June 25, 2013 9:46AM

Doing Business Under Fire

Since its inception, World Bank’s Doing Business project has attracted a lot of criticism from groups that do not share its broadly pro-market policy ramifications. It is dispiriting to see the review panel of the project, appointed by the Bank’s president, Jim Yong Kim, cave to the attacks and regurgitate the ideologically motivated myths spread by the project’s most vocal critics.

The report by the review panel, which was released on Monday, and which will inform the decision about the future of the project, recommends stripping the publication of important parts of its content and weakening its role as a focal point for governments that are striving to improve business environments in their countries. That is a grave mistake.

1. Scrapping the rankings

The report recommends that the aggregate rankings of countries should be dropped:

The act of ranking countries may appear devoid of value judgment, but it is, in reality an arbitrary method of summarising vast amounts of complex information as a single number. (p. 20)

It is true that aggregation is always contestable and that there is no objective way of weighing the ten Doing Business indicators to create the final index. But that is true of any aggregate measurement exercise in the social sciences. As long as the weights used in creating the ranking are transparent and the underlying data are known, no information is lost in producing the ordinal rankings of countries.

If one is concerned about the arbitrariness of the weights attributed to the different indicators (they are weighed equally), it would have been easy to enhance the functionality of the Doing Business website to allow readers to pick their own weights.

But make no mistake, this is not an arcane dispute about methodology. One of the criticisms leveled against Doing Business was that its use of aggregate rankings encouraged governments to use them as focal points for their policymaking. Is that bad?

The aggressive reformers that recorded quick improvements in their Doing Business rankings—like Mauritius or Rwanda—have not only seen significant economic growth, but have also witnessed dramatic improvements in different measures of governance and a fall in corruption. The critics of the project and the panel fail to provide any evidence of cases where an unscrupulous pursuit of higher Doing Business rankings has led to a deterioration of either economic or social outcomes.

2. Scrapping the tax rate indicator

Another common criticism of the Doing Business report relates to its indicator of Paying Taxes which includes a measure of the total tax rate facing companies, adding different local, regional and nation-level taxes. According to the critics, the Paying Taxes indicator encourages governments to cut taxes, harms revenue collection and prevents governments from productive spending.

In response, in 2012 the Bank has introduced a threshold of 25.7 percent, below which tax cuts do not affect countries’ performance on this indicator. This time around, the review panel favors removing the indicator altogether because

a tax rate indicator is not a relevant measure of the ease of doing business in a country (although it does provide an imperfect indicator of the amount of tax paid by businesses). (p. 38)

That is preposterous. Tax rates do matter for locational decisions. Furthermore, it is recognized that corporate taxes are distortionary, and have potentially large economic costs. If one cares about economic efficiency, one should be happy about encouraging governments to rely more on other tax instruments.

But whatever one’s take on the issue is, it is obvious that marginal and average tax rates imposed on firms’ activities do constitute an obstacle to doing business, regardless of whether their final burden falls on consumers, employees, or firms themselves. The reasonable attitude would be to recognize the cost that business taxation represents and, if needed, balance it against other policy considerations. But to deliberately choose to disregard it is a recipe for disastrous policies.

3. Labor market regulations

Another area that irritated the opponents of the Doing Business project was that of labor market regulation. Until 2009, the Employing Workers Indicator (EWI) counted labor market regulations as a cost of doing business. The panel considers the removal of the indicator as “wise” and recommends that in the future the project takes into consideration

both the costs and the benefits of a comprehensive range of labour laws and regulations. The quantification should comprise conditions such as hours of work, rest and leave provisions, minimum wages, protection against dismissal, occupational health and safety requirements, social protection and respect of core labour standards. (p. 36)

Whatever one thinks of labor market regulations, it is clear these impose costs on businesses. The body of evidence suggesting that labor market regulations can have economic costs is large. To give one example, a paper by Botero, Djankov, La Porta, Lopez-de-Silanes, and Shleifer examined the experience of 85 countries and concluded that “heavier regulation of labor is associated with lower labor force participation and higher unemployment, especially of the young.” Again, to close one’s eyes to this fact is ill-advised—even if one thinks that there is a legitimate place for comprehensive labor market regulation.

The report cites the 2013 IFC jobs study which provides survey-based evidence according to which only a small proportion of firms in developing countries cited labor market regulations as an obstacle to job creation. The panel’s attitude is thus akin to recommending a drug that has been widely found to induce serious side-effects on the basis of one study that fails to find such side effects.

4. “Governance” of Doing Business

While the substantive part of the panel’s report is bad enough on its own, it is the panel’s recommendations regarding the “governance” of the project that sound the most ominous and are likely indicative of the politics behind the efforts to kill Doing Business.

Independent commentary of the kind undertaken by the Doing Business report requires robust oversight, governance and review. These tasks should not be left to the Doing Business team as it cannot operate as both principal and agent.

An appropriate governance structure would oversee the technical dimensions of the project and ensure that sufficient care is taken in presenting its findings, with an eye on their political consequences. (p. 30, emphasis added)

The panel recommends that the Bank sets up “a special oversight committee drawn from senior management” that would meet annually to “ensure that the Doing Business report’s goal, indicators and methodology align with Bank policy.”

While no further details are given, it is hard to read this as anything else as an attack on the independence and integrity of the project. If its purpose is to speak truth to power about costs of doing business, then it is necessary that the project is conducted without an eye on the political consequences of the findings.

My colleague Marian L. Tupy and I have written about this issue earlier herehere, and here. The panel’s report reinforces our prior argument that the review has not been a disinterested attempt to have a serious conversation about how Doing Business could be improved but rather an ill-hidden attempt to strip the project of its analytical sharpness and reduce its stature in the eyes of policymakers and public in the developing world.