The indicators of institutional reforms
Since 2004, Doing Business has been tracking reforms aimed at simplifying business regulations, strengthening property rights, opening up access to credit and enforcing contracts by measuring their impact on ten indicator sets. According to Doing Business (2009), a few years of Doing Business data have enabled a growing body of research on how performance on Doing Business indicators (and reforms relevant to those indicators) relate to desired social and economic outcomes. Among the findings are:
- • Lower barriers to start-up are associated with a smaller informal sector;
- • Lower costs of entry can encourage entrepreneurship and reduce corruption;
- • Simpler start-up can translate into greater employment opportunities.
Castro et al. (2004) seek to answer the question of whether investor protection promotes economic growth. They show through a theoretical model that investor protection has two opposing effects on economic growth. First, the demand effect that improved investor protection leads to better risk-sharing, which promotes a strong demand for capital. This effect implies a positive relationship between investor protection and economic growth. Second, the effect of supply works in the opposite direction - better investor protection implies a higher interest rate due to changes in demand forecasts, which in turn reduces the income of entrepreneurs.
Empirically La Porta et at. (1998) show that the effect of supply is lower than the demand effect in countries with lower restrictions on capital flows. If investors are not protected, the financial markets fail to grow and banks become the only sources of funding. Therefore, companies fail to reach the size they would need to be competitive because of inadequate funding, which hampers economic growth. The existence of legal and regulatory instruments to protect investors account for more investment decisions than the characteristics of the business (World Bank 2008).
Other studies, such as that of Haidar (2009), confirm that the level of investor protection determines the differences in GDP growth between countries, countries with better protection for investors growing faster than those with low protection. Economies that rank among the best in the index of investor protection impose strict conditions for disclosure of information to shareholders and give general access to information, both before and during court proceedings, so determine the liability of directors.
Using a cross-sectional analysis, Perotti and Volpin (2006) show that the rate of entry of new firms and the total number of procedures are positively correlated with investor protection in areas that are financially dependent. Then countries with greater credibility of political institutions have better investor protection and a low entry cost. The results show also that investor protection depends on both the quality of legal rules and their performance; it is influenced by politicians and bureaucrats. Weak contract enforcement reduces access to finance and creates an effective barrier to entry for poor entrepreneurs.