(Not So) Mysterious Link Between

Doing Business Index and Economy

Dr. Apoorva Javadekar

(Ph.D. Boston University)

India stands at 130^th place out of 190 nations in the 2017-Doing Business Rankings of the World Bank (WB), just a spot higher than the 2016 rankings. Is this a worrisome sign? Surprisingly, the answer is “Not so much” according to the recent research. (see the article published in mint newspaper and the paper by IIM Banglore faculty)  A curious case is being made in the recent times that the higher rankings do not really imply good economic outcomes like higher FDI inflows or higher GDP growth. I will argue that the case being made is curious because it is based on the dodgy economic foundations.

My argument is based on the simple logic that ease of business rank is a stock concept: It represents the till the date reforms that has taken place in a country on various issues like infrastructure, legal system etc. over the last couple of decades or even more. Hence this rank ought to be more intricately associated with corresponding macroeconomic stock variables like level of per capita GDP instead of flow variables like growth in GDP or additional FDI flows during a given year. With this concept in mind, figure 1 plots the average ease of business rank during 2010-2015 against the per capita GDP level. The message from the figure is clear: In the long-run, a country can’t become rich in per capita sense unless it has a high ease of doing business index. Only oil-rich countries like Kuwait, Qatar, Venezuela, and Angola managed to get sufficiently rich even with a very low ease of business score. On the other hand, if you have a sufficiently high ease of business score, then you are almost guaranteed to become rich. The outlier to a marginal degree to this rule is two emerging nations: Thailand and Malaysia. But both the countries are growing fast and in a sustainable way precisely because of solid infrastructure and institutions they have built and over the next half a decade these would move out of this marginal outlier list. This is a tremendous macro relevance attached to the ease index. It’s not the index that matters but the institutional and infrastructure set up that this index reflects that is important.

   Figure 1: Ease of Doing Business Score and Per Capital Income

Once we know that high ease of business index is almost equivalent to being a rich country, it is foolhardy to expect that high index would also imply higher GDP growth. Why? The answer lies in the convergence hypothesis proposed by the neoclassical growth theory which says that poorer countries tend to grow faster in per capita terms. Figure 2 illustrates the convergence result. A unit increase in log per capita GDP reduces the annual growth rate by almost 0.90%. We can then adjust the observed growth rates by this magnitude for each unit of per capita GDP while comparing the results for various countries. With this background let’s look at the growth data. 

   Figure 2: Convergence Result

Ease of Business Score	GDP per capita (in 2010 constant US Dollars)	Annual GDP Growth (2010-15)	Adjusted Annual GDP Growth (2010-15)
score<50	1587	2.35%	0.22%
50<score<70	6768	1.75%	1.62%
Score>70	38561	0.50%	1.88%

The adjusted GDP growth column adjusts the growth rate upwards or downwards considering how rich or poor the economy is compared to the mean economy. In statistical parlance, this is called controlling the effect of the GDP per capita. The result shows that after adjusting for the convergence effect, the countries with better ease of business score actually also register higher growth.

What about the other economic outcomes like FDI inflows? Again, one must compare the stock variable with a stock variable. OECD provides the data on the Inward FDI stock for various countries which represents the total FDI that a country has received so far over the long-run as a percentage of the country’s current real GDP. Again, ease of business index is associated with higher FDI stock. The only exception seems to be Korea Rep. and Japan on the downside. The problems with Japanese FDI are well known like Japanese customer’s liking for domestic known products and connected nature of Japanese firms. Hence it is possible that some country-specific cultural factors can play an important role in FDI outcomes, but on average, better ease of business score implies greater cumulative inward FDI for the country in the long-run.

   Figure 3: Ease of Business Score and Inward FDI Stock

In summary, the ease of business rankings might not be an end in itself, but the underlying developments the rankings capture like infrastructure, low corruption, efficient legal process, good bankruptcy laws etc. are vital for the long-run economic success. India’s quest for improving the rankings hence is not an unnecessary obsession!