Measuring the Law: The Economics of Doing Business

Measuring the Law: The Economics of Doing Business Timothy Fisher and Mark Melatos Economics University of Sydney

Overview • economics and law • legal origins theory • Doing Business reports • criticisms of DB methodology • detailed analysis • conclusions • discussion

Economics and Law . . . the rights which individuals possess, with their duties and privileges, will be to a large extent, what the law determines. As a result, the legal system will have a profound effect on the working of the economic system and may in certain respects be said to control it. Ronald Coase, 1991 Nobel laureate

Law and economics • law tries to regulate behaviour • economics analyses behaviour EXAMPLE regulating speeding B benefit of speeding F fine if caught p probability of being caught • individual compares the cost to the benefit • will not speed if cost exceeds the benefit

Law and economics • will not speed if p × F > B • e.g., F = 500, B = 20, p = 1%→ cost is 5, benefit is 20 → individual will speed • implications • law matters (F) • enforcement matters (p)

Comments • trade-off between p and F • higher F can compensate for lower p • public policy may try to influence B • e.g., campaign about the dangers of speeding • point: tools of economics to evaluate problems of law

Legal origins theory: seminal paper “Law and finance”, by La Porta, Lopez-de-Silanes, Shleifer, & Vishny, JPE 1998. • examine financial laws in 49 countries • corporate governance • shareholder protection • creditor rights

Law and finance • classify countries by legal origin • common law: UK, USA, Australia, Canada • civil code: French, German, Scandinavian • conclude: link between legal origin and development of financial markets • Common law • Scandinavian and German civil law • French civil law

Legal origins theory • link between financial market development and economic development • conclude: legal origin is an important factor determining economic development • Shleifer appointed by World Bank to oversee Doing Business project

World Bank Group (WBG) • a family of 5 organizations, of which two • International Bank for Reconstruction and Development • International Development Association are focused on developing countries • provides grants and low-interest loans • education, health, agriculture, environment, etc. • often tied to specific reforms

Doing Business database • objective measures of • business regulations • enforcement • input and verification by 3,500+ people • government officials • lawyers • business consultants • accountants

Doing Business database • comparableindicators across 175 countries • index based on 10 sub-indices • used to analyze which regulations enhance or constrain investment, productivity, and growth • DB published annually since 2004 • attracts widespread media coverage

Sub-indices in Doing Business Index • Starting a business • Dealing with licenses • Hiring and firing workers • Registering property • Getting credit • Protecting investors • Paying taxes • Trading across borders • Enforcing contracts • Closing a business

Ease of Doing Business Index

Doing Business Index specific rankings • Singapore • New Zealand • U.S.A. • Australia • Thailand • China • Indonesia

Obvious criticisms • law reform is ongoing • origin increasingly irrelevant (dropped 2005) • errors and omissions • e.g., Canadian bankruptcy law • ignores other factors • wars, corruption, cronyism, hyper-inflation

Example of “other factors” “Indonesian public services hit by unskilled spending” Financial Times, February 12, 2007. • inflexible budgetary system • inadequately trained civil service • especially at local government level • unable to spend increasing fiscal resources • unspent reserves at 3.1% of GDP in 2006

Criticisms of the methodology • national legal experts • who are they? how are they chosen? • optimality of law • index is based on WB preferences • e.g., index favours easy dismissal of workers • not necessarily optimal

Outputs versus inputs • real issue: does law achieve its goal? • WB index does not measure outcomes • measures the law (inputs) • empirical study of law • point: may be many ways to reach goals • many laws may be compatible with a given goal

DB reports • Poor countries regulate more • Schleifer (2005, EFM) “… American and European societies are much richer today than they were 100 years ago, yet they are vastly more regulated.”

Types of Regulation • “Procedural” vs “Behavioural” regulation • Transaction form vs quality • Behavioural regulation as a response to market failure • Social weight? • DB measures often emphasise form • Procedures, time, cost

Procedural Regulation • Costs: • Inefficiency, corruption • Complexity fosters uncertainty • Benefits: • Enforcement, consistency, fairness • Control of outcome • Procedural regulation and outcomes • Djankov et al. (2003, QJE)

Behavioural Regulation • Regulating the business environment: • Environmental Law • Competition Law • Consumer Protection Law • Costs  opportunities foregone • Benefits: • complexity, clarity, externalities

Procedural Regulation in DB • Starting/closing a business • Dealing with licenses • Registering property - property rights? • Paying taxes - clarity, dispute resolution? • Trading across borders • Protection, infrastructure? • Enforcing contracts • Success rate of appeals?

Behavioural Regulation in DB • Employing workers • Difficulty of hiring/firing • Rigidity of hours • Nonwage labour cost • Getting credit • Strength of legal rights • Depth of credit information • Credit registry coverage

Behavioural Regulation in DB (cont.) • Protecting investors • Extent of disclosure • Extent of director liability • Ease of shareholder suits

Interpreting the DB Reports • Cautious interpretation • Specific cases measured • Who is the regulator? What is their aim? • Endogeneity: Regulation ↔ Agent behaviour • Measurement difficulty: sample selection bias

Conclusion • Worthwhile exercise • Benchmarking  reform opportunities • Methodological issues • Interpret with caution

Measuring the Law: The Economics of Doing Business