World Bank’s Doing Business Is Dead for the Wrong Reasons

Reproduced from the SIOE Blog, October 5, 2021

The World Bank has announced that it is discontinuing the Doing Business (DB) indicators, which aimed to provide “objective measures of business regulations for local firms in 190 economies,” because of repeated irregularities in the application of its methodology.

The closure confirms that the Bank has squandered an excellent opportunity to further the measurement of institutions. But this is a lesser evil because, as I have been arguing since early on (Arruñada, 2007), DB’s influence has been damaging, with many countries using it as a guide for reform despite its serious flaws.

From its inception, DB only estimated some of the explicit costs of regulations. It never paid attention to their value, such as legal certainty or lower future transaction costs. Yet many institutions, such as courts, are catalysts for economic activity. The main attribute of their output is the quality of their judgments, rather than the time they take and their explicit costs.

Furthermore, DB only counted formal mandatory procedures. This favoured common law countries, where obligations of fact outweigh those of law. For example, in New York, the reference for the United States, each party to a real estate contract—be it buyer, seller or bank—retains a lawyer, thus at least three lawyers are present in each transaction. But their fees were never included in the Registering Property indicator. The excuse given by DB was that parties were theoretically free to provide legal support to themselves. DB did, however, compute the cost of notaries public, whose intervention is mandatory in most of Europe for registration of a land purchase or mortgage. This difference greatly distorted the comparison, since New York lawyers are nine to twelve times costlier than German or Spanish notaries and cost almost as much as a notary in France or Italy, these being countries with old registries of deeds like those in the USA.

The example illustrates DB’s main general flaw. By considering only some costs, it concealed the key tradeoffs: between regulating more or less; between controlling transactions before or after; and even between investing fixed costs in improving institutions (e.g., creating a modern registry) and incurring higher variable costs in each transaction.

Correcting these flaws should have been easy but was never an option because, despite the fragility of DB, the Bank pushed its scores, which barely proxied some costs, as if they measured regulatory efficiency. Moreover, it published them in a sports-league format, publishing country rankings that the press was happy to advertise, proving Coase (1974) right for claiming that the market for ideas fails more than the market for goods. Governments followed newspapers closely. Such prominence served the interests of the Bank well, allowing it to enjoy some influence when its very existence had even begun to be questioned by some US politicians.

Many countries devoted enormous resources to undertaking reforms that only modified their scores without improving their institutions, and in some cases actually made them worse. “One-stop shops” for business procedures flourished everywhere, as if, by itself, integrating procedures within state bureaucracies made them useful instead of merely hiding their cost for taxpayers. They also strove to facilitate company formation, as if law firms did not have a ready supply of “shelf companies” for urgent operations.

Additionally, DB was manipulating the application of its own method to obtain acceptable results. The USA has figured in the first positions of the Starting Business ranking although, if the time needed to register for Sales Tax in New York State were properly computed, it would fall below 60th and even 100th position, depending on the year (Arruñada, 2009). The Bank’s experts used to joke about the nice numbers given to “friendly” countries like Egypt or even Afghanistan.

In the end, it is reports on this type of gaming with specific countries that have sealed DB’s fate. But with 190 countries such manipulations likely entailed less damage than the design flaws applied to all countries and its ill-considered use as a guide to reform. DB is now being condemned by the same press that previously sang its praises, but in both cases for the wrong reasons.

It is not only the Bank that should reflect on its mistakes, but also the press, the politicians and the libertarians who shared its simplistic vision of the state. Not to mention the researchers who are today nostalgic about the aggregate data of DB that for almost two decades they have been taking too seriously.

The closure will be positive for institutional reform because the DB data were a pretext for not thinking about the real problems. It was like the “management by numbers” of large firms. Without metrics, it is hard to decide well; but with metrics, it is tempting to game them or to rely on them alone, making decisions worse. The Heisenberg principle also applies to the Social Sciences: as repeatedly observed since Campbell (1975), the more a quantitative indicator is used to make decisions, the more corruption it will suffer and the more it will distort the processes it set out to measure. Different versions of this corruption take place everywhere, from management (Kerr, 1975) or Macroeconomics (Goodhart, 1975; Lucas, 1976) to that Holy Grail of “evidence-based policy,” which often ends up producing “policy-based evidence” (Boden and Epstein, 2006).

We must be wary of optimism: one of the reactions to the failure of management-by-numbers was the short-lived, and equally damaging, fad of “managing by wandering around”. Both stories share the same moral: easy recipes sell well because they hide complexity. Good policy and good management require acknowledging complexity and, therefore, relying on both quantitative and objective but also on qualitative and subjective information and methodologies.

See here an extensive discussion of Doing Business.