Fiscal crises such as the one spurred by the COVID-19 pandemic motivate regulatory reform, which in turn can speed up the economic recovery. Past evidence suggests that this acceleration takes place through two main channels: new local entrepreneurship and increased foreign direct investment (FDI).
Entrepreneurship is critical for the continued dynamism of the modern economy, as forcefully argued by Austrian economist Joseph Schumpeter in deriving his theory of creative destruction. Startups make economies grow faster – as a source of innovation and new jobs. The business environment needs to be conducive to growth for new businesses to be born in the first place, to get a “birth certificate” (formal registration with the authorities) and subsequently expand.
When faced with costly regulations, startups lose the freedom to innovate and grow their business efficiently, often opting to stay informal. Friedrich Hayek, one of LSE’s many Nobel Prize winners in economics, is best-known for promoting such freedom. Informal firms are less productive and can erode formal firms’ market share and societal resources available to boost productivity, which slows down economic growth.
The global analysis illustrates that countries with easier business regulatory processes tend to inspire more new business creation (figure 1). This finding mirrors a recent study using panel data for 10 years across more than 180 economies which finds that an improvement of 10 points in the overall measure for business regulations is linked to an increase of 50 new businesses per 100,000 adults. To put this estimate in perspective, hypothetically it would mean an additional 26 thousand new businesses in the United Kingdom each year.
A hypothetical improvement in business regulations from lowest quartile to highest quartile of countries globally is associated with a 0.8 percentage point increase in annual per capita growth. Again, to put this estimate into perspective, it hypothetically implies an additional 18 billion pounds of GDP growth in the United Kingdom in 2019, a sizable effect. Conversely, costly regulations hamper the creation of new firms, especially in industries that should have high entry.
Figure 1. Economies with more conducive business environment have more startups
Source: World Bank’s Doing Business and Entrepreneurship databases. Note: The relationship is significant at the 1 % level. The sample includes 135 economies.
Over the last 15 years, governments around the world have implemented more than 3,800 business regulatory reforms in an effort to facilitate new businesses. This reform dynamism ought to accelerate after the health crisis is over. Along with the more traditional tools of eliminating minimum capital requirement, reducing time and cost for business incorporation or property transfer procedures, new digital solutions are emerging that further ease the entry of “recovery entrepreneurs” and property registration for new real estate owners.
Improving the business regulatory environment brings benefits to domestic firms but also influences foreign investors to stay or enter a market (figure 2).
Figure 2. Economies with better business environment attract more FDI
Source: World Bank’s Doing Business and World Development Indicators databases. Note: The relationship is significant at the 1 % level. The sample includes 170 economies.
Using the latest data on FDI inflows, we find suggestive evidence that the size of FDI inflows per capita is larger in economies with more flexible business regulations. This finding is supported by previous literature too. This association is important – in particular – for emerging markets and developing economies which suffered unseen capital outflows since the beginning of the pandemic crisis. The task of rebuilding investors’ confidence is more challenging than ever. FDI is a critical source of external finance, creating jobs and raising productivity (through new capital and technologies) thereby improving household incomes and lifting people out of poverty.
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Notes:
- This blog post expresses the views of its author(s), not the position of LSE Business Review or the London School of Economics.
- Featured image by mauro mora on Unsplash
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Doing Business – Data Irregularities Statement
WASHINGTON, August 27, 2020 – The World Bank Group today issued the following statement on the Doing Business Report:
Over the 17 years of its existence, the Doing Business report has been a valued tool for countries seeking to measure costs of doing business. Doing Business indicators and methodology are designed with no single country in mind, but rather to help to improve the overall business climate.
A number of irregularities have been reported regarding changes to the data in the Doing Business 2018 and Doing Business 2020 reports, published in October 2017 and 2019. The changes in the data were inconsistent with the Doing Business methodology.
The integrity and impartiality of our data and analysis is paramount and so we are immediately taking the following actions:
We are conducting a systematic review and assessment of data changes that occurred subsequent to the institutional data review process for the last five Doing Business reports.
We have asked the World Bank Group’s independent Internal Audit function to perform an audit of the processes for data collection and review for Doing Business and the controls to safeguard data integrity.
We will act based on the findings and will retrospectively correct the data of countries that were most affected by the irregularities.
The Board of Executive Directors of the World Bank has been briefed on the situation as have the authorities of the countries that were most affected by the data irregularities.
The publication of the Doing Business report will be paused as we conduct our assessment.