Tim Harford The Undercover Economist

Articles published in 2004

Easy way to rule out hawkers (New Zealand Herald)

New Zealand shows benefits of keeping business regulation simple

By Michael Klein and Tim Harford

WHAT do Jakarta and many other Asian cities have that Wellington doesn’t? A vast, unregulated scrum of clever and hard-working street vendors, often women and children.
Peanut hawkers and street vendors add colour to the streets of many developing-world cities, but they are a sign of ill-health for the economy.
New Zealand has one of the world’s smallest “informal sectors”.
That’s good news for New Zealanders.
Formal businesses pay their taxes and have to give workers their legal rights. Informal businesses are off the regulatory radar screen.
They can avoid providing basic protection for their employees who are disproportionately women, low- skilled workers and young people.
Yet businesses do not lurk in the informal sector for fun. Unregistered businesses don’t have access to the courts, to police protection and to credit from the banks.
Unregistered property is useless for securing a loan. If entrepreneurs could reasonably enter the formal sector, they would do so.
There is no longer any mystery as to why so much economic activity in developing countries is in the informal sector.
The World Bank’s new report, Doing Business in 2005: Removing Obstacles to Growth, has shown that poor countries are tying up their formal economies in red tape.
Compare New Zealand, where it takes two days to set up a limited liability company, with Indonesia where it takes more than 150 days and Papua New Guinea, Fiji and Samoa, where it takes more than 50 days.
The World Bank believes New Zealand has a lot to contribute as a model to its Pacific neighbours because of its procedures for setting up businesses, hiring new workers, getting credit, enforcing a contract or selling property – all areas in which it is consistently among the cheapest and fastest in the world.
Where a New Zealand business will take on average 50 days to recover a bad debt, it will take a small business in Solomon Islands 18 months and cost more to chase the debt than the debt itself.
Firing an incompetent worker in Kiribati or Vanuatu can cost around a year of that worker’s salary. Starting a new business in Papua New Guinea takes eight bureaucratic steps and costs the equivalent of 30 per cent of a Papua New Guinean’s yearly income.
In New Zealand, it takes two steps to set up a business at the cost of 0.2 per cent of an average Kiwi’s annual income.
The result of too much regulation and a lack of legal enforcement is clear. Businesses in poorer countries won’t do business with large unknown customers except for cash, employers will be slow to hire and conservative about giving a chance to inexperienced workers, and credit goes only to those with the right connections.
We’ve discovered that cutting red tape is more straightforward than many people think.
In Ethiopia last year, the rate of establishing new businesses grew 48 per cent. Surely it is no coincidence that this was the same year that Ethiopia cut the cost of registering a business by almost four years’ salary.
The reform was a matter of abolishing a requirement to publish an unnecessary and expensive public notice in the newspapers.
Ethiopia is a particularly clear example of a common thread in our work – regulations that are often straightforward do the job they were supposed to do without pushing people into the informal sector, where they get no benefit from regulations anyway.
In one year, 58 of the 145 countries included in the report have measurably improved some aspect of their business environment.
Unfortunately, many of the countries which are most in need of reform are not reforming.
That means the people most in need of protection – small businesses, women with part-time work, young people looking for a job – are not getting it.
It is a myth that efficient regulation which protects those it should protect without distorting the economy is a luxury that only New Zealand can afford.
Doing Business in 2005 has shown that regulations that work can be simple to design, cheap to introduce and fair on vulnerable groups.

Michael Klein is chief economist of the International Finance Corp and a vice-president of the World Bank and IFC. Tim Harford is a World Bank/IFC economist. The Doing Business data is available online at http://rru.worldbank.org/DoingBusiness.

Published in the New Zealand Herald, 29 December 2004.

29th of December, 2004Other WritingComments off

Teenage smoking

Dear Economist,
A lot of my friends at school have started smoking. It seems really cool. Do you think that I should give it a try?
Yours,
Liz Sydney

Dear Liz,
If it was easy to quit smoking, then the decision to smoke would be what economists call a “costlessly reversible investment”. You would be well advised to follow your instincts that the cool, sexy image and the nicotine buzz are attractive enough to outweigh the financial costs plus the aging skin, bad breath, wheezing, stained teeth, and the likelihood of cancer or heart disease. There would be no harm in giving smoking a try because you would continue to learn more about both its costs and its benefits. If at some future stage you decided you had made a mistake, you could simply stop.

In reality, it is not easy to quit. The decision to start smoking is therefore not costlessly reversible. In an uncertain world it is usually worth waiting to find out more before making decisions which are hard to reverse. Even if a primitive cost-benefit analysis recommended smoking, a more sophisticated view would recognise that plunging in too quickly has a hidden cost: you lose the opportunity to wait and find out more. Admittedly, if the benefits of smoking seem very large and the costs of smoking seem very small, even the hidden cost of starting young would not be enough to discourage you.

Still, the fact that few 35-year-olds suddenly decide it’s time they started smoking suggests that there is some value in waiting for a few years to gain a new perspective. I should mention that if you confidently expect to die tomorrow, the value of waiting to learn more is zero and you should puff away. The tradition of the last cigarette for the condemned man is therefore perfectly rational.

First published at ft.com.

4th of December, 2004Dear EconomistComments off

Shell/Economist Prize Winner: Import People, or Export Jobs?

This essay won a bronze award ($5000) in the 2004 Shell-Economist writing prize. This is the second time I’ve been lucky enough to win a Shell-Economist prize – the first is here.

Import workers, or export jobs?
The local economy is facing new competition from cheap imitators to the east. Our trade deficit is large and growing. I see immigrants everywhere I turn, while jobs are being destroyed by economic change. In short, life is good.

Economists are notorious for their inability to understand the human impact of migration or outsourcing, even as they praise the abstract phenomenon of economic globalisation. Yet the more closely one looks at real people, the better globalisation appears for all concerned. Import workers, or export jobs? Both, please, for all our sakes.

Start with the local economy and the cheap competition from the east. My local economy is Dupont Circle, Washington DC. To the east lies the booming region of 14th Street, where new apartment blocks are quickly rising from the rubble of abandoned warehouses, while former pawn shops, brothels and fortified liquor stores metamorphose into stylish furniture showrooms and hip bars – inasmuch as anything is ever stylish or hip in Washington. The change is incredible; 14th Street’s economy is probably growing faster even than that of China. It’s hard to tell because 14th Street, unlike China, does not report economic accounts.

One might think that the success of 14th Street must be coming at the expense of Dupont Circle’s restaurants, shops and bars. Dupont Circle hasn’t adopted income accounting either, so anecdotal evidence will have to serve. Wandering around on a balmy June evening, the bars are overflowing and the late-night shops have plenty of customers. There is no hint that the Circle is suffering as a result of competition. The truth is that one region is growing more prosperous without drawing wealth away from the other – a process mysterious to some, but which economists call ‘growth’.

How did the growth happen? First, Dupont Circle imported workers. The waiters and kitchen staff are ‘economic migrants’; they actually live in other parts of the city, and travel to where they can earn more money. Dupont Circle could never have begun to prosper by employing only locals.

Then, Dupont Circle started to export jobs. As the Circle grew more popular as a night spot and the space grew more crowded and more expensive, entrepreneurs saw an opportunity to replicate success. First 17th Street and then the more economically deprived 14th Street played the role of Japan and China – investing heavily, bringing the latest ideas, and training new staff to keep up with demand. (14th Street, like China, plays host to a lot of investment by outsiders.)

Yet no matter how many jobs Dupont Circle exports, it still seems to have as many as it started with. This is hardly surprising. 14th Street is only a competitor at all because of the high rents around the Circle. The high rents are a symptom of success, not a cause of failure. The ice-cream shop that moved from the Circle to 14th Street wasn’t sucked away by low rents: it was pushed out by the fashion boutique that was willing to pay more for the space.

When economists talk about gains from trade through ‘comparative advantage’, they are talking about the ice cream shop moving from Dupont Circle to 14th Street, because although the shop is a good business for the Circle, the boutique is an even better one. This shouldn’t be a frightening process. American wages are higher than those in China for precisely the same reason as rents are high in the Circle, and American jobs are ‘exported’ to China not because they are unproductive relative to China, but other parts of the American economy are even more productive.

Even those newspapers which accept that trade makes us richer, not poorer, will wring their hands over mysterious numbers – for instance, America’s bilateral trade deficit with China. But what does this statistic mean? My own family’s bilateral trade deficit with 14th Street is enormous. We spend money there almost every day, even though all our income is earned on Penn Avenue. (Economist Steven Landsburg helpfully and accurately defines a trade deficit as ‘the amount you spend in a given place minus the amount you earn there.’) Self-evidently, my family’s bilateral trade deficit with 14th Street is a blessing, not a problem. But it’s the kind of thing that politicians get excited about in election year, especially when the deficit is with China rather than 14th Street.

All very well, but surely the competition between Dupont Circle and 14th Street is not the same as that between, say, the United States and China? The process is surprisingly similar: Dupont Circle – or the United States – finds a formula that works, imports workers, and prospers. After a time, others (14th Street, or China) find a way to copy those ideas, import capital, and they, too, grow in wealth. The rest is detail. What is happening in China seems different because the Chinese are emotionally and physically more distant than the 14th streeters – and because national income accounts are drawn up so that newspapers can report the bilateral trade deficit with China, as though that number meant something. What is going on in China is just as beneficial as what is going on in 14th Street. It is a natural and familiar process of economic growth, led by economic connections between regions. The only difference is that it is on an unprecedented scale.

Many Chinese still remember the Great Leap Forward, which resulted in a famine so severe that people were reduced to cannibalism. Twenty-something Washingtonians recall cruising down 14th Street for a teenage thrill, looking at the prostitutes and giggling at the risks they were taking by entering an area where drug-related violence was rife. In both cases, thanks to importing workers and exporting jobs, the suffering is becoming no more than a memory.

There may be little economic difference between what happens at the local level and what happens at the global level, but there is a large political difference. The Chinese cannot emigrate to the United States with the ease that a 14th Street shopkeeper might open a business in Dupont Circle.

The reasons are not hard to see. Governments do not win elections with a soft line on immigration. The lucky residents of rich countries labour under the strange impression that an Afghan farmer might expend the money and take the risks necessary to make his way to Britain or France simply to enjoy a life of ease on the welfare state. It’s easy to conjure up such paranoid fantasies as long as one doesn’t think too hard.

It is clear enough that when workers from move from places where they are not productive to places where they are is good news for them. The more interesting question is whether the poorer countries which are losing their brightest people are suffering unfairly.

Often, they are not suffering at all. The Mexican labourers who built the apartment block in which I live used their wages to send home money – part of the ten billion dollars which flow every year to the citizens of Mexico from relatives abroad. This is five hundred times what Mexico receives in grants from other governments. For developing countries as a whole, five dollars of remittances flow in for every two dollars of government grants and loans. The remittances are more stable than private investment or government money, and they flow disproportionately to small and poor countries, according to Dilip Ratha of the World Bank. So those who claim that the migrants should stay in Mexico, for the good of Mexico, are not fooling anyone but themselves.

Washington is also full of highly skilled migrants – doctors, software engineers, and even economists – sparking talk of a ‘brain drain’ back home. Yet according to Professor AnnaLee Saxenian of the University of California, Berkeley, many of these skilled migrants return home, or hook up with contacts at home. Returning migrants from Silicon Valley are behind the growth of Chennai, Bangalore and Shanghai.

Not everyone returns home. My Iranian doctor has lived in America most of her adult life. A moment’s reflection about the position of women in Iran may tell you why. Some governments, and some societies, do not deserve to keep their best people. If the threat of emigration encourages them to reform, that is one more argument in favour of it.

We live in a world where borders are still barriers. Wherever the barriers can be more easily breached by brave and adventurous, but otherwise quite ordinary people, the world becomes a freer and a wealthier place. We learn that lesson not from the newspapers or from economics textbooks, but by looking at our own neighbourhoods. Import workers, or export jobs? We’d be fools not to do both.

Tim Harford, August 2004

19th of November, 2004Other WritingComments off

Entrepreneurship in Failed States

View the discussion at: http://rru.worldbank.org/Discussions/topics/topic56.aspx
(Open for comments until December 6th)

Discussion moderated by Ian Bannon and Tim Harford

The inventiveness of entrepreneurs in some failed states borders on the legendary. Yet that success is fragile, inherently limited and rare. How can donor agencies support, sustain and spread these achievements?
Entrepreneurs in Somalia have used three tactics to operate in an institutional vacuum. First, they have “imported institutions,” for example by using banking systems in nearby countries. Second, they have used clans and other local networks of trust to help with contract enforcement, payment and transmission of funds. Third, they have simplified transactions to a point where other tactics are not needed. How can these tactics be reinforced or defended? Are there others that can be supported?
There are inherent limits to what the private sector can achieve without the support of a capable state to enforce property rights and provide basic public goods. But there is also a risk that a failed state will be replaced by a predatory one. How can fledgling states be encouraged to support, rather than predate on, entrepreneurs?
Entrepreneurs often need to bridge religious, ethnic or tribal boundaries to get things done. Can entrepreneurship be harnessed for peace and reconciliation?
Many failed states have a large Diaspora with money, experience and energy. How can the expertise and financial capital of diasporas be encouraged?

15th of November, 2004Other WritingComments off

The Future of Aid

My notes about ‘The Future of Aid’ with Michael Klein and other co-authors are being collected here.

6th of November, 2004Other WritingComments off

Donor Performance: What Do We Know, and What Should We Know?

By Tim Harford and Michael Klein

It would be hard to disagree with the objectives of the international aid industry. But how much are donors contributing to their achievement? Despite recent progress, we still know surprisingly little. We know that some donors give much more than others relative to income. We also know that donors are focusing aid less on poor countries and more on countries with strong institutions or good policies. And we know that there appears to be no tradeoff here: the countries that give the most aid also target poor countries and those with good policies. Yet we are still in the dark about which donors, or which projects, are achieving the best results.

http://rru.worldbank.org/PublicPolicyJournal/Summary.aspx?id=278

3rd of November, 2004Other WritingComments off

Aid Agency Competition

By Tim Harford, Bita Hadjimichael, and Michael Klein

Critics of the aid industry have accused it of acting like a cartel (Easterly 2002). The accusation has some bite—globally the industry remains somewhat concentrated, and for the typical recipient country, highly concentrated. Yet the most striking fact about the industry is how relentlessly competitive pressures are building. There has been a constant stream of new entrants, a steady fall in global and local concentration, and a clear tendency for donors to break out of historical patterns of aid and compete with one another. Could greater competition improve the efficiency of the aid system?

http://rru.worldbank.org/PublicPolicyJournal/Summary.aspx?id=277

3rd of November, 2004Other WritingComments off

The Supply of Aid: How are donors giving, and to whom?

By Tim Harford, Bita Hadjimichael, and Michael Klein

This note reviews trends in official development assistance, focusing on volumes, sources, forms, and recipients. Several patterns emerge. First, a long-term trend of official flows taking the form of “hard” loans rather than grants and “soft” loans, with low interest and long maturities, has been reversed in the past five years. Second, both grants and loans are increasingly aimed at middle-income countries rather than the poorest. And third, official flows have fallen relative to rich-country income by 30 percent in the past 30 years.

http://rru.worldbank.org/PublicPolicyJournal/Summary.aspx?id=276

3rd of November, 2004Other WritingComments off

Anarchy and Invention: How Does Somalia’s Private Sector Cope without Government?

by Tatiana Nenova and Tim Harford

Somalia has lacked a recognized government since 1991—an unusually long time. In extremely difficult conditions the private sector has demonstrated its much-vaunted capability to make do. To cope with the absence of the rule of law, private enterprises have been using foreign jurisdictions or institutions to help with some tasks, operating within networks of trust to strengthen property rights, and simplifying transactions until they require neither. Somalia’s private sector experience suggests that it may be easier than is commonly thought for basic systems of finance and some infrastructure services to function where government is extremely weak or absent.

http://rru.worldbank.org/PublicPolicyJournal/Summary.aspx?id=280

3rd of November, 2004Other WritingComments off

It takes 89 days to set up a business in India, only 2 in New Zealand – India Abroad

Published in India Abroad, 29 October 2004.

By Michael Klein and Tim Harford

We can all agree that too many Indians are poor. But why? Certainly not because of a lack of entrepreneurial skill or ambition. From Chennai to Delhi, Mumbai to Calcutta, city streets all over the country are crowded with clever and hard-working street vendors, often women and children. They can be a pleasure for the tourist, a convenience for the locals – but they are a sign of ill-health for the economy.

‘Informal’ businesses pay no taxes and can avoid providing basic protection for their employees, who are disproportionately women, low-skilled workers and young people. Yet businesses do not lurk in the informal sector for fun. Unregistered businesses are denied access to the courts, to police protection, and to credit from the banks. Unregistered property is useless for securing a loan. If entrepreneurs could reasonably enter the formal sector, they would do so.

According to one authoritative estimate, nearly a quarter of India’s economy is in the grey economy – almost twice the level of China. And there is no longer any mystery as to why so much economic activity in India, as in many developing countries, is informal. The World Bank’s reports, Doing Business in 2004 and 2005, have shown that poor countries are tying up their formal economies in red tape: it currently takes just two days to set up a limited liability company in Australia, New Zealand or Canada, but over 150 days in Indonesia, Brazil, Mozambique, Congo, Lao or Haiti.

Indian entrepreneurs face particularly difficult obstacles. India’s regulations are more cumbersome than the South Asian average (not a challenging benchmark) when it comes to setting up a business, labor regulation, simple court procedures and bankruptcy. The contrast with China is even more striking. Chinese entrepreneurs can set up a business in 41 days at a cost of less than eight weeks’ income; in India it takes 89 days and costs over six months’ income. The Chinese can register property in half the time and for less than a quarter of the cost – very handy for getting secured loans. Indian courts are nearly twice as expensive and take nearly twice as long to enforce a simple contract.

We should hardly be surprised to hear that in India, property is often traded informally (making it useless for securing loans); businesses are often unregistered and pay no tax; entrepreneurs will avoid large contracts with unfamiliar customers. Facing among the most cumbersome redundancy procedures in the world, employers will be slow to hire and conservative about giving a chance to inexperienced workers.

The good news is that these problems are often very easy to fix. Rich and poor countries the world over have pioneered simple regulations and administrative systems which do the job they were supposed to do without pushing people into the informal sector, where they get no benefit from regulations anyway.

Even more surprising for those who have bemoaned the ‘licence Raj’ for so many years: India was one of the top ten reformers in the world last year. The country has introduced a credit bureau, which will build up information on credit histories and so gradually allow those who are worthy of credit to get it, whether or not they have the right connections. (It will also discourage defaulters, who will fear black marks on their credit record.)

India’s new securitization law, having survived a challenge in the supreme court, will allow businesses which have not been paid by suppliers to enforce the commercial court’s judgment more quickly and cheaply. Since enforcement costs have historically been over twice the costs of going to court in the first place, progress here will pay dividends.

Meanwhile, ambitious reforms of the bankruptcy law should, in time, make it easier for new businesses to raise capital. India still has the world’s slowest bankruptcy procedures – it takes ten years to close a business. But, following repeal of the Sick Companies Act and the rapid spread of specialized bankruptcy tribunals (which have worked very well in companies as diverse as Latvia and Tanzania), we expect matters to improve significantly over the next few years. In countries where bankruptcy is quick and investors believe they can retrieve some money when things go wrong, entrepreneurs have less trouble convincing banks to lend them money to grow.

It would be wrong to think that red tape is the only concern of Indian entrepreneurs – in business surveys, the cost and reliability of utilities such as electricity also rank high in the list of worries.

Yet the recent reforms need to be applauded. They have been tough to implement and they will make a real difference. The progress is good news for the poor. While the country remains a byword for bureaucracy, Indian citizens most in need of protection – small businessmen, women with part-time work, young people looking for an apprenticeship – will not get it. The faster and more profound the improvements in the business climate, the more these vulnerable people have to gain.

It is a myth that efficient regulation, which protects those it should protect without distorting the economy, is a luxury that only rich countries can afford. Doing Business in 2005 has shown that regulations that work are simple to design and cheap to introduce, that they are fairer on vulnerable groups but also good for economic growth.

India has made great progress in the past year. We wish the country every success in the year to come.

Michael Klein is Chief Economist of the International Finance Corporation and a World Bank / IFC vice-president. Tim Harford is an IFC economist.

Open a scan (450k) of the original article.

29th of October, 2004Other WritingComments off
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