Friday, November 28, 2014
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What to Do with Doing Business?

CAMBRIDGE – Under pressure from China and other governments, the World Bank is considering discontinuing its Doing Business report. It has asked Trevor Manuel, a long-time South African cabinet minister, to lead a commission to look into the matter.

Doing Business – the brainchild of, among others, my Harvard colleague Andrei Shleifer and Simeon Djankov, a World Bank staffer who later became Bulgaria’s finance minister – measures such indicators as the time and cost required to register a business, pay taxes, trade across borders, obtain a loan, get a construction license, or enforce a contract. The data are provided by law firms, which complete a questionnaire about the legal and administrative requirements of performing these tasks.

The project emerged from a research question that goes to the heart of the debate on the proper role and actual motivations of the state in regulating markets: Does regulation exist to achieve some laudable social goal or mainly to extract rents? This question has long divided economists along a right-left axis, at least since University of Chicago economists George Stigler and Milton Friedman argued that many, if not most, regulations were motivated by rent-seeking among bureaucrats and business incumbents.

The Doing Business project calculates dozens of separate indicators that are then averaged into a single number. As with all numerical indicators that try to express a very complex reality, there is always room for improvement.

I, for one, find the underlying indicators more informative than the average. Averaging the numbers assumes that all components are substitutes: if you cannot improve on one, you can compensate by improving on another. But I think of them as complements: if you cannot build your plant, you do not benefit from more accommodating trade rules. A single problem can be fatal, even if other indicators are strong.

Moreover, Doing Business measures the burden of compliance with regulations, not their effectiveness. The indicators do not penalize a country that cheaply and expeditiously authorizes shoddy construction projects, dangerous imports, or abusive labor practices.

Nevertheless, the burdens in some countries are so obvious that they could hardly be explained as the consequence of anything other than ineptitude or predation. By making visible some government inefficiencies, the report has galvanized pressure to streamline procedures, with many countries adopting policies to reduce the burden that their regulations place on their citizens.

The indices name and shame poor performers, so it is no surprise that these countries – like China, which is ranked 91st – object to Doing Business. This should be reason enough to continue the report; indeed, the fact that China has the world’s highest investment rate suggests that, despite the Doing Business indicators, it is possible to do business there.

The idea of creating and publishing an index with country rankings is a strategy adopted by many organizations and social movements to raise awareness about issues such as corruption, governance, freedom, gender equality, competitiveness, productive knowhow, and the investment climate, among others. The main problem with these indices is not so much how they are calculated as how they are used.

In general, such indices work best as a catalyst for debate about an issue. By contrast, they work very badly when viewed as a policy framework. It is common – but almost never wise – to think that the goal of policy should be to improve countries’ rankings.

For example, in a recent paper, Shleifer and his co-authors measured government effectiveness by mailing letters to non-existent business addresses in 159 countries and measuring how long it took for the letters to be returned – or whether they were returned at all. They found that this indicator correlated very well with many other governance indicators.

Typically, countries that are bad at running a post office are also bad at running other organizations. But it does not follow that if a country wants to improve government effectiveness it should focus on returning wrongly addressed letters promptly.

This point applies to the Doing Business report. For example, to measure the difficulty of dealing with licenses, Doing Business’s indicators examine the burden of obtaining a permit to build a warehouse. But firms must deal with licenses in many areas – such as medical devices and drugs, radio stations, mines, bars, banks, insurance companies, airlines, and taxis – that are not included in the report’s indicators, even though they may be major obstacles to doing business. Countries that regard raising their ranking as a policy goal have no incentive to improve licensing procedures in any of these other areas.

Moreover, in the Atlas of Economic Complexity, my co-authors and I show that these indicators are weakly related, if at all, to economic growth. Improving on them does not foretell more economic dynamism.

Many countries – including Colombia, Liberia, Mexico, and Saudi Arabia – have at some point made improvement in the Doing Business ranking, or that of the World Economic Forum’s Global Competitiveness Report, a policy goal. This distracted them from focusing on what is important rather than on what was included in the index.

Countries should, instead, focus on the ultimate goal: generating a rapid increase in the number of productive jobs. The challenge consists in finding ways to get there, and is best addressed through rich and deep interactions between government and society. International benchmarks may be useful for getting an idea of achievable performance in a particular area; the more, the better. But the key is to improve on the areas that matter, regardless of whether existing global indicators cover them.

Read more from our "Imperfect Indicators?" Focal Point.

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    1. CommentedProcyon Mukherjee

      ‘Doing Business’ indicators must include how transparent and ‘not open to interpretation’ procedures and norms are, somewhat binary in their attributes that can be easily discerned by the community of business and the general society; most procedures are not so easily understood and interpretation steps in which easily leads to manipulation. If licenses are connected to land and pollution related issues for which specific clearances have to be sought, we are dealing with issues where there is no market clearing mechanism and here the State must play a role as a mediator.

      Rent collection is innate to Bureaucrats / Government departments and cannot be avoided, the best that State can do is run a transparent account such that the polity and the general public can see how much rent is connected to which industry/initiative, so that the prospective use of such rent could be disseminated such that it reaches to the right beneficiaries for whom such rent should have been actually deployed either in public works or in social areas.

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