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Pitfalls to Avoid when Measuring the Institutional Environment: Is Doing Business Damaging Business? Benito ARRUÑADA

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Presentation on theme: "Pitfalls to Avoid when Measuring the Institutional Environment: Is Doing Business Damaging Business? Benito ARRUÑADA"— Presentation transcript:

1 Pitfalls to Avoid when Measuring the Institutional Environment: Is Doing Business Damaging Business? Benito ARRUÑADA Pompeu Fabra University 2 nd Workshop on “Measuring Law and Institutions” Paris, December 15, 2007

2 Today’s talk will intersperse: ▪ Pitfalls ♦Arruñada, B. (2007), “Pitfalls to Avoid when Measuring the Institutional Environment: Is ‘Doing Business’ Damaging Business?” J. of Comparative Econ., 35(4), 729-47. ▪ Next step ♦Theory of business formalization ♦Lessons for measurement ♦Lessons for policy: priorities

3 Motivation ▪ Seeing how administrative simplification, inspired by DB, is being made in the field ♦Dubious “best practice” standards ♦Naïve incentives in international aid—e.g., MCC ♦Mistaken policies—observed: IDB, SNLE ▪ Several factors ♦Rent seeking ♦Magic power of numbers ♦Difficulties and mistakes in measurement ♦Measurement without any theory of the institution

4 Outline I. Theoretical weakness leads to unsound reform priorities II. Biased methodology impedes considering tradeoffs in institutional design III. Emphasis on averages precludes local adaptation IV. Coda on measurement errors

5 I. Lack of theory distorts priorities ▪ De Soto, Dankov et al. say formalization is valuable ♦But lack a theory as to why ♦In fact, focus on costs and mainly rent seeking (this explicitly in Djankov et al. “Regul of Entry” 2002 paper) ▪ Problem: the goal is efficiency, not cost ♦Focus on costs sensible if value is unaffected or secondary, but we are dealing with catalysts here ♦Rent seeking is only the price of specialization

6 Consequence 1: We should emphasize value—not costs ▪ Formalization is a catalyst: provides services that reduce transaction and enforcement costs, both private and public. ▪ Example: Companies registers  ♦Other firms (legal representative) ♦Courts  all contractual parties of registering firm

7 Consequence 2: A different concept of user is required ▪ Firms are not the only—not even the main— users ▪ Examples: ♦Courts do not only affect litigants but also produce precedents and have systemic effects on all firms ♦Company registers, no only registering firms but their future customers and creditors ♦Land registers equally affect future buyers & creditors

8 2. Defective methodology ▪ Double bias: ♦considering only mandatory & ex ante costs ▪ Two substitutions are relevant ♦b/w mandatory and voluntary ♦b/w ex ante and ex post

9 Consequence 3: Should consider standard instead of mandatory procedures ▪ No difference b/w procedures being publicly mandated or privately imposed by professional monopolies (e.g., lawyers in MA vs notaries in F) ▪ Likely to be the minimum cost as driven by free choice

10 Consequence 4: Consider facilitators ▪ When measuring ♦New indicators: cost of a shell company ▪ When reforming ♦Will avoid creating new public facilitating bureaucracies (e.g., one-stop shops) ♦No need to vertically integrate the facilitating function into public bureaucracy

11 Consequence 5: Should measure all costs, not only those incurred ex ante ▪ It avoids bias against legal systems relying more heavily on ex ante control ▪ Two examples: ♦Reality of ex ante control ♦Presence of ex post benefits

12 Months from default notice to execution sale (registration in blue, recording in yellow; data from EMF’02, Butler’03) b) Presence of ex post benefits: Substitution b/w ex ante & ex post costs in mortgage foreclosure

13 3. Emphasis on averages impedes adaptation ▪ Emphasizing average costs leads to ♦Forgetting demand and value ♦Capital intensive reforms that disregard demand, value and efficiency

14 Example 1: Economies to scale in Spanish registers Avg Cost Output

15 Example 2: Intl. cross section of DB data (income per head and starting business avg. cost)

16 Policy consequences of focusing on avg. costs ▪ No attention paid to fixed costs ▪ No attention to level of demand ▪ Two examples: ♦Peru titling effort spent a fortune to achieve little when compared to less formal titling ♦Spain: avg. subsidy of formalization in the one-stop window was about € 5,560 in the first 3 years a shell co. can be bought in one hour for €800 ▪ Waste, new bureaucracies, bad reputation of institutional reforms

17 Consequence 4: Need of gradual and multiple formalization solutions ▪ Arruñada, B., and N. Garoupa (2005), “The Choice of Titling System in Land,” J. of Law & Econ., 48(2), 709-27. ▪ Demsetz, H. (1967), “Towards a Theory of Property Rights”, American Econ. Review, 57(2), 347- 59.

18 4. Coda on measurement errors & biases. Just one example: ▪ What NY State says: ♦“If your business is required to be registered as a vendor, it must obtain a Certificate of Authority.... If your business makes taxable sales before it receives the Certificate of Authority, it may be subject to substantial penalties. To obtain a Certificate of Authority, you must complete Form DTF-17.... and send it..., at least 20 days before you begin operating your business” (NYSDTF, Publication 20 (10/04), p. 19). ▪ But Doing Business gives 1 day for NYC 

19 How Doing Business tells it: “within 20 days” “one day”

20 Is it exceptional? ▪ DB does seem to suggest that the 20 days term is exceptional: ♦“Businesses selling ‘tangible personal property (goods) as well as certain other goods and types of services’ are required to be registered … within 20 days before the company starts operating”) ▪ But it is not exceptional: 




24 Consequences for Doing Business ranking ▪ In 2007, USA ranks 3-5 in “Starting Business”, together with Denmark and Iceland ▪ Applying DB methodology correctly, USA would rank 57-60, with El Salvador, Lithuania and Sierra Leone

25 Summary ▪ Measurement errors not the main issue ▪ Function of business formalization calls for a change in priorities from cost to value ▪ Need to consider ♦Tradeoff b/w ex ante and ex post costs ♦Tradeoff b/w mandatory and voluntary services ♦Demand: local adaptation

26 Thanks

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