The higher the cost of entry, the lesser the number of new enterprises.
The cost associated with starting a business is a very important factor in determining the number of new businesses that enters a market. The higher the cost of entry, the lesser the number of new enterprises in the industry. Entrepreneurs then tend to prefer the non-formal economy to the formal. The effects of such is far-reaching.
On one hand, the entrepreneurs are forced to compromise any prospects of growth as operating in the non-formal sector means that their access to finance, volume of business, protection of properties, enforceability of their agreements with other parties are null to limited (at best). On the other hand, the consumers are also worse-off because now the competition in the formal sector is effectively curtailed and as a result, the consumers’ choices in terms of quality of products and prices are also reduced. Clearly then, it is on every party’s best interest to have a low cost of starting a business.
What are the costs associated?
First, there is the monetary cost, and then, the non-monetary. According to the World Bank’s Doing Business Report (2016), the monetary cost of starting a business in Nepal is 28.4 percent of GDP per capita (which is more than twenty thousand rupees). And that is only considering the cost of registering at the Office of Company Registrar, the Inland Revenue Office, getting a company rubber stamp, and enrolling the employees in the Provident Fund. But, for an entrepreneur to be able to operate his business (from the moment he starts his company registration process), he needs to get permission from the department of industry/cottage and small industry under concurrence of the associated ministry (say, agriculture or tourism, depending on the nature of the enterprise), register at the local agencies like the municipality/VDC, do an Environmental Impact Assessment (EiA), manage electricity supply for his enterprise, etc. So there is a whole host of other things that the report does not look into, and yet, the monetary cost of starting a business is massive.
Then, there is the non-monetary cost. For example, there are cases in Nepal where it has taken more than three years for an aspiring entrepreneur to get a clearance on EIA from the Department of Industries. With this, comes a huge opportunity cost. Also, if entrepreneurs got EIA clearances in (say) two weeks, instead of anything between a few months to a few years, the entrepreneur could have already started his business and started making money. The amount of time, energy and forgone revenue are also his costs. And then there are costs associated with acquiring professional/legal services should the aspiring entrepreneur choose to save his personal time and effort – costs that could have been avoided with a clear and simple process.
Apart from the cost to entrepreneurs, the government also has to bear the cost of administration of the works related to registration of businesses. As there are multiple number of government agencies that are involved in the process of business registration, it has increased the cost of regulating entry (of new businesses into the industry).
The agencies that are involved in the business registration process are Office of the company registrar, Office of Cottage and Small Industries, Commerce Office and Inland Revenue Office. Excluding the cost of operation of Office of the Company Registrar, the operation costs of other agencies regarding business registration (which includes only salaries paid to the government officials for the amount of labour hour they have spent on business registration) is more than 250 million rupees. As the government meets all these expenses from tax payer’s money, the ultimate incidence lies on the heads of tax payers.
Some of the best practices and reforms
If we look into the World Bank’s Doing Business Report, the best performers share some common features. In these countries the cost of starting a business is very low. It ranges from 0.3 to 2 percent of the GDP per capita. It takes maximum of two days to officially complete the works of registration. The procedures are limited to 2 to 3. Furthermore, an entrepreneur can apply for business incorporation online. This has made business registration process easy and cost efficient.
Apart from these top performers, some of the average performers have (in recent times) made reforms that have helped them reduce the cost significantly. Azerbaijan made an important reform – it started the operation of one window shop in 2008 for business registration. This single reform reduced the time and cost in starting a new business by half and business registration increased by as high as 40% in just 6 months. Similarly, in 2010 Mexico established an electronic platform for company registration and, in 2011, launched an online one-stop-shop for business registration.
Lessons that we can draw
As mentioned above, one potential reform can be establishing a one window shop which administers all the works related to registration. Given the current status of business registration, i.e. having to go to a multiple number of agencies to complete business registration, one stop shop is a good initial target. This can save a lot of time and energy of entrepreneurs, reducing the opportunity cost. Moreover, it reduces the cost of operation of multiple number of offices. The next level reform can be made by initiating electronic registration. Currently, the problem with electronic registration, is lack of agency to verify and regulate the digital signature and lack of provision of electronic payment. Only if these two things are made available, the next level reform will be possible. Registration through electronic platform is more convenient, requires less effort and saves time and money. These reforms will also encourage entrepreneurs operating in the non-formal economy to formalize their businesses.
This article was originally published in The Himalayan Times on September 11, 2016.
Ashesh Shrestha is an independent researcher. He has an Economics background and is interested in Monetary economics and Public finance.