Doing Business Blog - The World Bank Group

Regulation and Trust: Substitutes?

A new paper by Philippe Aghion (see picture) and co-authors makes the point that "in a cross-section of countries, government regulation is strongly negatively correlated with social capital (trust). We document, and try to explain, this highly significant empirical correlation. The correlation works for a range of measures of social capital, from trust in others to trust in corporations and political institutions, as well as for a range of measures of regulation, from product markets, to labor markets, to judicial procedures."

So what?

The main point is that culture (as measured by distrust) and institutions (as measured by regulation) co-evolve. Culture shapes institutions, and institutions shape culture. The causality runs in both directions. Unfortunately, it is very difficult to test this prediction of the model using instrumental variables, since many exogenous factors that influence trust might also directly influence regulation, and vice versa. For example, one can think of using legal origins as instruments for regulation (see, e.g., Djankov et al. 2002), but to the extent that colonizing Europeans who transplanted legal traditions also transplanted aspects of culture, the instrument would not be valid.

New Doing Business Report on South East Europe

The Doing Business team has just come out with a new subnational report, this time on South East Europe. It is a timely contribution - South East Europe is becoming increasingly integrated into the European economy, and business reform will undoubtedly help improve regional competitiveness. The subnational report provides detailed data on business regulation in 22 cities in the economies of Albania, Bosnia and Herzegovina, Croatia, Kosovo, FYR Macedonia, Montenegro, and Serbia. You can download copies of the report and the press release in seven languages at the bottom of this post. 

One of the big findings from the report is that the cities of South East Europe don't have to look far for models of reform - there  are already a number in the region. Bitola (FYR Macedonia) came out on top as the easiest city to do business. Business start-up in Bitola is both fast and cheap. Starting a business requires only 8 procedures and 10 days at a cost of 3.9 percent of income per capita. Shkodra (Albania) is another good example with six procedures, seven days, and a cost of 25.7 percent of income per capita to start a business. A hypothetical city combining all the best regional practices would rank among the top ten locations in the world on the ease of doing business – there is a big potential for sharing practices across the region.

As for the motivations behind reform, I leave you with a short tale from the authors of the report:

Zlatko has a dream. He wants to start a Web design company in his hometown of Bitola (Macedonia, FYR) after completing his computer science degree in Belgium...In only 10 days, his company will be operational and his first project can be well under way. He is fortunate. If he tried to register his business in Mostar (Bosnia and Herzegovina), he would have to wait for 61 days before he could welcome his first clients. He knows that even if he could wait that long, his clients could not.

Here are copies of the press release in a number of languages: 

Download doing_business_press_release_SEE_albania.doc

Download doing_business_press_release_SEE_bih.doc

Download doing_business_press_release_SEE_croatia_eng_version.doc

Download doing_business_press_release_SEE_croatia.doc

Download doing_business_press_release_SEE_english.doc

Download doing_business_press_release_SEE_fyr_macedonia.doc

Download doing_business_press_release_SEE_kosovo_albanian.doc

Download doing_business_press_release_SEE_kosovo_serbian.doc

Download doing_business_press_release_SEE_montenegro.doc

Download doing_business_press_release_SEE_serbia.doc

Here are copies of the Doing Business South East Europe report in various languages:

Download DB08_Subnational_Report_SEE_Albanian.pdf

Download DB08_Subnational_Report_SEE_Bosnian.pdf

Download DB08_Subnational_Report_SEE_Croatian.pdf

Download DB08_Subnational_Report_SEE_English.pdf

Download DB08_Subnational_Report_SEE_Macedonian.pdf

Download DB08_Subnational_Report_SEE_Montenegrin.pdf

Download DB08_Subnational_Report_SEE_Serbian.pdf

And here is a brief disclaimer for the most populous cities covered:

Download disclaimer_for_most_populous_cities.doc

Entry Barriers and Growth

A new paper by Antonio Ciccone (picture) and Elias Papaioannou looks at the link between entry regulation and growth. Or, more precisely, between entry regulation and the intersectoral reallocation of resources in the presence of economic shocks. Here is how the authors describe it:

"We study how restrictions on firm entry affect intersectoral factor reallocation when open economies experience global economic shocks. In our theoretical framework, countries trade freely in a range of differentiated sectors that are subject to country-specific and global shocks. Entry restrictions are modeled as an upper bound on the introduction of new differentiated goods following shocks. Prices and quantities adjust to clear international goods markets, and wages adjust to clear national labor markets. We show that in general equilibrium, countries with tighter entry restrictions see less factor reallocation compared to the frictionless benchmark. In our empirical work, we compare sectoral employment reallocation across countries in the 1980s and 1990s with proxies for frictionless benchmark reallocation. Our results indicate that the gap between actual and frictionless reallocation is greater in countries where it takes longer to start a firm."

A worthy read. You may also want to read this related paper.

Mighty Books

In the June issue of Forbes, its founder - Steve Forbes - praises Doing Business:

"The World Bank's reputation has plummeted in recent years because of alleged cover-ups of extensive corruption and growing doubts about how effective its projects have been in helping countries develop economically. But one of its undertakings is having an enormously positive influence on the global economy--and its cost is a nanofraction of the routine infrastructure undertakings that can end up costing billions of dollars.

Each year the World Bank issues a book entitled Doing Business. It surveys 178 economies--from Afghanistan to Zimbabwe--in regard to their regulations that affect how businesses are started and conducted. Countries are judged in ten categories that span the life of an enterprise, from its launching, to coping with licenses, obtaining credit, paying taxes, enforcing contracts and dealing with bankruptcy or dissolution of the entity.

This book is no mere academic exercise. Governments read it. The other day I ran into an important U.S. official who pointed out that there's now something of a competition in a number of developing countries to see which one can improve most in the Doing Business annual survey."

This made me think: what other books have stirred excitement in development? Here is a first list - readers, please add suggestions.

1. Hernando de Soto's The Other Path ushered in an understanding of the cost of burdensome regulation, namely the exclusion of many people from the formal sector.

2. Amartya Sen's Development as Freedom. As countries go richer, they also become more democratic. Or the other way round?

3. William Easterly's The Elusive Quest for Growth brought to the fore the discussion on development effectiveness.

4. Paul Collier's The Bottom Billion highlights civil wars, corruption and bad regulations in Africa.

5. Andrei Shleifer and Dan Treisman's A Normal Country focus on Russia in transition. We should have studied this transition more closely.

Helpful Governments

Do businesses perceive their government to be "very helpful, mildly helpful, neutral, mildly unhelpful or very unhelpful?" This question is asked in the World Bank enterprise surveys.

A recent paper by Mohammad Amin uses these data to find that "most regulatory measures lower a firm’s perception of how helpful the government is. Hence, it is unlikely that heavier regulation is an efficient or desirable response from the firms’ point of view to disorder."

It is not all that surprising that businesses consider the government to be a drag on their activity, a skeptic may say. After all, the governments make businesses pay taxes and go through all kinds of administrative hoops.

True, but this is the case for businesses in every country. Yet Amin's study sees different levels of satisfaction with the government across countries. So the analysis captures a relationship between the level of regulation and the satisfaction of businesses; not just that businesses are prone to complaining.

Cities of Global Commerce

MasterCard has just published its second annual ranking of the top-75 cities of global commerce. Sofia (Bulgaria) - my home town - is not among them.

London beats out New York for the top spot, followed by Tokyo, Singapore and Chicago. Bangkok, at #42, is the top-tanked city from an emerging economy. Bogota (Colombia), Ryadh (Saudi Arabia), and Cairo (Egypt) entered the list for a first time. That Beirut makes it, at #74, may raise some eyebrows. The United States has the most entrants, 12, followed by China, with 5.

The ranking scores seven areas: legal and political framework, economic stability, ease of doing business, financial flows, business center, knowledge creation, and livability. These carry different weights, with financial flows judged most important (22% weight), followed by ease of doing business (20%); while livability and economic stability have a weight of 10% each. Excitingly, the Doing Business indicators are heavily relied upon. They constitute 60% of the legal and political framework index; and 70% of the ease of doing business index. In other words, a fifth of the overall rank is based on the Doing Business project.

This may explain why Sofia hasn't made it yet.

The Pendulum Swings

In a recent forum on Africa, Paul Collier advances a novel idea: Africa is growing faster than ever before because (you guessed it) it has made many mistakes in the past. The full argument goes as follows:

"But the growth we are seeing today is not just a result of commodity booms. There is a process at work that does not depend on democracy and is so simple that analysts generally miss it: learning from mistakes. Since 1970 African societies have accumulated a huge stock of experience in how not to manage an economy. For example, from the mid-1970s until the mid-1980s Tanzania adopted regulatory policies that proved to be ruinous. The knowledge they gained through failure is valuable. Tanzania is now one of the best-managed of all Africa’s economies. The European society with the best record of containing inflation over the past sixty years is Germany. It has the best record because it used to have the worst: the experience of hyperinflation immunized Germans from macroeconomic folly." Read the whole comment here.

Collier's argument makes sense, even outside of Africa. Eastern Europe rivaled Africa in economic mismanagement until the 1990s. Now, the majority of top reformers in Doing Business come from that region.The rationale is simple: people get fed up.

If so, let's predict the top reformers of the future: Zimbabwe, Venezuela, Turkmenistan, who else?

EU Executive to Shake up Notaries Services

Last week, the European Commission (EC) published a landmark study by the Centre of European Law and Politics at Bremen University. Legal fees are a small fraction – between 0.34% and 2.94%- of an average real estate transaction, but vary widely across EU member states.

Among other interesting results, this study shows that I would be paying three times more in legal fees in France than in the Netherlands for the same €250,000 house. Why would my French friends be willing to pay more for the same service?

The European Commission is not opposed to all regulation of professional services if there are legitimate arguments for it, e.g. consumer protection. But it requires a strict proportionality test to justify a more restrictive regulation. Not meeting this test could jeopardize the basics of the European single market.

Cashing In on Property Rights

Hernando De Soto argues that property rights are the pillars of developed economies. After a significant publication in 1989, “The Other Path - The Invisible Revolution in the Third World”, he was hired by governments around the world to advise on capital creation.

Informal (unregistered) property in Egypt, according to De Soto, is valued at $241 billion – an amount comparable to 55 times the foreign direct investment that the country received over the last 200 years (including Suez Canal and Aswan Dam), or 30 times the size of the Cairo stock exchange. This, of course, is according to De Soto.

Shattering the Glass Ceiling

For many women in the developing world, it’s not the glass ceiling that prevents them from making it to the C-suite, but rather the obstacles they face along the way. The Global Entrepreneurship Monitor (GEM), which provides an annual assessment of entrepreneurial activity at the national level worldwide, found that overall there are higher rates of female entrepreneurship in developing countries than developed countries. But this distinction is borne of necessity.

The main challenges that women face are social inequality, lack of education and trouble in securing funding. A recent study by PricewaterhouseCoopers made an interesting finding; women in developing countries find it easier to break through the glass ceiling than their colleagues in the west. Samuel DiPiazza, the company’s global head said, “In some countries such as Germany and Switzerland, there are cultural and social perceptions of women that make advancement much more challenging. Whereas in the developing world, there is a huge cry for talent, where there is enormous growth, you must be able to adjust to these norms faster.”

Reforms in Business Regulation: Evidence From Russia

A new article by Evgeny Yakovlev and Ekaterina Zhuravskaya studies regulatory reforms in Russia between 2001 and 2004. Based on the analysis of 2,000 businesses over the period 2001-2006, the authors note that the reforms reduced the administrative costs of firms; but, the progress of reform had a substantial variation across Russian regions.

In particular, the reforms had better results in regions with a transparent government, low corruption, better access of the public to independent media sources, a powerful industrial lobby, and stronger fiscal autonomy. In regions that had these characteristics, Yakovlev and Zhuravskaya found a substantial positive effect on net business entry and the growth of employment in small firms.

Politically Exposed Persons

Denis Christel Sassou-Nguesso, son of the Republic of Congo’s President, knows a good bargain. In June 2007, British NGO Global Witness published documents that appear to show that he may have spent hundreds of thousands of dollars on shopping sprees in Paris and Dubai. The documents show that in August 2006 alone, $35,000 on purchases from designers such as Louis Vuitton and Roberto Cavalli were charged to his credit card. This when 70% of Congo's population lives on less than a dollar a day.

Few would have heard of this case except that Mr Sassou-Nguesso's lawyers tried to block the public display of the credit card receipts on Global Witness's website. The court ruled in favor of Global Witness and the story hit the main news.

Why Is Easy Entry Good

In The Other Path, Hernando de Soto shows that the prohibitively high cost of establishing a business in Peru denies economic opportunity to the poor. In 1983, de Soto’s research team followed all necessary bureaucratic procedures in setting up a one-employee garment factory in the outskirts of Lima. Two hundred and eighty-nine days and $1,231 later, the factory could legally start operation. The cost amounted to three years of wages—not the kind of money the average Peruvian entrepreneur has at his disposal.

"When legality is a privilege available only to those with political and economic power, those excluded—the poor—have no alternative but illegality," writes Mario Vargas Llosa in the foreword to de Soto’s book.

More recently, Djankov et al (2002) has attracted the attention of researchers and development experts to the field of measuring entry regulation. Following de Soto's work, it records the number of procedures, time and cost to start a business in 85 countries. The main finding: "heavier regulation of entry is generally associated with greater corruption and a larger unofficial economy, but not with better quality of private or public goods. Entry is regulated more heavily by less democratic governments, and such regulation does not yield visible social benefits."

Taxes – A Necessary Evil?

Yes, we do need taxes to live in a society. There are goods (such as roads, security) that due to their public nature most people agree should be provided by the state. And of course the state needs to finance them through taxes. Therefore, taxes are needed. But do they need to be evil (i.e. distortionary and resulting in bad economic outcomes)?

No, they don’t. In fact, countries across the world vary dramatically in their tax policies and in economic outcomes. Furthermore, countries with lower taxes are not necessarily the ones that have worse public goods. New research on taxes by Djankov et al (2008) finds that countries with high business taxes have lower investment, lower foreign direct investment and lower business entry.

High Entry Costs Reduce Productivity

It is common sense that if it costs a lot to start a new business, few businesses will start up. How high entry costs affect the productivity of existing firms is less obvious.

A new paper , by Levan Barseghyan at Cornell, looks at the effect of high entry costs on productivity and output. The main finding: "an increase in entry costs by 80% of income per capita, which is one half of their standard deviation in my sample, is estimated to decrease total factor productivity and output per worker by 22% and 29%, respectively." The analysis is done for over 100 countries.

The effect is quite large. It suggests that if Burkina Faso were to eliminate all entry costs (currently equal to 82.6% of income per capita, workers would be a third more productive. Why is that?

Measuring the Ease of Enterprise

The field of measuring the ease of enterprise is maturing. In 2001, a dozen organizations put together indicators and ratings of the environment for doing business. Six years later, four have overtaken the rest and become the source of information for reformers in government, for investors and researchers. These come from the Fraser Institute’s Economic freedom of the world, the Heritage Foundation’s Index of economic freedom, and the World Bank’s Doing Business project and Enterprise surveys .

A new paper shows a clear trend: moving from indicators constructed by commercial entities—as a side business for their clients—to indicators constructed by organizations that provide a public good. This has brought in improved methodologies and better sources of information. It has also resulted in an innovation: aid flows or advisory services informed by measurement of the ease of enterprise. The United States’ Millennium Challenge Account is the pioneer in this market.

Measuring Economic Freedom

Freedom is good to have, but difficult to measure. The Heritage Foundation has been doing it for more than a decade. Recently, the methodology of the Index of Economic Freedom was improved and the analysis made available for free on the web. Among the main improvements: constructing continuous indices from 0 to 100 (most free) in place of the previous discrete ones, which varies from 1 to 5; adding a category of labor freedom; linking the business freedom index to the business entry, business licenses, and business exit indicators in Doing Business; and doing regional comparative analyses.

What do the Heritage experts say about Azerbaijan, to take one example? It is the world's 107th freest economy (of 141 in the sample). Azerbaijan ’s overall score is just below the regional average. The country’s level of monetary freedom is high. Corporate tax rates enhance Azerbaijan 's score, although the government also imposes other taxes. Most of the state-owned businesses have been privatized. That and limited government spending give Azerbaijan a high “freedom from government” score. Financial freedom, investment freedom, property rights, and corruption remain problematic, as is an underdeveloped judicial system - see figure of Azerbaijan ’s scores in Heritage (2007).

Paying Taxes – Atlantic Tour

Albert Einstein once said regarding preparing his tax return: "This is too difficult for a mathematician. It takes a philosopher." Fortunately, 35 countries made it easier for companies to pay taxes over the past year, including 8 that actually went beyond rate reducing and simplified tax administration.

The World Bank/IFC jointly with PricewaterhouseCoopers launched on November 19^th a new report on taxes across the world – "Paying Taxes 2008 – The global picture". The report sent me on a world tour to present it and spread the word – taxes can be made simpler. I started in Brussels, city of chocolate and gauffres, but also high tax burden for business.

Luckily, the Belgians are planning on following their Dutch neighbors in business tax simplification. In Brussels the main discussion focused on corporate income tax and what should be the correct tax rate.

Doing Business Gets a Second Life

On Oct. 26, Doing Business turned its attention to the virtual world by launching Doing Business 2008 in Second Life. During the three-hour event, I presented the report and took questions from Second Life residents on Activ8 Island. In total, almost 700 residents and their online personas, known as avatars, attended. Another 1,000 tuned in by audio. It was the largest audience we have ever reached in a single event. It was also the first time for the World Bank to appear in Second Life.

Second Life is an online, virtual world created by its users, also known as residents. It offers a platform for communication, business, and education. Besides residents from North America and Europe, more than 1 in 5 residents logs on to the virtual site from Latin America, Asia or Africa. This may seem like old news to some of you. To me, it was really a news flash.