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How not to do business

Transaction costs keep FDI out. They also hurt India’s mallest businesses

Written by Bibekdebroy |
September 12, 2008 3:26:38 am

The World Bank has produced its Doing Business (DB) indicators for 2009 and India is 122nd out of 171 countries, slipping two ranks from 2008. We are just below Nepal and just above Lesotho, an enviable position to be in. Within South Asia, India performs better than only Bhutan and Afghanistan. To rub salt into the wounds, it isn’t just Maldives at rank 69 or Sri Lanka at 102. Pakistan is ranked 77 and Bangladesh 110.

The DB exercise quantifies and measures procedures in 10 stages of a business’s life — starting a business, dealing with construction permits, employing workers, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts and closing a business. It takes 13 procedures and 30 days (1 day in New Zealand) to start a business in India and costs of starting a business are 70.1 per cent of per capita income. Twenty procedures and 224 days (34 in Korea) are required for construction permits and costs are 414.7 per cent of per capita income. The rigidity of the employment index (low is good) is 30 in India (0 in Hong Kong) and firing costs are 56 weeks of wages. Six procedures and 45 days (2 in New Zealand, 5 in Nepal) are required to register property in India and costs are 7.5 per cent of property value.

For getting credit, India scores 4 (high is good) on a credit information index (New Zealand is 5) and 8 on a legal rights index (Malaysia is 10). India scores 6 on an investor protection index (high is good), New Zealand is 9.70. India requires 60 tax payments a year (2 in Sweden) and 271 hours per year (59 in Luxembourg) are spent in paying taxes. Tax rate is 71.5 per cent of profits in India and 8.4 per cent in Vanuatu. Eight export documents are needed in India (2 in France) and 17 days are required to export (5 in Denmark). Cost of exporting is $945 per container ($450 in Malaysia). Nine import documents are needed in India (2 in France) and 20 days are required to import (3 in Singapore). Cost of importing is $960 per container ($439 in Singapore). Forty-six procedures (20 in Ireland) and 1420 days (150 in Singapore) are required to enforce a contract in India and costs are 39.6 per cent of claim (6.2 per cent in Ireland). Ten years are required for insolvency proceedings in India (0.40 in Ireland), cost of insolvency is 9 per cent of estate value (1 per cent in Singapore) and recovery rate is 10.4 per cent (92.5 per cent in Japan).

Finally, between June 2007 and June 2008, the only area where India has reformed (marginally) is trading across borders. There is no reason to accept everything emanating from the Bank as absolute truth and the WB itself accepts some problems in DB exercises. First, not everything relevant for doing business is captured directly in DB indicators — physical infrastructure, law and order, macro-economy, institutions are instances. Second, information is based on subjective responses to questionnaires and this raises issues of sampling biases. For instance, information collected from a corporate in Hyderabad shouldn’t indiscriminately be applied to informal enterprises in Andhra. Third, some variables (those expressed as shares of per capita income or indices) aren’t particularly convincing. Therefore, one shouldn’t assume the numbers to be very robust. They are roughly indicative and no more and should be used to track a country’s performance over time, rather than indulge in cross-country comparisons. After all, one is quantifying and measuring transaction costs and these aren’t easy to pin down. Nor should DB results be correlated with investment flows. More investments aren’t going to flow into Nepal, Lesotho or Vanuatu.

Having said this, transaction costs in India are high, especially when compared to East Asia, and aren’t declining as fast as they should. It is understandable that capital should flow into India. Thus, we have FDI inflows of $25 billion in 2007-08 and $35 billion in 2008-09. Information on FDI flowing out of India isn’t that easy to get a handle on, perhaps almost $20 billion in 2007-08. Is this because of mergers and acquisitions and companies seeking to become globally competitive? Or are domestic transaction costs driving capital out? Transaction costs are certainly a factor and the point to note is that an exit option (for both capital and labour) is only available to relatively larger companies and individuals. Transaction costs hurt the relatively small more. To take one example, there was Madhu Kishwar’s work on street vendors and cycle-rickshaws in Delhi, something that won’t figure in DB databases.

There is a tradition of cross-country economic freedom ratings. China doesn’t do that well on those. However, a valid point has been made about China to the effect that in such a large and heterogeneous country, aggregate scores are misleading and southern coastal provinces (when disaggregated data are available) perform better than many developed countries in economic freedom ratings.

In heterogeneity, India is no different. An Indian Chamber of Commerce (ICC) found that it takes 105 days to register property in West Bengal, compared to 2 days in Karnataka and 1 in Gujarat and there are similar results for other business transactions. It is tempting to pass the buck to state governments and argue that if red carpet in Delhi is replaced with red tape in Kolkata, states are responsible. Thanks to the Seventh Schedule, that’s partly true, but not entirely. Several procedures originate in Delhi and even when they don’t, the Centre can incentivise reforms. What needs highlighting is that not all procedural reforms require legislative changes. Hence, the red herring of blaming the Left and coalition governments won’t work. A lot can be accomplished through executive action. Not too many people know that the National Commission for Enterprises in the Unorganised Sector (NCEUS) was triggered by Madhu Kishwar’s work. That’s how its establishment got into the common minimum programme. The NCEUS agenda of skill formation and social security apart, what happened to the agenda of administrative law reform? Where did the national policy on street vendors, to take one example, disappear?

Executive inaction is the problem and reducing transaction costs is on no one’s agenda in Delhi. This is in contrast to it figuring prominently in economic advisory councils of earlier PMs. Economists may well be responsible. There are too many economists now involved in formulating policy. Frederic Bastiat wrote, “Everyone wants to live at the expense of the state. They forget that the state wants to live at the expense of everyone.” Economists are naturally inclined towards the first sentence, not the second.

The writer is a noted economist.

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