For the average country, the World Bank found a positive and significant association, but—and this is important for Indian policymakers to note—the Doing Business rank-FDI relationship wasn’t significant for the average developing country. Photo: AFP
For the average country, the World Bank found a positive and significant association, but—and this is important for Indian policymakers to note—the Doing Business rank-FDI relationship wasn’t significant for the average developing country. Photo: AFP

Doing business: Easier ranked than done

The paradox of a higher Doing Business rank but low foreign investments suggests the former might just be easier to achieve than actual business

Much excitement has been generated by India’s move up to 130th rank in the World Bank’s Doing Business Report, 2016. Fair enough. Policymakers typically believe an improved investment climate encourages more foreign direct investment (FDI), which is why they take these rankings seriously. In reality though, how much do the Doing Business indicators really matter for FDI investments?

The answer isn’t straightforward. The World Bank investigated this question some years ago. For the average country in the cross-section, it found a positive and significant association, but - and this is important for Indian policymakers to note - the Doing Business rank-FDI relationship wasn’t significant for the average developing country.

A possible reason for this difference is given by another study. This showed that firms’ actual experiences with respect to time and cost for compliance (as measured by enterprise surveys) differ with official compliance time and cost, which is what the Doing Business rankings reflect. Therefore, when eyeing FDI in developing countries, firms may ignore such grading because they know they are likelier to struggle with compliance in such countries as compared to developed ones.

Such a difference isn’t hard to imagine in India. It is well known, for example, that bureaucratic objections can have the effect of throwing the ball back into the applicant’s lap, even as a deadline for disposing of an application is met with. From the firm’s perspective however, the job is incomplete and actual time limit just got extended!

Moreover, the opposite is equally true as well. That is, economies that may be graded quite poorly on the Doing Business indicators nevertheless get a lot of FDI inflows. This means that foreign firms decide whether to invest or not on the basis of numerous other factors besides the business climate tracked and measured by the Doing Business report.

A further inference is that other weaknesses, those not captured by these indicators, could discourage FDI inflows notwithstanding improvements in a country’s rank in the Doing Business report.

A particular point for Indian policymakers to note is that this year’s elevation in the Doing Business ladder could get a sharp knock if the pace of foreign investments were to suffer a setback.

The moral of the story then is to not read too much into what essentially isn’t the broadest of gauges of a country’s investment climate. Or more worryingly, rest complacently on such laurels, assuming foreign investments that export and employ more workers will follow. While lower transaction costs, which is what a more efficient regulatory environment translates into, can attract foreign investments and employ more workers, it can hardly offset poor quality infrastructure, logistics and other features known to significantly influence FDI flows all over the world. The paradox of a higher Doing Business rank but low foreign investments suggests the former might just be easier to achieve than actual business.

Renu Kohli is a New Delhi-based macroeconomist.

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