Cost of doing business

December 7, 2015

The eradication of poverty is typically a cause for charities and celebrities.  Campaigns like “Make Poverty History” use advertising and other media to help raise funds and awareness to tackle inequality. Their methods are varied, and whilst songs have been written to help the starving in Africa, so far neither Bono, Bob Geldof or anyone else on the star-studded supporter list has written a song called “What would I do if I had capital?”.  For that you need an economist.

Opening lines to “¿Que haria yo, si tuviera capital?”

 What would I do if I had capital?

I’m going to tell you a story about a country

That’s doing really badly

Because only a small group of people has access to capital… 

 

Hernando De Soto Polar was born in Peru in 1941 but raised in Geneva after his family fled the 1948 military coup. It wasn’t until 1979 that he returned to Lima as an economist and became interested in why Peru was so poor compared to Switzerland.

De Soto saw traders in the street with unstructured businesses, who never expanded the scope of their operations or increased their revenue. At first he assumed they had insufficient funds to set themselves up in proper premises, but as he got to know them, he realised this wasn’t the case. The traders had built homes, had control of their finances and were even saving money – just not in a bank. Instead, De Soto often saw piles of bricks and bags of cement stored on the flat roofs of people’s homes. These were non-perishable commodities that could be stored and traded; a good alternative for those without access to a bank account.

De Soto decided to run an experiment. Hiring a lawyer and a group of students, he set up a T-shirt factory – legitimately. He opened a bank account, bought sewing and knitting machines and sent his team off to get a license to operate the business. The team obtained 11 permits from seven different ministries. They were asked for bribes 10 times and paid them twice. The permits had to be obtained in a specific order that was not immediately apparent and some ministries relocated premises without public announcement. The whole effort took 278 man-days.

De Soto started to understand the problem. He ran further experiments and found out that by comparison to others, his experience was relatively painless: starting a new bus route took 26 man-months; whilst opening a new market place required 13 man-years. As a result, small businesses starting out could not afford to operate legally. They couldn’t let their factories stand idle for months on end whilst they obtained permits and waited for official sanction to start trading. They were trapped outside the official economy.

The effect of this exclusion was significant. Businesses lived in constant fear of being closed down, they couldn’t own a brand or trademark, and were unable to raise capital or get credit. Basically they were excluded from all the benefits of a market economy that allow a business to expand. Hence the song.

De Soto was unlike many economists, in that in addition to identifying the theoretical problem, he looked to provide a practical solution. His first idea was to run an advertising campaign to raise awareness. He wrote a book in 1987 called “The Other Path” explaining the entrepreneurial spirit of small traders outside the law and why this spirit was thwarted.

De Soto even created a TV show with the Peruvian President, Alan Garcia. In the show, people would come to explain the problems they were having with red tape. The President would then write an order to the head of the appropriate ministry and a motorcycle courier would be dispatched to deliver the message: fix this problem or resign.

De Soto’s ideas were well regarded and in 2003 the World Bank started to publish annual statistics on the ease of doing business around the world: the ‘Doing Business Report’.

2015 Doing Business Report

Top 10

Singapore

New Zealand

Hong Kong SAR, China

Denmark

Korean Republic

Norway

USA

UK

Finland

Australia

Bottom 10 (numbers 180-189)

Haiti

Angola

Venezuela, RB

Afghanistan

Congo, Democratic Republic

Chad

South Sudan

Central African Republic

Libya

Eritrea

In this report, an assessment is made of each country on the ease of:

  • Starting a business
  • Dealing with construction permits
  • Getting electricity
  • Registering property
  • Getting credit
  • Protecting minority investors
  • Paying taxes
  • Trading across borders
  • Enforcing contracts
  • Resolving insolvency

Importantly, the countries are ranked in order causing some of them to compete with each other. When Georgia became formally independent of Russia in 1991 it made the Doing Business Report-ranking part of its official economic policy and is now ranked 15th out of 189 countries. In Surinam, every new business required the approval of the President and as a result the South American country was ranked 189th. In response to the report, the law has changed, and Surinam is now ranked 165th. Furthermore, other countries have taken out adverts in the Wall Street Journal and The Economist to boast of their improvement in the rankings.

Of course, there are multiple causes of poverty and a good ranking in the report doesn’t automatically lead to an eradication of inequality. In addition to his media efforts, De Soto founded the Institute for Liberty and Democracy (ILD) in Peru, which was responsible for hundreds of initiatives and laws that fundamentally changed the country’s economy by opening up the mechanics of economic ownership and participation.

With Peru now ranked 35th in the Doing Business Report, the situation has changed dramatically and many small businesses are now having to ask themselves: What am I going to do with my access to capital?

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