By Alan Finkelstein Shapiro and Victoria Nuguer
Registering a business in Latin America is not for the faint of heart. Multiple procedures — ranging from establishing by-laws and a legal structure to registering the company with authorities — have to be carried out. Labyrinthine bureaucracies have to be negotiated. Lawyers and accountants are often hired to avoid violations of government regulations and fines.
All in all, establishing a company can take anywhere from eight days in Mexico to as long as 49 days in Peru. The costs, moreover, can be enormous, ranging from less than 10% of per capita income in Chile to around 60% in Paraguay and 100% in Bolivia.
Barriers that weaken economies in the face of external shocks
These expenses mean not just headaches and thinner wallets for aspiring business owners in Latin America. They suggest that the economies of the region have created real barriers to firm creation. These barriers affect access to bank credit and can make economies weaker than they need be in the face of external shocks.
In a recent study, we take a broad look at this issue. We examine the different costs of firm creation and the correspondingly different degrees of resilience among emerging economies (EMEs) amid periods of external financial distress.
We do so by creating a model that allows us to simulate the impact of heightened financial distress originating in the United States on a variety of EMEs. We find that when crisis strikes, economies with lower barriers to firm creation have smaller contractions in bank credit and consumption than those economies with higher costs.
The mechanics of this relationship are complex. But they come down to a few basic principles. When the costs of firm creation are low, more firms become formalized; they gain access to bank credit and can expand the amount of capital and the amount of labor they use. As a result, their labor productivity increases and so does their resilience amid external shocks. The banking system also benefits, not only from getting greater deposits, but also from an expansion in their assets and net worth.
This can make all the difference when an external financial shock strikes. If more firms have access to bank credit due to lower entry barriers, fewer firms will shed workers, and fewer will cut back on investment. This greater stability will, in turn, resonate through the economy. It will ease the impact of the shock on household income and consumption and result in less dramatic and negative fluctuations in banks’ deposits and domestic bank credit.
A push for financial inclusion
At present, the percentage of firms that are registered in Latin America and have access to bank credit ranges from 14% in Honduras and El Salvador, to 18% in Bolivia, 25% in Paraguay, and a high of 32% in Chile. Not surprisingly, the push for greater firm formality and financial inclusion has been at the top of policymakers to- do lists.
Over the last couple of years, several countries in the region have made progress on this front. Brazil, for example, has introduced on-line systems for registering companies in Rio de Janeiro and São Paulo, Chile has introduced an electronic system, and Peru has reduced the time needed to get a municipal license and a safety inspection from the local council. All these reforms could lessen the burden of firm creation, improve firms’ access to external financing, and limit the adverse effects from external shocks.
The need for due diligence
As welcome as the reform movement may be, however, Latin America must also assure that in cutting paperwork and the overall cost of firm creation, it does not skimp on due diligence. The sub-prime crisis in the United States is still fresh in people’s minds. The region must ensure that firms are credit-worthy before they get better access to the banking system and credit.
Financial inclusion is crucial for many reasons. Preventing an external shock from transforming into a full-blown crisis must be among the most important. Whatever Latin America can do to lower the costs of firm creation, ensuring that more firms have access to credit while at the same time safeguarding the health of the domestic banking system and improving the resilience of the region’s economies, is certainly worth the effort.
Guest Author: Alan Finkelstein Shapiro is an assistant professor of Economics at Tufts University. His research lies at the intersection of macroeconomics, labor economics, and international macroeconomics. His work focuses on the study of labor market dynamics, financial frictions, and business cycles in both emerging and advanced economies, the importance of sectoral heterogeneity for the behavior of labor markets and short-run economic activity, search frictions and macroeconomic performance, and the role of macro policy in mitigating the impact of adverse shocks to the economy.