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Analysis

Slash regulation to solve productivity puzzle

by Steve Hanke

Slash regulation to solve productivity puzzle

 

Productivity and economic growth continue to disappoint in most countries. Although analysts show a great deal of concern for the so-called ‘productivity puzzle’, little attention is paid to the real solution: freer markets and increased competition. Unfortunately, in most economies, policy is moving in the opposite direction.

The World Bank has rigorously measured the ease of doing business in many countries for more than 10 years, producing an abundance of empirical evidence revealing different aspects of countries’ regulatory environments. The Bank publishes its results identifying levels of economic freedom each year in a report entitled ‘Doing Business’, which details 10 indicators (see Chart 1) that capture important dimensions of an economy’s regulatory environment.

Hanke chart 1

These are each measured by using standardised procedures that ensure comparability and replicability across the 190 countries studied. For each indicator, the scores range from a low of 0, designating failure, to a high of 100 for those countries that excel.

The overall ease of doing business (DB) score for a country is simply its average across the 10 indicators. Using the DB scores, we can determine whether there is a relationship between a freer regulatory environment (a high DB score) and prosperity as measured by GDP per capita. Chart 2 shows there is a strong positive relationship between DB scores and prosperity. The DB score for the US is 82.45, and its GDP per capita is $57,220. Meanwhile Zimbabwe’s DB score is only 47.1, and its GDP per capita is $1,081. All the remaining 188 countries are plotted on the chart. There are only five countries that are outliers with outsized GDP per capita relative to their DB scores: Qatar, Luxembourg, Switzerland, Norway and the microstate of San Marino.

Hanke chart 2

In addition to the positive relationship between regulatory freedom and prosperity, more deregulation yields increasing returns. Each incremental increase in the DB score yields greater gains in GDP per capita. With each improvement in regulatory freedom, there is a disproportionate improvement in prosperity. This explains why post-communist countries that embraced large-scale economic liberalisation, such as Poland, have done noticeably better than those that introduced only gradual changes.

Mimicking best practice
Economic prosperity is, quite literally, a matter of life or death. Higher individual and national incomes produce favourable effects on nutrition, standards of housing and sanitation, and on health and education expenditures.

While reductions in mortality have sometimes been the result of technological factors, it is clear that sustained economic growth is a precondition for the kinds of investments and innovations that, over time, significantly reduce mortality.

Knowing that a freer regulatory environment is associated with higher levels of GDP per capita, onlookers can observe that a freer regulatory environment is associated with higher life expectancies. Chart 3 illustrates the positive relationship between DB scores and life expectancy, albeit one characterised by diminishing returns.

Hanke chart 3

Many of the 190 countries reviewed in the World Bank’s 2017 ‘Doing Business’ report are far away from adopting best practice policies with regard to their regulatory frameworks. Consequently, prosperity and health in these economies are inferior to what they could be.

The easiest way for these countries to improve their regulatory frameworks is to imitate what is done in places where best practice prevails. This is an old and effective technique often used in industry, particularly when competitive markets thrive. The same strategy can be used by governments to slash excessive regulations and bureaucratic nuisances.

The Georgian example
Numerous examples support this position. Before 2009, businesses seeking to import and sell pharmaceuticals in the Republic of Georgia faced the same regulatory review process as if the drugs were produced domestically. Applicants would pay a registration fee and file a two-part form at the ministry of labour, health and social affairs.

The subsequent review process involved both expense and delay, with much deliberation between the applicant and the bureaucracy. This process was not intended to exceed six months, but often took much longer. In addition, the government required all importers to obtain trade licenses from foreign manufacturers, adding to their costs.

This system of government pharmaceuticals approval was costly to administer, and created an uncompetitive market which was dominated by three suppliers – PSP, Aversi, and GPC – which sold around 75% of all medicines consumed in Georgia. Prices tended to be high relative to Georgian incomes, and the number of treatments on the market was lower than in many other countries.

In October 2009, however, the Georgian government adopted a new ‘approval regime’. It compiled a list of foreign authorities with good regulatory track records so pharmaceuticals approved for sale by those entities could gain automatic consent in Georgia. In addition, registration fees were slashed by 80% for brand-name drugs, and packaging regulations were greatly simplified under a new reporting regime.

This regulatory outsourcing reduced the time and expense required to compete in the Georgian market. It was anticipated this would put significant downward pressure on prices and improve access to drug therapies in the domestic market. As Chart 4 shows, it did so quickly.
Georgia’s move to outsource regulation was not the only reform it implemented over the last two decades. Led by the late Kakha Bendukidze, economy minister between 2004-08 and a well-known free-market advocate, Georgia has since 2003 made sweeping free market reforms as part of its post-communist transformation. The country’s World Bank DB score increased rapidly during this period. In the 2017 report, it ranks 16th overall, just above Germany.

Hanke chart 4

Since 2003, Georgia’s GDP per capita has increased at an average annual rate of 6.4%. This is no coincidence. By inspecting and quantifying the various aspects of business regulation in its economy, Georgia could identify individual factors inhibiting business growth.

Georgia’s path shows that a country can unlock huge potential for increasing productivity, prosperity, and health by adjusting rules and regulations to allow the private sector to thrive. The productivity puzzle is easy to solve. Other countries would be well advised to mimic the Georgian example and slash red tape.

Steve Hanke is a Professor of Applied Economics at The Johns Hopkins University, Baltimore.

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