Thursday, November 21, 2013

Convergence in the Ease of Doing Business

Overlooking the central Kumasi marketSuppose that one were to divide the countries included in the latest Doing Business report into two groups. Call the first group (made up of some 44 countries) the “worst quartile”—that is, the countries with the costliest and most complex procedures and the weakest institutions. Call the other group the “best three quartiles.” Then let’s ask ourselves: how many days did it take to establish a business in both groups in 2005? The answer is 113 days in the worst quartile and 29 days in the best three quartile countries, meaning that in 2005 there was a gap of 84 days between the two sets. Now, let’s repeat the exercise for 2013. The worst quartile is down to 49 days and the best three quartiles is down to 16; the gap between the two has narrowed to 33 days, which is still sizable but a lot less than 84. Repeat the same exercise for time to register property and time to export a container. For property registration, the gap in 2005 was 192 days and by 2013 it has narrowed to 63. For time to export, the gap in 2005 was 32 days and in 2013 it was down to 23. (The figures are presented in the charts below. Only a small subset of the indicators has been included here, for illustrative purposes).

In other words, there is strong evidence that the countries with the most costly and complex procedures and the weakest institutions are adopting some of the more sensible practices seen in the better performing countries. There is a major process of convergence underway. Of course, a successful development agenda that facilitates convergence in income per capita and other measures of welfare (life expectancy, infant mortality, and so on) will involve many interlocking pieces. But, nevertheless, the sorts of rules that underpin the activities of the private sector—smart and light or cumbersome and heavy—are clearly an important part of this, as the private sector is the primary engine of job creation and economic growth.

In thinking about why convergence is taking place a couple of factors come to mind. There is greater understanding—in government, the business community, civil society—about the need to create a friendlier environment for private sector activity if economic growth is to take off and if countries are going to be able to benefit from greater foreign investment inflows. In an integrated global economy, local rules matter a great deal and the countries that strive for coherence, predictability and transparency in this area will make greater gains than those that don’t. The Doing Business indicators themselves may have been a key catalyst for change, focusing the attention of stakeholders on weaknesses in the regulatory environment and the presence of better practices in other countries.

There is another way to look at the convergence story. The graph below shows, for every region of the world, the evolution of the Doing Business “distance to the frontier” metric, a measure of the gap to best business practices in the world. As can be seen, the OECD is the best performing region of the world. This, in itself, is not surprising. What is notable about this chart is that ECA (Central and Eastern Europe mainly), in recent years, has overtaken other regions of the world and is now closing in on the OECD. This story has two angles. Many of these countries were engaged in significant economic and structural reforms in the period leading up to EU accession in 2004, intended to narrow the gap with respect to established EU members. After accession, countries like Poland, Latvia, Estonia, Lithuania, Slovenia and others have had to continue to reform to keep up with the likes of Sweden and Germany, tough partners and competitors. Furthermore, future members of the EU, such as Macedonia, Albania, Montenegro, and other countries in South East Europe are having to reform actively, for the same reasons as their predecessors 15-20 years ago. So, the EU has proved to be an extremely effective and powerful institutional mechanism for convergence. At a time when the EU brand has suffered because of the Euro crisis, it is important to remember that this impressive experiment of political and economic integration is having a lasting impact on all of its less privileged members, helping them to converge toward higher levels of efficiency and prosperity.

We have known for many years that in countries where governments make it difficult for businesses to be established—because of bureaucratic formalities or burdensome regulations—levels of informality will be higher and corruption will be more prevalent as well. Facilitating businesses to be legally registered has been shown to have positive employment effects in a number of countries, across the world. We also know that having property registration regimes that are sensible and transparent is important for the business community. An entrepreneur that has property rights that are ill-defined or subject to challenge, will have great difficulties accessing the financial system by using his/her property as collateral. So, a good system of property registration is far more than just another bureaucratic procedure to be complied with—it may often be a pathway out of poverty. For those businesses engaged in international trade, being able to export through the country’s main port in a way that is hassle free and not excessively burdensome in terms of cost, time and procedures, boosts the volumes of trade. Or, conversely, delay trade and the country will export less and this will negatively affect economic growth. The above convergence story highlights the important economic development implications associated with the recent evolution of the Doing Business indicators.

Friday, November 1, 2013

How can we reduce high income inequality?

There are many ways to think about income inequality. One can, for instance, look at it within the boundaries of a particular country and ask how is income distributed today among Brazil’s 198 million citizens? It is also possible to look at the average income per capita of all the countries in the world (or a region of the world) and ask: how unequal are income differences across countries at a particular moment in time? We can think of this as international inequality. One can also abstract from national boundaries and concepts of citizenship, view the world as one human family, and ask: how is income distributed among its 7 billion people? Call this global income inequality.

Inequality: 1950-2011
 Source: Branko Milanovic, 2013

One of the more interesting—and surprising—results that fall out of the data on international income inequality is that although Gini coefficients have risen steadily since 1950 (see the chart above, for a group of 130 countries accounting for the lion’s share of the world’s population), when one looks at the high income (largely OECD) countries, Gini coefficients have actually come down rapidly and are, today, about half of their levels in the early 1950s. In other words, there has been a massive process of convergence among the rich countries. Indeed, there is empirical evidence that suggests that this convergence probably goes back to at least the 1870s, if not earlier.[1] This convergence is highly significant given that these are the countries that have been at the center of global capitalism and that have spearheaded the process of globalization. These are the countries that have made the most progress in opening up their economies to each other. Indeed, much of the postwar trade liberalization that took place in the context of the GATT was of an intra-OECD nature, of which the opening up which took place as a result of the expansion of the EU is perhaps the most salient example; freer trade and higher incomes is at the heart of these countries’ postwar evolution. It is also likely that at least in regard to the EU, income inequalities among its members have narrowed because these countries have put in place mechanisms to reduce intraregional income disparities through a generous system of cash transfers from the richer to the poorer countries; during the early years of EU membership Spain and Portugal received the equivalent of 5 percent of GDP in annual transfers.

Two other features of the data shown in the chart worth noting: (i) international inequality has improved over the past decade, reflecting the impact of high economic growth rates in China and, to lesser extent, India; and (ii) the very high level of global income inequality, for which we have a few discrete observations showing sky-high Gini coefficients, hovering around 0.70.

What is the problem, from a development perspective, with large income gaps? First, the larger the gap, the more difficult it is to make the jump. If catching up is perceived as “highly unlikely within my lifetime” then incentives emerge to make another sort of jump, leading to migration (legal or otherwise), brain drain and the permanent loss of native talent. Furthermore, being far behind creates a difficult context for the implementation of sound policies. The populations of poor countries can readily estimate—due to the power of communications technologies—how far back they are vis-à-vis the rest of the world, particularly the rich economies of the industrial world. This is likely to create unrealistic expectations of catchup and, in turn, force governments to favor a populist path, instead of the deliberate, gradual and at times difficult path chosen by the few successful cases of upward income mobility. “Lateness is the parent of bad government” is how Harvard’s David Landes puts it, where he uses the noun “late” to mean late entry into the development process, captured by a low per capita income. 

At least part of our serious inequality problem would appear to reflect gross misallocation of resources. We have close to 800 million illiterates in the world, 530 million of them women; a large segment of the world’s population has thus limited access to the most essential tools to open the road to prosperity: knowledge and broad access to information. But we spend, according to the IMF, close to US$2 trillion annually subsidizing the driving habits of the global middle classes; a full 61 percent of the benefits of gasoline subsidies go to the fifth richest segment of the population, making these among the most regressive policies on the planet. Indeed, these subsidies are so sizeable that they also contribute tangibly to accelerate climate change. 

Contrast this, for instance, with investing in girls’ education, a powerful engine of women’s advancement, with multiple beneficial development impacts. Reallocating the resources which now go to energy subsidies to teaching 800 million illiterates to read and write would free up some $2,400 per person per year—an embarrassment of riches.

Sadly, it would appear that in many countries high illiteracy rates are not necessarily a consequence of poverty or resource constraints. No. They are a policy choice governments have made, with perturbing implications for income distribution and opportunity.

There is much hand-wringing in the world today about high income inequality and the associated societal dysfunctions. There is broad international consensus that we should do something about it. The IMF numbers quoted above suggest at least one clear path open to begin to deal with this problem in an effective way. As is often the case, there is no shortage of sensible solutions, given the political will to do the right thing.

[1] Japan’s income per capita in 1870 was $622 while that of the United Kingdom was $2,740, both in 1985 PPP dollars. Within a hundred years this gap had disappeared. Over the period 1870-1960, the 6 poorest of the 17 industrialized countries in 1870 had the fastest growth rates while the 5 richest had the lowest growth rates.