Slow Starters

April 30, 2001 • Commentary
This article appeared in Forbes on April 30, 2001.

A big part of the capital burden for a new business is what might be called the entry tax. How much, in the way of government‐​mandated costs, does it take to set up shop legally? This is important because new enterprises foster competition. And if the U.S. is the standard, new businesses function as a huge job machine.

Turns out, according to a recent study, that the U.S. does not have the lowest entry tax in the world. That honor belongs to Canada, by one measure, and New Zealand, by another. The worst offenders, tragically, are found amid the mass poverty of Africa.

It’s a natural inclination to support regulations and, yes, red tape to protect consumers, workers, the environment and you name it from the free market’s defects–even among economists. Most famously, the Cambridge don A.C. Pigou laid out a case for this interventionist hyperactivity 80 years ago in his treatise The Economics of Welfare. But others, notably the University of Chicago’s Ronald Coase, rose to challenge Pigou’s orthodoxy. Coase won the 1991 Nobel Prize for economics for arguing that just as the market has defects, so do regulations. His point: You have to evaluate the benefits and costs of state intervention.

Sounds simple enough. But it isn’t. Indeed, Coasian analysis requires detail work that most economists aren’t inclined to undertake. Fortunately, a team from Harvard University–Rafael La Porta, Florencio Lopez‐​de‐​Silanes and Andrei Shleifer–and Simeon Djankov from the World Bank have come up with such findings for the National Bureau of Economic Research.

Their study collects data on the government‐​mandated entry requirements for 75 countries. It covers only the official tab (not corruption or bureaucratic delays) and calculates the minimum time needed to meet them. The study counts out‐​of‐​pocket costs for fees, cost of forms, photocopies, fiscal stamps, legal and notary charges and so forth. If the hurdles are onerous, we can expect less new activity.

The sheer number of procedures to be completed before a business may open varies widely, from 2 in Canada to 20 in Bolivia, with the average being 10. The “start‐​to‐​finish” time ranges from 2 days in Canada to 174 in Mozambique. The average number of days required is 63. The all‐​important official entry costs range from 0.4% of per capita GDP in New Zealand to 216% in Egypt, with the average cost being 34% of per capita GDP.

The U.S. requires 4 procedures, a “start‐​to‐​finish” time of 7 days and a cost of 1% of our $35,000 gross domestic product per capita. In Japan the comparable figures are 11 procedures, 50 days and 11%. And in Euroland, including Switzerland, the averages are 8.8 procedures, 62 days and a cost of 16% of GDP per capita. It’s no wonder that Fritz Bolkestein, Europe’s competitiveness czar, threw cold water on the optimistic statements made after the recent EU summit in Stockholm by asking, “Where’s the beef?” And he wasn’t referring to the outbreak of hoof‐​and‐​mouth disease in Europe.

The relation of entry costs to income is revealing. Rich countries‐ -the top 25%–have relatively low entry costs at an average of 10% of GDP per capita. Poor countries represented in the bottom 25% have staggering entry costs, an average of 65% of GDP per capita. As the world’s do‐​gooders contemplate debt relief in Africa, they should ponder the official cost of starting a new business there: 85% of GDP per capita, almost an entire year’s income.

Separately, the study confirms that corruption increases as the number of entry procedures increases. More procedures means more politicians and bureaucrats who must be bribed. Also, the relative size of the underground economy is larger in countries with a higher number of procedures: Make it harder to enter the formal economy and the informal economy will grow. And last but not least, countries that are more competitive have lower entry costs.

What makes this all so interesting and brings it back to Coase is the fact that these entry hurdles and associatedcosts do not produce any tangible benefits for consumers, workers or the environment. Clearly official entry requirements don’t pass the benefit‐​cost test. And, given thecorruption associated with them, they don’t pass the smell test, either.

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