Can cutting red tape boost entrepreneurship? Most agree it can. But there are limits. The example of Georgia shows why.
In March last year I was in Tbilisi, the capital, for a short holiday. I was one of millions of tourists that are now flooding into the Switzerland of the Caucasus. I listened to the owner of a small hostel as he gave me a lift from the airport. He enthused about how just two years back the city was teaming with some 20 hostels. Now just five remained - his was one of them.
The recent boost in tourism in a country which has become known as one of the easiest in the world to start up a business drove demand. But a lack of innovation may be key to why many stay small or fail fast.
Countries that have been torn apart by war can rise from the ashes. They offer something peculiar to newly instated governments – a reason to cut red tape to the bone to attract new business and help the country to rebuild. At least this has been the experience in two such small countries – Georgia and Rwanda.
While April 7 marked the 20th anniversary of the commencement of the Rwandan genocide, it's 25 years to the day (April 9) since the Tbilisi Massacre in Georgia in which 20 people were killed during an anti-Soviet demonstration. The Caucasus country then suffered a civil war in the 1990s and was briefly invaded by Russia in 2008.
But today the two countries are ranked by the World Bank as the top two nations in the world when it comes to carrying out business reforms.
Rwanda, now the top reformer since 2005 according to the organisation’s 2014 Doing Business report, is the 32nd easiest place in the world to do business. Georgia is at eighth (see the table, left) spot.
Less red tape, more firms
The World Bank reveals in its latest Doing Business report notes that in Rwanda the number of firms per 1,000 adults rose from 0.3 to 3.4 between 2006 and 2012. While this is still substantially below the world average of 12.4, the increase over time it notes, is impressive. Over the same period the number of firms per 1,000 adult in Georgia increased from less than 20 to over 35.
Following the peaceful 2003 Rose Revolution Georgia embarked on numerous business reforms, slashing the time that it takes to register a business and reducing the number of tax types.
In 2006 the Ministry of Economy set up a regulatory review division which reviewed 21,000 laws and regulations – 12,000 were scrapped. Laws were streamlined in procurement, company law, public finance and tax and customs systems.
The World Bank in its 2012 report found that by 2008 senior managers in Georgian firms reported spending less than 2% of their time dealing with government regulations, down from about 10% in 2002.
There was a also significant drop in visits by tax officials between 2008 and 2005, from eight a year in 2005 to an average of just 0.4 in 2008. This followed the introduction of a new tax code which slashed the number of tax categories from 22 to six.
The government also tackled corruption – including the brazen firing of 16,000 traffic officers. Glass frontages were erected at police charge offices to make it more difficult for bribes to take place.
By 2008 just four percent of ﬁrms expected to make informal payments to public officials to get things done, compared with a regional average of 17%.
Today it requires only two procedures and two days to start a business. Back in 2004 it took 25 days and nine procedures.
After the reforms the informal sector fell from 67% in 2002 to 22% in 2010, according to the World Bank, while Georgian firms participating in 2005 and 2008 World Bank surveys reported adding an extra 23 employees – with average employment increasing from 61 to 84 jobs. Today small businesses in Georgia make up 20% of GDP and 90% of firms.
However despite the reforms about a third of Georgians still live below the poverty line and officially about 15% are unemployed.
A new World Bank report released last year (titled Fostering Entrepreneurship in Georgia) reveals that most Georgian firms remain relatively small and unsophisticated.
Out of a sample of 373 firms with average size of 12 employees, more than 90% had not carried out any research and development (R&D) in the last five years (compared to 50% in Armenia). Only seven percent had introduced a new or substantially improved product or service in last three years (versus 67% in Armenia).
Added to this because of a lack of financing options and high interest rates at banks, almost 90% of Georgian firms in the sample were funded by own savings.
The World Bank noted that Georgia does not have a specific SME or innovation policy – outside its State Strategy for Regional Development of Georgia for 2010-2017 - and suggests that the government should look at providing R&D incentives, more technical training in universities and mentoring for small businesses.
According to Lado Gurgenidze who helps run Smartex a local venture capital fund, innovative entrepreneurs there face several problems. In an interview last year with the American Chamber of Commerce in Georgia's magazine Investor.ge he listed among others limited broadband, low smartphone and tablet penetration and a small talent pool of software engineers.
But he remains positive that all that's needed is to showcase more examples of those who have succeeded. He hopes to do so through events like Tbilisi Startup Weekend. But the government, he says, should stay out of the way of entrepreneurs. His is an often-heard call, though better internet and more training could help.
Encourage an entrepreneurial ecosystem
Last week Brazil's President Dilma Rousseff once again promised to cut the time from the current over 150 days to just five days. But it is not enough for governments to slash red tape or put in place better systems to make it easier to pay taxes or register a business.
To flourish business owners also need better functioning entrepreneurial ecosystems - where it is easier to access finance, get help from mentors or incubators and where schools and universities actively encourage entrepreneurship.
For many emerging economies this remains a pipe dream. But one country - Chile - is striking ahead (read entrepreneur Nathan Lustig's article) . It has not only made it possible to register a business in just one day and simplified bankruptcy proceedings, but it is actively encouraging something many countries continue to sideline - the creation of more innovative entrepreneurs.
Governments should cut unnecessary red tape, use smart systems like web portals to save entrepreneurs' time and then work with the private sector to improve the entrepreneurial ecosystem without taking control of it. Like this more innovative firms will flourish.
Stephen Timm visited Georgia in March 2013 as part of an eight-day visit to the Caucasus.
Stephen Timm is a