ExplainSpeaking: Why improving on World Bank’s Ease of Doing Business rankings might have hurt economies

Questionable impact

Until then the conventional wisdom was — and it was based on many academic papers that studied these rankings and the economic performance of countries around the world — that improvements in Doing Business had a positive impact on GDP.

However, there was always a lingering question: How closely did these rankings capture the improvements (or otherwise) in the overall economy. That’s because — keeping aside unwarranted tweaks to ranking under political pressure — it could be argued that these rankings did not capture the broader reality in many countries and that they could easily be gamed by governments trying to figure out a way to rise up the ranking. For instance, India’s rankings were based on data from just two cities — Mumbai and Delhi. It was plain to most observers that just a few kilometers away from the borders of these cities (and often enough even within these cities), doing business was considerably more uneasy.

Surprising result

A new research paper — titled “Did Raising Doing Business Scores Boost GDP?” — published in the Journal of Comparative Economics in May provides results that run contrary to the conventional thinking about these rankings and their impact on the economy.

In this paper, Tamanna Adhikari (associated with the Central Bank of Ireland) and Karl Whelan (University College Dublin) look at Doing Business data over the years and conclude the following: “We report a robust finding that improvements in Doing Business scores have at least a temporary negative impact on GDP and find little evidence for a positive effect in the years following these improvements.”

Simply put, the authors find that far from being positive, when a country rose in the Doing Business rankings, it was accompanied by a negative impact on its GDP. Further, they do not find much evidence of a positive effect in the years after these improvements happen. The GDP or the Gross Domestic Product is the market value of all finished goods and services in an economy; it is the most commonly used variable used by economists the world over to keep score among economies.

What changed?

How did Adhikari and Whelan arrive at this stunning result? What did they look at that others did not? The authors point out three main differences between their approach and the past studies.

Looking at the full time series data: The first thing that they did differently was to look at data over a long period of time. Most of the previous studies were cross-sectional — looking at data of different countries at a specific time. “Our first contribution is the use of a panel data set to explore the time series dimension of the relationship between Doing Business scores and real GDP per capita.

Because of the relatively short time series available from the Doing Business survey, existing research on this question has focused on pure cross-sectional relationship,” they state. “With fifteen years of data from the survey now available, we believe there is sufficient time dimension in the data now to warrant an investigation of the impact of variation over time in the Doing Business indicators.”

Tackling statistical gaps: Suppose you are trying to figure out how GDP is impacted by Doing Business rankings. Imagine for a moment that the rankings have no effect on GDP. However, the rankings by themselves may be getting affected by some other factor that you have not considered — say, the economic and social consensus around what policies to follow. In such a scenario, thanks to that consensus, both the rankings and the GDP will go up at the same time.

This may give an impression that rankings are leading to an improvement in GDP when there is no such effect. Another problem is reverse causality: that is, instead of the ranking leading to better GDP, it is the better GDP that is leading to higher rankings. The authors have tried to tackle such loopholes via different statistical tools.
Tracking scores instead of ranks: They find that most of the earlier research looked at rankings instead of the country’s scores on which these rankings were based.

But the ranks did not accurately capture the improvement in the economy because ranks are relative and a country could rise or fall sharply despite not having improved as much, or at all. For example, New Zealand was ranked first for ease of doing business in the 2020 report with a score of 87.01. If New Zealand’s score had fallen by 5, its rank would have dropped by 9 places. In contrast, Sri Lanka was ranked 99th with a score of 61.8. If Sri Lanka’s score had fallen by 5, its rank would have dropped 26 places.

What explains the odd result?

Even though the findings are surprising, the authors believe their methodology “of using within-country time series variation to assess the effect of changes in the Doing Business score” is a valid one and “the results turn out to be robust across a wide range of different specifications, data types and estimators”.

What then explains that they could not find a positive impact of business-friendly reforms on GDP? They state that one possibility is that the Doing Business indicators did not do a very good job of measuring the ease of doing business to begin with.

And what explains the finding that improvements in the Doing Business score had a negative effect on GDP? “One possibility is that the widespread focus in the developing world on the Doing Business indicators has perhaps had a negative effect, with those countries that have had the best improvements in their DTF scores being countries that have focused on box-ticking exercises to improve their ranking rather than substantive reforms.

Another possibility is that implementing improvements in business environment takes time to have a positive impact—more time than the short time element in our analysis can pick up— and our findings are picking up some shorter-run disruptions that stem from reforms that ultimately have a positive effect,” they state.

They conclude by providing the caveat that further investigation of their findings is warranted.

The upshot

Between 2002 (when they were started) and 2018 (when serious allegations first emerged), the Doing Business rankings became more and more influential with each passing year. They became the go-to metric for global investors. A move up in these rankings could lead to international investors suddenly pouring in billions of dollars into an economy while a move down could trigger a backlash.

Over time these rankings also became a potent tool in the hands of the political class, which could gain both domestic and international fame by ensuring that the limited criteria required to move up the rankings were met, regardless of whether the tougher task of broad-based reforms happened or not.

Eventually, the rankings became a victim of their own influence as governments started gaming them.

Until next time,

Udit