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.
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