The shortcomings of the World Bank’s business-climate index

India is mildly obsessed with rankings. More claims for record-breaking feats come from the country than from any other bar America and Britain, according to Guinness World Records, the publishers of a popular compendium of them. Its politicians like to boast that, as China’s economy falters, India is (or will soon be) the world’s fastest-growing big economy. And this month the commerce department published a ranking of India’s states according to the progress they had made on economic reforms.

The initiative was inspired by the World Bank’s annual Doing Business report, which ranks countries on ten criteria, including the ease of starting a business, paying taxes and registering property. India lies a lowly 142nd out of 189 countries on the World Bank’s scorecard, but Narendra Modi, its prime minister, has pledged to propel it into the top 50.

Other leaders have similar ambitions. A favourable spot in the World Bank’s list is useful when pitching for foreign-direct investment or aid. Yet when such a measure becomes a target of policy, it may cease to be a reliable guide. Countries might seek to improve their ranking on the Doing Business index by amending regulations in ways that have little substance. Rwanda is often accused of this. It was ranked 46th (ten places above Italy) in the latest World Bank rankings, up from 158th in 2005, despite being one of the world’s poorest countries. The gap between the Doing Business ranking and average income is hefty in other places, too (see chart).

Such discrepancies feed concerns about shortcomings in the Doing Business report (about many of which the World Bank is admirably upfront). There are three broad criticisms. One is that the survey has a bias against regulation and taxes. A disputed labour-market gauge that looked at the ease of hiring and firing workers and the flexibility of working hours was cut from the survey in part to counter such criticism. But an indicator related to paying tax survives: it is based on the proportion of profits that firms have to fork over, as well as the number of taxes levied and the time taken to prepare tax returns.

High taxation may hamper the incentive to invest, but a low tax take can also hurt the business climate if it means governments do not have enough revenue to pay for essential infrastructure, education and health care. In a recent paper, Tim Besley of the London School of Economics found that the average rank of countries with a value-added tax in 2006 was 23 places lower than that of countries without one. Yet VAT is a vital plank of public finances in many countries where income taxes are hard to collect. In most cases, though, less really is more. Costly delays in starting a new firm, registering property or issuing building permits can hardly be the desired goals of regulation.

A second grumble about the World Bank index is that it does not cover important elements of the business climate, such as security, corruption, market size, financial stability, infrastructure and skills. The gauges that are included are often incomplete. For instance, the survey’s credit-market measure is based in part on how well the legal rights of borrowers and lenders are protected; it is not a gauge of how easy it is to get loans or how wisely credit is allocated. The survey captures how troublesome it is to get electricity connected but not how reliable the power supply is.

A third weakness of the report is that it is not based on surveys of businesses. Instead it looks at what is required by a county’s laws and regulations and tries to measure objectively how much time and effort it would take for a typical company to comply with them. Such yardsticks may be out of touch with reality.
Poor countries tend to have more rules but may not bother to enforce lots of them. In another recent paper, Mary Hallward-Driemeier of the World Bank and Lant Pritchett of Harvard University compared the Doing Business report with surveys of firms carried out by the World Bank. How business is done in theory and in practice was greatly at odds, they found.

The median time to get a building permit in the countries covered was 177 days according to the Doing Business report, but the median firm said it took just 30 days. The experiences of firms varied enormously, even within countries with a low ease-of-doing-business ranking. Some secured permits almost as quickly as peers in high-ranked countries. Such findings suggest that wherever strict rules are enforced by a weak state, connected firms find ways to escape the red tape. If India is successful in rising up the World Bank’s ranking, some of its business people may not notice much of a difference. But if a higher ranking curbs opportunities for graft, the effort to improve will still have been worthwhile.

(The Economist)