Must-read: Evan Soltas: “Is Pro-Business Reform Pro-Growth?”

Must-Read: A very interesting and smart early cut at the data on “business climate” reforms and growth from the extremely-sharp young whippersnapper Evan Soltas:

Evan Soltas: Is Pro-Business Reform Pro-Growth?: “I came up a simple trick to identify reforms directly from the World Bank data…

…I calculate the rolling sum of all the increases in the [Business Climate] index that are larger than some threshold kappa, which I define as the 95th percentile of all annual changes…. This is, I think, a reasonable way of doing things: Even if you are distrustful of the index, as am I, if the World Bank says that your country is in the top 5 percent of reformers in some year, there’s probably something to that…. According to this measure, 36 percent of countries had at least one reform in my sample, the average reform entailed an 18-point increase in the index, and there are 109 reform years across countries….

Using data from the Penn World Table on output-side real GDP per capita at chained PPPs…. The latest batch of data covers up to 2012, and the World Bank data begins in 2004, so my analysis is limited to that time period…. Burkina Faso is not many times poorer than the U.S. only because it is many times easier to do business in the U.S. than in Burkina Faso…. To identify the causal effect, we should consider whether a country’s per-capita output rises after a reform relative to similar countries in the same year…. I [find I] can bound the effect of pro-business reforms quite precisely around zero, with a 95-percent confidence interval for the effect of a 10-point reform on the level of per-capita output of -1.4 percent to 3.5 percent. That is far away from the claim that such a reform could double per-capita output….

It’s reasonable to think that the effect of reforms on output lags the reform, but these results are unchanged when I include lags of the reform and drift components…. Another claim one might make is that the effects of reform are being obscured by differences in the path of output across regions or income groups (e.g., low-income countries)…. I can control for it by interacting region or income-group dummy variables with the year dummies…. What these tests show is that my results aren’t unduly sensitive to the manner in which I measure the effect of pro-business reforms….

The issue of pro-business reform is most relevant to developing countries with weak institutions, who face meaningful pressure from international organizations like the World Bank to implement them. Yet the data give little reason to believe that countries can raise per-capita output in any notable way by making it easier for entrepreneurs to do business. Pro-business reforms probably have very limited effects, if any, on economic growth within a reasonable time horizon. There still may be compelling reasons to do them…. More prosaically, there are important limits to my empirical analysis. If the impacts of these reforms only begin to manifest themselves more than five years later, for instance, I won’t be able to see that. Measuring longer-run effects will have to wait for more data….

The lesson here is to beware the TED-talk version of development economics. Shortening the time it takes to incorporate a small business is not a substitute for deeper institutional reforms, such as those that support investment in human and physical capital, remove economic barriers that hold back women and ethnic or religious minorities, or improve transportation, power, and sanitation infrastructure. Easy pro-business reforms should not distract countries from pursuing changes that, while harder to make, we know to be richly rewarding in the long run.

I confess to being surprised: I am enough of a card-carrying neoliberal still to have expected modest positive effects…

May 7, 2016


Brad DeLong
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