
than current GDP per capita. Underperformance bodes
well for the future, because the platform is in place to
support higher GDP per capita if macro, political, or other
constraints can be eased.
Finland, Germany, Sweden, the United Kingdom,
New Zealand, and Singapore lead the advanced countries
with upside potential. Malaysia, Jordan, Morocco,Tunisia,
South Africa, China, and Thailand are among the middle-
income countries that should be able to support a higher
GDP per capita given microeconomic fundamentals.
India, followed by Indonesia, Kenya, Pakistan, Malawi,
and Sri Lanka, continues to head the list of low-income
countries with upside potential alongside.
Sustained underperformance can result from political
or geographic challenges, as discussed earlier. More transi-
tory underperformance can also occur in the aftermath of
a macroeconomic crisis that did not lead to a deteriora-
tion of the microeconomic fundamentals, as in Thailand,
Malaysia, and Singapore. Underperformance may also
reflect a lag prosperity adjusting upward to improving
microeconomic conditions.This seems to be the case in
Finland and the United Kingdom.
India and China are two particularly interesting cases. 43
The underperformance measured for both on a per capita
basis may well result from the sheer number of people
living at the subsistence level outside the mainstream
economy. In these and other countries, the Survey con-
firms large regional differences in business environment
quality, while Surveys tend to come from executives in
the more advanced regions.The average prosperity of such
countries will remain below measured microeconomic
potential 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 a
business environment that should be able to sustain higher
prosperity, including higher wages and more economic
activity.This imbalance makes the countries particularly
attractive for foreign investors that can tap into huge
markets where costs have not yet caught up with the level
of productivity that can be reached.
Regional disparities
As with last year, we included a question on regional
differences in a countrys 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 regional
heterogeneity could help explain the low level of GDP
per capita relative to the reported BCI since Survey
respondents will tend to come from companies in more
1.2: Building the Microeconomic Foundations of Prosperity
prosperous regions and not reflect average conditions in
the economy.
There are also many other smaller, often less devel-
oped, countries that register equal or even higher rates of
regional 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 countries
sometimes accentuate the problem by biasing investment
flows toward a few regions, notably the capital city.
Reducing regional disparities, especially the overconcen-
tration of economic activity in a few huge metropolitan
areas, is one of the critical agendas in the development
process that less advanced economies need to address.
More-advanced economies tend to have policies
aimed at fostering the development of less prosperous
regions.30 A good example is the system of Regional
Development Agencies in the United Kingdom, a deliber-
ate attempt to balance the dominance of the Greater
London 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 of
local competitiveness is daunting.The challenge is to
mobilize the economic potential of all regions, especially
44 when the demographic development will increase the
scarcity of labor, and overcome the tendency the use of
market interventions such as subsidies and trade barriers to
shelter less prosperous regions from competition.
Natural resources and development
Natural resources have played a prominent role in think-
ing about economic development. Historically, abundant
resources were seen as the source of national prosperity. In
the last decade, however, the importance of natural
resources has been called into question as the knowledge
and skill intensity of competition has risen.
As was the case in last years Report, we explore the
relationship between resource abundance and competitive-
ness. For 88 countries we were able to assemble data on
the size of minimally processed natural resources relative
to overall exports.32 The largest absolute natural resource
exporting countries remain the United States, Canada,
Russia, Australia, and Norway.The countries with the
highest share of natural resources exports to total exports
are Venezuela, Jamaica, Ecuador, Malawi, and Paraguay, all
with a natural resource share of greater than 50 percent.
Natural resource exports per capita as a proportion of
GDP per capita are plotted on Figure 9.
Natural resources result from endowments, not eco-
nomic competitiveness. A countrys world market share of
natural resource exports proves to be more closely related
to its geographic size than to its share of world GDP,
while non-natural resource exports are closely correlated
to a countrys share of world GDP. Natural resource
exports per capita are, controlling for country size (we use
population density, the inverse of land area per capita),
much less related to underlying competitiveness measured
by BCI than non-natural resource exports.We find that
the natural resource share of a countrys exports (and
GDP) is decreasing in GDP per capita, again controlling
for country size, as we might expect. Countries with
lower levels of productivity are more dependent on natu-
ral resource exports.
Theory suggests another effect of natural resources
that would counteract the positive direct effect on pros-
perity: abundant natural resources might bias policies
toward rent seeking and redistribution and work against
overall competitiveness. A crude analysis of changes in
BCI supports this view: both high 1997 (initial) natural
resource exports (share of GDP) and a dummy variable for
countries with high current natural resource exports
(more than 1 percent of GDP) are negatively and signifi-
cantly correlated with changes in the BCI rank between
1998 and 2003.33
Changing microeconomic competitiveness and prosperity
growth
We also examined whether countries that are improving
or worsening their competitiveness ranking register corre-
sponding trends in growth of GDP per capita. Changes in
BCI rank should affect growth in GDP per capita as per
capita income responds to a new sustainable level.
Although macroeconomic adjustments and other shocks
may also affect per capita income growth, the relationship
between shifts in BCI ranking and prosperity growth pro-
vides a tentative indication of causality in the relationship
between BCI and prosperity.
Regressing GDP per capita growth between 1998
and 2003 on BCI rank changes between 1999 and 2004
yields a statistically significant relationship that explains
about 18 percent of the total variation in the growth in
GDP per capita across countries.The relationship is highly
significant.The coefficient of the relationship implies that
an improvement of 10 BCI ranks over the five-year time
period is associated with a 1.9 percent higher growth rate
in GDP per capita, and vice versa.Two countries,
Venezuela and Zimbabwe, fall outside the 95 percent sig-
nificance interval in their relationship.Their GDP per
capita has dropped even more than predicted due to
falling BCI, not surprising given the political turmoil in
both countries.34
Conclusions
National prosperity is strongly affected by competitiveness,
which is defined by the productivity with which a nation
Figure 9: Natural resource exports share of GDP versus GDP per capita, PPP adjusted

20% Venezuela

18%
Algeria

Malawi
16%

14% Norway
Ecuador

Vietnam
12%

10% Jamaica Paraguay

Russian Federation

Zimbabwe

8% New Zealand
Latvia Argentina
Chile Australia
Honduras Namibia Estonia

Natural resource exports share of GDP, 2002

Ukraine
6% Colombia Costa Rica
Indonesia
Nicaragua
Trinidad and Tobago
Uruguay Malaysia
Bolivia South Africa Canada
Denmark
4% Netherlands
Ghana Macedonia, FYR Tunisia Lithuania Belgium
Tanzania
Peru Brazil
Ethiopia Guatemala Bulgaria Mexico Hungary
Kenya Georgia Botswana Czech Republic
2% Serbia and Montenegro Jordan Panama Thailand Ireland
Slovak Republic Spain
Sri Lanka Morocco Romania Poland Sweden Finland
Philippines Turkey Croatia United Kingdom Austria
China Slovenia Greece
Pakistan India Israel Singapore France
Portugal Cyprus Italy Germany Iceland
Mauritius United States
Bangladesh El Salvador Korea Malta Hong Kong SAR Japan Switzerland
0%
0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000

GDP per capita, PPP adjusted, 2003

45

1.2: Building the Microeconomic Foundations of Prosperity

1.2: Building the Microeconomic Foundations of Prosperity
utilizes its human, capital, and natural resources.
Competitiveness is rooted in a nations microeconomic
fundamentals, manifested in the sophistication of its
companies and the quality of its microeconomic business
environment.
Stable institutions, sound macroeconomic policies,
market opening, and privatization have long been consid-
ered the cornerstones for economic development. Our
results here, and in previous years, suggest that these fac-
tors are necessary but far from sufficient. More than 80
percent 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 natural
resources, explain why a countrys prosperity can deviate,
sometimes for long time periods, from the level supported
by its microeconomic fundamentals.We find, however, that
the absolute impact of these factors is significantly smaller
than that of the microeconomic fundamentals.
Without micro reforms, growth in GDP induced by
sound macro policies, market opening, and privatization
will be unsustainable or will not translate into improve-
ments in GDP per capita. Appropriate micro reforms,
which boost productivity and productivity growth, can
greatly ease the challenge of meeting governments fiscal
obligations and reducing macroeconomic distortions.
46 Microeconomic reforms can also reduce the political pres-
sure on governments trying to defend macroeconomic
stabilization and market opening against vested interests.
Citizens who see monopolies loosing their grip, businesses
reforming themselves, and opportunities for employment
and entrepreneurship increasing are much less likely to be
seduced by the false promises of redistribution and gov-
ernment intervention.
Over time, more countries are realizing that sustained
prosperity growth can be achieved only through continu-
ous improvement of the microeconomic foundations of
competitiveness.The experience with the 2000 Lisbon
Agenda of the European Union, however, is an indication
of how hard it is to move from realization to meaningful
action.The current economic climate in Europe has raised
the danger that politicians will fall back on tried and failed
models of industrial policy. More broadly, our results illus-
trate the challenges countries face, especially low- and
middle-income countries, in sustaining and continuously
improving their business environments when the bar is
rising in the global economy.
Our findings confirm the view that it is unwise to
view micro reforms narrowly in terms of reducing the
role of government and abolishing market distortions.
Such steps remain a critical challenge that many countries
still have to master.Yet government has a range of positive
roles that are fundamental to prosperity, such as investing
in human resources, stimulating sophisticated demand via
setting appropriate regulatory standards, and building
innovative capacity. Many nations need to move beyond
first-stage reforms and address these agendas.
The private sector has a crucial role in improving a
nations competitive platform through dialogue with
government, collective private activities, and cluster
development. Second-stage micro reforms require a new
perspective on the role of the private sector. Private sector
leaders are still not engaged enough in driving national
competitiveness programs and initiatives, especially in
developing countries.
The important role of clusters in competitiveness is
again validated by our results. Realizing that clusters are
important, however, is not the same as developing policies
and 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 their
impact.35 Our analysis, however, also makes it clear that
microeconomic reform is much more than cluster devel-
opment.While numerous efforts to enhance clusters
around the world are highly encouraging, countries also
need to pursue improvements throughout the business
environment. Otherwise cluster development initiatives
will ultimately be stymied.
Our results once again highlight the need to align a
nations economic priorities with its level of development.
There is strong evidence that microeconomic upgrading is
a sequential process in which countries at different levels
of development face distinctly different challenges.
Attempting to apply one policy model across disparate
countries is often not appropriate; a problem the
European Union is now facing after the accession of ten
mainly central and eastern European countries.This Report
clarifies the differing policy priorities and challenges for
low-, middle-, and high-income countries, and the diffi-
cult transitions between broad developmental stages.
Countries that have been very successful in one mode of
competing need to recognize the multifaceted adjustments
necessary for managing the transition to the next one.
This years Report also sheds light on the experience
of individual countries.The strong underlying competi-
tiveness of the United States, confirmed by its reclaiming
the top rank in the BCI, bodes well for the medium-term
prospects of the US economy, despite the turbulences in
the international environment. India, after an erratic histo-
ry, has now for a number of years registered a stable trend
of improvements in competitiveness. Indonesia, a crucial
country given its large Muslim population and role in the
region, has made heartening improvements in competi-
tiveness. Italy has seen an alarming deterioration of its
competitiveness position; part of it might be temporary,
related to the sentiment of the countrys business elite in
the wake of the Parmalat accounting scandal, but our

results indicate that the country has underlying challenges
that have become much more apparent in an environment
of slow growth and joint European currency.The data in
this Report provide detailed assessments of the strengths
and weaknesses in these and other countries.
China and India stand out as enjoying the fruits of
improvements in competitiveness that have run ahead of
wages.Their position as underperformerscountries with
current prosperity and productivity levels below the
potential of their microeconomic fundamentalshelps
explain the robust investment inflows into these countries:
They are attractive not because their wages are low in an
absolute 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 an
adjustment process that will, over time, tend to close this
gap 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 and
the quality of the business environment is the only way to
produce real improvements in efficiency, product quality,
and new business and job growth that support a rising
standard of living for citizens. In future years, we and the
Forum are committed to work toward improved data and
more advanced tools to enable leaders in government and
business to guide economic development.
Notes
1 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 the
model has been improved.
3 See, for example, OMahony and van Ark (2003).
4 Accordingly, the European Union has made increasing labor participation
one 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 on
Competitiveness, and Monitor Group, 2001); further reports on five
US 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 further
in joint work with Willis Emmons, Georgetown University. Porter and
Emmons (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 Slvell, Lindqvist,
and Ketels (2003)
11 Glaeser, La Porta, Lopez-de-Silanes, and Shleifer (2004).
1.2: Building the Microeconomic Foundations of Prosperity
12 One surveyed economy, Luxembourg, was not included in the calcula-
tions because, given its small size, functional concentration on a few
sectors, and almost complete integration into the neighboring
economies, it is better understood as a region within these
economies.
13 See World Bank (2004) and the web site
http://rru.worldbank.org/doingbusiness/
14 These reasons could include larger actual heterogeneity within the
country as well as greater uncertainty by respondents about appro-
priate international benchmarks.
15 Eighty-nine countries were included with all their responses; four
countries (Ghana, Macedonia, Namibia, and Tanzania) were included
with 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 worker
can be increased by high unemployment or low workforce participa-
tion, which do not increase wealth. Also, holders of capital, not only
workers, contribute to national productivity. In comparing the United
States and France, for example, the United States has absorbed a
huge influx of new workers (higher workforce participation) over the
last decade, while France has maintained high GDP per worker
through 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 the
size of dividend outflows to foreign investors. Irelands GDP is about
20 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 Global
Competitiveness Report. These regressions show no statistical rela-
47
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 common
over 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 confidence
interval for a given level of competitiveness over repeated observa-
tions. The forecast region method, in contrast, reflects a higher
degree of inherent uncertainty in predicting a single observation. As
a result, interpretation of the proximity of data points to the regres-
sion line should be undertaken with appropriate caveats. Note that
the forecast region widens slightly as it moves away from the cen-
ter of the graph. The center is the point located at the intersection
of the mean GDP per capita level and mean factor score.
24 Our ranking has an interesting correlation with the FDI potential index
calculated by UNCTAD (2004). The FDI potential index includes natu-
ral resource deposits and a large domestic market as elements, both
factors 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 includes
GDP per capita, an indicator highly correlated with the BCI and many
of 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 variables
included in the BCI are significant.
27 For a more detailed examination of Japans competitive situation, see
Porter, Takeuchi, and Sakakibara (2000).
28 This implies also a high correlation between these indicators and the
BCI, providing a statistical challenge for distinguishing their inde-
pendent effects.
1.2: Building the Microeconomic Foundations of Prosperity
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. For
an assessment of the current situation in the United States see
Porter, 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,
19972001, SITC Rev.3. A list of SITC industries included can be
obtained from the author.
33 The time-series data available for this analysis unfortunately still
include few low-income countries with high natural resource export
share. The analysis will be expanded as more country data become
available over time.
34 When Venezuela and Zimbabwe are dropped from the regression, the
explanatory power of the equation falls to 13.6 percent and the coef-
ficient falls to an increase of 1.2 percent annual GDP per capita
growth for an increase of ten ranks in the BCI over five years.
35 See, for example, the tools provided by the Foundation Cluster and
Competitiveness (www.clustercompetitiveness.org), an institution
launched on the initiative of the Catalan government.
Selected References
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49
1.2: Building the Microeconomic Foundations of Prosperity
Appendix A: ANOVA Analysis for Survey Responses
I. COMPANY OPERATIONS & STRATEGY R2
Production process sophistication. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.422
Nature of competitive advantage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.358
Extent of staff training. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.342
Extent of marketing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.339
Willingness to delegate authority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.278
Capacity for innovation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.382
Company spending on research and development . . . . . . . . . . . . . . . 0.322
Value chain presence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.392
Breadth of international markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.412
Degree of customer orientation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.227
Control of international distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.178
Extent of branding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.396
Reliance on professional management . . . . . . . . . . . . . . . . . . . . . . . . . 0.297
Extent of incentive compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.263
Extent of regional sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.366
Prevalence of foreign technology licensing . . . . . . . . . . . . . . . . . . . . . 0.221
II. NATIONAL BUSINESS ENVIRONMENT R2
A. FACTOR (INPUT) CONDITIONS
1. Physical Infrastructure
Overall infrastructure quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.553
Railroad infrastructure development . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.608
Port infrastructure quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.500
Air transport infrastructure quality. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.408
Quality of electricity supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.487
Telephone/fax infrastructure quality . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.438
2. Administrative Infrastructure
Reliability of police services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.355
Judicial independence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.426
Efficiency of legal framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.408
Administrative burden for startups. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.222
50
Extent of bureaucratic red tape . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.081
3. Human Resources
Quality of management schools . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.352
Quality of public schools . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.480
Quality of the educational system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.347
Quality of math and science education . . . . . . . . . . . . . . . . . . . . . . . . . 0.387
4. Technology Infrastructure
Availability of scientists and engineers . . . . . . . . . . . . . . . . . . . . . . . . . 0.274
Quality of scientific research institutions . . . . . . . . . . . . . . . . . . . . . . . 0.327
University/industry research collaboration. . . . . . . . . . . . . . . . . . . . . . 0.299
5. Capital Markets
Financial market sophistication . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.432
Ease of access to loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.226
Local equity market access . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.343
II. NATIONAL BUSINESS ENVIRONMENT (Contd.) R2
B. DEMAND CONDITIONS
Buyer sophistication . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.334
Sophistication of local buyers' products and processes . . . . . . . . . . 0.269
Government procurement of advanced technology products. . . . . . 0.170
Presence of demanding regulatory standards . . . . . . . . . . . . . . . . . . . 0.426
Laws relating to ICT. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.305
Stringency of environmental regulations . . . . . . . . . . . . . . . . . . . . . . . 0.411
C. RELATED AND SUPPORTING INDUSTRIES
Local supplier quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.314
State of cluster development. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.220
Local availability of process machinery . . . . . . . . . . . . . . . . . . . . . . . . 0.341
Local availability of specialized research and training services . . . 0.278
Extent of collaboration among clusters . . . . . . . . . . . . . . . . . . . . . . . . . 0.263
Local supplier quantity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.216
Local availability of components and parts . . . . . . . . . . . . . . . . . . . . . 0.323
D. CONTEXT FOR FIRM STRATEGY AND RIVALRY
1. Incentives
Favoritism in decisions of government officials. . . . . . . . . . . . . . . . . . 0.272
Cooperation in labor-employer relations . . . . . . . . . . . . . . . . . . . . . . . . 0.218
Efficacy of corporate boards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.148
Intellectual property protection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.418
Protection of minority shareholders interests . . . . . . . . . . . . . . . . . . . 0.259
Regulation of securities exchanges . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.338
Effectiveness of bankruptcy law. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.359
2. Competition
Hidden trade barrier liberalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.267
Intensity of local competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.163
Extent of locally based competitors . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.174
Effectiveness of anti-trust policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.315
Decentralization of corporate activity . . . . . . . . . . . . . . . . . . . . . . . . . . 0.261
Business costs of corruption. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.254
Tariff liberalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.225
Centralization of economic policy-making . . . . . . . . . . . . . . . . . . . . . . 0.207
Prevalence of mergers and acquisitions. . . . . . . . . . . . . . . . . . . . . . . . 0.181
Foreign ownership restrictions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.216
 4.2: Country Profiles

Spain
Competitiveness Rankings
Growth Competitiveness Index Rank 23 Business Competitiveness Index Rank 26

Macroeconomic Environment Index Rank .....................16 Sophistication of Company Operations

Macroeconomic Stability Subindex Rank .............34 and Strategy Rank ............................................................25
Government Waste Rank .....................................17 Quality of the National Business
Country Credit Rating Rank ..................................16 Environment Rank ............................................................26
Public Institutions Index Rank..........................................34
Contracts and Law Subindex Rank ......................42
Corruption Subindex Rank....................................32
Technology Index Rank ......................................................20
Innovation Subindex Rank ....................................24
ICT Subindex Rank ...............................................30
Technology Transfer Subindex Rank
(out of 79 non-core innovators)........................11

The Most Problematic Factors for Doing Business

382 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 to
their rankings.

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

 4.2: Country Profiles
National competitiveness balance sheet
NOTABLE COMPETITIVE ADVANTAGES NOTABLE COMPETITIVE DISADVANTAGES
Growth Competitiveness Index Rank/104 Growth Competitiveness Index Rank/104
Macroeconomic Environment Macroeconomic Environment
2.26 Interest rate spread, 2003.................................................2 2.24 Real effective exchange rate, 2003 ................................88
2.30 Country credit rating, 2004 .............................................16 2.07 Access to credit ..............................................................50
2.22 Government surplus/deficit, 2003...................................17 2.25 Inflation, 2003 .................................................................50
6.06 Wastefulness of government spending ..........................17 2.01 Recession expectations ..................................................49
Technology 2.23 National savings rate, 2003 .............................................39
3.18 Cellular telephones, 2003..................................................8 Public Institutions
4.22 Tertiary enrollment ..........................................................14 6.01 Judicial independence.....................................................50
6.22 Irregular payments in public utilities ...............................39
6.03 Property rights.................................................................38
6.18 Organized crime ..............................................................38
6.10 Favoritism in decisions of government officials..............36
6.23 Irregular payments in tax collection ................................34
6.21 Irregular payments in exports and imports .....................31
Technology
3.15 Government success in ICT promotion ..........................69
3.14 Government prioritization of ICT .....................................52
3.02 Firm-level technology absorption ....................................52
3.13 Quality of competition in the ISP sector .........................46
3.06 Company spending on research and development ........41
3.16 Laws relating to ICT ........................................................39
3.12 Internet access in schools ..............................................38
3.19 Internet users, 2003........................................................36
3.01 Technological readiness ..................................................33
3.08 University/industry research collaboration ......................33
3.21 Personal computers, 2003 ..............................................31
3.03 Prevalence of foreign technology licensing ....................29
3.04 FDI and technology transfer............................................29
5.08 Telephone lines, 2003 .....................................................29
383
3.17 Utility patents, 2003 ........................................................28
3.20 Internet hosts, 2003........................................................27

Business Competitiveness Index Rank/93 Business Competitiveness Index Rank/93

Sophistication of Company Operations and Strategy
9.14 Extent of incentive compensation ..................................18
9.09 Control of international distribution .................................18
9.02 Value chain presence ......................................................21
Quality of the National Business Environment
6.15 Centralization of economic policymaking ..........................4
3.18 Cellular telephones, 2003..................................................7
9.16 Quality of management schools .......................................8
Sophistication of Company Operations and Strategy
9.10 Extent of regional sales...................................................43
9.13 Willingness to delegate authority....................................40
3.06 Company spending on research and development ........39
Quality of the National Business Environment
6.16 Reliability of police services ............................................77
7.05 Administrative burden for startups .................................61
9.20 Cooperation in labor-employer relations..........................52

Other Indicators Rank/104 Other Indicators Rank/104

4.07 Present business impact of HIV/AIDS ..............................7 4.13 Maternity laws impact on hiring women .......................95
2.04 Soundness of banks........................................................14 9.18 Hiring and firing practices ...............................................89
9.05 Ethical behavior of firms .................................................21 7.08 Private-sector employment of women ..........................83
4.04 Disparity in healthcare quality .........................................22 7.09 Wage equality of women in the workplace ....................83
2.14 Business impact of foreign trade barriers .......................80
9.26 Company promotion of volunteerism .............................78
2.17 Tax burden.......................................................................76
9.19 Flexibility of wage determination ....................................76
7.10 Regional disparities in quality of business environment .74
2.13 Business impact of domestic trade barriers ...................73
4.14 Childcare availability ........................................................72
10.07 Subsidies for energy or materials ...................................70
2.02 Business costs of terrorism ............................................69
9.25 Charitable causes involvement .......................................68
10.06 Political context of environmental gains .........................60

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