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Business Environment Reforms: Distinguishing Tokenism from the Real Thing

Inessa Love's picture

To promote the registration of new firms, many countries have been undertaking reforms to reduce the costs, days or procedures required to register a business. For example, the World Bank Doing Business report each year identifies the 10 most improved countries on the overall Doing Business index (comprised of 9 subindicators). One of these subindicators measures reforms related to starting a business, with 30-65 countries reforming in this area each year. A still unanswered question is whether some reforms are more important than others. A priori, it is not clear what magnitude of reduction in costs (or days or procedures) is necessary to create a significant impact on firm registration. In other words, what exactly constitutes a reform? Is a 20% reduction in the costs of registration sufficient, or is a 50% reduction necessary to get a substantial number of firms to register?

In a recent paper Leora Klapper and I empirically investigate the magnitude of reform required for a significant impact on the number of new registrations. We use a new dataset that is uniquely suited for this purpose: the World Bank Group Entrepreneurship Snapshots (WBGES), a cross-country, time-series panel dataset on the number of newly registered companies. We supplement it with data from Doing Business reports that contain the cost, time and procedures required for registration of new companies. Importantly, both datasets focus on limited liability companies. In an earlier paper, we used the same dataset to investigate the impact of the global financial crisis on new firm registrations

We classify countries as reformers using progressively higher cutoff points (i.e. 20% decline in costs, 30% decline in costs, etc). Our results show that small reforms—in general less than 40%—do not have a significant effect on new firm registration. Figure 1 below shows that in countries that undertook larger reforms (at least a 40% reduction in costs of registration), the increase in new registered businesses is more pronounced than in countries that undertook small reforms (a 10-40% reduction in costs), even though the “big-reform” countries seem to have been lagging in terms of new registrations prior to the reform (denoted as year t on the graph). Our results suggest that token reforms, perhaps motivated by political or multilateral pressures to reform, do not have the intended effect on private sector activity.

Figure 1: Impact of small and large reforms on new registrations

Often a country that is reforming the business registration process will make changes in the process along several dimensions. For example, as the number of procedures goes down, the length of the process will also go down, and often the costs will be reduced as well. It is possible that when several changes occur simultaneously, smaller changes along each dimension will produce significant results, while a single-parameter change will not.

In fact, we find that reforms in multiple indicators (e.g. cost and time in setting up a business) have a larger impact on business registration. The timing of reforms also makes a difference. For example, one country may reduce costs in one year and eliminate one or more procedures in another year, while another country may do these two changes simultaneously. We find larger impact from simultaneous changes.

Finally, we explore whether a country’s initial conditions matter and find that countries that start out with higher registration costs need larger reforms to induce a significant number of new registrations. Our paper offers a likely explanation: In countries with high initial registration costs, the benefits of registration are significantly less than the costs of registration, likely because of limited access to finance or rigid labor markets. In these countries larger reductions in costs are necessary to give firms the extra incentive to incur the costs of formal registration.

Our results highlight the importance of defining a reform so that it is consistent with expected outcomes—in this case, the number of newly registered businesses—and does not reward tokenism. The methodology developed in this paper can offer alternative classifications of reformers, which can be useful to policymakers, researchers and practitioners working to improve the business environment and private sector development. Our results can also help policymakers see the benefits of larger, and consequently tougher, reforms.


Resources:

Access the entrepreneurship database.

Read the working paper that explains the survey.

Further Reading:

Klapper, L. and I. Love, 2010. The Impact of the Financial Crisis on New Firm Registration, World Bank working paper.