FEBRUARY 1997

INVESTMENT POLICY

FRAMEWORK

IN PAPUA NEW GUINEA

i1 i | i | g By Pirouz Hamidian-Rad, Senior Economist, EA3PI

F &

PAPUA NEW GUINEA DISCUSSION PAPER SERIESNUMBER I

A ~~~~~~~EAST AsIA AND PACIFIC REGION -COUNTRY DEPARTMENT III

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SUMMARY

INVESTMENT POLICY

FRAM EWORK

IN PAPUA NEW GUINEA

Pirouz Hamidian-Rad, Senior Economist, EA3PI

Papua New Guinea (PNG) has greatpotential for economic development.However, despite sharp increases in averageincome and public spending over the pastdecade, PNG continues to have some of theworst social indicators in the world, and theyare deteriorating.

In response to an internally generatedfinancial crisis which brought Governmentoperations to a halt in late 1994, theGovernment has taken important, initialsteps towards promoting a transparent andpredictable trade and investment regime.

These policies have to be maintained anddeepened. In addition, the institutionsresponsible for the enforcement of policiesand the promotion of investment must benurtured consistently over a long period oftime if PNG is to reap the benefits of thereforms and emerge as a competitiveinvestment destination and an economicforce in the Pacific region. DISCUSSION PAPERS PRESENT RESULTS OF COUNTRY

ANALYSES UNDERTAKEN BY THE DEPARTMENT AS PART

OF ITS NORMAL WORK PROGRAM. To PRESENT THESE

RESULTS WITH THE LEAST POSSIBLE DELAY, THE

TYPESCRIPT OF THIS PAPER HAS NOT BEEN PREPARED

IN ACCORDANCE WITH THE PROCEDURES APPROPRIATE

FOR FORMAL PRINTED TEXTS, AND THE WORLD BANK

ACCEPTS NO RESPONSIBILITY FOR ERRORS. SOME

SOURCES CITED IN THIS PAPER MAY BE INFORMAL

DOCUMENTS THAT ARE NOT READILY AVAILABLE. THE

WORLD BANK DOES NOT GUARANTEE THE ACCURACY

OF THE DATA INCLUDED IN THIS PUBLICATION AND

ACCEPTS NO RESPONSIBILITY FOR ANY CONSEQUENCE

OF THEIR USE.

PAPUA NE-w GUINEA

DISCUSSION PAPER SERIES

fInvestment Policy Frameworkin Papua New GuineaBy Pirouz Hamidian-Rad, Senior Economist, EA3PI

Papua New Guinea (PNG) has great potential for economic development. Fewcountries are endowed with similar abundant natural resources. Its present level of

income of US$1,160 per capita (in 1995) offers possibilities which are not readilyavailable to many developing countries. Geographically, it is located in what isconsidered to be the most dynamic region in the world, in terms of economicdevelopment. Despite the sharply rising level of average income and the high level ofpublic spending in the past decade, PNG has some of the worst social indicators in theworld, and they are deteriorating (Figure 1). Eighty percent of the population earn lessthan US$350 per annum.

I. INTRODUCTION

PNG is emerging from an internally generated in absolute terms and as a share of GDP) publicfinancial crisis which brought Government investment and maintenance outlays as well asoperations in late 1994 to a halt, substantially non-mining private investment have continuederoded public confidence in the Government and to fall, resulting in a steady depletion of thethe economy, and encouraged massive capital stock of capital. This has contributed to theflight. The crisis was a result of deep-rooted falling employment and income in the non-structural problems, a lax fiscal stance in the late mining sector.1980s and early 1990s, and an inconsistent and However, in the past couple of years, with theunstable policy environment, increasing integration of PNG in the global

Past policies to promote investment in PNG economy in the context of its membership in thehave been restrictive and inward looking, aimed Asia-Pacific Econormic Cooperation forum andat localization, import substitution and its pending membership in the World Tradereservation of economic activities in the non- Organization, as well as its efforts to addressmining sector for PNG nationals. The results structural bottlenecks in the economy, thehave not been encouraging. Despite rising levels Government has taken a good number of initialof public expenditures in the early 1990s (both steps towards promoting a transparent and

P AP U A N E w G UI N EA D I S C U SS IO0N PA P ER S E R I E S

Figure 1: The Paradox of Papua New Guinea

Per Capita GNP Rising... But Social Indicators Deteriorating

1400 (US$) (1980=100)

1200 - 180 El 1'D~~~~ ~160

1000M ~~~~~~140

8001 120100

600 80

400 6

4200 20 1990

0.~~~~~~~~~~~~~~~~~Crime Rate1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 WaterSupply Road Maint

Source: World Development Indicators, 1996 and other editions, World Bank

predictable trade and investment regime not only II. WHAT ARE THE KEYfor the mining sector but also for the INGREDIENTS OF ANnonresource-based economy. APPROPRIATE INVESTMENT

These policies have to be maintained and POLICY FRAMEWORK?deepened, and the institutions responsible for The objective of investment policy can beenforcement of policies and promotion of described as achievement of sustained economicinvestment nurtured consistently over a long growth with relative price stability. Stagnationperiod of time if PNG is to reap the benefits of or growth of the economy is a function of athe reforms and emerge as a competitive range of factors. Recent empirical work oninvestment destination and an economic force in economic growth in various countries points tothe Pacific region. the primacy of government choices. CountriesThis paper addresses three key questions: that have pursued policies conducive to a

broadly free-market economy (particularly trade* What are the key ingredients of an appropriate liberalization and the maintenance of secure

investment policy framework? property rights), characterized by smaller

* What have been the key characteristics of government, lower government spending, andinvestment policy in PNG? and the promotion of the development of human

capital, have enjoyed higher rates of growth* What can and should the Govemment do to than countries which have pursued inward-

make PNG attractive for foreign and domestic oriented, nonmarket-based arrangements.investment?

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Investment promotion depends first and activities, "prestige" projects, or projects withforemost on the existence of an effective inadequate feasibility studies. Such investmentspolitical leadership and credible government often fail the tests of competitive productivity.dedicated to economic growth and national The democratic regime and particularwelfare. Government's contribution to a geographic configuration of PNG has led to asuccessful investment policy requires large degree of decentralization of economicintervention in three inter-related areas: management and revenue sharing.macroeconomic stabilization, development of Democratization and decentralized managementinfrastructure and human resources, and, lastly, are usually accompanied by significant socialcreation of an efficient admninistration., r. vo.

pressures in favor of income redistribution andMacroeconomic stability, a precondition of rising consumption. The requirements of capitaleconomic dynamism, can only be achieved formation, by contrast, call for certainthrough government determination and constraints oncontinuation of appropriate policies. This has consumption andalready been initiated by the Government of some initial THE SUCCESS OF

PNG. The improvement of infrastructure and tolerance of growing DECENTRALIZATION

development of human capital depend on the income gaps among REQUIRES A STRONG

availability of funds and their judicious use. major social groups. CENTRAL ADMINISTRAnON

Administrative reform should result in a leaner The reconciliation of CAPABLE OF ENSURING

and more liberal-minded bureaucracy capable of these opposing COMPLIANCE WITH

creating the right chemistry between the public forces is not easy. CENTRAL GOVERNMENT

and private sectors. Though local OBJECTIVES OF

The choice of development strategy does not governments should INVESTMENT PROMOTIONalways work out to be an optimization of returns have a high degree INVSENO PROMTIOop muza ion of ~~. I. AND ECONOMIC GROWTH.on investment. The objective of sustainable o autonomy vis-a-growth is often tempered by such other notions vis the centralas "balanced growth" or "social welfare," government, theyhowever defined. For example, popular pressure should have a shared sense of purpose. Althoughdemands that the largest possible percentage of local governments need to maintain a degree ofthe present population share in the benefits of autonomy, they must not be subject to capture bymineral receipts. However, excessive attention to special interest groups. Otherwise the state willwelfare via transfer payments may often result in be unable to act coherently, and the uniquethe too familiar stifling of work incentives and character of the contribution of decentralizationin the reduction of industrial competitiveness, would be lost. The success of decentralizationSimnilarly, the concentration of mineral export requires a strong central administration capableincome in the government's hands may result in of ensuring compliance with central governmentcrowding out the private sector in areas which, objectives of investment promotion andby their nature, are better managed by the latter. econoic growth.

A sudden increase in the prices of minerals and Within this context, an appropriate investmentsubsequent "revenue boom" may result in hasty policy framework should focus on creatingallocation of revenues to politically popular productive employment and diversification of

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the production base. It should specifically be investment policy should be to expand therecognized that mnineral reserves are depletable export base through product diversification inand the prices of a limited number of renewable order to make up for dwindling earnings fromresources are subject to sharp fluctuations in the minerals and unexpected changes of the pricesinternational market. of agricultural commodities. Mineral revenue

cannot be considered a continuous stream ofTransparency and nondiscriminatory rules and future income flow, but rather a "cashed" valueregulations are key for promoting a healthy of a given stock of capital that is transformedenvironment for investment. Rules and from one form (mineral deposit) to anotherreuatosshudbeapicbetoal(financial assets). Unless these assets are further

enterprises without exception. This calls for: (a) transformed through appropriate investment intoprivatization, divestiture, and liquidation - at a sustainable revenue base, economicnational as well as provincial level of public development cannot be ensured. This situationsector activities that compete unfairly with the calls for an appropriate model of developmentprivate sector - and; (b) repeal of specialanadpinoannvsm tplcybednprivileges granted to some enterprises. The produc adiverioofication.etetpliybsdodiscrim-ination in favor of these enterprises can poutdvriiainbe terminated on the basis of some The availability of foreign exchange is only onearrangements to be mutually agreed upon by the requisite for viable domestic capital formation.govemnment and the private investor. For Other complementary factors, such as rawinstance, the government, while remaining firm materials, skilled labor, entrepreneurship,on its principle, might extend these privileges project implementation capacity, and adequatefor a given period (in the form of a 1-2 year infrastructure are as impor-tant and often in shorttime-bound "grandfather clause"), supply. As the economy grows, these shortages

will be elimrinated, or reduced. But this processIn countries overwhelmingly reliant on is gradual and effective only in proper sequence.resource-extraction activities, the objective of

Figure 2: Dualistic Growth

A Mining and Oil Boom, But Non-Extractive Sectors Stagnant(% per year growth)

70

60

50o. Extracfive sectors_----'

40 /'

30 - -

2010 -' O~~~~~~~~~~rAgric~~~~~~Agicul6ua.

0 6=4-r -1d*4 1985 1986 1987 1988>\ 1989 1,- 191 1991 1992 1993 1994 1995

-20

-30t-40

Souirce: World Development Indicators, 1996 and other editions, World Bank

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Figure 3: Investment Performance and Public Consumption

Low Public Investment... ..Accomodated Rising Public Consumptionr1/6ofGDP) 1,60 (Icina mill.)

30.0 i Public S Non-mning t Mining 1,400 C3Current Spending

250 1200 1Capta 1Spe1k9ig1,000

20.0-

800-15.0-

600

10.0 400

|O eet .=v, 0t'-1tr rl 19200 1985 1986 1987 1988 1989 1990 1991 1992 1993 19 8 9618 98 991W 19 9 9 1994 1995

Source: World Development Indicators, 1996 and other editions, World Bank

For instance, importation of machines and image that investors have of PNG as a difficultequipment should be undertaken when port and investment climate arose from its weakroad facilities are in place; similarly, effective investment policy environment, high risks,university training requires adequate elementary infrastructure bottlenecks, lack of skilledand secondary education. manpower, and lack of internally consistent

If investment is too rapid, the benefits may be incentive systems.considerably diminished as a result of inflation, Total investment in PNG has fluctuated overa deteriorating trade balance, incorrect relative time and is relatively low by the standards ofprice signals for tradable goods production, and low to middle-income countries. While grossshortages leading to waste. A further problem domestic investment in PNG was comparable toarises when the investment that is undertaken is that in sub-Saharan Africa, it has been fallingof poor quality - something more likely in an relative to GDP - from a high of 27 percent ofenvironment of inadequate planning, inflation, GDP in 1991 to an estimated 24.5 percent inand shortage of factors of production. Even 1995 (Figure 3). Net investment has alsowhere investment is in the traded goods sectors, declined sharply from a peak of 15 percent tothe future output from present investments may beyond replacement value (if one takes intoprove hard to market - a particular danger if account the depletion of the country's naturalthe size of the domestic market is not large resource base and the poor productivity ofenough to absorb this output. investment).

III. WHAT HAVE BEEN THE KEY With a high capital-output ratio, over seven,CHARACTERISTICS OF compared to an average of about three in mostINVESTMENT POLICY IN PNG? developing countries, and a low and declining

PNG's economy has suffered over the years output-labor ratio, particularly in agriculturefrom many weaknesses. The weaknesses in the where the labor force is growing at 3 percent perpolicy path, followed by successive year, it would be difficult to identify attractivegovernments of PNG, have had serious proposals in the non-minerals sector.consequences. To a large extent, the prevailing Furthermore, public investment relative to GDP

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has been declining steadily since the rmid-1980s since the closure of the Panguna Copper Mine into inadequate levels with a large unmet need for 1989.physical and social infrastructure. This is in spite Moreover, mining activity is highly capitalof increased government spending on public intensive and skill intensive with input

construction projects. requirements vastly different from the country's

In PNG, as in most developing countries, the domestic factor availabilities. The localrelationship between private and public economy is not in a position to take advantageinvestment is functional. For private investment of mining activity, except for the provision ofto occur, public investment in infrastructure unskilled labor and only for a limited time. Thisdevelopment and education must lead. With has led to a dual economy with isolated centersrespect to private investment in mining, of capital-intensive, advanced technologyhowever, the functional relationship between the without any relation to the surroundingpublic and private sector is not binding. The environment.sector relies mostly on foreign experts and Nowhere is thebuilds the additional infrastructure it needs for failure of past INVESTMENT IN THE MAIN

the purpose of exploiting and exporting minerals r LABOR-ABSORBINGpolicies as

and oil products. Unfortunately, especially in the transparent as in the SECTOR OF THE ECONOMY,nonresource sector, the importance of this nonresource-based PRIMARILY AGRICULTURE,

functional relation between public and private sector of the HAS SHOWN NO

sector investment has not been fully appreciated. economy. SIGNIFICANT GROWTH

As a result, adequate and appropriate public Investment in the RELATIVE TO GDP OVER

investment has not been undertaken ahead of main labor- THE YEARS.

time to attract private sector investment, such as absorbing sector ofin infrastructure and human resource the economy,development. Furtherrnore, lack of proper primarily agriculture has shown no significantmaintenance of existing investment has prowt arelativet GDP sove th ys.adversely affected the private sector's ability to growth relative to GDP over the years.

Agriculture, where 85 percent of the populationexpand. earn their livelihood, and with the potential for

The resource-based sector (primarily mineral) absorbing most of the labor force, has longhas dominated the sectoral composition of suffered from low productivity and highinvestment. However, investment in this sector domestic costs. These problems arise fromis relatively lumpy, and accounts for much of the policy rigidities in the labor market, exchangevariability in the size of total investment. The rate, and infrastructure bottlenecks. Thesector has no significant linkages to the rest of manufacturing sector (mainly food processing,the economy. Despite its significant fiscal beverages, tobacco, and timber processing forcontribution (about 27 percent of total small local markets) has stagnated over the pastgovernment revenue) and foreign exchange two decades, and its contribution to GDPearnings (about 70 percent of export earning), it remains just under 10 percent, while it hasis highly capital intensive and unable to generate become heavily dependent on Governmentmore than 0.3 percent of total formal sector support through tariffs and other protectiveemployment, and even this has been declining measures.

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Land is one of the major factors of production. policies - has undermined both growth andIn PNG, nearly 97 percent of the land is held employment. The "hard kina" policy pursuedunder customary ownership arrangements. from 1975 to the early 1990s discouraged localEntitlements are often undocumented and food production, import substitution, and growthfrequently disputed. Past policy reforms have of existing and potential exports. The fiscalnot devoted the attention needed to address this policy that had been pursued in support of theissue. As a result, administrative problems are hard kina policy and resultant high real wages,experienced to mobilize and transfer land rights. left little margin for government expenditure onThree percent of the land belongs to the goods and services or on public investment.Government and can be used for development The wage structure inherited from the pre-purposes. This land is partially utilized under independence administration was recognized toshort-term leaseholds (averaging 5 years) with4:1 ~~~~be far out of line with the country's laborrelatively high rent. The Government is trying to productivity and realease the problem through the promotion of wagesIin_competingindustrial estates. The weakness of this approach countries TheP TIMELINESS IN POLICY

is to concentrate activities in few centers, while co mpleTe TMENE P

the fragmented market of PNG requires these lnag ofpaeto SUSTMENTA

activities to be decentralized and spread all over thekcos of lvge NSSTENCY AREthe country. ~~~~~~~~~the cost of living CONSISTENCY ARE

index that was in CRUCIAL ELEMENTS FOR

Gross private investment, both foreign and place until recently, WINNING INVESTOR

domestic, in the non-mineral economy has not prevented the CONFIDENCE.

shown any increase over the years relative to Government fromGDP, averaging under 10 percent of GDP in using exchange raterecent years. A large segment of the economy is adjustment as a means of increasing PNG'sconsidered reserved, open only to domestic international competitiveness. The minimuminvestors, although there has been little or no wage legislation of PNG runs counter to theactivity in these reserved sectors, since these requirements for labor market flexibility andregulations were implemented almost a decade competitiveness that characterize anago. open-market economy. Various surveys indicate

Llthe cause that the level of official minimum wage makesLack of savings has not been generally PNG wokrctemstepnivsnEatAifor the weak performance of the nonresource- PNG workers the most expensive in East Asia

based investment. Theanawhile their productivity is far below the regionalbased investment. The national savings rate has average. Minimum wage legislation is not anbeen averaging 18 percent of GDP over the erage. gum wagelglon groth,decade ending 1993. Public savings have been efficient tool for pursuing employment growth,modest in the 1980s but have declined sharply in While PNG's trade policy involved a relativelythe 1990s due to expenditure overruns. simple tariff structure, and only modest trade

Timeliness in policy adjustment, sustainabiliy restrictions, it nevertheless suffered from threeTimeliness in poy ake defects: (a) high and variable effective ratesand consistency are crucial elements for winning y

investor confidence. The long delay in the of protection for manufacturing, construction,adjustment of PNG's three main economic and distribution services, and negative effective

adJustment~ ~ ~ ~ ~ ~ ~rae of proecio fo three agmiculturalpolicies - exchange rate, wage, and fiscal rates of protection for most agricultural

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commodities; (b) lack of responsiveness of surfaced. Much-needed bridges are often missing,some trade tax revenues to growth; and (c) further localizing the small national market. Theincreasing recourse to negotiated trade supply of reliable and affordable water andarrangements, involving import restrictions and electric power has also become a seriousdomestic market guarantees for large, new bottleneck in recent years and has addedprojects. The willingness to strike special deals substantially to the cost of production. Thefor individual projects imposes costs on the electric utility's monopoly on the generation andcommunity and allows the use of resources in sale of power poses legal impediments to privateuncompetitive activities, thereby effectively sector efforts to generate for their owntransferring resources from consumers and consumption, which has also exacerbated theusers to privileged entrepreneurs. Perhaps most situation.damaging are the signals sent to lobbyists and The supply of aninvestors that it is profitable to devote financial educated and skilledand other resources to pursue similar deals. labor force is one of HALF OF ALL WORKERS

Although difficult to quantify, fear of crime has the main elements HAVE NOT COMPLETED

come to represent a major barrier to the necessary to PRIMARY EDUCATION, AND

country's econornic growth. It disheartens local improving the ONLY 5 PERCENT HAVE

entrepreneurs, deters serious foreign investors, investment climate. COMPLETED SECONDARY

frightens off tourists, drives up significantly the However, the OR HIGHER EDUCATION.

cost of doing legitimate business, and national literacy ratediminishes the quality of life, especially in the in PNG is onlyurban areas. For existing businesses, by around 45 percent.damaging productive capital and increasing the Primary enrollment is less than 75 percent, and,private security cost, it has reduced the for the 13-to 16-year-old population, only one incompetitiveness and profitability of domestic six persons is enrolled at the secondary level.investment. Enrollment in upper secondary school and higher

education has remained virtually stagnant inlnfrastructure bottlenecks, especially in road sninfrastructure continue to represent a major recent years. The composition of the modemionfrstrucnture tinuevsector labor force reflects these shortfalls inconstraint to the development of thenonresource sector. In PNG, the road networks education development. Half of all workers havehave been developed mostly as local hub-and- not completed primary education, and only 5

sphhubs connected either by percent have completed secondary or higherair or more often via sea ports Road education. The shortage of educated nationals hasmaintenance has been insufficient and road led to broad reliance on expatriates to fillconditions have deteriorated since the early managerial and technical positions. At the same1980s. The condition of most roads is poor and time, the number of school leavers without skillsnew construction has added little to the road and quality education is increasing the ranks ofnetwork in recent years. More than 85 percent the unemployedof main roads and most feeder roads are earth-

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IV. WHAT CAN AND SHOULD THE The Govemnment has also initiated supportingGOVERNMENT DO TO MAKE PNG policies to promote productive investment. It hasATTRACTIVE FOR FOREIGN AND moved towards a more liberalized trade policy,DOMESTIC INVIESTMENT? including lower and more uniform protection,

Invesmentpolic shold aopt apragaticremoving, quantitative restrictions and bans as

approach and consider with objectivity the wl sdt xmtos rgesv asocio-political reality as well as the actual regime (including forestry); promotingcapability and resources of the country. Most competition through expediting the privatizationdeveloping countries are tempted to imitate program; increasing efforts to promote privatemore advanced countries in the selection of their investment through the Investment Promotioninvestment projects. This has led some countries Authority (IPA); and increasing expenditures on

to euateecoonii groth ith argeandinfrastructure maintenance. The Government has

visible projects which are usually inappropriate aservniictedrfrs civil________

to the needs of the country. The temptation is srierfrsgreater for those countries which are fortunate public financial INVE-STMENT POLICY

to possess substantial income derived from management reform SHOULD ADOPT A

extraction of m-ineral resources. This has (allocation of PRAGMATIC APPROACH

resulted in some countries, such as Algeria, to budgetaryANCOSDRWTexpenditure), and ANCOSDRWT

invest inlarge infrastructure and industrial legal and regulatory OBETVYTHprojects (par-ticularly steel mnills and reom.SOCIO-POLriICAL REALITYpetrochem-icals) with disappointing outcomes. If reforms.TH ACUA

the same financial and human resources had In the medium term, CAPABILITY AND

been applied to investments with more modest PNG's policy makers RSUCSO h

projects but greater marginal productivity, the need to focus on the RSUCSO H

concemned countries could have achieved by following key CUTY

now the same economic outcomes as the high- elements ofperforming East Asian countries which have investment policy if the progress made toalso relied on innovation and increased access to date, under the structural adjustment reforms, isworld markets. to contribute to the resolution of the fundamental

Although PNG has made similar investment problems:choices in the past, the structural reforms which * strengthen the return to macroeconomicthe Government has been implementing since stability;late 1994 have contributed to the creation of an -dee h non a n rd eom nenabling environment for private sector led address other outstanding issues;

growth through: -~~~~~ ensure that the market determines factor* price stability by adopting a responsibleprcsadcestodquecei;

mediumproedm fasctr cstsatby; andjutn thea avoid inconsistency and reversal of policies• imrove fator ost by djusingthe ealwhich will undermine investor confidence;

exchange rate and wage rate.

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* refrain from entering into special deals, taking sectors with a declining proportion of the urbanequity interest or guaranteeing investments, labor force employed in the former. To reduceloans, or any financing arrangements for unemployment and the cost of labor, theprivately funded commercially based minimum wage legislation should be repealed,investments; while ensuring that the status of the present

expedite the divestiture program and support industrial work force is not alteredthe role of IPA as promoting, and not Such restrictive legislation might, in the mostregulating, investments; optimistic case, give some protection to those

* limit the role of the public sector to what it who have a secured job. But it hamperscan best do; and economic growth and is against the best

* continue thedevelopment of the Box 1: Effects of Minimum W agescapital market. on Employment, Investment and Welfare

On the structural There is considerable evidence from both developed and developing countries that shows thepolicy front, further adverse effects of minimum wage legislation on employment. Recent work in Indonesia isrefop m of the wale illustrative of the issues involved.policy and the labor Following the introduction of minimum wage legislation in 1989, minimum wages on averagemarket is imperative tripled in nominal terms and doubled in real terms between 1989-95. Productivity growth,to lower the cost of however, was rapid enough to keep pace with the large increases in the minimum wage, at leastlabor. Government until 1993. Between 1993-94 minimum wages grew about 10 percent faster than productivity.wage setting and The recent sharp increases during the 1 990s are estimated to have increased labor costs inintervention in labor Indonesia and reduced wage employment and investment. The 100 percent increase inmarket conditions minimum wages are estimated to have pushed up average wages by about 10 percent.have caused an The doubling of minimum wages was estimated to have led to a 2-3 percent reduction in wage

imbalance between employment Since minimum wages are more binding for young workers and women, thesupply and demand, employment reduction effect is greater for these two group-estimated at 7 percent for therepresented by former. Moreover, the loss in employment is likely to become greater, the closer the minimumunemployment. wage approaches the average. This work also indicated that a doubling of the minimum wageMoreover piece rates, has a strong negative impact on investment, which was estimated to have declined by about 5-7the most common percent of GDP. This decline in investment would in turn lead to further decreases inform of incentive employment.payment relatingwages to productivity, Finally, the minimum wage is not an appropriate instrument for poverty alleviation. It onlyare prohibited. The covers wage employees, and of those, only formal sector employees. The poor in Indonesia, asurban economy is in Papua New Guinea are, by and large, not wage earners but the self employed and ruraltherefore people. Since most of the poor are self employed, the direct role of labor markets in the welfarecharacterized by of the poor is small. Labor market policies, such as the minimum wage policy, that slow downwidening wage the rate of wage employment, especially wage employment in the highly productive formaldifferentials between sector, are therefore likely to have an adverse impact on poverty alleviation in Indonesia.formal and residual Source: Indonesia: Dimensions of Growth, Report No. 15383-ID, World Bank 1996.

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interests of the vast majority of the unemployed that the state's initially indispensable role in(Box 1). The labor leaders (and politicians) investment could be replaced by skilled privateshould be persuaded that they have a stake in entrepreneurs who would assess the economy'spromotion of investment and subsequent comparative advantage. The backbone of theeconomic growth. The achievement of this goal, present economic success of some East Asianin a market economy, requires recognition of the countries is attributed to the quality of theirrole of private entrepreneurs and their manpower. For instance in Korea, about 10contribution to job creation and, ultimately, the percent of the population aged 25 and above haswelfare of the working class. On the other hand, had some post-secondary school education. Theentrepreneurs should realize that workers are disadvantage of human capital investment is thatassets. The need for great flexibility in labor the return on this investment usually occurs overlegislation does not mean disregard for the a long period of time, the educationwell-being of workers, but rather the fact that infrastructure may take time to construct, andsuch legislation should contribute to economic the particulargrowth and expansion of employment disciplines, typically EQUAL AND

opportunities. offered, may notma NON-DISCRIMINATORY

On the institutional front, the apparent lack of correspond to thelong-term financing has led existing enterprises country's immediate TREATMENT OF ALL

to use short-term credit for medium and and long-term INVESTORS IS THE MOST

long-term investments. This is, however, not the technical and IMPORTANT ELEMENT OF

proximate source of credit failure; as in most professional needs. AN INVESTMENT POLICY.

countries with well-functioning credit markets, Equal andsuch financing arrangements are the norm with non-discriminatory treatment of all investors isshort-term credit being rolled over regularly on the most important element of an investmentthe basis of low risk. Rather, the underlying policy. Otherwise, the field would be dominatedproblem is an insufficiency of credit relative to by monopoly-seekers, and there would be nothe large unmet demand combined with a high- room for growth of a healthy and dynamicrisk environment. Thus, the Government needs private sector. In countries blessed withto address these underlying problems as part of substantial income from natural resources, theits broader financial sector strategy and temptation is great for the government to getplanning. Once the fundamentals are in place, involved in various industrial, agricultural, orthe term structure of credit should adjust to the service projects. This tendency, if not resisted,needs of the market. diverts financial resources from their optimal

PNG should invest more in developing its use and distorts the rules of the game of ahuman capital and skilled labor. The advantage market economy. In such cases, private investorsof this investment is that it provides relatively are always interested to have the government ashigh adaptability and flexibility in development their partner. It allows them to ask for, andstrategy. It is an investment with a rate of return eventually obtain, advantages that are notthat is typically only slightly affected by external accessible to their competitors. There aredecisions and policies. Over the long run, presently a number of enterprises in PNG whereinvestment in human capital offers the prospect national or provincial governments have equity

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participation. The Government should elaborate options, consistency in policy, and perseverancea program for divestiture of these assets. The in its implementation. It requires an open debateGovernment should (at both national and by all organized political and social forces onprovincial levels) divest its interests in principal issues and objectives. Securingcommercially-oriented enterprises and consensus on investment policy can and shouldencourage and promote the private sector. The transform it into a nonpartisan issue. This willgovernment cannot be at the same time a neutral enable it to follow a steady course in spite of thearbiter and an interested party. The policy normal vicissitude of political life.framework should focus on setting up a level A successful policy reform needs to be simple,playing field and reducing the cost of factors. realistic and within Goverment's administrative

The gradual development of modem agriculture ability to implement. Investment policy in PNGshall require less and less manpower. Lack of has suffered from untimely adjustment,econormic opportunity is partly responsible for inconsistency, and lack of sustainability. As amigration of an increasing number of people result, the policy environment in PNG has failedfrom rural to urban areas. Investment policy to win investor confidence, especially in theshould also encourage enterprises which, by nonresource-based sector. Therefore, thetheir nature, are labor intensive. In many investment path taken aggravated the economicactivities, particularly manufacturing, there is a difficulties instead of contributing to theirrange of possibilities of substituting labor for solution.capital. The choice of appropriate technology isdee- ie ytcnca nweg n ao The structural reformns undertaken to date havedetermined by technical knowledge and labor hle obigaotasiti oiyprdg

legislation. The greater the flexibility allowed in- ~~~~~~~~and in getting the fundamentals right. Goodthe use of labor, the more entrepreneurs tend to

progress has been made in the past couple ofsubstitute it for capital. tyears, yet, much more remains to be done. TheV. SUMMARY AND CONCLUSION country should take advantage of its present

There is no short-cut in economic development, favorable position and set the foundations forThe condition for achieving sustained economic sustained and more stable economicgrowth is objectivity in the assessment of development.

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Figure 4: Comparative Social Indicators: Papua New Guinea and Selected Countries

Primary Enrollment Rate (%) Adult Illiteracy (%)

120 6D_ _ bil PNG

100 Ulndonesia ,;~' t " 50 1 B Indonesia

80 -- Thailand 40 .hailand ,30 Philippines

60 ' - PNG . 203-;L PGO Thailand

20 10

O 0

1965 1980 199 1985 1995

Life Expectancy (years) Infant Mortality (per'000)

140

60 __ Sdonesia 80 ailand \PNG

55 _-~~60~~~~~~~~~PNG 40

SD 201984 1994 1965 1980 1994

Central Govt. Expenditures on SocialSectors (Education, Health, other)

12

PNG10 -

% f6 Thailand

GNP 4 |Indonesia

2 |Philippines

1980 1994

Soutrce: World Development Indicators, 1996 and other editions, World Bank

p A P U A N E W G u I N E A D I s c u s s I o N P A P E R S E R I E S

13

The World BanEast Asia and Pacific Region, Country Department n rI

1818 H Street, NW El_-II-Washington, DC 20433-0001 c'A 5 J

Marianne Haug, Director

PAPUA NEw GUINEA DISCUSSION PAPER SERIES

INVESTMENT POLICY FRAMEWORK IN PAPUA NEw GUINEA (No. 1)

DARIUS MANS, 1996

PROJECT QUALITY AT ENTRY: TEN KEY ELEMENTS (No. 2) 0

RICHARD CALKINS, 1996

The~~ Wol Bn

East Asla ancl Pacific Region, Country Department III |1818 H Street, N-W

Washington, DC 20433-0001~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~0