Why Business Environment Reform

A) General rationale for Business Environment Reform

The business environment can be defined as a complex of policy, legal, institutional, and regulatory conditions that govern business activities. It is a sub-set of the investment climate and includes the administration and enforcement mechanisms established to implement government policy, as well as the institutional arrangements that influence the way key actors operate (e.g., government agencies, regulatory authorities, and business membership organisations including businesswomen associations, civil society organisations, trade unions, etc) (DCED, 2008).

Along with other private sector development initiatives, the business environment affects the performance of private enterprises in both the formal and informal economies. Business environment reform promotes the development of markets that encourage competition and enhance the effectiveness and sustainability of other development interventions. A conducive business environment is one of the pre-requisites for economic growth and poverty reduction.

The positive impact of economic growth on poverty reduction has often been questioned in development circles. Some evidence has however been presented for this; for example, Ravaillon finds that a one percent increase in mean income is associated with an average 2.5 percent reduction in the poverty rate in 50 developing countries (with individual poverty reduction rates ranging from 0.6 to 3.5 percent). DFID argues that “growth accounts for more than 80% of poverty reduction, and has lifted 500 million people above the poverty line since 1980, while less than 20% came as a result of changes in inequality. In East Asia, where growth has averaged 9% a year over the last 15 years, 300 million people are no longer poor” (DFID, 2008).

However, in many developing and transition countries, the business environment is hostile to market-led growth; private enterprises suffer excessive regulatory barriers and in most respects regulatory costs are higher than in developed economies ( Bannock et.al., 2002) Poor business environments are also more likely to have a disproportional negative impact on women-owned businesses, which are more likely to remain informal. It is recognised that good regulations are necessary to secure benefits, protect workers, consumers and the environment, to promote the rule of law and for the efficient functioning of market economies.

Development agencies design reform support programmes in developing and transition countries that create a business environment more conducive to the growth and competitiveness of the private sector, by reducing legal, institutional and regulatory constraints for doing business.

 

B) Sequence of expected results in Business Environment Reform Programmes

Typically, business environment reforms are designed to bring about one or several of the following three direct results:

  • More firms are encouraged to start-up or register as formal businesses, for example as a result of simplified business registration procedures or tax incentives.
  • Firms invest more following the improvement of legislative or regulatory frameworks, or otherwise change their behaviour in ways that are conducive to their business.
  • Firms directly increase their sales/turnover or net income, for example through the removal of trade barriers or savings from more efficient licensing and inspections processes.

In addition, increases in firm turnover and/ or profit can be the outcome of one of the following scenarios:

  • Formalisation enables businesses to grow in turnover/ profit.
  • A change in firm behaviour, for example the use of new legal opportunities that allow firms to save money, leads to increased turnover/ profit.
  • Formalisation allows businesses to become more productive, for example by gaining access to government services, which in turn increases profitability.
  • A change in firm behaviour, such as the investment in new technologies, leads to greater productivity, which in turn increases profitability.

When a business is started, this obviously has a direct positive impact on employment at the firm-level, at the minimum for the entrepreneur himself. Moreover, expected or actual increases in firm turnover/ profit as a result of business environment reforms can lead firms to expand and employ more people.

Finally, by causing improvements in firm productivity and firm turnover/profit, business environment reforms are expected to contribute to aggregate economic growth.

 

C) More information: success stories and research on evidence