Doing business in a deals world - The doubly false premise of rules reform

The World Bank’s Doing Business (DB) reports have evoked an intense policy debate about whether countries should simplify regulatory rules, in order to stimulate investment and growth, or make them more stringent, in order to achieve public policy objectives. Both sides of this debate, however, assume that the business environment in developing countries is defined and determined by the exact implementation of these rules by the state and by firms, an assumption demonstrated to be false by a number of studies. These studies seem to indicate that doing business in developing countries is based on deals struck between firms and the political or bureaucratic arms of the state. In this paper, we undertake a cross-country analysis of the relationship between the rules related to doing business and these deals. Using data from the DB reports, the World Bank’s Enterprise Survey and other sources, we show that (i) while there is a relationship between rules and deals, it is a weak one; and (ii) this relationship is itself dependent on the level of a country’s state capability; and (iii) with stringent rules and very low levels of state capability, the relationship becomes perverse, with more stringent rules leading to less compliance, rather than more. Based on these results, we provide a diagnostic approach to rules reform, where the appropriate reform depends on the level of stringency of the rules in a country, and the level of its state capability.