What is the investment climate?

a man is sitting and showing something on the board

Investment climate definition explains the economic, financial and social-political conditions in a country that influence decisions by institutions, banks, or individuals to invest in businesses there.

There are several factors affecting investment climate, such as crime levels, poverty rate, employment rate, judicial system, political stability or instability, regulatory uncertainty, stability of financial markets and tax regime.

This investment climate influences decisions by all types of economic players – from micro to big business players – whether to start or expand a business, hire workers, or find a new location for their next production facility.

Indicators of a good investment climate in a country include standard good governance practice, availability of basic infrastructure such as roads, electricity and communication (internet, telephone), low level of corruption, market-friendly regulations, and an impartial court system.

However, It can be difficult to use ‘governance’ to determine whether a country or region has a favourable investment climate. Governance is a broad concept that can be implemented in a variety of ways.

There are also different types of governance, from political governance (the type of of political system, constitutional set-up, relations between state and society), economic governance (state institutions that regulate the economy, competition, property and contract rights), and corporate governance (national and company laws and practices that determine corporate conduct, shareholder rights, disclosure and transparency, accounting standards).

What does a good investment climate mean?

A favourable investment climate encourages productive private investment, which can spur growth and reduce poverty.

The World Bank lists benefits of a good investment climate:

“It creates opportunities and jobs for people. It expands the variety of goods and services available and reduces their cost, to the benefit of consumers. It supports a sustainable source of tax revenues to fund other important social goals. And many features of a good investment climate – including efficient infrastructure, courts, and finance markets – improve the lives of people directly, whether they work or engage in entrepreneurial activities or not.”

When potential investors encounter numerous obstacles, such as the absence of public business infrastructure – sound regulations, market-friendly law, and transparent procurement system – they may find the business/investment environment in a country unfavourable. These challenges are common in developing countries, making it difficult to attract investment from both domestic and foreign private sectors.

Some investors, on the other hand, may be willing to take risks and invest in an unfavourable investment climate if it promises high returns.

How investment climate is improved

A key component to remove investment barriers is regulatory reform. For example, simplifying regulations and applying electronic/online permit applications can reduce red tape and lower corruption risk.

Several nonprofit organisations, such as the Investment Climate Reform Facility, help countries improve their investment climate.