Is the Doing Business of the World Bank a good predictor of business environment?

This has led to somewhat paradoxical situations: is it really so that regulatory environment is more business-friendly in Georgia (ranked 6. in the DB) than in the US (8), or the UK (9)? Or that business in Macedonia (10) is less burdened than in Sweden (12) or Australia (18); or that Belarus (37) is a better business destination than Switzerland (38)?

When you don’t see the forest since you are too focused on individual trees

Measuring the character of business regulation is not an easy task. Existing international benchmarks use either hard data (such as duration or costs of a procedure, level of tax rates, etc.) or perception of business people and experts or a mix of both. Objective data are more reliable, but they are more narrow since they can be used to depict a situation in several areas only; on the other hand, perception of business people regarding business regulation they face in their everyday activities is more general in scope, but also almost impossible to describe the situation in detail. The former approach cannot see the forest since it focuses on individual trees, while the latter cannot see individual trees from the forest.

Doing Business uses exclusively objective parameters. This means that it had to restrict its coverage of regulatory environment, in order not to lose itself in too many details that may not be expensive or impossible to gather. This s narrow view, however, leaves out a lot of regulatory areas which may be also important, since the regulatory framework in modern countries is measured in tens of thousands of pages. For example, the acquis communautaire or the common EU legislation is considered to be nearing 170 000 pages. At the same time, the regulation assessed by the DB is several thousand pages in length at the most. Therefore, since DB is rather narrow, it means that regulation outside of its scope can still be very burdensome, but this will not have an impact on a country’s rank in the DB.

If it’s measured - reform it, if it is not – turn the blind eye

Since DB is both narrow, transparent and relies on objective data only, it is relatively easy to implement regulatory reforms that would boost a country’s score and improve its ranking. Furthermore, DB does not have an ideological flair that some other benchmarks do, so it is politically more appealing to use it as a policy measure. But this also means that there is a danger of over-focusing only on the DB indicators, at the detriment of other also important measures of regulatory quality. A clear example of this could be found even in the names of several government working groups that are active in the field of regulation improvements: instead of being called working groups for improvement of business regulation, they are often named working groups for improvement of DB ranking.

These DB characteristics could explain why some countries have had a significant improvement in their DB score or rankings, but not so stellar results in other regulatory benchmarks.

’’Toto, I've got a feeling we’re not in Kansas anymore’’

Living in countries in transition, one often encounters a proverb that ’’good laws are not the problem, but their actual implementation in practice’’. These sentences are not only uttered in circles of political or NGO activists, but also in those of legal scholars and business people, and are even written into EU progress reports or other publications that cover legal or business environment in respective countries. This lackluster implementation of rules and regulations stems mostly from weak institutions and absence of rule of law, due to the political control that governments and other important stakeholders exert over the judiciary and civil service. In transition countries, this may be legacy of the authoritarian regimes before 1989 that kept a firm grip on all three branches of power, also over media and the economy as a whole, but also of different political views of constituencies in these countries, compared to Western Europe, or even cultural differences.  

This different situation regarding the way in which judiciary and civil service operate in countries in transition compared to other advanced economies is clearly visible when international benchmarks that measure rule of law, corruption perception and government effectiveness.

In the case of the business environment, the presence of rule of law would entail that all business entities are subject to the same rules and regulations, no matter who their owner/manager may be. However, partial implementation of business regulations in practice can be often used to gain competitive advantage – for example, if the authorities turn the blind eye if a selected company does not implement costly regulations, while they are very efficient in making other companies follow these rules. This situation does not cover the cases in which regulations are discriminatory per se, as long as they apply to all entities, which can also advance the interests of those with close connections to high ranking government officials.

Graph 1: Doing Business vs Rule of Law index

The chart shows the connection between Doing Business score of the World Bank and the Rule of Law Index of the World Justice Project. Transition economies are in red, while the EU15 are in blue. Notice that there is a clear connection between these two variables (although on a small sample) and that most transition countries have a much lower score in the rule of law segment than it would be expected by their DB score alone.

The similar situation is also visible in the filed of corruption. On average, countries in transition report a higher perception of corruption compared to their EU15 counterparts. The chart below shows the connection between the Corruption Perception Index of the Transparency International and the Doing Business score (once again, EU15 in blue, and transition countries in red). There is a strong correlation between these variables, but once again most transition countries score better on the DB than it would be expected on their CPI results alone.  

Graph 2: Doing Business vs Corruption Perception Index

When government effectiveness data from the World Governance Indicators of the World Bank are considered, we encounter once more the similar pattern: countries in transition (in red) have on average a lesser degree of government effectiveness than the EU15 8in blue), but also many of them have higher DB score than their governance indicators would make us suspect.

Graph 3: Doing Business vs Government Effectiveness, World Governance Indicators

These three small overviews of the Doing Business scores for transition countries all point out to the same conclusion, that the DB scores in some of the transition countries are significantly inflated since these scores are not followed by high scores in rule of law and government effectiveness, and low perception of corruption.

Is Doing Business still relevant?

After having a look at these problems, one question arises: is the Doing Business still relevant for describing the business environment in a country? Well, like all things in life, it depends.  

More business-friendly regulation does have a positive effect on economic activity, and DB can grasp at least some changes and evaluate them. But, although the DB does provide a good brief overview of the key business legislation in a country at stake, per se it is not enough to make a good nuanced view of the whole regulatory framework and its actual implementation in practice. DB can, therefore, provide a false picture of the situation.

The DB should, therefore, be accompanied with other important international measures, in order to account for its weak points. These should be some benchmarks that evaluate business regulation, such as Global Competitiveness Report, Economic Freedom in the World or Index of Economic Freedom, but also those that evaluate the level of rule of law and corruption. Only this broader view of the whole regulatory environment can really inform us about the character of the business regulation in a certain country.