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Measuring the Law: The Economics of Doing

Business

Timothy Fisher and Mark Melatos

EconomicsUniversity of Sydney

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Overview

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

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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

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Law and economics

law tries to regulate behaviour• economics analyses behaviour

EXAMPLE regulating speedingB benefit of speedingF fine if caughtp probability of being caught

• individual compares the cost to the benefit• will not speed if cost exceeds the benefit

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Law and economics

will not speed ifp × 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)

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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

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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

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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

1. Common law2. Scandinavian and German civil law3. French civil law

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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

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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

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Doing Business database objective measures of

• business regulations • enforcement

input and verification by 3,500+ people • government officials • lawyers• business consultants• accountants

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Doing Business database comparable indicators 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

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Sub-indices in Doing Business Index

1. Starting a business2. Dealing with licenses3. Hiring and firing workers4. Registering property5. Getting credit6. Protecting investors7. Paying taxes8. Trading across borders9. Enforcing contracts10. Closing a business

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Ease of Doing Business Index

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Doing Business Index specific rankings

1. Singapore2. New Zealand3. U.S.A.

8. Australia

18. Thailand

93. China

135. Indonesia

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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

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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

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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

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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

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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.”

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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

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Procedural Regulation

Costs:• Inefficiency, corruption• Complexity fosters uncertainty

Benefits: • Enforcement, consistency, fairness• Control of outcome

Procedural regulation and outcomes• Djankov et al. (2003, QJE)

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Behavioural Regulation

Regulating the business environment:• Environmental Law• Competition Law• Consumer Protection Law

Costs opportunities foregone Benefits:

• complexity, clarity, externalities

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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?

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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

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Behavioural Regulation in DB (cont.)

Protecting investors• Extent of disclosure• Extent of director liability• Ease of shareholder suits

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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

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Conclusion

Worthwhile exercise

Benchmarking reform opportunities

Methodological issues

Interpret with caution