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February 26, 2019

Fast Fact: Positive Feedback Loops between Ease of Doing Business and Economic Growth Exist Across Income Groups

In 2016, Stanford Economist John Cochrane correlated economic growth (using the variable GDP Per Capita) and ease of doing business (using the World Bank’s Distance to Frontier score, which is now called the Ease of Doing Business score). He found a tight positive correlation between the business regulatory environment and the level of economic activity in a country. Similarly, our NITI Aayog - IDFC Institute Enterprise Survey observed a virtuous cycle between a better doing business environment and higher per capita income. We found that firms in Indian states with a higher economic growth rate, on average, report a better business regulatory environment (such as in fewer number of days taken to receive approvals, in fewer hours of power/water shortage faced, and in less severe obstacles encountered in doing business) than firms in low growth states. Though we don’t analyse which way relationship flows, the results suggest that causality runs in both directions where each variable reinforces the other (and vice-versa). An updated version of Cochrane’s graph is constructed below:

 

 

Building on this analysis, we split the GDP per capita dataset at the median and reproduced the graph for countries below and above the median respectively:

 

 

 

It is interesting to note that the correlation between economic growth and ease of doing business is tighter for poorer countries (Below Median) than for richer countries (Above Median), but not by a large margin. This strong association holds across countries in different income groups. Hence, it is in the interest of all countries to improve their doing business environments. Some measures towards this end are: streamlining the number of approvals required, enhancing access to finance and availability of credit, and making labour laws more flexible. Better regulatory reforms can attract large investments and increase production of goods and services, thereby augmenting per capita income. Consequently, the feedback loops will perpetuate the positive relationship between economic growth and ease of doing business.

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