Doing Business and Poverty Reduction

The World Bank’s Doing Business survey is a comprehensive annual analysis of which countries are the best and worst places to business. This year’s results have just been published, and they make fascinating reading and provide valuable information about the business climate in different countries.

This survey tells us quite a bit about the relationship between the investment climate and poverty. As Tim Harford puts in the PSD blog:

As we’ve discovered in previous years, it seems that the poorest countries are also the ones with the most intrusive regulations.

Nine of the worst ten countries for doing business are in Africa, as are 17 of the worst 20. The graph below of the Doing Business rank against income per person illustrates that there is a very strong relationship between improving the climate for business and rising prosperity.

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(I have used a log scale for income, which means this graph visually understates the growth of income as the Doing Business rank increases.)

To get a sense of the importance of this relationship, look at the trend line: simplistically, it shows that an increase in the Doing Business ranking of one place is correlated with a more than 20 percent increase in income per person.

A word of caution about this relationship. First, it probably goes both ways. As a country gets richer, it can afford to make improvements which improve the climate for doing business (lower tax rates, more efficient bureaucracy etc). So some of the correlation flows from higher prosperity to better business environment. Second, it is likely that improvements in the business environment and rising prosperity share some common causes – the most obvious candidate being the existence of accountable and effective government. So this very strong correlation does not, by itself, prove that improving the climate for doing business would necessarily increase prosperity.

But as consultants like to say, though the size of the relationship is uncertain, the result is “directionally correct”. The correlation is sufficiently clear to conclude what we all instinctively know: part of the reason for prosperity in richer countries is that they have created a good environment for businesses, which create jobs and rising prosperity. Furthermore, the size of the correlation is big enough to suggest that the benefits of creating a better climate for business could be very significant.

This is one of those situations where economics, common sense and the data all point in the same direction. I hope that governments in poor countries and aid agencies will use the Doing Business report to identify the steps they can take to improve the environment for business, including using the report to learn from the ways in which other countries address the same challenges.  Many of the steps that governments could take to remove senseless red tape and improve economic institutions are not particularly expensive (though that doesn’t mean that they are always easy).  This is an agenda that they cannot afford to ignore.

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