Doing Business Blog - The World Bank Group

Where Companies Start Up

Two weeks ago, the OECD and the EU's statistics agency, Eurostat, published the first set of comparable data on measures of entrepreneurial activity, such as entry and exit rates, and the rate of formation of high-growth companies. So far the data -- which the OECD and Eurostat collected this year from the business registers maintained by national statistics offices, using harmonized definitions of the variables -- cover 15 European countries, the U.S., Canada and New Zealand. It is the beginning of a data collection project funded by the Kauffman Foundation.

Taxes and the Crisis

No one likes paying taxes, and yet the government needs tax revenues to finance itself, and the various infrastructure and social projects it develops. Businesses benefit from these projects (unless the money is wasted in corruption). The real question is how much tax to pay to make both the government and businesses happy.

The Doing Business background study of the effect of taxes on investment, growth and entrepreneurship deals with exactly this question. It investigates all taxes that businesses need to pay in 85 countries.

Take Bulgaria as an example. The average Bulgarian business pays the following taxes: corporate income tax (10% of profit), social security contributions (24% of gross salaries), municipal fee (1% of the value of land and buildings), vehicle tax (950 leva per vehicle), property tax (0.15% of the value of land and buildings), and value added tax (20% on the value the business created using the various inputs and labor). If the average business paid all its taxes, about 35% of its profits will go to the tax collector.

Is 35% the right level of business taxes for Bulgaria? Let's compare to some other countries. Austrian businesses pay 55% of profits in taxes. German businesses pay 48%. Latvian businesses pay 33%. Irish businesses – 29%. Former Yugoslav Republic of Macedonian businesses pay 18%.

There is a good rule in setting taxes: the poorer the country, the lower the tax burden. This is for two reasons. First, poorer countries waste more tax money through corruption. Second, lower tax burdens for businesses lead to more economic activity.

Better Courts, More High-Tech Exports

Respect for the rule of law and efficient courts are good for any economy: how true, yet trite. But what would really help a minister of justice in his budget talks with the treasury?

How about: “A country that assures the enforcement of written contracts enjoys a comparative advantage in relationship-specific industries.” Nathan Nunn, an economist at Harvard, found that the quality of a country’s contract enforcement explains more of its export pattern than its physical capital and skilled labor combined. Put simply, if you want to grow your high-tech exports, fix your courts.

His argument: The number of intermediate inputs required determines the relationship-specificity of an industry. While corn milling or petrol refinery are less, automobile or computer equipment manufacturing are more relationship-specific. The more hands you shake with business partners, the more sweat can run.

Power to Rent in Sub-Saharan Africa

Last week, Botswana’s energy utility, Botswana Power Corporation, signed a contract with Chinese firms for the development of a 600 megawatts (MW) power station. The contract was concluded with China's construction consortium, China National Electric Equipment Corporation and Shenyang Blower Works Electro-Mechanics Import and Export Co. Ltd (the CNEEC-SBW Consortium), to build the Morupule B power station. With this investment, Botswana aims to expand its generating capacity and eventually reduce dependency on energy imports. The country is heavily reliant on foreign energy supply and its major power supplier is Eskom in South Africa.

Not only does Botswana need to improve its existing generating capacity, but so do other African countries as well. Power outages are frequent in the sub-Saharan region, which on average counts 14 power outages in a typical month. The economic loss for companies represents around 6 percent of sales due to power outages. This is much higher than in other regions in the world with 8 power outages and a 3 percent loss of sales for Eastern and Central Europe, and 3 power outages and 4 percent loss of sales in Latin America and the Caribbean. Infrastructure, and in particular a lack of power capacity and reliability remains a major constraint for doing business in most African countries.

Naturally Madagascar

Such is the slogan adopted by the government of Madagascar for its development vision. Conceived in 2002, it's meant to allude to the abundant natural beauty with which the island is endowed. It could also refer to the island's aspiration to become a natural choice for foreign investors. The far-reaching reform program that's supposed to make this a reality places a heavy emphasis on improving the regulatory framework to enable the private sector to act as the main source of growth. On a short visit to the capital this week, I've been impressed by the flurry of reform activity in seemingly every quarter.

Trade facilitation is a case in point. This year, Madagascar was one of the top reformers on the Trading Across Borders indicator, introducing an electronic data interchange that links all the main entities involved in the import and export process from customs and the ports to the commercial banks, the Central Bank and the Treasury. Based on the Singaporean model and inspired by Ghana's experience, the system is run by Gasynet, a public-private partnership between the government and SGS, a private company. In conjunction with improvements at the island's main port at Toamasina, the reforms introduced by Gasynet have so far led to an impressive three-week drop in the time required to clear import goods.

Becoming a Super-Reformer

If you want to know how you start from nothing and build up an economy - with the various reforms needed - here is an excellent prop. Kakha Bendukidze, the engineer of Georgia's reforms since 2004, talks about how these came about and what they have achieved so far in a Cato Institute forum. The video is about 45 minutes, worth the time.

Under Bendukidze's leadership, Georgia has moved from 137th on the Ease of Doing Business in 2003 to 15th in 2008. Many other problems remain, political as well as economic. But there is no question that the economic reforms have spurred a previous moribund economy. They have also had a regional effect: Azerbaijan has studied Georgia's reforms and has itself become a top reformer.

Entrepreneurship - the key to prosperity?

Following the G20 summit this weekend, the leaders of the world's largest economies issued a statement explaining how they intend to remake the world's economic architecture. On the very first page of the statement you'll run across the following:

Our work will be guided by a shared belief that market principles, open trade and investment regimes, and effectively regulated financial markets foster the dynamism, innovation, and entrepreneurship that are essential for economic growth, employment, and poverty reduction.

It might be tempting to treat this merely as empty rhetoric, but I think it's worthwhile to look at what the data actually shows about these relationships. The most recent data from the World Bank Group Entrepreneurship Survey - which covers 100 countries - indicates a very strong (and statistically significant) relationship between entrepreneurship and economic well-being. (Entrepreneurship is measured by the entry density rate of limited liability companies and economic well-being is measured by GDP per capita.)

 

The Birth of a Doing Business Report

November 14 was my due date: I'm supposed to deliver my first baby. It is a girl. Nothing has happened so far. Looking back over the past 9 months, I'm wondering about other events in life that take about the same time and go by (too) fast. A graduate program for example. Or the Doing Business report cycle.

Early January of each year, Doing Business sends out surveys, one for each of the 10 topics, to our 6,700 local experts in 181 economies around the world.

Local experts or 'respondents' as we call them, are asked to return the completed questionnaire 3 weeks later, towards early February. Some do it immediately, others need more encouragement. All 6,700 experts share their expertise for free, "pro bono", knowing their work- through the publication of the Doing Business reports, helps to inspire governments to reform business regulations and cut red-tape.

Keeping SMEs in Kyrgyzstan Powered

On the 1st of November the heating season officially started in the Kyrgyz Republic, a top global reformer in Doing Business 2009. The question of whether the country will be able to avoid major heat and electricity outages has become more pressing than ever.  Due to the especially dry weather since the summer of 2007 the level of water in Toktogul reservoir, which supports the country’s hydro power plant, has been especially low. 

To maintain water reserves for the heating and electricity needs of the cold winter season, the Kyrgyz government imposed electricity rationing in late August.  Every day power was cut for up to eight hours a day in different regions of the country  Naturally electricity cuts were not welcomed by the population as they damaged the economy, especially hurting small and medium enterprises which do not have access to back-up generators

Whether the planned electricity cuts had the desired effects remains unclear.  Saparbek Balkibekov, the Minister of Industry, Energy and Fuel Resources, reported that during October Kyrgyzstan saved over 30 percent of its power energy, and said there should be no electricity blackouts after the 1st of November. However, contradictory to earlier promises, he also reported that both industrial and residential buildings will experience power cuts if consumption limits are exceeded.

The Mighty Potato

A new paper by Nathan Nunn (Harvard University) and Nancy Qian (Brown University) comes up with a startling conclusion: the adoption of potatoes in the Old World (meaning Europe) explains 17% of the post-1700 increase in population growth and 37% of the increase in urbanization growth.

The basic story is that potatoes require less space than grains to produce the same calorie intake (about two-thirds less, to be exact); they store well; can be planted in fallow lands; do not require much cultivation; and can be eaten by cows and pigs, who in turn provide meat and milk. So much for laughing at the Germans' steady diet of meat-and-potatoes. Turns out it is based on potatoes-and-potatoes.

The introduction of potatoes to Europe can be thought of as an agricultural innovation, akin to cell phones (in communication) or the Doing Business project (in regulatory reform).

Guatemala: Going Forward with Secured Lending

Just a year ago, being a small company trying to get a loan in Guatemala was not an endearing situation, especially if the assets you could provide as collateral were movables. The answer from the bank was almost always negative. The reality was that to get money from a bank you either had to be a big company with a solid client history, have enough immovable property to be considered as low risk investment, or you had know the “right people”--sounds familiar, right? Guatemala’s ranking on the ease of Getting Credit was 61 is Doing Business 2008.

Since January 1, 2008, the situation has changed for Guatemalan entrepreneurs. The Movable Property Guaranties Law (Ley de Garantías Mobiliarias) became effective, providing micro, small and medium companies with the possibility of using their movable assets as collateral while keeping possession of the latter. Allowing companies to use those same encumbered assets and generate income enabling them to repay the loan was not the only innovation. Among other features, the law also established a transparent system of notice to third parties, lowered the risks for creditors by providing the parties with the possibility of using extra-judicial methods for the enforcement of collateral. And, most importantly, it opened the door of opportunity to a large sector of the Guatemalan society that wanted to do business.

Tajikistan Reduces Capital Requirements for Small Business

Earlier this month Tajik President Emomali Rahmon issued a law reducing the minimum capital requirement for new businesses from approximately $2,000 to $73 (500 Tajik som). To put it differently, a new business previously had to pay more than twice the average income per capita (219%, to be exact), while now the requirement is equivalent to only 16%. Quite a jump.

A recent survey on reforms in entry regulation, written by Simeon Djankov, finds that Tajikistan joins a large number of countries who have recently made this jump. For good reason, it is hard to argue about what benefits such minimum capital requirements bring except that they make it difficult or impossible for poorer entrepreneurs to start a business. This is the type of regulation no sensible government wants to have on its conscience.

How to Use the Enterprise Surveys

Over the last decade the World Bank has invested heavily in developing the Enterprise Surveys. In the last 30 months, after the management of the database moved fully to the private sector and finance vice-presidency, all surveys have been put on the web and the methodology is now uniform across all regions. Previously, regions and even country teams could add whatever questions they thought were appropriate, without regard for the cross-country comparability of data. In short, the data are better and more accessible.

Now comes the hard part: making use of them. Traditionally, the enterprise surveys have fed into country-specific Investment Climate Assessments (in World Bank speak - ICAs). These are part analysis, part story-telling. They typically take a year to produce and often have suspect methodology. Some of the policy recommendations that come out of such work are, not surprisingly, naive. Last year, for example, I witnessed a meeting of the ICA team on Mauritius with a government delegation. An author of the report stated that the big issue in Mauritius was lack of reliable electricity, citing as proof the high percentage of businesses that have back-up generators. "These are needed during storms. No electricity grid can withstand the type of storms that sometime come through the island," answered a senior official. Somehow that had escaped the ICA team.

Be that as it may, how can the Enterprise Surveys be put to good uses? Here are 4 ideas:

A second time in Second Life

For the second time in a row, the Doing Business team is venturing into Second Life - an online virtual world - to release its annual report. I'll be assisting Dahlia Khalifa with the presentation on October 30th, 2pm EST. If you want to join in, you can watch streaming video of the event. The more adventurous among you can get an avatar - registration on Second Life is free - and teleport to our 'build' on this island.      

To get a feel for Second Life, check out Dahlia's interview yesterday on the upcoming virtual release of Doing Business 2009 on the Real Biz in SL show. (Dahlia handled the interview like a pro, this being her second year in Second Life.)

Cross-posted on the PSD blog.

Doing Business in FYR Macedonia

One little-noticed reform that will have a big effect: FYR Macedonia announced that effective October 1 most foreigners can enter the country without a visa. Georgia did the same thing 3 years ago, and it is always fun to go through immigration at Tbilisi Airport. After a couple of long flights the last thing someone needs is to sit around at the visa desk. Sounds like a small thing but it can be a memorable annoyance if you travel often. Here is a list of countries that require me (a citizen of Bulgaria, of European Union pedigree) to get a visa and where I get annoyed each time this comes up: Azerbaijan, Colombia, Egypt, Kazakhstan.

What is the rationale that, say, the Kazakh government wants me to get a visa? It's not like there is a rush of Bulgarians going to Kazakhstan. If I were to ask the minister of the interior, and I intend to, my guess the answer will be that this has always been the case. Not really. We are comrades. Built socialism together for quite some time and I am still struck by how many Kazakhs have been to Bulgaria pre-socialist-collapse.

So bravo to FYR Macedonia to not sticking to non-existent rationale and doing away with unnecessary bureaucracy. More foreigners will come, and those who would have come anyway would have an easier time. These things are remembered.

Crisis Snobs

"I am struck by how little interest is shown in the lessons learned from the numerous financial system crashes that have occurred in developing countries over the past two decades," says Bill Easterly of NYU fame. "I guess American policy makers and analysts are 'crisis snobs' that don't think they can learn from Argentina (even Japan and Sweden seem to be a stretch.)"

Think of these who have encyclopaedic knowledge of these crises, like Ross Levine at Brown and Jerry Caprio at Williams. It's all in their book (joint with James Barth) - Rethinking Bank Regulation: Till Angels Govern. Treasury people across OECD countries have a lot to learn from them. (Jerry was my director for a couple of years and I can tell you he knows this stuff inside and out.)

This knowledge matters not just for central bankers and Treasury officials. Coffee bean growers in Indonesia reported this week that their prices have fallen by 40 percent since August. Why? If anything, there must be more coffee-drinking at financial institutions and their supervisors around the world. No. It's because shippers cannot get trade credit. And without shipping, coffee beans don't get to your Starbucks.

Crisis Talk (3)

Who holds the risk in securitization? A nice paper by Markus Brunnermeier (Princeton University) talks about how financial innovation precipitated the current crisis. A good read for anyone who is trying to understand why things unravelled as fast as they have.

The main thesis of the paper is that the financial innovation in the last decade or so, clouded the view of who holds the risks. The author says (page 9): "The main disadvantage of securitization is that the transfer of credit risk distances the borrowers from the lenders. First, it makes it unclear who holds what risk. In the end, it might very well be that the risk comes back to the issuing bank, even though it thought it had transferred the risk on to, say, a hedge fund. Second, the banks' incentive to carefully approve loan applications, and their incentive to monitor (and even to collect) these loans, is drastically reduced. Since a big part of the risk is now borne by other financial institutions, banks essentially hold the full risk only for some months before it is passed on to others. Put differently, nowadays a bank faces only a "pipeline risk." That is, only risks that are not yet passed on and are still in the bank's pipeline are the bank's concern."

The article is forthcoming in the Journal of Economic Perspectives.

Belarus: A Top Reformer

Earlier this year, the government of Belarus publicly announced its goal to enter the top quintile of the Doing Business ranking. The government was determined to overhaul its business regulatory framework from the get-go.

In January, it held a series of extensive consultations with experts from the Doing Business team. The team explained its methodology in great detail and offered a set of recommendations on what to reform and how. The government of Belarus took its homework seriously and pledged to pass 63 regulations aiming to ease business regulations in the country in the first half of the year.

Crisis Talk (2)

Yesterday we started a new series of blog postings on the unfolding financial crisis. Today's topic: how bad can things become?

Bad. Germany's forecasters just updated their views for 2009, now suggesting growth of 0.2%, and possibly as low as -0.8%. "A number of negative shocks from outside Germany had already clouded the economic climate. But the dramatic developments on the financial have led to an even sharper deterioration in prospects," the forecast added.

The Irish economy has already gone into a recession, with production declining by 0.5% in the last quarter. Capital investment was also 18.8% lower in the quarter compared with 2007, with significant declines in house building as well as in the acquisition of transport equipment and machinery. During the same period, France and Italy shrank 0.3%, while the Netherlands saw zero growth.

Hungary also cut its 2009 forecast last Friday, to 1.2%. Ukraine is facing troubles too. The Baltics and the Balkans have bigger external deficits than Hungary, and may come into trouble too.

Meanwhile, the Korean won has lost more than 30% of its value relative to the dollar this year. This makes it difficult for businesses to access credit. In a statement yesterday, the government said it would guarantee for three years all external debt taken on by South Korean banks before 30 June 2009 in order "to avoid placing domestic banks at a comparative disadvantage in terms of overseas funding and to allay fears in the financial market."

What does all this mean for the world economy? The latest IMF forecast is, for once, overly-optimistic: 0.5% growth in the rich world and 6% in developing countries. Or around 2% globally. This is likely to be revised downward fast. Can it go negative? It could. The unfolding crisis is affecting a larger number of countries and, coupled with slowing economies, may have amplifying effects. If the world goes negative growth in 2009, it would be the first time in a long while. Hold on to your seats.

Crisis Talk (1)

This entry starts a series of blogs on the unfolding financial crisis. Seen as primarily a US phenomenon only a month ago, the crisis has now reached countries as diverse as Hungary, Ukraine, Indonesia and Brazil. The stock exchanges in several countries, including Russia, Romania and Indonesia, were closed for days to avoid further loss of value. Banks in quite a number of emerging markets have experienced runs. Where is all this coming from, what are the remedies, and what are the implications for reforms in financial systems?

This blog has a modest aim: to talk about the likely impact on regulatory reform work. This has been increasing fast in the last few years, fueled by expanding economies and a desire to improve international competitiveness. On the latter, macroeconomic issues had subsided and so governments had turned their attention to regulatory reform. This was in part due to some new research work, notably around Hernando de Soto and our own Doing Business project. Mostly, however, it was due to an economic boom that made competition for capital and even qualified labor global. So you had to be more competitive than your neighbor to attract resources. This time may now be over.

Three things will change. First, the attention of governments will turn away from micro reforms and into financial and fiscal reforms. This is especially true in Eastern Europe and Central Asia, which are likely to be significantly affected by the crisis. The second region already affected is South Asia. Others will follow. Second, the nature of reforms will shift: from mostly administrative reforms like business entry, business licenses and customs reforms, to mostly legal - bankruptcy, investor protections and tax. The latter because governments will try to adjust fiscal policy in the face of falling revenues and bigger demands on the budget. Third, the reforms will be done in a rush: a declining economy pushes many businesses into insolvency, and hence the need for faster bankruptcy procedures. Capital flows will start to dry up and governments will be hard-pressed to come up with ways to keep foreign capital. Improving laws on investor protection will be one answer.

What does this imply? Unpopular reforms - no one cares about bankruptcy in a booming economy - become urgent. The demands on finding good examples of bankruptcy and investor protection regimes will increase. Lawyers will become hip.