Archives For World Bank

The way less travelled…

accapr —  12 November 2013 — Leave a comment

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By Jason Piper, tax and business law manager, ACCA

How can governments use the tax system to promote economic growth? The stock answer is ‘reducing the burden of taxation on business’, or some similar form of words. Across the world, policy makers have answered the call by cutting the rates of tax, and in some cases the base on which that tax is levied. And the result has been concerns about the race to the bottom, and a focus on who may be making up the shortfall in domestic treasury receipts if companies aren’t paying the tax.

But 8 years of research from the World Bank suggests that governments may be missing a trick in focussing on the direct tax charge recorded in the accounts as they try to attract new business to invest in their jurisdiction. Although the correlation hasn’t been tested to scientifically confirm the link, economic growth across the hundred or so economies measured in the annual ‘Paying Taxes’ survey is linked more closely to reductions in the administrative burden of complying with the tax system than it is with the actual rates applied. (You can find the 2013 survey, which sets out the conclusions, here ) To put it another way, business is more worried about how hard it is to fill the forms in than it is what numbers actually go into it.

There’s an obvious logic when you think about it – time spent on tax compliance is specifically diverted away from the productive efforts of the business. Reducing the time spent on administration will increase the time available for creation of economic wealth. On the other hand, changing tax rates (the distribution of the profits already earned) simply reallocates the existing wealth in the system. For that reallocation to actually promote growth, it needs to be reinvested by the business, and for it to promote the maximum amount of growth the business return has to be greater than the multiplier effect of the equivalent public spending funded by the taxation. And while you can argue about the relative multiplier effects of private or public sector investment, the fact remains that any growth based on that investment is only going to come on stream some time in the future; the extra hours spent on making product, or chasing sales, this year will have an impact straight away. The opportunity cost of wasting business time on sterile administrative bureaucracy is, or certainly should be, clear.

So what can governments do to reduce that administrative burden? Well, keeping taxes simple is the answer. Of course that’s easier said than done, and as ACCA’s paper on Simplicity in the Tax System explores there is a tremendous amount to think about. Key to the whole affair though is clarity of mind and clarity of purpose from the policy makers. If a single tax is expected to perform several roles then it’s inevitable that there will be tensions in how it is set up, and between the different outcomes it is supposed to deliver. Society as a whole pays the price of undue complexity in the tax system, and politicians owe it to us all to think more carefully about the broader impact of every tweak to the system, every tinker at the edges – and to shift the direction of travel towards simplification, rather than rate reduction.

This is the first of a series of case studies called ‘Financing the Global Recovery.’ The series is based on interviews with ACCA members and aims to share their first-hand experiences of raising finance across borders and the lessons they’ve learned over the past few years.

With the exception of the World Bank Group and its subsidiaries, the names of all companies involved in this particular case study, as well as the locations in which they are active, have been altered to protect the identity of the interviewee.

About the project

Mr P (an ACCA member) was until recently Finance Manager at KB Power Ltd, a special purpose vehicle (SPV) created by BW Energy Company (BWEC) to support a World Bank-funded hydropower project in a landlocked frontier market in South Asia (the Host Country).

The KBA project aims to create a capacity of 37.6 MW or 201 GWhs of energy generation per year; it involves diverting a nearby river through a 4.3m tunnel at a significant elevation above sea level. Following approval by the Host Country’s government in October 2009, the contract for KBA was awarded to BWEC and a project development agreement (PDA) was signed in January 2010. Energy production is expected to begin in September 2015.

Financing KBA

Financing a project of this magnitude requires a great deal of expertise, and KBA has from the beginning involved different parts of the World Bank Group; most notably the International Finance Corporation (IFC) and International Development Association (IDA). However, it is ultimately KB Power Ltd that has executed the Project Development Agreement with the Host Country Government, promising to develop the project on a Build-Own-Operate-Transfer (BOOT) basis.

To deliver the project, KB Power requires ca. $78m of debt and equity at a ratio of 77.5:22.5 respectively, with the World Bank providing about $50m of the credit required. KB Power therefore approached local commercial banks to form a financial consortium that would provide the remaining $10.5m, while also looking into the possibility of raising quasi-equity funding from the IFC. In addition to a much needed injection of funds and expertise, either of these financing options would provide a strong external signal: the IFC only invests in for-profit projects and typically requires an exit mechanism, hence its involvement would provide a vote of confidence; domestic banks, on the other hand, could signal their maturity and their involvement would instil confidence in the Host Country’s financial services sector.

Although the Host Country is still in all respects a frontier market, Mr. P notes that its private commercial banks are innovative and highly customer-focused, with a strong drive to provide value-added services. In recent years, they have rolled out innovative products such as targeted sector loans, as well as a number of foreign deals to simplify remittances and worldwide banking facilities for Host Country citizens working abroad. Local banks, he notes, would also stand to gain substantially by providing trade finance and Letters of Credit to facilitate the import of huge amounts of high value-added technology equipment for the purposes of KBA. Nonetheless, the current political deadlock has made the formation of a consortium of local banks impossible.

Easier said than done

As with any internationally-funded power project, KBA involves substantial risk. However, most problematic is the fact that all funding will be channelled through the Host Country’s Government, which essentially borrows the funds from the World Bank to lend on to KB Power.

Crucially, it is up to the Host Country’s Government to finalise the transaction, after which the World Bank should start to disburse its share of the funds within as little as six months. Funds will be released on a proportionate basis and subject to both monitoring of each phase of construction and evaluation by a panel of experts.

Interest on the World Bank’s loan to the Government is 4%, a very good rate keeping in mind the Host Country’s poor repayment record, the Government’s fiscal constraints and what Mr. P calls a ‘dire’ need for hydropower generation in the Host Country. But the interest charged to BWEC/KB was originally at 10.5% and likely to rise further under a revised Power Purchase Agreement between the two. This has made the financing of the project very expensive and made the rate of return unattractive to promoters.

However, the cost of capital is just one of a number of ways in which reliance on Government is complicating the financing of KBA, which remains only partially funded as of July 2013.

During 2012 and 2013, the Host Country faced a constitutional crisis as the Constituent Assembly was dismissed in June 2012, having failed to ratify a new constitution in what international stakeholders called ‘a serious setback’ for the country’s economy. Subsequently, elections for a new Constituent assembly were repeatedly delayed, leaving a caretaker government in charge. Moreover, as agreement on a detailed full-year budget for 2012/13 remained elusive, the Host Country headed into its very own ‘fiscal cliffl,’ unable to mobilise public spending.

Mr. P noted that this pattern of political instability in the country had created substantial delays in the design and financing of the project; “the many slow-working faces of bureaucracy and political intervention” have held back what promises to be a valuable investment.

There will be a next time

Thinking of potential future projects, Mr P’s suggestion would be to reduce reliance on government funding – direct private investment, whether local or foreign would have reduced the level of intervention and avoided bottlenecks.

The World Bank and IFC, he says, should consider channelling their loans through more accessible means, while insisting on transparency, proper internal controls, audit, due diligence and expert advice at each phase of the project. In particular, he notes that using high quality local expertise can prevent substantial repatriations of money out of the Host Country.

Emmanouil (Manos) Schizas

By Manos Schizas, senior economic analyst, ACCA

Ever heard that your country is the nth best place in the world in which to do business? Have you chuckled or raged at the list of developing countries that rank inexplicably higher? If you have, chances are you have heard of the World Bank’s Doing Business reports. What you may not have heard of is that these rankings very nearly ended up being consigned to history this summer.

On 24 June 2013, the Independent Panel reviewing the Doing Business methodology reported on its findings and recommendations. The most controversial of them all? Scrap those pesky country rankings. To understand how they came to suggest this, and whether this is a good idea, you need a little bit of background.

The study itself

The Doing Business methodology is based on replicating the hoops a medium-sized (eventual headcount of ca. 60 employees) formal business has to jump through throughout its lifecycle: Starting up, dealing with construction permits, getting electricity, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts, and resolving insolvency. The researchers then assign scores to each category, with countries with low levels of burden scoring higher, and aggregates those into a single ‘Doing Business’ score for the country.

Drawing on published documents and the experience of professional advisers (see here for a full listing), the methodology generally considers three types of burden: time, money, and access to legal instruments or information; all measured in standardised increments. Any distinct ‘process’ is assumed to take at least a day (even if one could, in theory, conduct it in seconds or simultaneously with other processes). Costs are standardised as shares of each country’s per capita GDP. Businesses are assumed in most cases to be located in the country’s capital city. The list goes on, but you get the picture. There are substantial limitations that casual readers will tend to ignore, or dismiss.

Incidentally, some of these topic names are misleading too. ‘Getting credit’, for instance, does not reflect the ease of getting credit in a country. Rather, it reflects how burdensome it is for a lender to provide a business with credit – can they get sufficient credit information on the borrower, for example? Or how easily can they enforce a claim?

Even worse, measurement errors can make any such composite rankings nearly irrelevant. The Independent Panel cited evidence that measurement errors alone can change the Doing Business ranking of a mid-ranking country such as Vietnam by about 30 places.

Finally, the way topic scores are aggregated into a single country score assumes that all elements of the Doing Business indicators are equally important (i.e. it applies no weighting). This is clearly not true as the importance of different obstacles shifts within a business’ lifecycle and between different stages of economic development. Burdens, moreover, do not accumulate in an additive way: being unable to access electricity, for instance, would make it irrelevant how well regulated the business is in other respects.

The Magic Circle

Doing Business was, from its inception, part of an elite group of global policy-relevant publications. If you’re interested in such data you will no doubt have your own list, but here’s mine:

To make this Magic Circle, a publication needs to offer regular, scheduled releases and a guarantee of longevity. But it also needs to produce two things that policy wonks crave: first, summary tables that condense a range of very complex issues into standard, quantitative information. Second, country scores and rankings covering a three-digit number of countries – ideally downloadable through a user-friendly interface.

The first of these features is valuable because the policy industry has, over time, become more standardised and de-skilled, relying on large numbers of bright but relatively inexperienced graduates. Sitting on top of these four datasets, one can offer sage opinions on Cambodia’s regulatory shortcomings or key medium-term challenges for Burkina Faso without being able to point to either on a map.

The second feature, national scores and rankings, is important for three reasons. First, because rankings ensure a high profile for otherwise dry subjects; they inject an element of urgency and national pride into matters that are otherwise hard for either politicians or Joe Public to care about. Second, because rankings point out best practice. The world is an impossibly big place and most people will never see much of it, so it is hard to know which countries have the best-financed small businesses, much less what one might be able to learn from them. And finally, because scores can be correlated with other variables, such as per capita GDP or unemployment, in order to demonstrate the potential impact of reforms.

The Crisis and the Critics

This is not the first time in its 10-year history that the Doing Business methodology has come under scrutiny. Despite DB’s many methodological flaws, the reason for such attention often has little to do with the quality of the work itself – simply put, Doing Business influences policy and occasionally capital allocations on a global scale. You can’t do that without making enemies.

As DB became more successful in setting the agenda for regulatory reform, especially in the developing world, stakeholders began to take particular issue (see here, here, here and here) with the ‘Employing Workers’ pillar of the DB index, which measured the ease and cost of hiring and (crucially) firing across countries. The charge was that both the DB methodology and the World Bank’s commentary rewarded reforms that served to reduce employment protection, including some in breach of the International Labour Organisation’s (ILO) guidelines.

It was becoming unclear whether the ‘Employing Workers’ score was measuring genuine ease of doing business or whether it was an ideologically-driven measure of the balance of power between employees and employers. Similarly, the ‘Paying Taxes’ score, it was argued, largely reflected countries’ political preference for a big or small state and the ability of some nations to rely on natural resource revenues rather than tax to finance the state.

Eventually, and despite having published an independent evaluation already in 2008, in 2009 the World Bank asked a Consultative Group representing Unions, civil society organisations, businesses and the legal profession to review its methodology once again. This new Group reported on its findings in 2011and the World Bank has not reported Employing Workers scores ever since.

These debates are typical of a wider debate on Better Regulation – that of accounting for the benefits of regulation to small business (see here for a nuanced discussion).

Cost and benefits are properties of the entire regulatory framework related to business activity and must be seen in context. Providing information to government or a third party is costly but whether or not it is a burden depends on what the entity would have done without coercion and what the market and society get in return. Being pro-market and being pro-business are two different things and it is dangerous to confuse them. This was, in fact, ACCA’s rationale when we lobbied against the European Commission’s proposals to exempt micro-companies from the need to file annual accounts.

ACCA’s brief experience of Doing Business

As a global organisation, ACCA often has good reason to use such datasets too. A good example can be found here. It is taken from our Accountants for Small Business report), where we demonstrate (tentatively) that the financial system is better able to allocate capital to SMEs in countries where more borrower information and legal protection are available to finance providers.

But we’ve also been more intimately involved from time to time. Back in 2009, the UK was in the throes of a regulatory reform fever, which we reviewed in our report, Coming of Age: What next for the UK Regulatory Reform Agenda? as well as a detailed submission to the UK Regulatory Reform Committee. As part of this range of activities, the Better Regulation Executive within the UK’s Department for Business, Innovation and Skills (BIS) was actively considering ways of improving the UK’s already-high Doing Business ranking, so they spoke to ACCA about company registration and taxation, as well as the general governance of regulatory reform. By 2010, the UK had overtaken Denmark to become –quite symbolically- Europe’s ‘best place to start and grow a business.’

The BIS staff even presented their thoughts to ACCA’s UK Small Business Forum, and were extremely honest and clear about the following:

  1. Britain’s high rankings on Ease of Doing Business helped put into context the constant complaints from small business bodies about how over-regulated their members were.
  2. the government of the day had made a political decision not to try to improve Britain’s Employing Workers ranking (Britain’s weakest DB score at the time) as the financial crisis had increased support for regulation in this area
  3. they found Doing Business to be methodologically flawed and were discussing their concerns with the World Bank and IFC.
  4. they were keen for a greater and more varied pool of expert contributors (including accountants) to become involved in informing the Doing Business scores.
  5. they believed there were limits to how high a liberal democracy and EU member could rank on Doing Business, as well as how quickly they could climb in the rankings.
  6. That they nevertheless thought the ranking element of Doing Business was crucial to their efforts to raise the profile of the regulatory reform agenda with ministers.

This last point is crucial. Kai Wegrich of the Hertie School of Governance has demonstrated that, once a critical mass of countries have adopted a particular regulatory reform tool, a race of ‘leaders v. laggards’ tends to develop that spurs more countries to adopt whatever methodologies are seen as best practice for fear of being left behind on a regional or global basis. Tools such as Doing Business create a drive for reform and convergence.

Besides the UK, the Doing Business disciples are not a collection of aid-dependent emerging markets at the mercy of the Washington Consensus – Russia, for instance, had a stated target of getting to the top 20 by 2018 (from 112th place in 2013), and was hoping to attract increased foreign investment in the process.

This time the critics mean business

Why then is this year’s review different? First, because it reflects the growing assertiveness of the BRICSA countries, whose representatives instigated the review in the first place. Forbes hints strongly that the review panel was intentionally balanced between BRICSA and non-BRICSA representatives. Second, because it comes at a time of increased questioning of top-down reforms based on the notion of ‘quality of institutions’.

Essentially, this wonkish debate is part of the much bigger tectonic shift currently underway in what people call the Washington Consensus. Emerging markets are claiming their place in global governance and at the helm of the international institutions that once dictated policy to them. For now, the World Bank’s President has indicated that ‘rankings are part of [Doing Business’] success,’ which I guess must mean they are here to stay. But little by little, the World Bank, and the World, are changing.