The importance of improving business conditions is widely accepted. However, there is debate on what metrics should be used to assess a “good” business environment, what qualifies as improvement in the business environment, how to compare nations on their business environment, and what policy reforms should be incentivized to achieve an improved business environment.
Despite these difficulties, the World Bank’s flagship Ease of Doing Business (EDB) report purports to assess nations’ business environments by scoring them on their regulatory and legal frameworks and assigning them a rank compared to other nations. The report declares itself as a good signal of a nation’s business conditions. Further, it explicitly advocates for nations to implement reforms that would help them improve their scores and advance their rankings. Since its inception, seventy plus countries created regulatory reform committees using EDB indicators, inspiring more than 3,800 reforms (World Bank, 2020). These rankings significantly influence policymaking particularly in developing nations, investment and aid decisions, and are widely used in academia (Doshi et al., 2019; World Bank 2020)
Nonetheless, it is contested whether a nation’s improving EDB rank indicates its business conditions improved. In Rwanda and India, for instance, both nations’ rankings soared, despite limited evidence of improved business conditions and poor performance on metrics such as per capita national income and percent of population in poverty (Besley, 2015). There is evidence that nations intentionally game the ranking by selectively targeting indicators for reputational and political reasons and to attract investment, as opposed to using it as genuine guidance to improve business conditions (Doshi et al., 2019) These examples question the relevance of the ranking in assessing improvements in a nation’s business environment. They also reflect the political economy of the rankings in development policy and the problematic nature in incentivizing nations to implement reforms that may not be relevant to substantially improving business conditions yet may be used to improve optics (Besley, 2015; Doshi et al., 2019; Manuel et al., 2013). Thus, this paper answers the question: to what degree does an improvement in a nation’s EDB rank indicate that its business conditions improved and what may account for any divergence?
This paper constructs six hypotheses that may account for improvements in a nations’ EDB rank without improvement in its business environment.
1) Disparity between de jure and de facto measures of business conditions
2) Improvement in topics that are not relevant for most businesses
3) Improvement in topics driven by sub-indicators that are not relevant
4) Factors outside the scope of the EDB ranking are more influential to business conditions
5) Ranking masking regional heterogeneity
6) Intentional gaming of the rankings
This paper explores five of them in the context of Russia. In 2012, Putin made a decree to improve Russia’s EDB rank by 100 points, titled the “100 steps program” (Yakovlev, 2014). Alas, Russia nearly achieved its target — improving from ranking 125th at its worst in 2010 to 28th in 2019. However, looking at other metrics of Russia’s business environment over this time period, including new enterprise creations, number of enterprises exits, and share of small and medium enterprise (SME) contribution to GDP, presents a divergence (European Parliamentary Research Service, 2018; OECD, 2020). These trends are apparent even before 2015 when Russia experienced an economic contraction due to sanctions and decreasing commodity revenues (European Parliamentary Research Service, 2018). These metrics indicate that Russia’s business environment has not drastically improved, but instead worsened. Thus, this paper argues that a nation’s improved EDB rank does not indicate that its business conditions improved. The rest of the paper is focused on exploring this divergence using the hypotheses to explain how this can happen.
This paper uses the 2008–2009 and 2011–2012 rounds of the Business Environment and Enterprises Performance Surveys (BEEPS) for Russia to explore whether despite this divergence, there were improvements in perceptions and objective measures of business conditions in the areas in which Russia improved between 2008 and 2012. Then, it uses BEEPS data and secondary academic and grey literature to build evidence for each hypothesis. The aim of this paper is exploratory, as opposed to coming to definite conclusions on which hypothesis represents the cause.
In this context, the paper shows that perceptions did improve in certain areas — such as electricity and trade regulation- that were reformed. However, these areas were not considered large obstacles by most businesses, thus improvements did not address binding constraints. Further, in areas that were considered large obstacles, such as taxes and getting credit — despite reforms that led to improvements in the EDB rankings — BEEPS data and secondary academic and grey literature reveal that enterprises still struggle. Also, BEEPS data and secondary literature show that structural issues outside the scope of the EDB rankings, such as workforce skills, corruption, and political instability impact enterprises significantly, and prevent the business environment from meaningfully improving in Russia. Further, BEEPS data shows that there is considerable regional variation in the business environment in Russia and that a rank based on just Moscow and St. Petersburg likely masks regional heterogeneity. Finally, Putin explicitly targeted improvement in these rankings as a policy agenda (Yakovlev, 2014), indicating potential “gaming” of the rankings. Thus, this paper shows that these factors help explain a divergence between Russia’s improved EDB, despite lack of improvements in indicators of its business environment.
This paper contributes to the debate by pointing out this divergence in Russia, which has not been previously explored in the literature. It also contributes to the literature by constructing a framework and six hypotheses that may be used in further research to examine divergences in other nations. Finally, it contributes by using BEEPs data to explore these hypotheses. This research is especially important due to the significant influence these rankings hold on policy making, as well as on investment, aid, and academia.
EDB Background
The World Bank’s Ease of Doing Business (EDB) report ranks 190 countries, from best to worst, according to its assessment of their business climates and thus purports to assess the economy’s “investment climate”. The rankings’ rationale is that overly cumbersome regulations stifle entrepreneurship and lead to underinvestment. Its methodology rewards decreasing regulatory burden while strengthening legal systems, access, and efficiency. Although the EDB ranking does not cover everything related to business conditions in an economy, it nonetheless claims to serve as an important signal of a nation’s business environment (World Bank, 2018). The report influences investment, aid, and academia. It also influences policy discussion and brought attention to topics important for the business environment that were previously poorly understood and oftentimes overlooked (Manuel et al., 2013).
The report launched in 2003, with only 5 sets of indicators for 133 economies and has since expanded (Besley, 2015). Economies are currently measured on 10 topics: starting a business, dealing with construction permits, getting electricity, registering property, getting credit, protecting minority investors, paying taxes, trading across borders, enforcing contracts, and resolving insolvency. Topics consist of multiple component indicators that are scored. Scores for each sub-indicator are simply averaged into one score for the topic, and all topics are averaged to create one score. Thus, all topics have equal weight, and all sub-indicators for each topic also have equal weight. Nations’ ranking is based on their aggregate score. Most economies’ rank is based on their largest business city; however, since 2013, the second largest business city for eleven economies has been considered in their rank as well (World Bank, 2020).
The Doing Business team within the Bank obtains data through questionnaires and consultation with country level experts in the private and public sectors on relevant laws and regulations. Most indicators are based on laws and regulations; however, some indicators are based on actual practice. Data is collected from the previous year. After processing, verifying, and confirming the data, the team shares the preliminary results with the Bank’s Executive Directors and Bank’s Country Management Units (CMUs), who then debrief the governments on their reforms. Throughout this process, government authorities and World Bank staff can alert the team about reforms that were not reported or about additional reforms. The Doing Business team formally addresses comments and explains their scoring decisions to governments and regional staff (World Bank, 2020).
As discussed by (Besley, 2015), questionnaires are not processed transparently. An “in house” team at the Bank verifies the responses and creates an index score on each dimension, creating “raw” data which is shared on its website. The data-gathering and reporting process allows significant collaboration and input from governments and government officials who want to improve their rankings. There is criticism of frequent changes in methodology, which could be potentially politically motivated. Paul Romer, the Chief Economist of the World Bank, said that the EDB indicators were manipulated in Chile to make its business conditions look worse under a socialist president (Zumbrun & Talley, 2018). Whether or not this is true, this admission reflects a lack of transparency behind the rankings and questions over their accuracy.
The ranking rests on the theoretical framework that a strong private sector requires good rules in the form of business regulations and legal framework (Djankov et al., 2002) and that a strong private sector creates jobs, promotes economic growth, and reduces poverty (World Bank, 2018). Starting off with Djankov et al.’s paper on “The Regulation of Entry,” which motivated the start of the project, academic research substantiates much of the individual reforms. See the papers posted on the Doing Business methodology page (https://www.doingbusiness.org/en/methodology). Further, research suggests undertaking EDB related reforms and having a higher EDB rank significantly influences economic growth (Djankov et al., 2006; Haidar, 2012).
However, there is evidence that EDB rankings are not a good proxy for nations’ business conditions. Besley (2015) discussed the case of Rwanda, which improved to 47th in the rankings, scoring better than Italy, although its per capita national income was lower than $1,000 and had higher than 40% of its population in poverty. India’s EDB rank also improved despite limited evidence of better business conditions, and evidence the government intentionally targeted the rankings to improve optics (Doshi et al., 2019). Indeed, Van Stel et al. (2007) critiqued the notion that reducing regulatory burdens is sufficient for economies becoming more prosperous. They found that entry barriers from regulatory burden have no significant impact on entrepreneurship. Accordingly, EDB rankings do not measure many areas including institutions, security, macroeconomic and financial stability, involvement of government in economic processes, all aspects of infrastructure, corruption, labor skills, or even all aspects of regulation. However, these areas significantly impact the business environment (Dollar et al., 2006).
Goodhart’s law states that using a measure of the economy as an indicator for the economy undermines its value as an indicator because people start to game it (Goodhart, 1983). In addition to prescribing that the EDB rankings would cease to serve as an indicator of nations’ improvement in their business conditions, it also describes a risk that the EDB rankings influence nations in a misguided way.
An independent review panel of experts was commissioned by the World Bank to review the EDB rankings. They highlighted concerns of the lack of causal relationship between assessed areas and growth, especially on a country level, data and methodological concerns, especially since small revisions or inaccuracies in data may significantly affect a country’s ranking, lack of external review, and aggregation of indicators which creates a value judgment on what is “better” for doing business (Manuel et al., 2013).
EDB Influence
Despite shortcomings, the Bank explicitly incentivizes countries to implement its suggested reforms by ranking them (World Bank, 2018). To help them do this, there is an Indicator Based Reform team that helps nations target policies effectively (Doshi et al., 2019). The rank format is significant because being compared internationally invokes nations’ reputational concerns and appeals to global norms (Kelley, 2017).
Additionally, the rankings influence investment and aid. Countries with higher EDB ranks attract more Foreign Direct Investment (FDI) (Corcoran & Gillanders, 2015). Perhaps this is because market actors use the EDB ranking as a proxy for a well-regulated economy. A nation’s EDB rank significantly impacts investors intent to recommend investment (Doshi et al., 2019) As such, governments believe that the rankings influence investment (Jayasuriya, 2011). Thus, many countries use improvements in the rankings as a tool to attract investors, which is included in some government export promotion strategies (Arndt, 2008; Hanusch, 2012). For example, Serbia’s Prime Minister, Alexsander Vucic stated, “Serbia wants to enter the top 30 countries on the World Bank’s list […] because the better positioned we are, the more we will be able to attract foreign and domestic investors” (Doshi et al., 2019).
The EDB rank also has political consequences. Constituents judge policies and politicians based on their country’s rank. Thus, governments and their bureaucrats care about the rank from a reputational standpoint, making rising in the EDB rank a policy goal in and of itself (Kelley, 2017). Some bureaucracies developed institutionalized procedures to improve in the rankings, and the indicators are sufficiently specific that bureaucrats face consequences for not delivering an improvement. This is especially true in emerging markets due to a strong incentive to signal a business-friendly environment, which was seen in India (Doshi et al., 2019)
Showing that nations’ care about their rank, seventy plus nations created regulatory reform committees based on the EDB indicators and completed 3,847 related reforms, which is under-reported because multiple reforms improving an indicator’s score is counted as one (World Bank, 2020). Further, within one year of the Bank releasing ranks, many governments specifically requested advice on improving their ranks as opposed to general regulatory advice. Many governments and high-ranking government officials made statements of their intent to improve their ranks including particular targets they wanted their country to achieve, publicized efforts making EDB reforms, and compared themselves to other nations. Some nations initiate reforms specifically to improve their rank because it may be an easier way to attract investment than undertaking more difficult, yet worthwhile policies, which was seen in India (Doshi et al., 2019)
The Independent Review Panel recommended that EDB reforms should not be taken as literal policy prescriptions or as a template for development because countries should decide what is best for their economies. However, a political economy surrounding the rankings emerged (Besley, 2015). Thus, countries compete to become the EDB annual top-reformer (Saleh, 2013). Aware of the EDB rank’s significant influence, governments shift their priorities, alter their bureaucracies, and engage with the Bank to better their rankings. Thus, whether or not they are beneficial, EDB reform ideology dominates policy making especially in developing countries that feel pressure to meet expectations (Doshi, et al., 2019).
Theory
In light of the debate on whether a nation’s rising EDB rank indicates business conditions improved, this paper presents six possible hypotheses that may explain how a nation can improve its EDB rank without business conditions improving.
The first hypothesis is a disparity between de jure and de facto measures of business conditions. Most indicators are based on laws and regulatory provisions and even those based on the actual practice introduce a degree of judgment. They also assume that entrepreneurs know about all regulations and comply with them; when, entrepreneurs may spend significant time figuring out how to navigate the regulations or avoid them all together (World Bank, 2012). Hallward-Driemeier and Pritchett (2011) found that there was indeed a significant difference between the de jure and de facto measures of regulation, comparing EDB data to enterprise surveys of the actual realities. This also had to do with the heterogeneity of firms and preferential treatment accorded to some and not to others.
The second hypothesis is that a nation may improve in topics of the EDB index, which contribute to its heightened rank, that are not considered large obstacles by most businessmen. All topics are weighted equally, and their simple average is taken when calculating a nation’s score and rank. There is no differentiation between topics that may be more important to businesses in the nation (World Bank, 2020). Some of the regulatory topics covered by the EDB indicators may not even be relevant obstacles to businesses. Indeed, Manuel et al., (2013) found the relevance of the EDB regulations varies vastly between countries. Thus, an improvement in such a topic may not be felt by businesses.
The third hypothesis is that reforms that contributed to an improvement in a topic’s ranking were not the appropriate reforms needed to resolve the obstacle businesses faced in that area. Thus, an improved ranking on that topic may obscure the fact that businesses continue to struggle in that area. For example, India ranked 23rd on the Getting Credit indicator, despite multiple studies reporting that Indian SMEs struggle with credit availability and cost (Manuel et al., 2013). This can happen because the simple average is taken across multiple indicators to create the topic’s score. However, some sub-indicators could be significantly more relevant for businesses on that topic than others — so despite improving in the topic overall, this area has not improved. For the “paying taxes” topic, the number of payments, the time it takes, the post filing time, and the tax rate are considered equally when calculating the topic’s score (World Bank, 2020). However, businessmen may struggle more with tax rates rather than administrative aspects of paying taxes, such that an improvement in the topic would be misleading.
The fourth hypothesis is that factors outside the scope of the EDB rank are more important to business conditions. EDB rankings only focus on the regulatory aspects of the business environment. However, factors excluded may be more important to business conditions. Dollar et al. (2006) found that the business environment is impacted by the quality of institutional policies, macroeconomic and financial stability, infrastructure, corruption, and involvement of the government in economic processes. Thus, despite improvements in aspects of the business environment, there may not appear to be any overall improvement in the business conditions due to other factors being more important.
The fifth hypothesis is that an aggregate rank masks regional heterogeneity in the business environment. For most nations, the EDB rank is only based on the nation’s largest business city, and since 2013, it is also based on their second largest business city for eleven nations (World Bank, 2020). However, the business environment and relevant obstacles may significantly vary depending on area.
The sixth hypothesis is that nations “game” the ranking through selective targeting. Goodhart’s law describes how using measures of the economy as an indicator of the economy leads people to gaming the indicator (Goodhart, 1983). Indeed, Doshi et al. (2019) show that nations, particularly developing and emerging economies, are impacted by being publicly ranked and adapt their bureaucracies to undertake reforms that would strategically improve their nation’s rank. This was seen in India, where Modi explicitly targeted improving by 100 points to the 50th rank, as validation for his administration’s success and to signal a positive investment climate. Modi made improving in the rankings a part of the government’s agenda, including coordination with agencies, and implementation through local governments, using sub-national rankings to create competition and put pressure on Indian bureaucrats (Doshi et al., 2019). This elucidates how a government uses the EDB ranking as a tool to improve optics, as opposed to policies leading to genuine improvements in the business environment.
Russia Case
This paper uses Russia as a case study to investigate whether an improvement in a nation’s EDB rank indicates its business conditions improved and what may account for any divergence. Russia is a post-socialist country and historically business conditions were poor (Golikova et al., 2007). In the post transition, Russia’s institutions changed profoundly, yet SMEs still struggled with a weak and unpredictable formal institutional environment (Molz et al., 2009). Aidis and Adachi (2007) show there are also many informal constraints for Russian businesses including inconsistent enforcement of regulation, lack of rule of law, regional autonomy, and pervasive corruption, which constrain both business formation and firm survival and exit rates. The regulatory framework also hinders businesses. In the 2010–2011 Global Competitiveness Index, Russia scored in the bottom decile for its burden of government regulations, and its weak institutional framework was presented as a major challenge to growth (World Economic Forum, 2010).
Russia’s economy heavily depends on oil and gas revenues. Despite significant economic growth in the 2000s, it was primarily attributed to rising revenues from oil and gas commodities (Sonin, 2019). Even when commodity prices boomed between 2010 and 2013, growth decelerated, suggesting deep structural problems hinder the economy. These structural problems include an over-reliance on commodity revenues, inefficient state-owned enterprise which dominate the economy, an uncompetitive private sector, lack of innovation, and a high level of defense spending, which distract from more productive investments (European Parliamentary Research Service, 2018).
Russia is a vastly heterogeneous country. Much of the regional heterogeneity in economic performance is due to natural resources (World Bank, 2012). Further, during the transition period in Russia, inter-regional variations emerged in institutional quality, creating differences in the level of bureaucracy, legal protection, and corruption, with varying degrees of relative obstacles for SMEs based on their location. By and large, the distribution of income is federally controlled, and economically weaker regions receive fewer subventions from Moscow, so some regional social programs cannot be implemented. Since 2012, there have been increasing local protests due to rising regional economic inequality and unemployment– with over 60 of the 83 regions considered economically underdeveloped. These trends could destabilize Russia politically and lead to a fall in foreign and domestic investment (Kuznir, 2016; Yukhanaev et al. 2014).
Due to decreasing natural rents, which have been vital to Russia’s economy, and recognizing that economic growth is essential for political stability, Putin made improving business conditions to boost the economy a top priority. In 2011, Russia prepared a new strategy for economic growth through 2020– called “Strategy 2020”. Russia’s interest in improving business conditions was also to attract investment because it is critical for its growth (Yakovlev, 2014), with Putin citing investment as the second source of growth after innovation in his presidential address to the federal assembly (Putin, 2018). The strategy aimed to foster in Russia one of the most conducive business environments in the world, promote long-term investment, and for Russia to become one of the top five world economies by 2020 (World Bank, 2012).
As part of efforts to improve business conditions, in February 2012, Putin made a decree to improve Russia’s EDB ranking by 100 points, from 120th to 20th in 2018, dubbed the “100 steps program” (Yakovlev, 2014). Russia nearly achieved its target, climbing to 28th in 2020 ranking (World Bank, 2020). Contributing to this rise in the rankings, Russia has made dozens of reforms since 2008 (World Bank, 2020). Figure 1 shows the improvement in Russia’s EDB ranking from 2010 to 2019. The table is consistent with the year in which data was retrieved because the EDB reports are based on data from the previous year for comparison sake to other statistics.
Figure 1: Russia’s Ease of Doing Business Ranking
Despite Russia’s rise in the rankings, other indicators of the business environment have not improved. Figure 2 shows the decline in new enterprises created in Russia from 2010 to 2017. Figure 3 shows an increasing number of enterprise exits in Russia from 2011 to 2017. Compared to other former communist countries, there are fewer new enterprise creations in Russia, and established companies have higher profit margins, suggesting static markets. According to the World Bank and Eurostat, Russian SMEs represent only one-fifth of the nation’s GDP, which is considerably less than in the EU (European Parliamentary Research Service, 2018). A study of Russia’s measures improving the investment climate found large companies are more likely to perceive positive changes in the business environment because of their better access to top government officials and influence on government policy. However, small businesses are more likely to perceive business conditions have worsened (Yakovlev et al., 2015).
Figure 2: Russia’s New Enterprise Creations
Figure 3: Russia’s Number of Enterprise Exits
Since 2010, when Russia started improving its EDB ranking, several factors impacted the business environment. In 2014, oil prices declined by nearly 75% and the west imposed sanctions over Russia’s aggression in Ukraine, which significantly contracted Russia’s economy, collapsed the Ruble, led to soaring inflation, and significant capital outflows (European Parliamentary Research Service, 2018). According to the Central Bank of Russia, capital outflows reached $151.5 billion in 2014 (Kuznir, 2016). Despite sanctions persisting, oil prices partially recovered. Still, economic recovery was slow. It is predicted that Russia’s share of the world economy will shrink and fall even further behind the world’s most competitive economies. Although sanctions hamper the economy, the main constraints to growth are deep long-standing structural issues (European Parliamentary Research Service, 2018). Although Russia improved its regulatory and legal framework, facilitating its rising EDB ranking, Yakovlev (2014) and Kuznir (2016) believe that there was no meaningful improvement in the business conditions.
Method and Data
The paper focuses on improvements in nations’ EDB rank as opposed to its score because of the methodological changes that affect how the score is calculated over time and most importantly, due to the large attention and influence wielded by the rank, including its effects on investment and policymaking, particularly among developing nations attempting to improve to signal better business conditions.
This paper uses Russia as a case study to explore the theoretical hypotheses of whether a nation’s EDB rank can improve without evidence that its business conditions have. This paper uses five of the theoretical hypotheses to explore this divergence in Russia. Although the first hypothesis — disparity between de jure and de facto measures of business conditions — is highly relevant in Russia as studies and reports find that the enforcement of laws and regulations for business in Russia is often inconsistent (Aidis & Adachi, 2007), this hypothesis will not be explored due to lack of available data and limited scope of the paper.
The analysis examines whether aspects of the business environment improved in which EDB reforms were made and five hypotheses exploring the divergence. When analyzing EDB reforms and rankings, the paper uses the year for which data was collected as opposed to when the report was published to maintain consistency with other sources of data. Instead of evaluating which hypothesis is the cause, this paper explores existing evidence for each of the hypotheses that may account for the divergence in Russia to speak back to the debate. There may be further reasons, which account for the divergence that are not discussed.
This paper uses quantitative and qualitative secondary data. Quantitative data comes from the Business Environment and Enterprise Performance Survey (BEEPS) for Russia from the European Bank of Reconstruction and Development (EBRD) and is analyzed through descriptive statistics. The 2008–2009 and 2011–2012 rounds of BEEPS were used with a total of 1256 and 4220 firms across 7 and 37 regions, respectively. Questions include measures of respondents’ perceptions and objective measures of the business environment. Respondents, who were business owners and top managers, were asked questions such as the degree to which areas of the business environment posed an obstacle to their operations and which element of the business environment posed the largest obstacle to their operations from fifteen governance and administrative obstacles.
There are several limitations of this data. The surveys include questions on perceptions of the business environment; however, these are not objective measures and may be biased. There is selection bias. For example, for the 2011–2012 round, only 22 percent of the firms were surveyed, 56 percent of the contacted firms refused to participate, and some firms were found ineligible to participate (EBRD, 2012). Additionally, all of the firms included in the survey survived Russia’s difficult business environment, thus there is a “success” bias of the firms included. There is limited scope of the data. Although the survey explores many areas of the business environment, including 15 factors that present the largest obstacles, this is not fully comprehensive. Further, BEEPS data does not have similar questions to every topic covered by the EDB index. Also, some of the questions including those on corruption may be considered sensitive by respondents, which may undermine their accuracy.
The qualitative literature will draw on secondary academic and grey literature, pertaining to Russia’s business conditions and factors that influence its business conditions. Grey literature includes reports, Russian government publications, and articles from international and Russian media.
Analysis
Did aspects of the business environment improve?
Although there is evidence that Russia’s business conditions worsened over the time period in which its EDB rank improved, the areas reformed may have improved. Between 2008 and 2012, ten reforms were made which improved Russia’s EDB ranking including two reforms in dealing with construction permits, one reform in getting electricity, two reforms in registering property, two reforms in paying taxes, and one reform in trading across borders (World Bank, 2020). Although this section cannot prove whether the reforms were the cause, this section uses BEEPs data to explore whether there were improvements in perceptions or objective measures of the business conditions in these areas between 2008–2012. Not all areas in which EDB related reforms were made have corresponding questions on the BEEPS; thus, this section focuses on those that do.
In some areas reformed, enterprises’ perceptions of that element of the business environment improved. In 2011, Russia reduced the cost of getting electricity by changing the taxes for connection (World Bank, 2020). Figure 4 shows that the percent surveyed who cited electricity as a major or very severe obstacle to the current operations of the establishment decreased from 44% in 2009, the closest prior data point, to 26% in 2011.
Figure 4: Percent surveyed who cited electricity as a major or very severe obstacle
Further, in 2011, Russia facilitated trading across borders by decreasing the documents required for each export and import transaction and reducing their cost (World Bank, 2020). Figure 5 shows a decrease from 23% in 2009 to 10% in 2011 in the percent surveyed who cited customs and trade regulations as a major or very severe obstacle to the current operations of their establishment.
Figure 5: Percent surveyed who cited customs and trade regulations as a major or very severe obstacle
However, in other areas, BEEPS data shows there was no improvement in business conditions despite reforms. There were two reforms made to ease getting a construction permit. In 2010, Russia created a single window for all procedures related to land use, and in 2012, Russia eliminated requirements for several pre construction approvals (World Bank, 2020). Figure 6 reveals that despite the reform in 2010, the average time it took to obtain a construction-related permit increased from 103 days in 2009 to 172 days in 2011. However, after the reform in 2012, there was a decrease from 172 to 160 days in the time it took to obtain a construction permit.
Figure 6: Average number of days it took to obtain a construction-related permit
Further, in 2009, Russia reduced its corporate income tax rates from 24 to 20% (World Bank, 2010) Despite this reform, Figure 7 reveals the percent of enterprises who cited tax rates as a major or very severe obstacle rose from 50% in 2008 to 53% in 2009. In 2011, Russia increased employers’ social security contribution rate (World Bank, 2020). In that year, there was a steep increase from 53% in 2009 to 60% of enterprises who cited tax rates as a major or very severe obstacle.
Figure 7: Percent Surveyed who Cited Tax Rates as a Major or Very Severe Obstacle to Current Operations of the Establishment
These descriptive statistics show that in some topics reformed such as electricity and trading across borders there have been improvements in perceptions of business conditions. However, in other areas reformed, such as ease of getting a construction permit and paying taxes, there were no improvements in perceptions or objective measures despite reforms.
Hypotheses
Hypothesis 1: Topics improved were not large obstacles
Figure 8: Element of the business environment which is the biggest obstacle faced by the establishment
The first hypothesis is that topics that significantly improved in the rankings and contributed to Russia’s significant rise in aggregate rank were not considered large obstacles by most enterprises. Thus, a rise in that topic would not address the most pressing constraints. The preceding section showed how following reforms, perceptions of electricity and trading across borders improved. However, Figure 8 shows that in 2008, only 3% and 1% of firms cited electricity and customs and trade regulations as their largest obstacles to operations, respectively. Thus, these topics indeed were not considered large obstacles by most enterprises.
Further, despite few enterprises citing electricity and customs and trade regulations as their largest obstacles, Russia continued to reform electricity and trade regulations after 2012. As a result, Russia’s ranking in these topics significantly improved, contributing to the improvement in Russia’s overall rank. In 2012, Figure 8 shows that only 2% of Russian enterprises cited electricity as their largest obstacle to business. However, three reforms were made and Russia improved from the 184/185th rank in 2012, or the second to worst performing economy in this topic, to 7/190th in 2019. Further, again, Figure 8 shows only 3% of Russian enterprises cited customs and trade regulation as their largest obstacle to business in 2012. However, three reforms were made and Russia’s trading across borders rank improved from 162/185th in 2012 to 99/190th in 2019 (World Bank, 2020). Although BEEPS data does not include perceptions on all topics in which Russia implemented reforms and rose in the rankings, it is possible this is the case for other topics as well.
These two examples show how Russia completed reforms in electricity and trading across borders, significantly improving those topics’ ranks, contributing to Russia’s improved overall aggregate rank. However, these factors were not considered large obstacles by most Russian enterprises. Thus, despite potential improvements in these factors, they would not be addressing enterprises’ binding constraints in the business environment. Because of the ranking’s methodology, each topic is weighed equally for the aggregate rank, even though topics are not equally relevant to businesses conditions. This may be misleading when assessing if a nation’s business conditions improved if topics driving the aggregate rank’s improvement are not relevant. This may also be problematic if policymakers were focused on the worst performing elements of its aggregate EDB ranking, such as electricity, in which Russia was ranked the second to worst performer in 2012, as targets for reforms, as opposed to elements of the business conditions that enterprises cited as their largest obstacles to operations.
Hypothesis 2: Reforms addressing topics were not helpful
Other topics where Russia made EDB related reforms and improved in the rankings were cited by Russian businessmen as very large obstacles. Figure 8 shows that enterprises cited access to finance as their largest obstacle to business in 2008 and second largest in 2012. Russia made two reforms in 2015 and 2017 that strengthened access to credit (World Bank, 2020). Russia’s rank in getting credit rose from 61st in 2014 to 25th in 2019 (World Bank, 2020). Despite this improvement, Russian executives cited access to finance as their third largest obstacle in the World Economic Forum’s 2017 Global Competitiveness Report. The report ranked Russia 107th out of 137 nations for financial market development (World Economic Forum, 2017). Reports show that entrepreneurs face difficulty getting loans, finding affordable financial services, and have limited financing options from Russian investors. Poor access to credit is attributed to long-standing structural weakness of Russia’s banking sector due to burdensome regulation, irresponsible lending, and lack of transparency in the governmental structures. This problem was exacerbated with the Ukraine related sanctions. Because Russian banks and businesses rely heavily on foreign loans, they were significantly impacted by sanctions restricting lending from EU and US banks to Russia. (European Parliamentary Research Service, 2018).
Alas, this calls into question the relevance of the sub-indicators. For getting credit, these include the strength of legal rights index and depth of credit information index. The first measures whether collateral and bankruptcy laws facilitate lending, and the second measures the depth of credit information available through credit reporting service providers (World Bank, 2020). Indeed, reforms addressing these sub-indicators would not be the most relevant in addressing Russian enterprises’ struggles with “getting credit” — explaining why businessmen continue to struggle despite the rank’s improvement.
In 2008, enterprises cited tax rates as their second largest obstacle (EBRD, 2009). From 2008 to 2012, Russia made two reforms addressing “Paying Taxes” (World Bank, 2020), and its rank increased from 134/181th to 64/185th in that factor (World Bank, 2009; World Bank, 2013). However, Figure 8 shows the percent of businesses that cited tax rates as their largest obstacle to operations increased from 17% in 2008 to 32% in 2012. Analyzing the reforms — although one reduced the corporate tax rate from 24% to 20%, the second reformed tax administration, when only 3% of Russian businessmen cited tax administration as their largest obstacle in 2008 (EBRD, 2009). Further, in 2011, Russia increased companies’ social security contribution rate, and the percent of businesses that considered tax rates a major or very severe obstacle rose from 53% in 2009 to 60% in 2011(EBRD, 2016; World Bank, 2020).
After 2012, three additional reforms were made in “Paying Taxes”, and its rank further improved from 64/185th to 53/190th in 2019 (World Bank, 2013; World Bank, 2020). Despite the topic’s improvement, Russian executives rated tax rates as their second largest issue for doing business in the World Economic Forum’s 2017–2018 Global Competitiveness Report (World Economic Forum, 2017). Further, in 2019, Russia increased the value added tax (VAT) from 18% to 20%. Russian media discussing the improved EDB ranking quoted an analyst from a leading Russian private equity firm saying that newly created businesses still face a high tax burden. It also quoted a senior analyst at a leading Russian finance company stating that businesses were unlikely to feel any substantive improvement in the business environment when their business costs would increase due to an increased VAT (Eremina & Petrova, 2018).
“Paying Taxes” includes the following sub-indicators: the number of payments, the time it takes, the post filing time, and the total tax contribution rate (World Bank, 2020). However, Russian enterprises struggled most with the tax rates, as opposed to administrative aspects of paying taxes. Thus, reforms in sub-indicators driving improvement in the topic’s score and rank would not be most relevant to addressing constraints in this area of the business environment. Further, the improved ranking obscures the large effect of tax hikes, which significantly increase business obstacles with paying taxes.
These two examples show that reforms contributing to an improvement in a topic’s score and ranking may not be appropriate to addressing obstacles faced in that area. This happens when reforms driving improvements in the sub-indicators used to measure a nation’s score in that topic are not relevant to what is most needed to improve business conditions in this area.
Hypothesis 3: Factors outside the scope of EDB rankings are more important
Figure 9: Largest obstacles to Business in Russia
The third hypothesis is that factors outside the scope of the EDB rankings are more influential for business conditions. As discussed, the EDB rank assesses the regulatory and legal framework; however, there are many factors that impact the business environment. Looking at Figure 9, the top 5 obstacles for Russian businessmen between 2008 and 2012 were consistently tax rates, access to finance, workforce skills, corruption, and political instability. Indeed, workforce skills, corruption, and political instability are outside the scope of the EDB rankings, yet top challenges in Russia’s business environment.
Russian employers struggle with a shortage of skilled labor, which precludes Russia’s economic development and relegates it to the “middle-income trap” (Yakovlev, 2017). This is exacerbated by the persistent brain drain. According to the Federal State Statistics Service, from 2012, the number of Russians emigrating tripled, reaching 250,000 in 2016, and this is further undermined by Russia’s shrinking working age population. This is additionally concerning as many of the Russians leaving are highly skilled, entrepreneurs, and in the IT sector — representing the most vital workers for Russia’s economy — looking for better economic opportunities abroad (European Parliamentary Research Service, 2018).
Corruption is ubiquitous in Russia. It affects Russian entrepreneurs through extortion for bribes when dealing with government authorities, selling firms’ shares at prices set by regional officials, and informal practices used to exert pressure on businesses (Ledeneva & Shekshnia, 2011). Corruption particularly affects SMEs (Safavian et al., 2001). Unlike established producers who are often a part of the government elite, new firms are particularly vulnerable to heavy bribes and expropriations. Thus, corruption reduces innovation and the rate of economic growth (Murphy et al., 1993). It also threatens investment as investors see it as a major concern (Hellman, 1998).
Further, corruption undermines reform efforts (Kuznir, 2016). Many formal laws fail to be implemented because they are out of line with economic interests of certain economic actors (Olimpieva, 2010). Transparency International’s Corruption Index ranked Russia as the most corrupt country in Europe in 2018, and the 42nd most corrupt country in the world (Transparency International, 2018). Putin and Medvedev declared corruption as the main obstacle to economic development and implemented initiatives, including the National Anti-Corruption Plan, to address it. However, these initiatives have not improved corruption in Russia but instead de facto worsened it. Some experts believe that the anti-corruption discourse is unrelated to the practical fight against it. These measures can also be seen as a tool used by the Kremlin to control political elites and members of the opposition (Kuznir, 2016).
Political instability affects Russian businesses in many ways. After Russia’s annexation of Crimea and the resulting sanctions in 2014, foreign investment decreased significantly and the business environment weakened considerably (Kuznir, 2016). Russia’s response illustrated that geopolitics are more important than economic stability (Kuznir, 2016).
There is also significant government and political interference that block business interests. Without political connections, entrepreneurs representing political threats and medium sized businesses are targets of violent pressure from bureaucracy and law enforcement structures. One famous example involves the owner of the leading Russia oil company, Mikhail Khodorkovsky, who was convicted to eleven years in prison. Many businessmen are forced to flee. This political climate undermines efforts to improve business conditions, decelerates economic growth, increases capital flight, and deteriorates the investment climate (Kuznir, 2016; Yakovlev, 2014)
Thus, although improving the regulatory and legal framework is beneficial, there are areas outside the scope of the EDB rankings that significantly affect business conditions. Despite Russia’s reform efforts, deep structural issues such as workforce skills, corruption, and political instability undermine Russia’s business environment. The latter two significantly undermine foreign investment, which is particularly problematic as this investment is vital to Russia’s economic growth (Kuznir, 2016; Yakovlev 2014). Even easing tensions with the West and getting sanctions lifted would be a significant step in the right direction (Sonin, 2019). Overall, substantial reforms addressing deep structural issues are necessary to tangibly improve business conditions for Russia’s SMEs (Aidis &Adachi, 2007; Puffer & McCarthy, 2007). Russia’s improved EDB ranking masks a lack of substantive improvement in these areas.
Hypothesis 4: Heterogeneity by region
Figure 10: Regional Heterogeneity of top three obstacles to Russian business
The fourth hypothesis is that the ranking based on one or two largest cities masks the heterogeneity in the business environment by region. As of 2013, the score for Russia has been calculated based on its first and second largest business cities — Moscow and St. Petersburg — before that it was based on Moscow (World Bank, 2020).
Indeed, Figure 11 shows that in Russia there is considerable heterogeneity by region in what enterprises consider their first, second, and third largest obstacle to operations. Even Moscow and St. Petersburg differed in their three largest constraints. Of the 28 regions covered by BEEPS in 2012, only five replicated the top three perceived obstacles for Moscow: tax rates, access to finance, and workforce skills. Most enterprises in all regions cite tax rates as their largest obstacle. However, there are regions such as Krasnoyarsk and Yaroslavl where most enterprises cite access to finance as their largest obstacle, and in Smolensk, most enterprises cite corruption as their largest obstacle. In Republic of Sakha, an equal amount of enterprises cites business licensing as their largest obstacle to operations as tax rates and access to finance. Although some regulatory areas covered by the EDB indicators such as customs and trade regulations, business licensing, and electricity are not considered large obstacles when looking at data for Russia overall, in multiple regions they are considered first or second priority obstacles.
This insight also suggests that solely looking at the regulatory environment in Moscow and St. Petersburg for calculation of the EDB ranking would be misleading when giving a ranking to the country as a whole and mask the heterogeneity in business environments across the nation.
Hypothesis 5: Gaming
Putin made a presidential decree for Russia to improve in the EDB rankings by 100 points. Supported by the Ministry of Economic Development and the Ministry of Finance, the Agency for Strategic Initiatives (ASI) was founded in 2011 as an independent non-governmental organization with the aim of promoting medium-sized enterprises and improving the business climate, with Putin as the chairman of the supervisory board. As discussed in his February 2012 campaign statement, Putin defined ASI’s agenda to include improving Russia’s rank in the EDB rankings, the development of new criteria to measure bureaucracy performance, and the introduction of business ombudsmen. ASI created guides on how to simplify obtaining construction permits, change customs regulations, boost exports, and create new standards for regional governments’ activity to boost investment. In 2012, the government passed these guides and made them mandatory for government offices. Further, ASI worked with eleven regions to create a project called “Standard of business climate improvement at the regional level” based on evidence of best practices of regional governments’ efforts to boost investor relations. Putin made a presidential decree in September 2012 to use indicators of these standards to evaluate regional governments. Despite ASI’s measures, there has not been an improvement in Russia’s business conditions. Further, experts suspect that regional governments and federal agencies created “dummy panels” with a ceremonious response to higher orders, without any legitimate changes in their interactions with business (Kuznir, 2016; Yakovlev, 2014).
This evidence shows that Russia used the EDB rankings as a policy target, influencing its bureaucracy and regional governments to deliver on its goal of rising in the EDB rankings. Although the goal was achieved, there is limited evidence that business conditions improved.
Discussion
Although not in every area, the analysis found perception of the business environment in topics such as electricity and trading across borders improved, in accordance with EDB related reforms. However, these areas were not considered large obstacles by most enterprises. Yet, Russia continued making reforms in these topics and their ranks improved significantly. For example, despite the fact that only 2% of enterprises cited electricity as their largest obstacle to business in 2012, this topic improved from being the second to worst ranked economy to within the top decile in 2018. This improvement significantly contributes to Russia’s improved aggregate EDB ranking, as each topic is given equal weight. Further, in areas that were considered very large obstacles, such as paying taxes and getting credit, Russia implemented several reforms that increased the topics’ rankings. However, BEEPs data and secondary literature revealed that enterprises continued struggling in these areas. These examples showed that reforms can be made to improve a topic’s ranking despite not addressing the obstacle faced. This is due to the fact that certain sub-indicators used to score the topic were not relevant to enterprises’ obstacles in that area. For example, enterprises struggled getting loans and finding affordable finance in the “getting credit” topic, while the sub-indicators used included strength of legal rights index and depth of credit information index. Additionally, BEEPs data and secondary literature showed that deep structural obstacles such as workforce skills, corruption, and political instability hold Russian enterprises back. Even though improving aspects of the regulatory and legal framework may be beneficial, unless there are substantial reforms addressing these and other deep long-standing structural and institutional issues, there will be little improvement in Russia’s business conditions, resulting in little growth in Russia’s SME sector and poor economic growth (Aidis & Adachi, 2007; Puffer & McCarthy, 2007). Further, BEEPs data shows significant regional heterogeneity in perceived business obstacles, supporting the hypothesis that the rank for Russia based on just Moscow and St. Petersburg masks regional heterogeneity in the business environment. Finally, Putin’s decree to improve Russia’s EDB rank as a policy target and the creation of ASI to influence regional government and bureaucracy to fulfill this goal support the thesis that Russia strategically reformed to improve in the rankings. This is especially problematic in light of the previous sections that illustrated many of the indicators and topics in the EDB rankings were not relevant to alleviating obstacles in the business environment. To meaningfully improve Russia’s business and investment conditions and boost Russian SMEs, there should be greater focus on deep structural and institutional reforms instead of targeting an improved EDB rank that may only improve optics as opposed to catalyze genuine change.
Conclusion
This paper examined the degree to which improvements in a nation’s EDB rank indicated its business conditions improved and what may account for any divergence. Using Russia as a case study, where its EDB rank soared despite a lack of improvement in other metrics of its business environment, this paper concludes that an improving EDB rank does not indicate a nation’s business conditions improved. This question is particularly important to examine due to the EDB rank’s significant influence on international policymaking, investment and aid decisions, and in academia.
The analysis of these hypotheses revealed that in Russia, in some topics that were reformed, such as electricity and trading across borders, perceptions improved. However, hypothesis one concluded these elements of the business environment were not considered large obstacles by most businessmen. Thus, improvements in these topics were not the relevant improvements needed to improve Russia’s business environment. Further, hypothesis two found that topics that were considered large and relevant constraints for most businessmen — such as “Paying Taxes” and “Getting Credit”- improved in the rankings despite still being large obstacles for most businessmen. This hypothesis showed that not all sub-indicators that contribute to a topic’s score are relevant to addressing an obstacle in that area. Additionally, hypothesis three found that areas outside the scope of the EDB index were extremely relevant to Russia’s business conditions, including political instability, corruption, and workforce skills. Scholars agree that unless deep reforms are made to address long-standing structural issues, there will not be any meaningful improvement in Russia’s business environment. Further, hypothesis four found that there is significant regional heterogeneity in perceptions of the business environment and the most relevant obstacles. Thus, the aggregate rank given based solely on Moscow and St. Petersburg may not be relevant to each region individually.
Across these hypotheses, two major themes emerge: relevance and context. The EDB ranking purports to meaningfully signal a nation’s business conditions through assessing 10 topics given equal weight, and each topic with multiple sub-indicators also given equal weight. However, not every topic is relevant, not every sub-indicator is relevant to the topic, and overall, areas outside the scope of the topics covered may be significantly more relevant to the business conditions across nations. Further, indicators of the topics in one to two of the largest business cities in a nation may not be relevant across the nation. Thus, improvements in a nation’s EDB rank does not indicate that the nation’s business environment improved because what the index has captured is not relevant to addressing the most profound constraints to the business environment across the nation.
These themes lead to the fifth hypothesis: gaming. In Russia, Putin targeted improving in the rank as a policy target and created an organization with the agenda of fulfilling this target with influence on governors and federal agencies (Yakovlev, 2014). As discussed by Besley (2015), there has emerged a political economy to the rankings in development policy and Doshi et al. (2019) show the rankings significantly impact nations’ reform agendas. These findings highlight the danger of the rankings. Although the EDB rankings drew attention to previously overlooked regulatory and legal areas of the business environment, its significant influence over policy making is problematic when nations improve their ranks as a policy target, distracting from more worthwhile policies, especially when the EDB rankings are not relevant across and within nations.
This paper has several policy implications. The World Bank should cease ranking nations and instead publish the underlying data and sub- indicator scores. There is no good justification for simply averaging the indicators and sub-indicators to produce aggregate ranks when they are not equally relevant to nations’ business conditions. Further, there are many topics left out of the ranking. Publishing the underlying data and scores would help nations understand their performance in specific areas as opposed to incentivizing them to compete to be a top-performing nation for this sake alone, distracting them from more worthwhile policies.
When working with nations on the EDB report, such as through the Indicator Based Reform Team, the Bank should discourage nations from improving their ranking as a policy target or from taking the EDB reforms as explicit policy prescriptions and instead promote the report as a tool informing policy.
The World Bank should improve transparency on the rankings. In particular, there should be further clarity on methodological changes, the underlying data including contributors’ submissions, and the extent to collaboration with nations’ representatives when creating the EDB reports.
Investors, lenders, and aid organizations should cease using the EDB rankings in criteria or in decisions.
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