Restrictive regulations positively correlated to corruption

After reviewing recent literature on the relationship between restrictive regulation, corruption and business environment reforms, the World Bank’s Investment Climate Department (CIC) found that corruption is positively correlated with restrictive regulation.

Using databases of investment climate reforms and corruption, the figure below shows a significant positive correlation between corruption and the number of procedures required to start a business in 183 countries.

Figure 2A below shows that “for a given number of procedures, the number of days to start a business is positively correlated with corruption.”

Figure 2B below shows that “the greater the number of documents needed to import and export, the higher the corruption rank, even after accounting for the number of procedures to start a business.”

According to the CIC, a 25-day reduction in the number of days required to start a business “improves the control of corruption ranking by about 1 point. If the number of days to import and export is reduced by 25, the control of corruption ranking increases by 4.4 points.”

Labor regulations in a dual labor market economy

How do labor regulations effect a dual labor market economy? Rita Almeida and Pedro Carneiro from the World Bank study this question in their new working paper, ‘Mandated benefits, employment, and inequality in a dual economy.’

This paper studies the effect of enforcing labor regulation in an economy with a dual labor market. The analysis uses data from Brazil, a country with a large informal sector and strict labor law, where enforcement affects mainly the degree of compliance with mandated benefits (severance pay and health and safety conditions) in the formal sector, and the registration of informal workers. The authors find that stricter enforcement leads to higher unemployment but lower income inequality. They also show that, at the top of the formal wage distribution, workers bear the cost of mandated benefits by receiving lower wages. Wage rigidity (due, say, to the minimum wage) prevents this downward adjustment at the bottom of the income distribution. As a result, formal sector jobs at the bottom of the wage distribution become more attractive, inducing the low-skilled self-employed to search for formal jobs.

Interesting fact on the African informal sector

From the World Bank’s PSD Blog:

Data on informal firms in Ivory Coast, Madagascar and Mauritius show that these firms are larger in terms of total sales and also generate more output per worker. They rely less on physical infrastructure and machines, but more on human capital of the manager. The latter is especially true in smaller cities and among male-owned and those that were started because the owner could not find a satisfactory job.

Report: Protectionism on the Rise

From the Associated Press:

The world’s major powers are repeatedly breaking their pledges not to erect trade barriers, and there’s no sign the “protectionist juggernaut” will ease as countries recover from the global downturn, an influential monitoring organization said Friday.

Since first taking a no-protectionism vow at a summit meeting last November, the world’s 20 major economies have been responsible for as many as 121 “blatantly protectionist” measures, with 134 more in the pipeline, said Global Trade Alert, a monitoring service overseen by the London-based Centre for Economic Policy Research and supported by the World Bank and other international organizations.

The findings, bound to come up at next week’s Group of 20 summit in Pittsburgh, follow a report earlier in the week by the Geneva-based World Trade Organization that cited “continued slippage toward more trade restricting and distorting policies” by the U.S. and its major trading partners.

“The real economy may now be shrinking at a slower rate, and a recovery may be in view, but unemployment will continue to rise for some time to come. Pressures to protect jobs at home will grow and governments will find these pressures difficult to resist,” said the new report.

“The protectionist juggernaut shows no sign of slowing down,” it said.

Capitalism Is Thriving

Freakonomics points to a great article from the Economist that suggests that Capitalism is thriving. According to the World Bank’s annual Doing Business report, “which tracks changes to the regulations that affect business”:

In the year since June 2008, 131 countries introduced 287 pro-business reforms—20% more than in the previous 12 months and more than in any year since the World Bank started the survey in 2004.

Low and lower-middle income economies accounted for two-thirds of the action, with Rwanda turning out to be the world’s champion reformer—the first time a sub-Saharan country has claimed the prize. Eastern European and Central Asian countries were the most energetic reformers by region for the sixth year in a row (26 out of 27 governments there introduced reforms). Middle Eastern and North African countries were not far behind (17 out of 19 countries), and 17 high-income countries also spruced up their business regulations.

Of significance, the article also notes that,

…in poor countries, a ten-day reduction in the time it takes to start a business can lead to an increase of 0.4 percentage points in GDP growth. Another shows that people who have a formal title to their property invest as much as 47% more in their businesses.

The Power of the Poor

On October 8, PBS will braodcast The Power of the Poor, a new documentary featuring Hernando de Soto, among my favorite economists. The documentary was produced by the same team that brought us Milton Friedman’s classic documentary series Free to Choose. Below is a preview of what to expect:

The Power of the Poor will demonstrate “how free markets, individual freedom and especially the right to property can transform the poor into the most powerful resource in the world. At its heart is the potential triumph of capitalism as a system.”

Click here to read my previous post on the ideas of Hernando do Soto.

Why millions of the world’s poor still choose to go private

Tim Harford from the Financial  Times writes,

Imagine that your daily earnings were less than the price of this newspaper. Would you consider buying private education and private healthcare?

Before you make up your mind, here are a few considerations: government healthcare and primary education are free; the private-sector doctors are ignorant quacks and the teachers are poorly qualified; the private schools are cramped and often illegal. It doesn’t sound like a tough decision. Yet millions of very poor people around the world are taking the private-sector option. And, when you look a little closer at the choice, it’s not so hard to see why.

Take the doctors of Delhi, who were studied carefully by two World Bank researchers, Jishnu Das and Jeffrey Hammer. These doctors are busy people – the average household visits a doctor every two weeks, and the poor are particularly likely to visit. And, surprisingly, three-quarters of those visits are to private practitioners – despite the fact that public-sector doctors are better qualified. Why?

Click here to continue reading.

The Invisible Economy

Jeremy Main of Fortune Magazine writes,

The underground economy, also called the informal, invisible, or black economy, is regarded around the world as a refuge of drug traffickers, smugglers, and tax evaders. Now a new view is taking hold: At least in the Third World, the underground economy is mainly good, not bad. It embodies the entrepreneurial energy of ordinary people striving in admirable ways to break out of poverty. It comprises thousands of craftsmen, storekeepers, truck and bus drivers, and food vendors whose operations would be perfectly legal in the U.S. but whose governments force them to ply their trades illegally. The underground economy is part of the solution, not the problem. If this entrepreneurial spirit were legalized and nurtured rather than fettered and suppressed, goes the argument, a burst of competitive energy would be released. Living standards, which have been dropping in much of the Third World, would start rising. International trade would increase, and developing countries could service their huge and debilitating external debts more easily.

Using data from the World Bank’s 2002 World Development Report, Peruvian Economist Hernando de Soto calculates that,

The total value of real estate held but not legally owned by the poor of the developing world is at least $9.3 trillion.

He estimates that the total amount of land informally or illegally held is 85% of total urban land holdings and 53% of total rural land holdings. By assigning a fair market value to all this informally held land, the grand total comes to $9.3 trillion-more than the total value of all the companies listed on the New York, Tokyo and London stock exchanges.

De Soto also points out that,

In Argentina, according to Marcos Victorica of the Institute of Contemporary Studies, an economic research organization, the unreported, informal economy last year produced $50.4 billion, vs. the official GNP of some $70 billion.

In Kenya the lethal minibuses called matatus that cruise around Nairobi are the most colorful expression of the unofficial economy, which the ministry of planning says contributes about 35% to the country’s GNP.

He explains,

Extra legal businesses are taxed by the lack of good property law and continually having to hide their operations from the authorities. Because they are not incorporated, extralegal entrepreneurs cannot lure investors by selling shares; they cannot get low interest formal credit because they do not even have legal addresses. They cannot reduce risks by declaring limited liability or obtaining insurance coverage. In fact, the only ‘insurance’ available to them is that provided by their neighbors and the protection that local bullies or mafia are willing to sell them. Moreover, because extralegal entrepreneurs live in constant fear of government detection and extortion from corrupt officials, they are forced to split and compartmentalize their production facilities between many locations, thereby rarely achieving important economies of scale. With one eye always on the lookout for police, underground entrepreneurs cannot openly advertise to build up their clientèle or make less costly bulk deliveries to customers.

Ultimately, De Soto concludes,

Most people do not resort to the extralegal sector because it is a tax haven but because existing law, however elegantly written, does not address their needs or aspirations. In Peru, where my team designed the program for bringing small extralegal entrepreneurs into the legal system, some 276,000 of those entrepreneurs recorded their businesses voluntarily in new registry offices we set up to accommodate them – with no promise of tax reductions. Their underground businesses had paid no taxes at all. Four years later, tax revenue from formerly extralegal businesses totaled US$1.2 billion.

Informal Economy as percentage of GNP (follow link for complete data):

For more on the invisible economy, Capitalism’s struggle in the developing world, and property rights, I would highly recommend reading Hernando do Soto’s The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else.

Economic Freedom and the Average Size of the Informal Economy

The World’s Improved Poverty Trends

In a 2008 World Bank report, Shaohua Chen and Martin Ravallion write,

Yet the data also provide robust evidence of continually declining poverty incidence and depth since the early 1980s. For 2005 we estimate that 1.4 billion people, or one quarter of the population of the developing world, lived below our international line of $1.25 a day in 2005 prices; 25 years earlier there were 1.9 billion poor, or one half of the population. Progress was uneven across regions. The poverty rate in East Asia fell from almost 80 percent to under 20 percent over this period. By contrast it stayed at around 50 percent in Sub-Saharan Africa, though with signs of progress since the mid 1990s.