What is Ease of Doing Business? How it is Determined?

Definition: Ease of doing business is an index published by the World Bank. It is an aggregate figure that includes different parameters which define the ease of doing business in a country.

Description: It is computed by aggregating the distance to frontier scores of different economies. The distance to frontier score uses the ‘regulatory best practices’ for doing business as the parameter and benchmark economies according to that parameter.

For each of the indicators that form a part of the statistic ‘Ease of doing business,’ a distance to frontier score is computed and all the scores are aggregated. The aggregated score becomes the Ease of doing business index.

Indicators for which distance to frontier is computed include: Starting a Business, Dealing with Construction Permits, Getting Electricity, Registering Property, Getting Credit, Protecting Minority Investors, Paying Taxes, Trading Across Borders, Enforcing Contracts, Resolving Insolvency, Ease of Doing Business Score. Countries are ranked as per the index.

Ease of doing business score and ease of doing business ranking:

Doing Business presents results for two aggregate measures: the ease of doing business score and the ease of doing business ranking, which is based on the ease of doing business score. The ease of doing business ranking compares economies with one another; the ease of doing business scores benchmark economies with respect to regulatory best practice, showing the proximity to the best regulatory performance on each Doing Business indicator.When compared across years, the ease of doing business score shows how much the regulatory environment for local entrepreneurs in an economy has changed over time in absolute terms, whereas the ease of doing business ranking shows only how much the regulatory environment has changed relative to that in other economies.

Ease of doing business ranking
The ease of doing business ranking ranges from 1 to 190. The ranking of economies is determined by sorting the aggregate ease of doing business scores.

Doing Business 2020 uses a simple method to calculate which economies improved the ease of doing business scores the most.

First, it selects the economies that in 2018/19 implemented regulatory reforms making it easier to do business in 3 or more of the 10 topics included in this year’s aggregate ease of doing business score.

Second, Doing Business sorts these economies on the increase in their ease of  doing business score over the previous year,  and the scores for both years are calculated using the same macroeconomic data (such as income per capita and currency conversion rates) to remove the effect of changes in these variables.

Selecting the economies that implemented regulatory reforms in at least three topics and had the biggest improvements in their ease of doing business scores is intended to highlight economies with ongoing, broad based reform programs. The improvement in the ease of doing business score is used to identify the top improvers because it allows a focus on the absolute improvement in contrast with the relative improvement shown by a change in rankings that economies have made in their regulatory environment for business.

Ease of doing business score

The ease of doing business score measures an economy’s performance with respect to a measure of regulatory best practice across the entire sample   of 41 indicators for 10 Doing Business topics (the employing workers and contracting with the government indicators are excluded). For starting a business, for example, Georgia and New Zealand have the lowest number of procedures required (1). New Zealand also holds the shortest time to start a business (0.5 days), whereas Rwanda and Slovenia have the lowest cost (0.0). Australia, Colombia, and 118 other economies have no paid-in minimum capital requirement.

Calculation of the ease of doing business score

Calculating the ease of doing business score for each economy involves two main steps.

1.In the first step individual component indicators are normalized to a common unit where each of the 41 component indicators y (except for the total tax and contribution rate) is rescaled using the linear transformation (worst – y)/(worst – best).

In this formulation the highest score represents the best regulatory performance on the indicator across all economies since 2005 or the third year in which data for the indicator were collected.

Both the best regulatory performance and the worst regulatory performance are established every five years on the basis of the Doing Business data for the year in which they are established and remain at that level for the five years regardless of any changes in data in interim years. Thus an economy may establish the best regulatory performance for an indicator even though it may not have the highest score in a subsequent year.

Conversely, an economy may score higher than the best regulatory performance if the economy reforms after the best regulatory performance is set.

For example, the best regulatory performance for the time to get electricity is set at 18 days. In the Republic of Korea it now takes 13 days to get electricity, and in the United Arab Emirates it takes just 7 days. 

Although the two economies have different times, both economies score 100 on the time to get electricity because they have exceeded the threshold of 18 days.

For scores on indexes such as the strength of legal rights index or the quality of land administration index, the best regulatory performance is set at the highest possible value (although no economy has yet reached that value in the case of the latter). 

For the total tax and contribution rate, consistent with the use of a threshold in calculating the rankings on this indicator, the best regulatory performance is defined as the total tax and contribution rate at the 15th percentile of the overall distribution for all years included in the analysis up to and including Doing Business 2015.

For the time to pay taxes, the best regulatory performance is defined as the lowest time recorded among all economies that levy the three major taxes: profit tax, labor taxes and mandatory contributions, and value added tax (VAT) or sales tax. For the different times to trade across borders, the best regulatory performance is defined as one hour even though in many economies the time is less than that.

In the same formulation, to mitigate the effects of extreme outliers in the distributions of the re-scaled data for most component indicators (very few economies need 700 days to complete the procedures to start a business, but many need 9 days), the worst performance is calculated after the removal of outliers. The definition of outliers is based on the distribution for each component indicator. 

To simplify the process two rules were defined: the 95th percentile is used for the indicators with the most dispersed distributions (including minimum capital, number of payments to pay taxes, and the time and cost indicators), and the 99th percentile is used for number   of procedures. No outlier is removed for component indicators bound by definition or construction, including legal index scores (such as the depth of credit information index, extent of disclosure index, and strength of insolvency framework index) and the recovery rate.

2. In the second step for calculating the ease of doing business score, the scores obtained for individual indicators for each economy are aggregated through simple averaging into one score, first for each topic and then across all 10 topics: starting a business, dealing with construction permits, getting electricity, registering property, getting credit, protecting minority investors, paying taxes, trading across borders, enforcing contracts, and resolving insolvency. More complex aggregation methods—such as principal components and unobserved components—yield a ranking nearly identical to the simple average used by Doing Business. Thus Doing Business uses the simplest method: weighting all topics equally and, within each topic, giving equal weight to each of the topic components.

An economy’s score is indicated on a scale from 0 to 100, where 0 represents the worst regulatory performance and 100 the best regulatory performance. All topic ranking calculations and the ease of doing business ranking calculations are based on scores without rounding.

The difference between an economy’s score in any previous year and its score in Doing Business 2020 illustrates the extent to which the economy has changed in its business regulatory environment over time. In any given year, the score measures how close an economy is to the best regulatory performance at that time.

Treatment of the total tax and contribution rate

The total tax and contribution rate component of the paying taxes topic enters the score calculation in a different way than any other indicator. The score obtained for the total tax and contribution rate is transformed in a nonlinear fashion before it enters the score for paying taxes. As a result of the nonlinear transformation, an increase in the total tax and contribution rate has a smaller impact on the score for the total tax and contribution rate and therefore on the score for paying taxes for economies with a below-average total tax and contribution rate than it would have had before this approach was adopted in Doing Business 2015. For economies with an extreme total tax and contribution rate (a rate that is very high relative to the average), an increase has a greater impact on both these scores than it would have had before.

The nonlinear transformation is not based on any economic theory of   an “optimal tax rate” that minimizes distortions or maximizes efficiency in an economy’s overall tax system. Instead, it is mainly empirical in nature.

The    nonlinear   transformation along with the threshold reduces the bias in the indicator toward economies that do not need to levy significant taxes on companies like the Doing Business standardized case study company because they raise public revenue in other ways for example, through taxes on foreign companies, through taxes on sectors other than manufacturing, or from natural resources (all of which are outside the scope of  the methodology). In addition, it acknowledges the need of economies to collect taxes from firms.

Calculation of scores for economies with two cities covered

For each of the 11 economies in which Doing Business collects data for the second largest business city as well as the largest one, the score is calculated as the population weighted average of the scores for these two cities. This calculation is done for the aggregate ease of doing business score, the scores for each topic, and the scores for all the component indicators for each topic.

Variability of economies’ scores across topics

 Each Doing Business topic measures a different aspect of the business regulatory environment. The scores and associated rankings of an economy can vary, sometimes significantly, across topics. The average correlation coefficient between the 10 topics included in the aggregate ease of doing business score is 0.50, and the coefficients between two topics range from 0.32 (between getting credit and paying taxes) to 0.68 (between dealing with construction permits and getting electricity). These correlations suggest that economies rarely score universally well or universally badly on Doing Business topics.

Variation in performance across topics is not at all unusual. It reflects differences in the degree of priority that government authorities give to particular areas of business regulation reform and in the ability of different government agencies to deliver tangible results in their area of responsibility.

Change in the score gap

Many topics assess the impact of data changes on the basis of the absolute change in the overall score of the indicator set and the change in the relative score gap. The change in the score gap or the distance to the best regulatory performance is defined as (score prior year – score current year)/(100 – score prior year), where “score” is the aggregate score for the specific topic. For indicators using macroeconomic variables, such as the cost of starting a business as a percentage of income per capita, the macroeconomic data for the prior year are used to control for exogenous factors such as a change in income per capita. For example, in 2018/19 Papua New Guinea reduced the time and cost to trade across borders, resulting in an improvement in its aggregate score for trading across borders from 60.5 to 65.8. This improved the overall score by 65.8 – 60.5 or 5.3 points, and reduced the score gap for Papua New Guinea by (60.5 – 65.8)/(100 – 60.5) or 13.4% on trading across borders in Doing Business 2020.