Impact of Business Environment Reforms on New Firm Creation

Introduction

New firm creation is often touted as an engine of economic growth. Yet policymakers are often left guessing when it comes to deciding how best to use their resources to encourage entrepreneurship. A lack of comparable data on entrepreneurship at the international level has left policymakers guessing on how improvements in the business environment affect entrepreneurship. What’s more, the impact of large, macroeconomic trends on new firm creation has not been well understood in the past, resulting in a poor understanding of how to boost entrepreneurship in the wake of an economic downturn.

Since 2005, we have undertaken an effort to collect high-quality, internationally comparable data on new firm creation. Solicited directly from business registries around the world, we clean and compile the data each year into the publicly available World Bank Entrepreneurship Database (WBED). The most recent edition of the WBED, released in October 2012 in conjunction with the World Bank's Doing Business project, contained data from 130 economies covering 2004 to 2011.1

Not surprisingly, we have found that new firm creation varies enormously across economies and regions. On average, 4.34 new formal companies with limited liability are registered each year per 1,000 working-age adults in high-income economies – we call this measure ‘new firm entry density’.2 In the developing world the average new firm entry density is 1.27. Put another way, about 20,000 new firms register each year in Belgium — which has an average new firm entry density for high-income economies in the 2012 sample. By contrast, only about 4,000–5,000 new firms register each year in Belarus, Guatemala, and Tunisia — each of which falls in the middle of the distribution of the new firm entry density for developing economies and has a working-age population similar in size to that in Belgium. Beyond just counting firms, however, the WBED is a powerful tool for investigating trends in new firm creation. In the rest of this article, we will describe two areas — business registration reforms and the global recession — that can be better understood through the lens of good data.

2. Business environment reforms

A simple and inexpensive business registration process is frequently heralded as a critically important component of the business environment. Each year, the World Bank’s Doing Business report shines a spotlight on business registration reforms, attracting the attention of policymakers, private sector leaders, and international institutions. In its annual report, the Doing Business team meticulously measures the amount of time, procedures, minimum capital and total cost to register a typical limited liability company in 168 countries. Most countries closely monitor their ranks and many make enormous efforts to improve them.

According to the Doing Business 2013 report, the top reformer in Starting a Business in 2011/12 was Burundi, which created a one-stop shop at the Burundi Revenue Authority thus reducing the number of procedures required to register a business from 8 to 4, the time required from 13 days to 8, and the total cost from 117 to 18 percent of income per capita. These reforms bumped Burundi from 99th to 28th in the global ranking on Starting a Business. But what do these reforms mean in practice? Did Burundi’s reforms spur new business registrations? If so, how large was the effect? Could a smaller reform have generated the same impact? Do reforms that simultaneously affect more than one aspect of the registration process — such as by reducing both the cost and the number of procedures — pack an especially large punch?

With these questions in mind, we recently released a Working Paper that seeks to measure the effect of business registration reforms on new firm registrations. Merging the WBED with data from Doing Business we classified various business registration reforms according to the year-on-year percentage reduction they represent for an indicator. We then performed regression analysis to determine the effect of each type of reform (for example, a 20 percent reduction in the number of procedures required to register a business), on new firm registrations. Importantly, the analysis looks at variation within economies over time by controlling for time-invariant country characteristics3.

In our sample of 92 economies, we found that registration reforms can significantly boost new firm registrations but generally only if they are large. For example, the analysis suggests that a 20, 30, or 40 percent reduction in registration time does not significantly increase new firm registrations. But the 31 economies that had at least one year-on-year reduction in registration time of 50 percent or more experienced a statistically significant boost in new firm registrations. The results are similar for reductions in registration cost. For procedures, by contrast, even a 20 percent reduction is effective in spurring new firm registrations. Among OECD high-income economies in the sample, a reduction of 50 percent or more in registration cost leads to an increase in new registrations of 19 percent on average, and a reduction of 50 percent or more in registration time to an increase of 30 percent.

The research also finds important complementarities in simultaneous and sequential reforms. The results show that there is something of a tradeoff between the magnitude of reform and the number of reforms. For a single reform to have a significant effect on new firm registrations, it must generally reduce a registration indicator by at least 50 percent. But three sequential or simultaneous reforms at the 30 percent level will, on average, generate a significant increase in new firm registrations. Controlling for the magnitude and number of reforms, the analysis shows that simultaneous (those done in the same year) reforms generally have a larger effect than sequential reforms (those done in sequential years). The results also show that economies with a relatively weaker business environment need to implement relatively larger reforms in order to have an impact on new firm registrations.

Our findings show that the ease of starting a business is a significant predictor of new business registrations. But it also shows that small reforms generally have no significant effect on new firm registrations. This suggests that “token” reforms, perhaps motivated by political or multilateral pressure to reform, will not have the intended effect on private sector activity. There is also evidence of synergistic effects of reforms. The results should motivate policy makers to undertake larger, more significant, and more comprehensive reforms.

3. The crisis

What was the impact of the crisis on new firm registration? With the WBED data we can also answer this relatively straightforward question as well as examine the country-level characteristics that are associated with particularly large drops in firm registrations over the crisis period. Beginning in 2008, new firm creation dropped sharply, though by varying degrees across economies. In general, the speed and intensity with which the crisis affected new firm creation varied by income level and crisis intensity. Economies with higher levels of income (GDP per capita), those with highly developed financial systems (as measured by the ratio of domestic credit to GDP), and those hit the hardest by the crisis experienced earlier and sharper contractions in new firm creation.4 In Ireland, for example, new firm registrations fell by 29 percent between 2007 and 2009. Indeed, in high-income economies the rate of new firm creation in 2009 was lower than it had been in 2004.

The impact of the financial crisis on new firm creation in much of the developing world followed a different path. Growth in entry density in developing economies stalled in 2008, but about 70 percent of developing economies still had a higher entry density that year than in 2007. By 2009, however, less than 50 percent of developing economies achieved positive annual growth in entry density. It appears that the crisis hit later and adversely affected new firm creation rates in fewer economies in the developing world than among high-income economies.

While it’s still too early for a comprehensive analysis of the rebound in new firm creation following the crisis, data from 2010 and 2011 begin to shed light on the recovery patterns. There was an undeniable turnaround in 2010, with 66 percent of economies in the sample seeing an increase in entry density over 2009. But for the majority of economies, entry density in 2010 remained significantly lower than in 2007. In 2011 only about 60 percent of economies saw a year-on-year improvement in the rate of new firm creation, considerably below the precrisis average of 75 percent.

4. Conclusion

Our hope is that better firm registration data will lead to sounder analysis and more evidencebased policymaking. We are encouraged to see that practice of continually requesting disaggregated registration statistics has already spurred registries to expand data collection efforts and we hope to eventually be able to gather data on new firm creation spliced by gender, size, and legal type. Future rounds of data will allow us to further explore the impact of registration reforms as the time-series and country coverage grow larger. We will also be able to further explore the factors that support a robust rebound in formal entrepreneurship in the wake of the global financial crisis.

Endnotes

1 The complete dataset, methodology, and related research are available at http://www.doingbusiness.org/data/exploretopics/ entrepreneurship

2As in the World Bank’s annual Doing Business report, the units of measurement are private, formal sector companies with limited liability. Due to the exclusion of informal firms and firms without limited liability, the database does not provide comprehensive coverage of firms in the 130 economies surveyed.

3Leora Klapper and Inessa Love, "The Impact of Business Environment Reforms on New Firm Registration", Policy Research Working Paper 5493, World Bank, 2011.

4Leora Klapper and Inessa Love, "The Impact of the Financial Crisis on New Firm Registration", Economic Letters, 2011.

 

Leora Klapper is a Lead Economist in the Development Research Group, Finance and Private Sector Research Unit, at the World Bank. Since joining the Bank as a Young Economist in 1998, she has published articles on entrepreneurship, access to finance, corporate governance, risk of financial institutions, and bankruptcy and risk management. Her current research focuses on the impact of financial crises and civil conflict on entrepreneurship, and developing global indicators of financial inclusions. She has over 30 publications, and is currently a member of the Journal of Comparative Economics editorial board, the OECD Entrepreneurship Indicators Steering Group, and the G-20 Working Group on SME Finance Data Collection. Prior to coming to the Bank she worked at the Board of Governors of the Federal Reserve System, the Bank of Israel, and Salomon Smith Barney. She holds a Ph.D. in financial economics from New York University Stern School of Business.

Douglas Randall is a Research Analyst in the Finance and Private Sector Development Team of the Development Economics Research Group. He joined the Bank in September 2009 and is currently the lead data analyst and project coordinator for the Global Financial Inclusion (Global Findex) Database project. He has a B.A. in Political Science and Economics from Tufts University and an M.S. in Applied Economics from Johns Hopkins University.

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