The World Bank's Regulation Rankings: Flawed but Necessary

Jim Yong Kim, president of the World Bank Photograph by Jin Lee/Bloomberg

The World Bank’s Doing Business rankings rate countries on the complexity and time taken to follow the official steps to set up and run a company. It may sound like a banal process, but the ranking has sparked a bitter international argument. It’s put the World Bank president, Jim Yong Kim, in the awkward position of arbitrating between the bank’s biggest shareholder—the U.S., ranked fourth, which likes Doing Business—and some of the bank’s most important funders and clients, notably China (91st), which hates the rankings.

Doing Business measures things like how many steps it takes to register an enterprise and how long it takes to get a construction permit. Each year, the bank rates countries on the principle that the quicker and simpler the processes are meant to be, the better. That alone raises eyebrows: Presumably we want some regulations, on building safety, for example. What’s more, the selection and weighting of indicators that go into the final ranking is arbitrary. Why is getting electricity on the list, but transport regulation out? Does the simplicity of paying taxes matter more or less to doing business than the ease of registering property?

There are also concerns with the survey’s approach. It asks, for instance, for the “official” number of steps to set up a business rather than what the normal entrepreneur actually faces when she tries to register her company. Mary Hallward-Driemeier of the World Bank and Lant Pritchett of the Center for Global Development found there was no relationship between the Doing Business indicator of how long it should take to get a construction permit in a given country and evidence from firm surveys of how long getting a permit actually takes.

One reason for that is the relationship between onerous regulation and rates of corruption. World Bank analysis suggests that countries with lower Doing Business scores also see more corruption reported by surveyed firms. If it’s complicated and time-consuming to get a permit, that gives more leverage to officials to ask for a bribe to do it quickly.

Yet while regulation is surely a burden on enterprises, it’s still hard to trace how much it affects a company’s performance. For example, a big concern about excessive business regulations is that they create “barriers to formality.” Rather than face the costs and hassles of registering and complying with regulations (or bribing regulators to avoid them), companies operate in the informal economy. This often comes at the expense of worker safety and conditions, as well as access to finance and services that might help the firm grow. In developing countries, this black-market economy may account for as much as 40 percent of GDP.

Analysis by economists Rafael La Porta and Andrei Shleifer, however, suggests that informal firms aren’t small and inefficient because of high regulatory costs. They’re small and inefficient because they’re badly run, have few customers, and don’t market their products. Most informal microenterprises are a last option for some of the world’s poorest people; they’re not startup firms on the way to a stock market listing. Registered microenterprises in La Porta and Shleifer’s sample of countries did see 18 percent higher value added per employee than unregistered microenterprises, but the value-added gap between unregistered microenterprises and small, formal enterprises was six times larger at 154 percent.

That may be one reason why it is hard to find a strong relationship between Doing Business rankings and broad development outcomes. After all, China is 87 places behind the U.S. in the rankings, but that hasn’t stopped China from more than doubling the size of its economy over the past 10 years (nor has it stopped the U.S. from falling into recession).

Pritchett and Hallward-Driemeier find that regulations affect performance because of capricious enforcement more than the level of regulation in the first place. Take the example of Egypt: In 2010 the country was lauded as one of the top 10 Doing Business reformers worldwide on the basis of its improved rankings—but the World Bank itself issued a report pointing out that for all the de jure progress, the business environment in the country was rooted in cronyism and connections. Regulations and inspections were for the new guy—the old guard could ignore them.

So the burdens surveyed (however imperfectly) by Doing Business do matter. In countries with weak oversight and regulatory bodies, more regulation all too often means more bribery and delay. Countries should pare back regulation to that with the highest social value and which they can fairly and effectively enforce. But that’s by no means a guaranteed path to riches, and nor is an improved Doing Business ranking necessarily a strong indication that it has happened.

World Bank President Kim has tried to outsource the decision of what to do with Doing Business to a panel of eminent thinkers headed by South African National Planning Minister Trevor Manuel. Manuel has issued a draft set of recommendations to the bank’s board that should be released next week, but in the end Kim himself will have to decide whether he’s going to grasp the hot potato (burns and all) or drop it. The short answer is the survey is useful and should continue, but the rankings should go.

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