Slow Starters

This article appeared in Forbes on April 30, 2001.
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A big part of the capital burden for a new business is what might be called the entry tax. How much, in the way ofgovernment-mandated costs, does it take to set up shop legally? This is important because new enterprises fostercompetition. 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 honorbelongs to Canada, by one measure, and New Zealand, by another. The worst offenders, tragically, are found amidthe mass poverty of Africa.

It's a natural inclination to support regulations and, yes, red tape to protect consumers, workers, the environment andyou name it from the free market's defects--even among economists. Most famously, the Cambridge don A.C. Pigoulaid 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 NobelPrize for economics for arguing that just as the market has defects, so do regulations. His point: You have to evaluatethe benefits and costs of state intervention.

Sounds simple enough. But it isn't. Indeed, Coasian analysis requires detail work that most economists aren't inclinedto undertake. Fortunately, a team from Harvard University--Rafael La Porta, Florencio Lopez-de-Silanes and AndreiShleifer--and Simeon Djankov from the World Bank have come up with such findings for the National Bureau ofEconomic Research.

Their study collects data on the government-mandated entry requirements for 75 countries. It covers only the officialtab (not corruption or bureaucratic delays) and calculates the minimum time needed to meet them. The study countsout-of-pocket costs for fees, cost of forms, photocopies, fiscal stamps, legal and notary charges and so forth. If thehurdles 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 20in 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 GDPin 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 domesticproduct per capita. In Japan the comparable figures are 11 procedures, 50 days and 11%. And in Euroland, includingSwitzerland, the averages are 8.8 procedures, 62 days and a cost of 16% of GDP per capita. It's no wonder that FritzBolkestein, Europe's competitiveness czar, threw cold water on the optimistic statements made after the recent EUsummit in Stockholm by asking, "Where's the beef?" And he wasn't referring to the outbreak of hoof-and-mouthdisease in Europe.

The relation of entry costs to income is revealing. Rich countries- -the top 25%--have relatively low entry costs at anaverage of 10% of GDP per capita. Poor countries represented in the bottom 25% have staggering entry costs, anaverage of 65% of GDP per capita. As the world's do-gooders contemplate debt relief in Africa, they should ponderthe 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. Moreprocedures means more politicians and bureaucrats who must be bribed. Also, the relative size of the undergroundeconomy is larger in countries with a higher number of procedures: Make it harder to enter the formal economy andthe 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 associatedcostsdo not produce any tangible benefits for consumers, workers or the environment. Clearly official entry requirementsdon't pass the benefit-cost test. And, given thecorruption associated with them, they don't pass the smell test, either.