India and the Doing Business index

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October 20, 2021 4:15 AM

The demise of the index is a good time to take stock of the true state of what it is like to run a business in India

The current MD of the IMF has come under fire for her role in these issues when she was at the Bank.The current MD of the IMF has come under fire for her role in these issues when she was at the Bank.

In September, the World Bank discontinued its Doing Business Report and Ease of Doing Business Index (EBDI), after 18 years, following the uncovering of possibly serious data irregularities, motivated by political influence. The current MD of the IMF has come under fire for her role in these issues when she was at the Bank. I think I first wrote about the EBDI in this column in 2005, in its early days.

That year, India was ranked 116 out of 155 countries, triggering a defensive response from some of India’s industry associations. The EBDI has 10 components, and rankings on each one helped to highlight where India did relatively the worst. These were: enforcing contracts, trading across borders, dealing with licenses, closing a business, and hiring and firing.

In many of these areas, India has made little real progress. Its ranking changed little through 2017, over a decade. But bankruptcy law reforms, and some other changes, contributed to a rapid improvement, from 130 out of 189 in 2017, to 63 in 2020. This triggered some triumphalism, but the real picture is less rosy.

The EBDI was always subjected to scrutiny and criticism, as well as to the potential of misuse through overstating its implications. Its simplicity and salience are what led to increasing pressures for manipulation. Because of its attempt at broad global coverage, the EBDI was always going to be both shallow and incomplete. But obligatory cautions to this effect from its producers were inevitably submerged by the needs of politicians for evidence of concrete progress.

In that respect, perhaps it was no worse than other such indicators, like the Human Development Index (HDI), or other variants of measurable development goals. Indeed, broader measures that are more politically charged, like the Heritage Foundation’s Economic Freedom Index, have even greater problems.

The demise of the EBDI is a good time to take stock of the true state of what it is like to run a business in India. By contrast to the country’s soaring EBDI ranking, it has been struggling in this period with weak investment, stagnant exports, a manufacturing sector that is still failing to take off, inadequate employment growth, and failing small businesses. Some of this was due to the Covid pandemic, but much of it is connected to a central problem of Indian business, one that the EBDI did not capture at all. The EBDI included getting credit and investor protection as two components. Like the rest of the exercise, these measures reflected external legal and regulatory perspectives, with larger businesses as the model.

Indian industry is well known for having a “missing middle”—some corporate giants, many very small businesses, and not enough in the rest of the distribution of firms by size. When all but the largest firms sell to those giants, or to the government, or to foreign buyers, they are constantly subject to delays in payment, and sometimes even non-payment. These firms are invariably short of working capital, and subject to cash flow crises, let alone having the ability to accumulate retained earnings and grow. The pandemic was a terrible blow to these firms.

What is worse, the implementation of the GST, which began in 2017, has compounded these existing problems. As the government is withdrawing its temporary forbearance in GST collection from smaller firms, they are going to be hurt even more. The problem is systemic, because, at the best of times, a small supplier has to pay GST up front, and recover this cash outlay when its large customer finally pays.

Essentially, the operation of GST for smaller firms is a body blow in a system where smaller suppliers cannot collect payments from buyers in a timely manner, and have no access to working capital loans, bridge loans, or factoring arrangements. None of this was ever captured in the EBDI. But it is a problem that was apparent in India well before the pandemic (bit.ly/3jgmMmV).

India’s manufacturing sector will not evolve into a balanced and robust ecosystem of firms that can grow and generate employment at the level that the country needs, until it develops an effective system of small-firm finance for everyday operations. Meanwhile, it should be possible to modify GST implementation to make large buyers responsible for tax payments, so that when they delay payments to their smaller suppliers, the latter are not being hit twice.

Professor of economics, University of California, Santa Cruz

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