Environment for Business in Low-Income Countries

Published: August 01, 2013

This is a writeup of a shallow investigation, a brief look at an area that we use to decide how to prioritize further research.

In a nutshell

  • What is the problem? Inefficient or costly regulation may impair the environment for business and hamper economic growth in some low-income countries.
  • What are possible interventions? We do not have a good sense of what interventions are available. A philanthropist may be able to support think tanks or civil society groups advocating for changes, or research and data-collection about the scope of the problem.
  • Who else is working on it? There does not appear to be much foundation or non-governmental organization activity in this field. The World Bank and regional development banks play a major role.

1. What is the problem?

A poor regulatory environment for businesses, particularly for medium-sized businesses, is often cited as a major constraint to economic growth in low-income countries.1 Development scholar Lant Pritchett has suggested that the underlying problem is a combination of stringent official regulations and intermittent, asymmetric enforcement, in which large firms are able to “buy their way out” of regulations and small firms are too difficult to effectively enforce regulations upon, leaving mid-size firms effectively subject to a much higher regulatory burden than other firms.2 Our current understanding is that the problem is not so much that appropriate regulations are unknown as that political obstacles prevent their adoption.3

We have not yet fully vetted these claims, and we believe them to be subject to some disagreement amongst development economists. Were we to move forward with further investigation of this area, more fully investigating the relevant academic literature would be a top priority.

2. What are possible interventions?

We do not have a good sense of the opportunities that may be available to philanthropists in this field.

It may be possible to support think tanks working on these issues in low-income countries, or civil society or advocacy groups, such as chambers of commerce.4 There may be opportunities to improve the collection of data related to regulatory reform, though the World Bank already does much of this work.5

3. Who else is working on this?

A significant amount of World Bank, regional development bank, and official development aid funds are devoted to efforts to improve the regulatory environment for businesses in low-income countries.6 We are not aware of any systematic estimates of total spending across these groups.

A 2008 evaluation of the Doing Business report estimated that the World Bank provided $4.8 billion in funding over four years related to this topic (broadly construed to include more than just straightforward regulatory issues), with $102 million in funding over that period for technical assistance related to this issue.7 The World Bank’s Facility for Investment Climate Advisory Services, formerly the Foreign Investment Advisory Service, which has a mission to “facilitate reforms in developing countries to foster open, productive, and competitive markets and unlock sustainable private investments in sectors that contribute to growth and poverty reduction,” now has an annual budget of about $30 million.8 These estimates span more than an order of magnitude (from ~$30 million/year to ~$1 billion/year, though different quantities are being estimated). Accordingly, we do not feel that we have a strong sense for how much World Bank funding is devoted to this area or what it is spent on.

International and domestic companies sometimes lobby to advance their business interests, which may include broad regulatory reform in some cases, though typically will be more parochial. International non-governmental organizations (NGOs) tend not to focus on improving the regulatory environment for business.9 However, there are domestic think tanks and civil society groups in many low-income countries that advocate for reforms to improve the business environment.10

4. Questions for further investigation

Our research in this area has been quite limited, and many important questions remain unanswered by our investigation.

Amongst other topics, further research on this cause might address:

  • How strong is the academic evidence that improvements in the regulatory environment for business promote economic growth? How do the returns to regulatory reform efforts compare with other broadly “institutional” reform efforts?
  • There seems to be relatively little international NGO or philanthropic involvement in this area. To what extent is that a result of limited returns to work in this field (as opposed to, e.g., an aversion to supporting business)?
  • Who are the relevant players in attempts to improve the regulatory environment for business? How do they vary at the country level? What kinds of resources do they martial? Our existing understanding of the answers to these questions is particularly limited.

5. Our process

We initially decided to investigate opportunities to improve the regulatory environment for business in low-income countries because development scholar Lant Pritchett suggested it to us as one of three potentially extremely high-return philanthropic areas in an open-ended conversation in June 2012.11

Our investigation to date has been quite cursory. In addition to our conversation with Pritchett, we spoke with two additional individuals with knowledge of this field:

  • Mwangi Kimenyi, senior fellow and director of the Africa Growth Initiative at the Brookings Institution.12
  • Vijaya Ramachandran, senior fellow at the Center for Global Development.13

We also did some preliminary desk research on the magnitude of World Bank resources deployed in this field.

6. Sources

Doing Business: An Independent Evaluation: Taking the Measure of the World Bank-IFC Doing Business Indicators Source (archive)
Managing for Impact: FIAS Strategy for FY12–16 Source (archive)
Notes from a conversation with Lant Pritchett, 6/18/2012 Source
Notes from a conversation with Mwangi Kimenyi, 7/2/2013 Source
Notes from a conversation with Vijaya Ramachandran, 6/4/2013 Source
Expand Footnotes Collapse Footnotes

1. “Prof. Pritchett sees an opportunity for transformative philanthropy in trying to change the regulatory environments in poor countries, so that successful small firms have the opportunity to expand to medium firms, and so that medium firms can prosper. This would be a hard battle to fight because both large firms (which benefit from the current policies) and the left wing are in favor of the current regulations. The payoff of success would be in the trillions of dollars.” Notes from a conversation with Lant Pritchett, 6/18/2012.

“Some African countries could improve the business environment for entrepreneurs by making it easier to build companies. A major hurdle for entrepreneurs in many parts of Africa is meeting the requirements of overstretched and often-corrupt licensing regimes. For example, 10 years ago in Kenya, a supermarket needed about 100 licenses to operate its business. AGI worked on this through trade licensing reform and the country introduced a single business permit for most business operations. Better policy would reduce the number of licenses required to do business in many African countries.” Notes from a conversation with Mwangi Kimenyi, 7/2/2013.

“Regulatory reform is important for the growth of the private sector. Customs regulations, complex processes and long waits to get licenses, excessive paperwork and a variety of other regulatory issues are impediments to business. The issue impacts mid-sized businesses most of all: large businesses are sophisticated and can deal with the regulations more easily, and regulations often aren’t binding on small businesses, which in practice can often get away with whatever they want.
The issue is not finding the best regulations – those are already fairly well-known, and the World Bank gives good advice – but is instead how to actually implement reforms. The government tends to profit from existing systems (e.g. through bribes), and as long as people in charge are benefiting from the current state of affairs there will be resistance to change.” Notes from a conversation with Vijaya Ramachandran, 6/4/2013.

2.“The United States has many medium sized firms whereas poor countries tend to have many small firms and many large firms but few medium sized firms.
The situation seems to arise from poor countries’ corporate regulatory systems. Poor countries are generally not able to enforce their regulatory standards. Prof. Pritchett has coauthored a paper titled “Deals vs. Rules” providing empirical data that what firms report to doing doesn’t match up with the laws where they work. Regulatory standards are enforced asymmetrically: large firms can afford to buy their way out of them and small firms are too small for the government to keep track of. As a result, medium firms end up subject to more regulations than small firms or large firms, and thus are at a disadvantage relative to them. Furthermore, large firms are able to use their influence to block their smaller competitors from growing.”
Notes from a conversation with Lant Pritchett, 6/18/2012.

3.“The issue is not finding the best regulations – those are already fairly well-known, and the World Bank gives good advice – but is instead how to actually implement reforms. The government tends to profit from existing systems (e.g. through bribes), and as long as people in charge are benefiting from the current state of affairs there will be resistance to change. This is a challenge that everyone has run in to and is very difficult for an external player to solve.” Notes from a conversation with Vijaya Ramachandran, 6/4/2013.

4.“There are also domestic reform movements in some countries, with the private sector vocally demanding reform through chambers of commerce, manufacturing associations, and other groups. Private philanthropic organizations could potentially support those kinds of organizations to move regulatory reform forward. Other domestic pressure can come from think tanks, which tend to exist in middle-income countries, such as the Centre for Development and Enterprise in South Africa.” Notes from a conversation with Vijaya Ramachandran, 6/4/2013.

“In the past, actors in the private sector tried to deal with complex and corrupt regulatory regimes by getting personal exemptions, which sustained the dysfunctional system of doing business. Business associations bring businesses together so that they can demand better private sector policy instead. Examples of business associations are the Kenya Private Sector Alliance and the East African Business Council.
Other small-scale groups working on improving business regulation are local chambers of commerce and local business councils. These business organizations are especially motivated to change the current system because they are the ones who would benefit most from more transparency and more efficient regulation.
Many African think tanks work to improve public policy around the business environment, usually making policy recommendations that are tailored to local contexts. In general, African think tanks have strong technical skills and do sound policy work on issues like determining optimal tax rates. However, they generally have had difficulty influencing government leaders on policy matters….
Some NGOs are involved in improving the business environment. For example, taxpayers associations are focused on ensuring that tax money is being spent appropriately, which has some overlaps with creating a favorable business environment.” Notes from a conversation with Mwangi Kimenyi, 7/2/2013.

5.“The Gates Foundation funds some data collection and monitoring around regulatory reform issues, specifically regarding agricultural business. Private players could fund more of this. The tracking of regulatory reform is very fragmented – the World Bank does more than the regional banks but does not do everything. The Foreign Investment Advisory Service is a key resource for tracking and discussion of these issues.” Notes from a conversation with Vijaya Ramachandran, 6/4/2013.

6.“The World Bank and regional development banks have large programs to encourage regulatory reform, focused on providing technical advice to governments. These efforts aim to improve regulations, reduce the burden on firms, and encourage informal firms to become formal. The World Bank sends advisors to countries seeking help, normally through a fairly complex process associated with a loan. The documents from these projects are now public and available online, and may serve as a useful source of relevant information.” Notes from a conversation with Vijaya Ramachandran, 6/4/2013.

7.“As depicted in figure A.1, the Bank provided $9.8 billion in loans and grants for the 130 projects mapped to the Financial and Private Sector Development (FPD) Sector Board. Not all of this funding was related to strictly DB-measured indicators. Regulation and competition policy, small and medium-size enterprise support, and export development and competitiveness have the most funding and account for nearly three quarters (72 percent) of the total $4.8 billion allocated to the 11 DB-related themes.
To estimate how much IFC allocated to technical assistance and advisory services for DB-related areas, the evaluation reviewed the six subareas of business lines that correspond most directly with the DB indicators. These were one from the Access to Finance business line (credit bureau) and five from the Business Enabling Environment (BEE) business line (dispute resolution, diagnostic and monitoring and evaluation [M&E], policy, regulation and institutions, subnational, and cross-border). As shown in figure A.2, of the 906 technical assistance projects undertaken by IFC between 2004 and 2007, $102 million (16 percent of a total of $647 million) were spent on these six subareas. Diagnostic and M&E and policy, regulation, and institutions account for more than two thirds of this amount.” Doing Business: An Independent Evaluation: Taking the Measure of the World Bank-IFC Doing Business Indicators, pgs 59-60.

8.“FIAS was established by IFC in 1985 to provide advice on foreign direct investment (FDI) to client countries. It rapidly grew to include the World Bank (IBRD), the Multilateral Investment Guarantee Agency (MIGA), as well as an increasing number of donors and partners, and its focus expanded to the broader investment climate area, providing support to governments on reforms needed to improve their investment climates for domestic as well as international investors.
Today, the mission of the FIAS program is to facilitate reforms in developing countries to foster open, productive, and competitive markets and unlock sustainable private investments in sectors that contribute to growth and poverty reduction.
After many years of rapid growth, the FIAS program is currently operating with an annual budget in the order of $30 to $35 million, co-financed by IFC (International Finance Corporation), MIGA, the World Bank, and over a dozen donor partners.
FIAS is administered as a Donor Funded Operation under IFC’s Advisory Services governance and managed by the World Bank Group’s Investment Climate Department (CIC), which is part of the Bank Group’s Financial and Private Sector Development (FPD) Vice Presidency. CIC has about 100 staff located in Washington, D.C. and four decentralized offices (in Istanbul, Vienna, Nairobi, and Dakar).
All FIAS interventions are implemented with internal World Bank Group and/or external partners.
Given the evolution of FIAS’ mission over the past decade, FIAS’ official name is changing from Foreign Investment Advisory Service to Facility for Investment Climate Advisory Services, effective with the FY12–16 strategy cycle.” Managing for Impact: FIAS Strategy for FY12–16, pg 1.

9.“There is some international lobbying, mostly by businesses. International NGOs tend to focus on delivering social services, and investor groups like Private Investors for Africa are interested in regulatory reform. Large western corporations do a certain amount of lobbying for regulatory reforms, for their own interests.” Notes from a conversation with Vijaya Ramachandran, 6/4/2013.

10.“There are also domestic reform movements in some countries, with the private sector vocally demanding reform through chambers of commerce, manufacturing associations, and other groups. Private philanthropic organizations could potentially support those kinds of organizations to move regulatory reform forward. Other domestic pressure can come from think tanks, which tend to exist in middle-income countries, such as the Centre for Development and Enterprise in South Africa.” Notes from a conversation with Vijaya Ramachandran, 6/4/2013.

“Many African think tanks work to improve public policy around the business environment, usually making policy recommendations that are tailored to local contexts. In general, African think tanks have strong technical skills and do sound policy work on issues like determining optimal tax rates. However, they generally have had difficulty influencing government leaders on policy matters.” Notes from a conversation with Mwangi Kimenyi, 7/2/2013.

11.Notes from a conversation with Lant Pritchett, 6/18/2012.

12.Notes from a conversation with Mwangi Kimenyi, 7/2/2013.

13.Notes from a conversation with Vijaya Ramachandran, 6/4/2013.