Good News in Tough Times

Stephen DeAngelis

September 24, 2009

I have written a number of posts in which I’ve mentioned the World Bank’s Doing Business Report and the positive impact it has had on the global business environment. It may well prove to be one of the most important things that the World Bank has ever done. The World Bank just released it latest report and, according to The Economist, it provides some good news in these tough times [“Reforming through the tough times,” 12 September 2009 print issue]. Writing about governments’ responses to the recession, The Economist writes:

“The World Bank’s annual Doing Business report, which tracks changes to the regulations that affect business, suggests that governments have handled the storm well. In the year since June 2008, 131 countries introduced 287 pro-business reforms—20% more than in the previous 12 months and more than in any year since the World Bank started the survey in 2004.”

Not surprisingly, most of those reforms have been enacted in developing countries, where corruption has been a lot more prevalent than sensible regulation. In fact, many regulations have been set up to guarantee that unethical leaders and their cronies get their slice of national treasure before it can be used to help the rest of the country. The article reports that developing countries are beginning to make real strides toward reform.

“Low and lower-middle income economies accounted for two-thirds of the action, with Rwanda turning out to be the world’s champion reformer—the first time a sub-Saharan country has claimed the prize. Eastern European and Central Asian countries were the most energetic reformers by region for the sixth year in a row (26 out of 27 governments there introduced reforms). Middle Eastern and North African countries were not far behind (17 out of 19 countries), and 17 high-income countries also spruced up their business regulations.”

Anyone who regularly reads financial news sources, like the Wall Street Journal, Financial Times, or The Economist, knows that some Eastern European and Central Asian countries have mounted significant ad campaigns to attract businesses. Reform has been a large part of those campaigns. Rwanda’s improving climate is not a big surprise either. For more on Rwanda, see my post Moving Forward in Rwanda], which was written in June 2008 just as Rwanda was making its big jump up the Doing Business Index. As I’ve noted in previous posts that mentioned the Index, its primary contribution has been to spur competition among nations to see their scores rise. As the article puts it, “reform seems to be contagious.”

“Countries try to emulate leaders in their regions. Many African governments, for example, have taken note of the success of Mauritius’s deregulated economy. They also respond to competition. Germany introduced laws to make it easier to establish joint-stock companies, scrapping ancient regulations, because so many German companies were taking advantage of the single European market and incorporating in Britain. Amazingly, given the fiscal pressure on governments, only one country increased its corporate income-tax rate: Lithuania, from 15% to 20%.”

Old habits of corruption and ways of doing business are hard to break. So the real question is whether reported reforms are taking place only on paper or are they having a real effect on the way business is conducted. According to the article, reforms seem to be taking hold.

“[Reforms appear to be having real impact], according to a growing body of academic literature (so far there are 405 articles in academic journals and 1,143 working papers devoted to studying the impact of the Doing Business reforms). Lower barriers to entry are associated with a smaller informal sector. Informal businesses have lower wages, lower growth rates, poorer safety records, tend not to pay taxes and are prey to corruption. Reducing the cost of doing business leads to higher rates of growth and entrepreneurship. One study shows that, in poor countries, a ten-day reduction in the time it takes to start a business can lead to an increase of 0.4 percentage points in GDP growth. Another shows that people who have a formal title to their property invest as much as 47% more in their businesses.”

The key for me is that reforms are increasing entrepreneurship. It’s entrepreneurs who start new businesses, create jobs, and know how to succeed in local economies. While economies need to be anchored with large companies, it is generally small businesses that provide most of the jobs. The article notes that reform doesn’t always come easy.

“It often takes a shock to set the reform machine in motion. Several countries that have been racked by civil wars, including Rwanda, Afghanistan and Sierra Leone, have brought in new company laws. The best reformers have several things in common. Their reforms are part of a broad agenda of boosting competitiveness. Over the past five years such pace–setters as Rwanda, Egypt, Colombia and Malaysia have each implemented at least 19 reforms. And they never stop. Those paragons Hong Kong and Singapore introduce substantial reforms each year. The willingness of governments to keep reforming in such tough times strengthens the prospects for recovery. Sensible regulations not only make it easier for new firms to get started, but also help established firms change direction and clapped-out firms declare bankruptcy.”

In discussions with government leaders about Development-in-a-Box™, I stress the importance of having a strategic plan to guide them as they move forward. The article calls this having “a broad agenda,” but developing countries need more focus than that to make the hard choices leading to a better future. Although the news is good, the article insists that now is not the time to rest on past laurels.

“There is no cause for complacency. Businesses in low-income countries struggle with twice the burden of regulation as those in high-income countries. Developed countries have an average of ten times as many newly registered businesses for every adult as countries in Africa and the Middle East. Almost two-thirds of the world’s workers are still employed in the informal sector. The World Bank’s latest progress report, optimistic though it is, is a reminder of how far there is still to go in getting business regulations right.”

The development community now widely recognizes the fact that impoverished countries will remain poor unless they can attract more foreign direct investment (FDI) than foreign aid. As long as corruption, over-regulation, instability, disease, illiteracy, and lack of infrastructure plague poor nations, they will have a difficult time attracting investors. The purpose of aid should be to help establish the conditions that can attract FDI. Countries develop only as fast as a sustainable middle class arises. Middle classes only emerge when relatively good-paying jobs are created by investors. That is the reason that the World Bank’s Doing Business Report has become such an important tool in helping developing countries steer towards a brighter future.