Employment creation is synonymous to development in Eastern Europe and Central Asia, where the problem of underemployment has acquired an unprecedented scope. According to the recent World Bank study, an average male spends eleven years of his productive life unemployed and inactive in a country which is making a transition from planned economy to a liberal market system. This period is one and a half times longer for an average female, which stays outside of the workforce for seventeen years, or almost a half of her productive life. 1
The role of governments in Eastern Europe and Central Asia abruptly transitioned from providing employment through state-run enterprises to enabling private-sector lead job creation by reforming the law and building supportive institutional frameworks. This process has become a major task and a major challenge for the governments in Eastern Europe and Central Asia. Several international institutions, including the European Bank for Reconstruction and Development and the World Bank, have searched for avenues to measure business environment in the region and to provide policy advice. The avenues chosen to measure business climate in the region are important, because by identifying the areas in which government regulations can be improved, it becomes possible to effectively allocate the governments political capital and time in favor of companies which create most jobs. Recent studies suggest that the majority of jobs are created by a fraction of small and medium-sized companies, which are marked by rapid expansion and employment growth. Creating favorable business environment for small and medium rapidly growing companies, so-called gazelles, has been a focus of the World Banks economic policy consulting in Eastern Europe and Central Asia. This paper compares the
1 Back to Work: Growing with Jobs in Europe and Central Asia. The World Bank. Annual Report. January 15, 2014 < movement in the World Banks Doing Business index as a measure of legislative and institutional reforms with reform implementation on the ground, as perceived by gazelles.
The World Banks Doing Business Index provides business climate assessment by ranking countries according to their regulatory environment, the strength of their institutional framework, the complexity and the cost of their regulatory processes. The index provides a de-jure measure for businesses climate in a country by comparing its legal system and institutions to defined best-practice benchmarks in ten different business areas. The ranking is publicly available in Doing Business Annual Report and on the Doing Business website. It is widely used by multinational companies to make investment decisions, by governments to identify the areas for improvement and by researchers and scholars to conduct comparative studies.
The idea behind making the ranking publically available is to motivate governments to reform the law in order to win support of existing businesses and to attract new investments. However, de jure measures of business climate do not always reflect de facto business environment. De facto business environment is also affected by macroeconomic conditions, external shocks, corruption and foreign policy. These factors are not reflected in Doing Business index, but are crucial to implementation of legal and institutional reforms in Eastern Europe and Central Asia.
This paper explores a divergence between de jure measures in Doing Business index and de facto business environment as perceived by firms on the ground in Eastern Europe and Central Asia. In order to obtain a micro-level de-facto measures of business climate in the region, the World Bank started a joint project with the European Bank for Reconstruction and Development under 6 the name Business Environment and Enterprise Performance Surveys (BEEPS). BEEPS researchers survey companies in Eastern Europe and Central Asia every two to four years to learn about companies perceptions of the business environment in the region. While Doing Business Index measures de-jure business environment, the Enterprise Survey is focused upon de-facto business environment, derived from small and medium enterprises responses about regulatory and institutional barriers to doing business.
In this paper, I will investigate whether the upward movements in Doing Business rankings of the countries in Eastern Europe and Central Asia are matched with an improved perception of the business environment by gazelles, fast-growing small and medium companies, which account for the most new employment. I will use BEEPS database to obtain the data on de facto business climate in the region. My hypothesis is that de jure improvements measured by Doing Business index will be matched by de facto improvements in business environment only in those Eastern European countries, which are candidate states for the European Union membership or have already acceded to the EU. I expect that stringent EU membership requirements and continuous monitoring process imposed by the EU on candidate countries and members assure that legal changes rated by the Doing Business index are translated into de facto improvements in business climate for small and medium growing businesses. The European Commissions first criteria for accession stipulates that countries wishing to join the European Union must have the ability to take on and implement effectively the obligations of membership, including adherence to the aims of political, economic and monetary union. 2 Economic perks of the EU membership, particularly, the promise of free access to the EU consumer and financial markets, provide a
2 Official webpage on Enlargement. European Commission. Retrieved at: http://ec.europa.eu/enlargement/policy/conditions-membership/index_en.htm
D strong incentive for the governments of candidate countries to implement regulatory reforms. Monitoring of compliance with the EU membership directives leads to implementation of institutional and legal reforms and de facto improvements in business climate.
Consequently, I expect to see no or minor gap between de jure and de facto improvements in Eastern European countries, which acceded to the EU in 2004 and 2007. I expect the countries, which were acknowledged as EU candidates, but were not part of the EU, to have a larger gap between de jure progress and de facto improvements in business climate. I also expect to observe the highest discrepancy between the Doing Business assessment of legal reforms and their implementation on the ground in non-EU candidate countries in Eastern Europe and Central Asia. Countries without the EU membership prospect are not subjects to external monitoring of reform implementation in line with the EU Enlargement directives. In the absence of external monitoring, governments have stronger incentives to change their laws according to Doing Business prescription in order to attract foreign investors, while not focusing as much on de facto impact of legislative changes for the small and medium companies on the ground.
The contribution of this paper is to assess the applicability of de jure measurement of business environment in Eastern Europe and Central Asia while focusing on the needs of the fast growing small and medium enterprises, which create jobs and foster development. I argue that one-size- fits-it-all benchmark, relative to which the Doing Business Index assigns country rankings, does not provide an accurate measure of progress in the countries, where de jure reforms are not followed by effective implementation. @ ,# -$&.'/&*'. '.0$.1
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Gazelles is a term introduced by David Birch, an economist at the Massachusetts Institute of Technology, in early nineties. In his book, The Job Generation Process, published in the late eighties, Birch introduced an idea that a small fraction of businesses in the United States, namely fast-growing small and medium enterprises, create most of the new employment. 3 In 1994, he revised his thesis, separating job-creating companies under the umbrella term gazelles, characterized by rapid expansion. Birch characterized gazelles as private businesses, which have at least $100,000 in annual revenues (roughly $250,000 today) and which sustain annual revenue growth of more than 20% over a four-year period. 4 Birch contrasted gazelles with elephants big companies, such as Wal-Mart, and mice small companies, such as a corner barbershop. Birch estimated that although gazelles constituted only 4% of all the U.S. companies in the eighties, they were responsible for 70% of all new jobs.
Today the term gazelles has become ubiquitous in the literature on government policy to promote economic growth and employment. Although there is a broad consensus around the impact of gazelles on employment, there is a vast divergence on what constitutes the defining characteristics of gazelles. In this paper, I am going to use Matthias Deschryveres, Friesenbichlers and Holzls 5 definition of gazelles. These three economists define gazelles as firms of all ages and sizes having a 20% growth in sales per annum over a three-year period.
3 Birch, David L: The Job Generation Process. MIT. Boston. 1979 4 Ibid. 5 Matthias Deschryvere conducted studies on gazelles at the Research Institute of the Finnish Economy. Klaus Friesenbichler and Werner Holzl conducted gazelle studies at the Austrian Institute of Economic Research.
A I will further describe the evolvement of academic scholarship on gazelles from Birch to Deschryvere.
In 2008, Zoltan, Parsons and Spencer revisited Birchs definition of gazelles and came up with a term high-impact gazelles, defined as American companies of all sizes, twenty five years old on average, characterized by rapid sales growth. 6 Zoltan, Parsons and Spencer find that high-impact gazelles constitute between 2% and 3% of private businesses in the United States; they can be found in any industry and account for 80% of employment in the country.
The definition of gazelles evolved not only across time, but also across geographic space. Gazelles in economies in transition are closely associated with new entrepreneurship and companies, which started expanding in the nineties and early 2000s. McMillan and Woodruffs study on of Russia, Poland, Vietnam and China (2002) discuss a striking rate of enterprise creations in these countries. Growing entrepreneurship improved welfare by creating jobs, supplying consumer goods, constraining the market power of the state-owned firms, and building a political momentum for reform. 7 More recent studies on Eastern Europe and Central Asia by the World Bank show that a small fraction of progressive high-growth firms, largely young, account for most of new jobs created in the region. 8
Mitusch and Schinke (2011), the researchers at the European Commission, use a different
6 Zoltan, J. Acs; Parsons, William; Tracy, Spencer. High Impact Firms: Gazelles Revisited. U.S. Small Business Administration. Office of Advocacy. June 2008 7 McMillan, John; Woodruff, Christopher. The Central Role of Entrepreneurs in Transition Economies. Journal of Economic Perspectives. Vol. 16, 3. Summer 2002. p. 153-170 8 Back to Work: Growing with Jobs in Europe and Central Asia, The World Bank, Annual Report, January 15, 2014 7 criterion to define gazelles than that suggested by Birch (1994), Zoltan, Parsons and Spencer (2008). They define gazelles as companies with 20% growth in salaried employment over a three-year period. Deschryvere, Friesenbichler and Holzl define European gazelles as companies growing at a rate of at least 20% per year. Deschryvere, (2008) finds that during the period between 2003 and 2006, 5.4% of Finnish private businesses with more than 10 employees created 90% of net new jobs. 9 Friesenbichler and Holzl (2009) find that 5-10% of Austrian firms delivered 50-80% of employment generation 10 in Austria. Mitusch and Schinke find that the percentage of gazelles in the private sector is significantly higher in Eastern Europe than in Western Europe. Gazelles constitute 3.9% of all enterprises in Germany, 3.8% in Belgium, and 5.4% in Norway, while in Lithuania, Bulgaria and Romania their fraction of all businesses is 22.3%, 20.3% and 18.2% accordingly.
Additionally, Gibson and Stevenson (2011) ""
introduced three distinguishing characteristics of gazelle entrepreneurs: innovative owners, strong management arrangements and availability of skilled and experience labor. Gibson and Stevenson find that gazelles are owned by a visionary, are managed by experienced specialists and are run by highly skilled labor. A strong entrepreneurial spirit of business founders is the first distinct characteristic attributed to gazelles. Strong spirit, drive, confidence and a tolerance for uncertainty, as well as relevant professional experience and a strong network are considered an important distinction of gazelle founders from other entrepreneurs. Second important characteristic is strong management arrangements.
9 Deschryvere, Matthias: High Growth Firms and Job Creation in Finland. Research Institute of the Finnish Economy. Helsinki. 2008 10 Hlzl, Werner; Friesenbichler, Klaus: Are the Gazelles More Innovative Than Other Firms? Austrian Institute of Economic Research. Vienna. 2009 11 Gibson, Tom; Stevenson, Hugh: High-Impact Gazelles: Should they be a major focus of SME development? IFC World Bank Group. October 2011 "5 Gazelle managers must possess technical skills and managerial abilities to be able to implement the vision of a founder or owner, who is not a strong manager. At last, gazelles rely on availability of skilled and experienced labor, in order to expand their sales in the second stage of growth. Therefore, most of gazelles put a lot of weight on quality and depth of employee training. "#
If gazelles are so important for development, than it is also important to understand what governments can do to support their emergence and growth. The World Banks 2013 report on Eastern Europe and Central Asia finds that there is no one-size-fits-it-all solution to harness gazelles, but macroeconomic stability and favorable business environment that allows existing firms to grow and new firms to emerge and succeed or fail quickly and at low cost 13 , are essential. Defining gazelles as product of innovative entrepreneurship allows me to further tap into an existing body of literature. Ardagna and Lusardi (2008) finds that country regulation plays a critical role to stimulate entrepreneurship, particularly for those individuals who become entrepreneurs to pursue a business opportunity. 14 McMillan and Woodruffs research (2002) suggests that early in the transition, the government's main contribution to entrepreneurship was to avoid impeding the entrepreneurs' self help. 15 Later, the entrepreneurs came to need positive assistance from the state, and especially government institutions to support contracting and finance.
12 Ibid. 13 The Central Role of Entrepreneurs in Transition Economies. The World Bank. October 7, 2014 14 Ardagna, Silvia; Lusardi, Annamaria. Explaining International Differences in Entrepreneurship: The Role of Individual Characteristics and Regulatory Constraints. The National Bureau of Economic Research, May 2008 15 McMillan, John; Woodruff, Christopher. The Central Role of Entrepreneurs in Transition Economies. Journal of Economic Perspectives. Vol. 16, 3. Summer 2002. p. 153-170 "" Doing Business index, the annual project of the International Finance Corporation (IFC) launched in 2002, focuses on the efficiency and strength of laws, regulations and institutions that are relevant to domestic small and medium-sized companies throughout their life cycle. In 2011, the World Bank Group outlined a new strategy for tapping into private initiatives to reduce poverty. The World Bank describes the Doing Business benchmarking as an effective tool to incentivize governments reforms in favor of small and medium enterprises, to harness employment and to combat poverty. The question this paper addresses is whether the one-size- fits-it-all benchmark, relative to which the Doing Business index assigns country rankings, serves the purpose of enabling governments to create favorable environment for gazelles in Eastern Europe and Central Asia.
To effectively answer this question, I will further describe the methodology used in Doing Business Index to evaluate a countrys performance relative to its peers. Doing Business provides a quantitative assessment measure to business climate in 189 economies. The first Doing Business report published in 2003 covered five indicator sets and 133 economies. The report of 2014, covers ten indicator sets in 189 economies. 16 The indicator sets used for evaluation of business climate today pertain to starting a business, dealing with construction permits, employing workers, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts and closing a businessas they apply to domestic small and medium enterprises. Doing Business does not measure all aspects of business environment that matter to firms and investors. In particular, it does not measure
16 Doing Business Index. Official Website. Last accessed on April 24, 2014 at: http://www.doingbusiness.org/about- us "# security, macroeconomic stability, corruption, the level of skills, or the strength of financial systems. 17
Doing Business researchers identify the best practices in each of the ten aforementioned indicators. The best practices are quantified at ten points each and constitute a baseline frontier, in relationship to which the institutions and the legal framework of all the 189 countries are ranked. Each country obtains ten ranking scores in each of the ten above-mentioned business indicators. Higher score indicates a better result. Then, an overall score is calculated by summing up the scores of all the ten indicators.
Doing Business project encompasses two types of data. The first data come from analyst assessment of the distance to frontier based upon readings of a countrys laws and regulations. The second data are time and motion indicators to achieve a regulatory goal (e.g. start a business) derived from a countrys established procedures and institutions, which serve small and medium- size businesses. The second set of data is verified and complete by local incorporation lawyers, notaries and government officials.
An outcome of these procedures is two reports: an absolute country ranking, which shows a countrys position in relation to the best practices frontier and a relative ranking, which shows a countrys position relative to its peers. Both reports show aggregate rankings and sub-indicator rankings and provide commentary on recent developments in every country, as well as suggestions for improvement.
17 Doing Business Index. Official Website. Last accessed on April 24, 2014 at: http://www.doingbusiness.org/methodology "= In summary, Doing Business Index methodology uses a one-size-fits-it-all best practices model, which shapes the World Banks evaluation of countries de jure performance and their ranking vis--vis each other. As we saw in the previous chapter, the proportion of gazelles and their characteristics vary greatly across countries. Therefore, it is instructive to ask whether one standard of legal framework and institutions applied across all the countries of the world could be a fair benchmark to measure progress. As each country has a different economy and history, and its own sui generis culture of entrepreneurship, it is hard to imagine that there is a set of best practices, which can be applied homogenously across the globe. Unsurprisingly, Doing Business one-size-fits-it-all methodology stirred extensive media debate about whether its directives lead to desirable social outcomes. The question often discussed in the media debate surrounding Doing Business and pertinent to my research is whether reforms suggested by the Index to economies in transition really work in practice. This paper examines whether improvements in Doing Business de jure rankings are translated into de facto improvements in business environment for gazelles in Eastern Europe and Central Asia.
This question is particularly important since many governments in the newly liberalized economies of Eastern Europe and Central Asia do not have extensive experience in stimulating investment and improving business climate without the help of external consultants. Governments use Doing Business recommendations as guidelines in the allocation of public resources to reform the institutions and legal framework to promote employment growth. At the same time, they choose to follow Doing Business guidelines to make their countries move up in rankings relative to their peers. An upward move in the ranking is not only seen as a tangible measure of improvements in institutions and legal framework, but also as a means to promote a "< country as a destination for foreign direct investments. Thus, Doing Business is as an influential policy tool in Eastern Europe and Central Asia, which recommends very concrete policy steps to the governments, provides them with a systematic evaluation of reforms and a very tangible reward in the form of country promotion to foreign investors. Given Doing Business influence over policy-making, it is important to analyze whether countries upward movements in rankings are substantiated with de facto improvements in business climate for employment-creating firms. 2# 3.&4()(-(56
In order to compare and contrast de facto and de jure measures of doing business in Eastern Europe and Central Asia, I will use the data from Doing Business index and Business Environment and Enterprise Performance Surveys (BEEPS) databases. BEEPS is a compilation of firm-level surveys of a representative sample of countries private sector, which covers various areas in business climate assessment, including access to finance, corruption perceptions, barriers to business licensing and operations. 18 The data is collected by contractor companies for World Banks Enterprise Analysis Unit and the European Bank of Reconstruction and Development in face-to-face interviews with top managers and business owners. The sample of firms interviewed is derived from a countrys statistical office or obtained from government agencies, such as tax authorities.
In my analysis, I compared the change in countries positions in Doing Business rankings from 2006 to 2010 to the change in gazelles perceptions of business climate from 2005 to 2009, as measured by BEEPS in the respective countries. Doing Business ranking provides assessment to
18 Enterprise Survey. Official Website. The World Bank. Retrieved at: http://www.enterprisesurveys.org/Methodology "6 a countrys reforms in the preceding fiscal year. Therefore, movement in Doing Business ranking in 2006 and 2010 provide assessment for reforms implemented in 2005 and 2009 accordingly. I will further discuss a step-by-step research methodology used to contrast de jure measures with de facto business climate.
First, according to BEEPS data availability, I selected twenty-five countries in Eastern Europe and Central Asia and divided them into five groups according to their relationship with the European Union. My hypothesis is that the greater the proximity and the influence of the monitoring process of the European Union is in a country, the higher is the pressure for governments to implement legal reforms and new institutional arrangements. Therefore, I expect to see a greater convergence of de jure and de facto measurements for those countries, which are closely tied to the European Union.
My first group of countries consists of the states, which acceded to the EU in the 2004 round of Enlargement. These are the countries, which McKinsey report on Eastern Europe calls early reformers 19 : Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, Slovenia, distinguished by early implementation of legislative reforms and higher productivity growth relative to their peers in the region. In the period from 2005 to 2010, these countries were already the EU members.
19 Labaye, Eric; Sjtil, Pl Erik; Bogdan, Wojtek; Novak, Jurica; Mischke, Jan; Fruk, Mladen; Ionu!iu, Oana: A new dawn: Reigniting growth in Central and Eastern Europe, McKinsey Global Institute Report, December 2013
"D The second group are countries which acceded to the EU in 2007: Romania and Bulgaria. In 2005 and 2010, these countries were in the process of implementing the EU directives on business regulations and institutional arrangement in order to become full-pledged members.
The third group are countries, which were officially acknowledged as EU candidates: Serbia, Bosnia, Croatia and Montenegro. These countries have identified joining the EU as their top foreign policy priority and started accession talks in 2009 or earlier.
The fourth group are Eastern European countries without a perspective of membership in the European Union: Albania, Belarus, Georgia, Ukraine, Moldova, Azerbaijan, Armenia. Although, in November 2014, Georgia and Moldova signed an association agreement with the European Union establishing a free trade zone, in 2005-2010, these countries were yet to express their European aspirations. Albania applied for the EU membership in April 2009, but has not yet been recognized as an official candidate.
The fifth group of countries are economies in transition, whose foreign policy is not shaped by the European Unions Enlargement policies: Russia, Kyrgyzstan, Tajikistan, Uzbekistan and Kazakhstan. The forces which shape legal and institutional design in these countries are much less influenced by the EU policy directives than in the other four groups. 20
After identifying the five country clusters, I calculated an average of the movement in Doing Business absolute ranking from 2006 to 2010 for five country groups. The average was
20 Graph 8 "@ calculated for each of the ten Doing Business indicators: I subtracted the ranking assigned to each of the twenty-five countries in 2006 from a corresponding ranking in 2010. I chose to use absolute ranking rather than peer ranking to assure that a countrys upward movement in the ranks is a result of its de jure progress, rather than drawbacks in business regulations in its peers. After subtracting each countrys ranking in 2006 from its ranking in 2010, I obtained the number, which shows the quantity of points, by which each countrys legal framework and institutions have become closer to Doing Business frontier of 100%. Then, I averaged the points for each cluster of countries by adding them and dividing by the number of countries in each group. As a result, I obtained numbers, showing average improvement in ranking in each of the Doing Business indicators 21 .
The second step is drawing comparison between de jure improvements measured by upward movements towards Doing Business frontier and de facto improvements measured by a larger percentage of companies, which perceive business climate as favorable to doing business according to BEEPS Survey. Movement in Doing Business rankings for each group of countries was compared to the change in percentage of firms which expressed their satisfaction with the business climate in four business areas: Getting Credit, Starting a Business, Paying Taxes and Trading Across Borders. The decision to select these four indicators is based on BEEPS data availability in these four areas of doing business.
First, I singled out gazelles from all of the firms surveyed in BEEPS, by selecting all the companies with 72.8% of compound growth in sales in three years. 22 I divided selected gazelles
21 Graph 9 22 Graph 7 "A into five groups, according to their countries of operation. The five groups correspond to the regions previously described: the EU member states, the EU Accession countries of 2007, the EU candidate countries, Non-candidate Eastern European countries and Russia and Central Asia.
Second, I selected four questions in BEEPS Survey, which ask firms whether four factors, corresponding to four above mentioned Doing Business indicators, constitute an obstacle to doing business. Such Doing Business indicators and corresponding questions are:
Getting Credit How much of an obstacle is access to finance? Starting a business Obstacle to the current operations: Business licensing and permits Paying Taxes Obstacle to the current operations: Tax administrations Trading Across Borders How much of an obstacle are customs and trade regulations?
For each of the questions, the owners of gazelle firms assessed the extent to which each of the factors presents an obstacle to current operations. The answers varied from No and Minor Obstacle to Major Obstacle and Severe Obstacle. The companies were then divided into two groups: those which do not perceive each factor as a major or moderate obstacle to business operations and those, which do. The percentage of all gazelle companies, which answered No or Minor Obstacle was calculated out of total number of answers. The percentage of companies which answered No and Minor Obstacle to the survey in 2009 was subtracted from the corresponding percentage in 2005. Obtained difference was compared to the change in the measurement of de jure improvements by the Doing Business index. "7 7# '.8*-&8 @"# %(550/9 +4(<05
Restricted access to finance was assessed as the most important obstacle to growth of gazelles in Eastern Europe #=#< and Central Asia 25 . Gazelles in economies in transition are associated with high growth and a high risk. A small volume of available venture capital in the region is grossly inadequate to meet financing needs of growing small and medium enterprises. To sustain high growth, gazelles need more widely available, long-term, non-asset-based risk capital instruments in the second stage of operations financing. Once the gazelles have exhausted available sources of early stage financing, such as friends, family and working capital loans from banks, they lack the longer-term funding needed to sustain their growth into the future. 26
In the Eastern European members of the European Union, only two thirds of SMEs had sufficient funding in the end of 2006 to see their projects through. #@ Comparison between Doing Business ranking and the companies perceptions on ease of getting credit on the ground shows that there is no gap between de jure and de facto progress in access to finance in EU member countries, while a large gap persists in non-EU member states.
Doing Business indicator on ease of getting credit measures improvements in facilitating access to finance for small and medium enterprises. A country goes up in ranking if the government
23 SME Access to Finance in the New Member States. The Gallup Organization. Flash Eurobarometer. European Commission. July 2006 24 Progress in the Implementation the Small Business Act for Europe. Eastern Partnership at European Commission. May 2012, p.16 25 Improving Access to Finance for SMEs in Central Asia through Credit Guarantee Schemes. OECD. May 2013, p. 19 26 Gibson, Tom; Stevenson, Hugh: High-Impact Gazelles: Should they be a major focus of the SME development? The World Bank. October 2011, p.5 27 SME Access to Finance in the New Member States. The Gallup Organization. Flash Eurobarometer. European Commission. July 2006 #5 implements applicable collateral and bankruptcy laws or if public credit registries and private credit bureaus provide accessible and comprehensive credit information to firms. The ranking is based on the percentile rankings on the sum of its component indicators: the strength of legal rights and the depth of credit information index. #A
Improvements Doing Business Getting Credit rank were compared to increases in the percentage of companies in each region, which reported that access to finance no longer constituted an obstacle to doing business in 2009.
My analysis shows that improvements in legal rights and the depth of credit information in the EU member states corresponds to a drastic improvement in companies perception on the ease of getting credit. In 2009, 21% more of companies surveyed did not view access to finance as an obstacle in comparison to 2005. (Graph 1) Likewise, Doing Business understates de facto improvements in access to credit in Romania and Bulgaria (EU 2007 group), as well as candidate countries of Eastern and Southern Europe. The average movement towards Doing Business frontier is only 3% and -1% for 2007 member states and the EU candidate states accordingly, while de facto access to credit in both regions improved. Increase in the number of companies which are satisfied with their access to finance in EU 2007 and EU candidate countries is 9% and 13% accordingly.
De jure and de facto relationship is reversed in non-candidate states in Eastern Europe and Central Asia. Doing Business index shows drastic de jure improvements of 20% for non-
28 Doing Business website. Retrieved at http://www.doingbusiness.org/methodology/getting-credit #" candidate states in Eastern Europe and 24% for Russia and Central Asia. However, the survey reveals that only 2% more of the companies in Eastern Europe and 4% more in Russia and Central Asia no longer consider access to finance an obstacle to their current operations. Graph 1: Improvements in Access to Credit from 2005 to 2009
These findings are in line with my hypothesis that one-size-fits-it-all de jure approach to measuring business climate does not shed light on de facto business environment for companies, which create jobs. Improvements in legal rights for borrowers and creditors and reduced asymmetry in credit information, as measured by Doing Business, have a greater impact in the EU member countries where the implementation of reforms in the financial sector is driven and monitored according to the EU regulations.
#"H =H J"H #H <H ?D @D !,D -=D -?D 1. EU Members as of 2004 2. EU Member as of 2007 3. EU Candidate State 4. Non-Candidate: Eastern and Southern Europe 5. Non-Candidate: Russia and Central Asia Access to Credit de facto de jure ## Apart from the EU Enlargement monitoring policy, there are at least two other reasons why de jure improvements translate into progress in EU member and candidate states and not in non- candidate countries of Eastern Europe and Central Asia.
First, lack of property rights enforcement in the Commonwealth of Independent States hinder government reforms in the financial sector. In the view of information asymmetries in the financial sector in the region, banks have to lend based not upon expected returns, but upon the ability of firms to pledge collateral to cover the risk. This system puts gazelles, which have high returns, but do not necessarily have a collateral, in a disadvantaged position in regards to access to credit to finance their operations. The weak enforcement of property rights in the region hampers governments efforts to develop an effective collateral guarantee scheme for small and medium enterprises. 29
Second, gazelles in non-EU member states use banks less frequently than gazelles in the EU member states. In the EU member states, three out of four SME companies admitted not being able to complete their projects without a loan from a bank =5 . In contrast, in Central Asia only 20% of small firms and 27% of medium firms use loans to finance their current operations 31 . The strength and the structure of the financial system plays a crucial role in defining success of implementation of de jure reforms in financial sector. Banks remain the major source of financing for fast-growing small and medium enterprises across all the five regions. However, the extent to which gazelles use banks to finance their operations vary greatly across the five
29 Improving Access to Finance for SMEs in Central Asia through Credit Guarantee Schemes, OECD, May 2013 30 SME Access to Finance in the New Member States. The Gallup Organization. Flash Eurobarometer. European Commission. July 2006 31 Improving Access to Finance for SMEs in Central Asia through Credit Guarantee Schemes, OECD, May 2013 #= regions. Thus, reforms in government policies pertinent to the banking sector lead to different de facto results. Regulations related to the access to collateral and reduction of information asymmetry between creditors and lenders will take more time to be appreciated by gazelles in the countries, where a smaller percentage of fast-growing companies use banks to finance their operations. @"! A5&450/9 & :;*0/(**
Doing Business ranks the countries with reduced number and cost of procedures for starting a business higher than those with an excessive bureaucratic processes needed to launch an enterprise. Ranking is based upon time and cost of obtaining all necessary licenses and permits to start a business, completing any required notifications, verifications or inscriptions for a company and its employees with relevant authorities. 32 Removing or reducing the amount of a paid-in minimum capital required to start a business is a critical benchmark for ease of starting a business in a country. 33
De jure and de facto comparison shows that reductions in cost and procedures pertinent to starting a business translated into improved perception of companies on the ground in four out of five country groups. In all of the non-EU member countries de jure changes were accompanied by de facto improvements. EU candidate states in Eastern and Southern Europe went up in ranking by 17%, non-candidate states in the same region by 21% and Russia and Central Asia by 26%. At the same time, the share of companies, which do not see obtaining a business
32 Doing Business website. Retrieved at http://www.doingbusiness.org/methodology/starting-a-business 33 Doing Business defines the paid-in minimum capital requirement as the amount that the entrepreneur needs to deposit in a bank or with a notary before registration and up to 3 months following incorporation. It is recorded as a percentage of the economys income per capita. #< permit or license as an obstacle to doing business increased by 13%, 20% and 24% for these regions accordingly.
Bulgaria and Romania remained an exception to the rule. In these two countries, 2% less of all companies were satisfied with conditions pertinent to obtaining a business permit or license, although the region went up in ranking by 9%. In contrast, in the countries which joint the EU in 2004, a small improvement in regulatory environment of 4 percentage points was matched by a large increase of 43% in the share of companies which do not see obtaining a business permit as an obstacle. Graph 2: Improvements in Ease of Obtaining Business Licensing/Starting a Business from 2005 to 2009
<=H J#H "@H #"H #DH ?D @D !,D -=D -?D 1. EU Members as of 2004 2. EU Member as of 2007 3. EU Candidate State 4. Non-Candidate: Eastern and Southern Europe 5. Non-Candidate: Russia and Central Asia Business Licencing / Starting a Business de facto de jure #6 There are several explanations for the difference between the perception of gazelles in the EU member states of 2004 Enlargement and gazelles in the EU member states of 2007 Enlargement. First, the gap between de jure and de facto reforms in Romania and Bulgaria is linked to companies dissatisfaction with short-term restructuring costs of implementing the EU regulatory norms. In 2009, companies in the countries which joined the EU in 2004 already adjusted to the EU regulatory system and the processes of obtaining business licenses and permits. They had enough time to understand the value of better regulations for their longer-term business development. On the contrary, in Romania and Bulgaria, businesses were yet to learn to adjust to new regulatory procedures, including the EUs stringent environmental and social standards. Gazelles in Bulgaria and Romania specialize in low- to medium-tech manufacturing, although the countries are making some progress to transition to a higher value-added manufacturing. In the EU, obtaining business permits and licenses for low-tech manufacturing is more cumbersome, than it is for high-tech production, because the EU employs many regulations and standards to restrict low-tech manufacturing imports from China and other East Asian countries. While Romanian and Bulgarian low-tech companies faced the challenge of readjustment to new standards, companies in 2004 Enlargement EU countries were gradually shifting towards high- tech industry, where licenses and permits were easier to obtain. 34
Second, despite the reforms, the administrative burden for medium and small business has remained and is substantial in Bulgaria and Romania. In 2013, European Commission identified administrative burden and high bribery rate as one of the major challenges to businesses in the
34 Industrial Competitiveness of EU Member States: Some Progress Made, but Many Challenges Lay Ahead. European Commission. September 25, 2013 #D region. 35 De jure reforms identified by the Doing Business index did not address the core issues of bribery and a flawed administrative system in obtaining business licenses and permits. For this reason, de jure measurements of progress did not translate into a better perception of business climate by gazelles on the ground. @"B C&D0/9 E&=(*
Doing Business works in cooperation with PricewaterhouseCoopers to assess the complexity of compliance and the appropriate rates for the profit or corporate income tax, social contributions and labor taxes paid by the employer, property taxes, property transfer taxes, dividend tax, capital gains tax, financial transactions tax, waste collection taxes, vehicle and road taxes, and any other small taxes or fees. =D The threshold for an appropriate tax rate is defined as the highest total tax rate among the top 15% of economies in the ranking on the total tax rate. It is calculated and adjusted on a yearly basis. In 2013, the threshold was 25.5%. Paying Taxes indicator contains three components: firm tax liability as a percentage of profits before all tax borne, number of hours per year to prepare, file returns and pay taxes and number of taxes per year.
My analysis shows that perception of regulatory environment for tax payments improved among gazelles in Romania and Bulgaria, as well as among gazelles in Russia and Central Asia. Although Doing Business index shows significant improvements in tax regulations in all five regions, the share of the companies which perceive tax administration as an obstacle to doing business remained the same in the EU 2004 group from 2005 to 2009. In non-EU members in Eastern and Southern Europe, the share of companies dissatisfied with tax administration increased by 9% and 8% for EU candidates and non-candidate countries accordingly. (Graph 3)
35 Ibid. 36 Doing Business website. Retrieved at http://www.doingbusiness.org/methodology/paying-taxes #@ Graph 3: Improvements in Ease of Paying Taxes from 2005 to 2009
Analysis of Paying Taxes indicator does not reveal any explicit relationship between the EU monitoring progress and the gap between de facto and de jure tax administration. However, it does reveal that despite of improvements in Doing Business ranking, the results on the ground vary greatly from region to region. @"@ E4&<0/9 F34,** :,4<(4*
Trading Across Borders Doing Business rank is based upon measures of time, cost (excluding tariffs) and complexity of the paperwork associated with exporting and importing a standardized cargo of goods by sea, land and air transport. The countries move up in rankings if they implement reforms, which lead to cutting red tape, or improve infrastructure and institutions, associated with transportation of goods and services abroad. 5H =H J7H JAH @H BD !!D ?D @D BD !" /* 7EFGEHI JI KL -==? -" /* 7EFGEH JI KL -==3 ," /* +JMNONJPE 6PJPE ?" %KMQ+JMNONJPER /JIPEHM JMN 6KSPTEHM /SHKUE B" %KMQ+JMNONJPER 'SIIOJ JMN +EMPHJV 0IOJ Paying Taxes de facto de jure #A Comparison between de jure and de facto improvements reveals that only in Bulgaria and Romania, which joint the EU in 2007, de jure reforms in trading across border were felt by the businesses on the ground. The upward movement of 20% towards Doing Business frontier was matched by improved perception among 6% of the companies in these countries. In the 2004 Enlargement EU member states, a 3% improvement in companies perception on ease of trade across borders is not associated with new legal reforms, but with better implementation of existing regulations. In the other three regions, the perception of trade across borders stayed the same or degenerated despite the improvements in across-border trade procedures and trade infrastructure, as measured by the Doing Business index. Graph 4: Improvements in Trading Across Borders from 2005 to 2009
=H DH J=H 5H J<H =D -=D WD !BD BD 1. EU Members as of 2004 2. EU Member as of 2007 3. EU Candidate State 4. Non-Candidate: Eastern and Southern Europe 5. Non-Candidate: Russia and Central Asia Trading Across Borders de facto de jure #7 Greater transparency of across-border trade in the EU member states is the main reason for the difference in the effect of de jure reforms pertaining to trade in the five regions on de facto business environment. Lack of transparency in the procedures pertaining to import licenses and export and import monitoring, as well as across border taxation, are not assessed by Doing Business, but present serious obstacles to trade across borders in the CIS region and Sothern Europe. Additionally, Doing Business measures of improvements in trade infrastructure, such as creation of new sea ports and airports, does not take into account the ownership of these critical objects. In the CIS region, the newly built airports and sea ports are often monopolized by political actors. Private control of a countrys trade infrastructure often leads to higher costs and decreased transparency of across border trade for small and medium-sized businesses, which do not have a strong political leverage in this region. 9# 8*33/'6 /%) -$3$&/&$(%8
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This paper analyzed whether improvements in de jure indicators of business environment from 2006 to 2010, as measured by Doing Business index, are translated into de facto improvements for fast-growing companies in Eastern Europe and Central Asia, based upon responses of the businesses surveyed in BEEPS in 2005 and 2009.
I used four out of ten Doing Business indicators, selected on the basis of data availability in BEEPS. I compared the gap between de jure and de facto measurements of improvement in =5 business climate for gazelles from 2005 to 2009 in five groups of countries in Eastern Europe and Central Asia. I made four de jure vs. de facto comparisons for each of the regions and twenty comparisons in total.
In ten out of twenty comparisons (50%), de jure reforms, as measured by Doing Business index, translate into a smaller or no improvement in the businesses climate on the ground. In the other ten comparisons (50%), de jure improvements go hand-in-hand with de facto improvements. (Graph 5)
Doing Business index most accurately describes improvements in business climate in the states which acceded to the EU in 2004 and 2007. (Groups 1 and 2 at graph 5) The index overstates improvements in only one out of four business indicators in the EU-2004 states and corresponds to de facto improvements in three remaining indicators. For the EU-2007 countries, Doing Business measurements also accurately describe de facto improvements in three out of four business climate indicators, while improvements in the forth de jure indicator are not reflected in gazelles survey responses.
De jure assessment is less accurate for economies in Russia and Central Asia. The index accurately shows improvements in two out of four business indicators. It overstates improvements in two other indicators, out of which one indicator was identified as an obstacle to doing business by a greater percentage of companies on the ground. (Group 5)
=" The largest gap between de facto and de jure measures persists among EU candidate and EU Partnership countries in Eastern and Southern Europe (Groups 3 and 4). In EU candidate states, Doing Business shows improvement in all four indicators, while three out of four were reported as obstacles to doing business by a greater share of companies in 2009. (Group 3) In non-EU candidate countries of Eastern Europe, two out of four indicators deteriorated de facto despite de jure assessment of being improved. One of the indicators improved to a lesser extent de facto that de jure assessment suggests. (Group 4) Graph 5: Comparison between de jure and de facto measurements of business environment
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! Improvements in de facto business environment are comparable or greater than de jure assessment in Doing Business ! Improvements in de facto business environment are smaller than de jure assessment in Doing Business " Changes in de facto business environment are opposite to de jure assessment in Doing Business
These findings suggest that in line with my hypothesis, de jure improvements in the EU member countries, as measured by Doing Business index, translate into de facto improvements for gazelle companies to a greater extent than in non-EU member countries. However, in contradiction to my hypothesis, Doing Business more accurately reflects improvements in de facto business environment in Russia and Central Asia (Group 5) than in EU candidate countries (Group 3) and the countries of Eastern Partnership (Group 4).
I attribute the gap between de jure and de facto progress in non-EU member countries in Eastern Europe to the governments intention to create a favorable image of their economies in the eyes of their EU neighbors. The majority of countries in Eastern European non-member states explicitly or implicitly identified joining the EU as a priority in their foreign policy. However, caught up in domestic financial turmoil and Greek debt crisis, the EU put its enlargement policy on hold. As a result, only Croatia successfully join the Union in 2013. The free trade agreements with Moldova and Georgia were ratified only in 2014. In the absence of active engagement and the EU reform monitoring policy, non-member countries of Eastern and Southern Europe continued implementing legislative reforms to improve the perception of their == business climate among the EU investors and trade partners, while not putting sufficient efforts into implementation of the reforms on the ground.
In contrast to Eastern European countries, the foreign policy of countries in Central Asia and Russia is not shaped by the desire to join the EU. Projecting an image of themselves as top reformer-countries is not among the main priorities in the decision-making process of the governments in this region. My analysis shows that de jure reforms in Russia and Central Asia have greater de facto effects than in Eastern and Southern European countries. In this region, the governments are prone to adopt and implement regulations which foster development of large state-run enterprises owned by political stakeholders. As my analysis suggests, the gap persists in de facto regulatory environment for gazelles pertinent to access to credit and trade across border. Large private and particularly state-owned enterprises have leverage over small and medium-size gazelles in obtaining export and import permits, as well as opening a credit line in banks. In contrast, in the areas in which reforms equally affect the companies of all sizes and types of ownership, such as starting a business and paying taxes, gazelles benefitted together with the large state-owned enterprises. G"! I0-05&50,/* &/< *;99(*50,/* J,4 J;5;4( 4(*(&432
First, my analysis could benefit from comparison between de jure and de facto indicators for each country, rather than per region. This would increase the number of comparisons from twenty to one hundred and four, adding validity to results. Unfortunately, the number of responses by gazelle companies in BEEPS varied greatly from country to country and from year to year. The difference in the population of gazelles per country was too great to draw effective conclusions using this research method. =< Second, the analysis could be improved by comparing more Doing Business indicators to firms answers in BEEPS survey. If all of the ten indicators were used, the number of comparisons could be increased to fifty adding validity to results. Unfortunately, the questions in BEEPS survey did not pertain directly to other six indicators in Doing Business Survey.
The third limitation of this research is the absence of time lag in the analysis. It takes time for the firms on the ground to feel the effect of legislative and institutional reforms. Therefore, it might be better to compare BEEPS conducted in 2005 and 2009 to Doing Business index of 2004 and 2008. Unfortunately, Doing Business database does not have all four business indicators for all twenty-five countries in 2004 to be compared to rankings in 2009.
Forth, further research can be done to identify macroeconomic factors, which affect firms perceptions of doing business on the ground, including the financial crisis. Macroeconomic environment is not measured by Doing Business, but it has important consequences for effectiveness of regulatory and institutional reforms. External shocks, such as financial crisis did not affect all of the countries equally. Accounting for differences in macroeconomic environment and the effects of external shocks will be helpful to draw more concrete results from de jure and de facto comparison, as well as to translate them into a policy advice. G"B +,/3);*0,/
My analysis has shown that de jure measurements of business climate are insufficient to understand the dynamics of regulatory processes for job-creating companies in Eastern Europe and Central Asia. In 50% of cases, de jure improvements did not translate into improved perception of business climate for fast-growing firms on the ground. Doing Business is a =6 powerful policy tool, which encourages governments to allocate political capital and time to improve defined regulatory areas. However, the improvements, which the World Bank recommends, are based upon a singular benchmark applied to all the countries in the world. Companies operating in economies in transition experience a very peculiar business environment. Although many economies in Eastern Europe and Central Asia are characterized by highly skilled labor and active entrepreneurship, their development is constrained by bribery and imperfections of emerging regulatory and judicial systems. Doing Business recommendations also do not take into account the macroeconomic environment of countries and their foreign policy. My research suggests that Doing Business de jure measurement successfully reflects changes in de facto business environment only in those Eastern European countries, where adoption of legislative reforms is followed by implementation and external monitoring by the European Union. A large gap persists between de jure and de facto business climate in Eastern European countries, which implement new regulatory policies partially to satisfy the EU requirements for association agreement or membership. Reforms encouraged by Doing Business index often do not translate into results for firms on the ground hampered by macroeconomic deterioration and corruption. As a result, the new regulations often remain on paper and do not help gazelles.
To conclude, the areas which Doing Business index suggests for improvement are not always the core areas needed to foster the development of gazelles. While countries go up in rankings, implemented by them regulatory and institutional reforms remain cursory to the needs of fast- growing firms, which create jobs and foster development. In order to turn Doing Business into an effective development tool, Doing Business team must reconsider its benchmarks of measuring =D de jure improvements and supplement de jure assessment of business climate with the analysis of micro-level data. Using enterprise surveys to supplement de jure rankings will lead to a better policy advice on allocating political capital in the areas important to the firms at the forefront of the private sector lead employment and economic development.
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=7 Enterprise Survey. Official Website. The World Bank. Retrieved at: http://www.enterprisesurveys.org/Methodology
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Graph 6: Selection criteria for gazelles among the firms surveyed by BEEPS
Graph 7: Groups of countries divided into 5 regions
1. EU Member Countries 4. Non-EU Candidate: Eastern Europe Poland Albania Estonia Belarus Czech Republic Georgia Hungary Ukraine Latvia Moldova Lithuania Armenia Slovakia 5. Non-EU Candidates: Russia and Central Asia Slovenia Tajikistan 2. 2007 Accession Uzbekistan Romania Russia Bulgaria Kazakhstan 3. EU Candidates Kyrgyztan Serbia Bosnia Macedonia Croatia
"55 "#5 "<< "@#IA 5 65 "55 "65 #55 #55D #55@ #55A #557 4HKZPT OM 6JVEI[ -==AQ-==@ \D] <" Graph 8: Questions from BEEPS Survey matched with ranked areas of Doing Business Index
Getting Credit How much of an obstacle is access to finance? Starting a business Obstacle to the current operations : Business licensing and permits Paying Taxes Obstacle to the current operations : Tax administrations Trading Across Borders How much of an obstacle are customs and trade regulations?
Graph 9: Average regional change in percentage points relative to Doing Business baseline frontier of 100% from 2006 to 2010
Getting Credit Paying Taxes Trading Across Borders Paying Taxes 1. EU Member as of 2004 4 5 0 5 2. EU Member as of 2007 9 11 20 11 3. EU Candidate State 13 4 8 4 4. Non-Candidate: Eastern and Southern Europe 20 9 15 9 5. Non-Candidate: Russia and Central Asia 24 5 5 5
<# Graphs 10.1 - 10.5: Improvements in de jure and de facto business environment indicators per country group
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