Tim Harford The Undercover Economist

Articles published in September, 2004

Africa needs less red tape – Business in Africa

We all agree that too many Africans are poor. But why? Certainly not because of a lack of entrepreneurial skill or ambition. From Addis Ababa to Yaoundé, city streets all over the continent are crowded with clever and hardworking street vendors, often women and children. They can be a pleasure for the tourist, a convenience for the locals – but a sign of ill-health for the economy.
There is no longer any mystery as to why so much economic activity in Africa is in the informal sector.
The World Bank’s Doing Business report showed last year that African 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 four months in Burkina Faso, Angola, Mozambique, or Congo.
That’s bad news 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.
But Africa’s problems are more widespread than delays in starting new businesses. When a customer doesn’t pay his bills in Nigeria, it takes the victim two years to enforce the contract. Firing an incompetent or redundant worker in Sierra Leonecosts three and a half years of his salary.
The results are obvious: businesses won’t do business with large unknown customers except for cash; property registers become hopelessly outdated; employers will be slow to hire and conservative about giving a chance to inexperienced workers; credit goes only to those with the right connections.
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.
Other developing countries have discovered the benefits of simple solutions to regulatory problems. In Tanzania, bankruptcy procedures are now carried out in a specialised court, which is fast and in high demand. In South Africa, small investors are protected because data on ownership and company finances are publicly available. Courts in Botswana have improved the efficiency of their courts by limiting nuisance appeals.
In just one year, 58 out of the 145 countries benchmarked in the Doing Business in 2005 report have measurably improved some aspect of their business environment.
What is frustrating is that most of the reforms have not been in places like Ethiopia, Slovakia or Colombia, but in Belgium, Norway or Spain. The countries which are most desperately in need of reform are not reforming. And that means that the people most in need of protection – small businessmen, women with part-time work, young people looking for an apprenticeship – 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 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. A lot of progress has been made in one year. Next year we’re pushing for even more.

First published in Business in Africa – Online.

29th of September, 2004Other WritingComments off

SUVs

Dear Economist,

I’m in the market for a new car and I was thinking of buying an SUV. What would you say were the pros and cons?
Yours sincerely,
— Vanessa Thorpe, Chelsea

Dear Vanessa,

An ordinary car will go half as far again, per litre, as the “Chelsea tractor” you are considering. Most people spend between three and four per cent of their income on fuel, so choosing the sport utility vehicle would be like putting a penny or two on your income tax. But since you are turning down the opportunity to buy a second-hand Fiat Punto, perhaps cost is little object to you.

Let us instead postulate that there are two types of Chelsea drivers: those motivated by fashion and those who desire safety. If you are seeking safety, game theory must be your guide. The safest choice depends on what other Chelsea drivers have chosen. SUVs have a tendency to flip over while going round corners, but they are a safe choice for crashing into other tall, heavy cars. Ordinary cars tend not to roll, but do not provide good protection when hit by SUVs.

There are therefore two stable equilibria, one where all the safety-conscious drivers choose SUVs and the other where none of them do. A shift in the driving habits of the fashion-conscious could presumably push all the other drivers from one equilibrium to the other. But whether style or safety is the motivating force, the advice is the same: if you feel that the tendency of the times is to buy SUVs, best to do likewise. If you feel that they are last season’s craze, get something smaller.

Implicit in this recommendation is that you do not care that choosing an SUV raises the risks to other road users. But then, why should you?

First published at ft.com.

Madonna

Dear Economist,

Will somebody please explain to me the behaviour of my 12-year-old daughter? Every moment seems to bring some new craze. It was Justin Timberlake; now it’s Madonna. Can I do anything to persuade her to make her own decisions rather than join some irrational herd of pre-teens?
Yours sincerely,
Tom Jacobs, Winchester

Dear Mr Jacobs,
Youthful “crazes” may not be as crazy as you think. You describe an “irrational herd”, but what if the herd was perfectly rational?

Your daughter surely has her own opinion about the merits of, for instance, Mr Timberlake. Yet she realises that other girls hold valuable information about his strengths and weaknesses, and the listening pleasure afforded by rival entertainers. It would be foolish to ignore this information.

Rationally, your daughter will observe the music chart and real- time information such as the popularity of the songs on file- sharing software, or celebrity trackers such as the BBC’s “Celebdaq”. (Madonna is up 0.17 per cent over the past hour at the time of writing.) Each person who downloads a Madonna track confirms the quality of the music. The result can be a chain reaction as more people download, or, if no one follows the lead of these early adopters, it can be a flop.

An economically illiterate observer, such as the father of a music fan, might observe frenzies and crashes in the popularity of artists. He would not realise they were the result of each girl making sophisticated inferences about the information held by the others. Your daughter is clearly a gifted economist.

I recommend that you study the subject yourself. Not only would you understand your daughter better than before, you might even gain an appreciation of Madonna.

First published at ft.com.

Will Russia ride the wave of reform? – Vedomosti

This op-ed was published in the Russian-language business paper, Vedomosti.
Read the original version in Russian.

By Michael Klein and Tim Harford

A wave of reform has been sweeping across Europe. Governments are discovering that they can free up their budgets, increase growth, and give economic opportunities to the most vulnerable – often with very simple reforms.

The World Bank and International Finance Corporation have been producing objective indicators of the everyday costs of doing business: setting one up, closing one down, hiring a worker, selling some property, or trying to raise a loan. Last year’s report, Doing Business in 2004, showed that the richest countries benefited from the most efficient regulations. The new report, Doing Business in 2005, has been tracking who has reformed, and how they have benefited. Unlike many such reports, which are based purely on subjective opinions, the Doing Business reports use objective, transparent indicators based on expert legal analysis of the law and customary practice.

Eight of the ten countries who reformed the most were from Europe, including Poland, Lithuania, and Slovakia. Meanwhile, many countries in the former Soviet Union have made little attempt to reform their bureaucratic regulatory systems. The result is lower growth and exclusion for young workers trying to get jobs, get credit, or start their own businesses.

Where does the Russian Federation stand? With the reformers of Europe? Or on the sidelines? The truth is a bit of both: progress has been made, but tempting opportunities for reform remain untouched.

Russia has been making effective reforms in several areas. Russia is one of the best places in the world for employers who wish to hire new staff: Russian employers have the flexibility to use extended term contracts and apprentice wages, and are free from unrealistically high minimum wages. Our analysis shows that flexible rules like these help the most vulnerable people: women and young workers find it much easier to get jobs if employers can hire them on flexible contracts which give them a chance to prove themselves.

Russia also boasts one of the least expensive systems for trading property, and recently took steps to improve the integrity of the ‘cadastre’ in which land and buildings are registered. That may not seem important until you consider that many businesses are only able to get loans because they can prove legal ownership. Better property systems mean more credit – especially for smaller businesses.

In 2002, Russia was one of the showcase reformers of business start-up, reducing the number of procedures required to start up a business from 19 (among the worst anywhere in the world) to 12, and reducing the time it takes to turn a business idea into reality from 51 to 29 days. Last year, Russia remained in the top 20 reformers of business start-up: the procedures were cut back further to from 12 to 9. New business registrations grew by an impressive 14 per cent. In countries where even more dramatic reforms have taken place, the growth, too, has been more dramatic.

Nevertheless, it’s important that the progress doesn’t stop there. It’s worth remembering that countries like Australia and Canada can register a business in two simple steps without collapsing into chaos – and do so cheaply, and in two or three days.

Nor is it difficult to implement many of the reforms identified by Doing Business in 2005. Many are simple administrative procedures, for example, Russia’s use of business help centers to give entrepreneurs a single point at which they can access all the relevant authorities.

According to our objective measures, corporate governance represents the biggest opportunity for reform in Russia. The Russian stock market is one of the world’s top twenty by capitalization, but could be substantially larger after simple reforms. The simplest of all is to improve disclosure: of family ownership, of indirect ownership, of voting agreements, and all using external verification. We estimate that if Russia was to stiffen its requirements for disclosure to the levels seen in Slovakia, the Czech Republic, or Lithuania, market capitalization could grow by around sixty per cent.

It used to be that disclosing ownership and financial information cost a lost of money. The Internet has changed all that. Many countries are taking advantage – not just the United States or United Kingdom, but Egypt, Thailand and Brazil. There is a big opportunity here for Russia to attract both foreign and domestic investment by reassuring investors that they can see clearly if their holdings are at risk.

Disclosure is not the only area where Russia could improve. Shareholders should enjoy the right to buy newly issued shares – such ‘pre-emptive’ rights limit the risk of expropriation. Small shareholders in Tomskneft would have been grateful for such rights in 1999, when the majority shareholder Yukos diluted their ownership from 49 per cent to 9 per cent. In the end, it is not just they who suffer, but any Russian company trying to raise capital by convincing potential investors that their money is safe.

The World Bank Group will continue to track the cost of doing business across the world, to find out the most effective reforms and the biggest success stories. Russia has provided us with some of the best such stories, and in doing so has improved opportunities for many citizens. We look forward to more good news next year.

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

9th of September, 2004Other WritingComments off

Cutting red tape for growth

This piece, eventually signed by World Bank President James Wolfensohn, explains some of the findings of the Doing Business project.

By James D. Wolfensohn, President, World Bank Group

WASHINGTON – A year ago, the World Bank Group published the Doing Business report, measuring for the first time the burdensome regulations and weak property rights in many poor countries that stifle the growth of a vibrant business sector.

With the publication this week of the second Doing Business report, we can see that significant changes have been occurring in the developing world over the past 12 months in this critical area. For example, the number of new businesses founded in Ethiopia last year leapt by almost 50 per cent. It may seem a miracle, but the reason is no mystery: the Ethiopian government cut the cost of setting up a new business by nearly eighty per cent, or about four years’ salary. Turkey and Morocco also simplified their procedures and saw the number of start-ups grow by around 20 per cent.

Obviously, making it easier for entrepreneurs to start new businesses is good for growth. The same seems to be true for the other activities the report tracks, which include trading property, ease of hand allowing the use of collateral to get credit. It should come as no surprise that countries with streamlined, efficient regulation of these areas enjoy higher growth.

What is less obvious, but just as important, is that inefficient regulations hurt vulnerable people. In too many of the 145 countries covered by our research, restrictive laws exclude women and young workers from the labor market. Unrealistically high minimum wages mean that unskilled workers can only work in the informal sector—the black market—without paying taxes or enjoying any protection. Attempts to enforce “jobs for life” make employers very reluctant to take a chance on new workers, especially women. In contrast, countries with more flexible rules have many more women in the private sector workforce and much lower youth unemployment.

Stronger property rights also benefit the poor. For example, when creditors have stronger legal rights, they provide more loans. Everybody benefits, but the effect is larger and more significant for the smallest firms. Similarly, when countries provide efficient property registration, all types of firms report that their rights are better protected, but small firms enjoy the greatest benefits.

Many countries doxycycline aspire to protecting the poor, but it is a myth that heavy, bureaucratic regulations achieve this goal. Norway, Sweden, Denmark or Finland are all on our list of the twenty countries with the simplest business regulation. They regulate where it counts: protecting property rights and providing social services. They have found that workers, investors and even the tax authorities can all be looked after without reams of red tape.

Nor are efficient regulations the exclusive preserve of rich countries. Lithuania, Slovakia, Botswana and Thailand are also on our top 20 list. This year’s Doing Business report shows that countries like India, Poland, Slovakia and Colombia found ways to simplify business regulations, strengthen property rights, or make it easier for businesses to raise capital.

We have also discovered and documented dozens of proven reforms which have worked for rich and poor countries alike. Ethiopia’s dramatic success was achieved by abolishing an unnecessary requirement to publish notices of incorporation in the newspapers. Tanzania’s bankruptcy courts work much better now they are staffed with specialist judges. Thailand now allows entrepreneurs to start business without paying in minimum capital. Most of these reforms quickly pay for themselves – and for lower taxes or better public services.

Since the solutions are sometimes so simple, it is frustrating to see that businesses in the poorest developing countries face three times the administrative costs and nearly twice as many bureaucratic procedures and delays than their counterparts in the industrialized countries. In effect, the countries that most need entrepreneurs to create jobs and boost growth – the poorest countries – put the most obstacles in their way.

For people striving to start or grow a business, last year was a good year in the 58 countries which measurably improved some aspect of their business environment. It is just a shame that more of the 58 were not poor countries, rather than rich countries fine-tuning systems which already work well. We hope that the poor countries which have demonstrated simple, successful reforms become a lesson and an inspiration to many others.

Strong property rights – and effective, simpler regulation – do not arise from miracles, of course. They occur when countries measure their red tape, sharpen their reform scissors, and clear the way for average citizens to participate in the economic life of the nation.

8th of September, 2004Other WritingComments off

Doing Business in 2005

The Doing Business project, led by Simeon Djankov and Caralee McLiesh, provides objective measures of business regulations and their enforcement. The Doing Business indicators are comparable across 145 economies. They indicate the regulatory costs of business and can be used to analyze specific regulations that enhance or constrain investment, productivity and growth.

I helped to edit the latest report on the project’s findings, Doing Business in 2005.
http://rru.worldbank.org/DoingBusiness/

8th of September, 2004MarginaliaComments off

Lottery

Dear Economist,

For fun, I always sign up for a lottery syndicate at my retirement home. Imagine my surprise when the syndicate won the roll-over jackpot. I now have a windfall of several hundred thousand pounds and, aged 88, I really have no need for the money. I would like to do something with it that will be of some wider benefit. Can you please advise?
— Edward Bowman, Torbay

Dear Mr Bowman,
Congratulations on your good fortune, your good nature, and your good sense. You’re wise to think carefully about how to make sure your money helps others. Some people in your position set up charitable trusts, but the sad truth is that it’s very expensive to pay administrators to make sure that the money is well spent. A far better approach is simply to burn the money. This will mean that the pound is suddenly in shorter supply, driving down prices in the shops. There are about £40bn in circulation. If you destroy £600,000, this will make each of the others buy about 0.002 per cent more – effectively, a gift of about a penny to each person in Britain.

Perhaps you feel that this is spreading a finite resource too thinly, and you might instead spend the money providing a so-called “public good”, which is costly to produce but cannot be used up through over-consumption. The most obvious public good is information on the internet, so you could use the money to fund a website that provides valuable information as a free service.

Your only problem will be deciding what information should be provided. You might consider paying for a weekly column – something educational and fun, which deserves to be read more widely. The answer is right in front of your nose.

First published at ft.com.

4th of September, 2004Dear EconomistComments off

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