Center for Economic and Financial Research at New Economic School

№22 November 2005

Monitoring the Administrative Barriers to Small Business Development in Russia. 5th Round O.Shetinin, O.Zamulin, E.Zhuravskaya, E.Yakovlev CEFIR Policy Paper series

MONITORING the Administrative Barriers to Small Business Development in Russia THE FIFTH ROUND November 2005

Nakhimovsky prospect, 47, office 720 117418 Moscow Russia Phone: +7 (095) 105-50-02 Fax: +7 (095) 105-50-03 Email: [email protected] Website: http://www.cefir.ru

1

Summary of the main results The Center for Economic and Financial Research (CEFIR) in Moscow in collaboration with the World Bank and financial support of USAID is monitoring the level of the regulatory burden imposed by the government agencies on small business. The purpose is to document the progressof de-bureaucratization reform recently started by the Russian federal government. The reform package includes laws, which are meant to significantly simplify procedures and reduce administrative costs of inspections, licensing, certification, and registration. At present, the results of the first five rounds conducted in the spring of 2002, the fall of 2002, and the spring of 2003, 2004, and 2005 are available. The first round of the survey collected the baseline information before any of the deregulation laws came in force. The data from the second and third round allowed evaluation of the reform progress after the enactment of three new laws: on inspections and licensing. The data from the third round enable an assessment of the effect of the newly introduced law on registration. Further development in these areas is assessed with the help of data collected in the fourth and fifth rounds. The main result of the first round was that in all areas of governmental regulation the situation in 2001 fell far short of the goals declared in the new laws. The second round revealed significant improvements in the areas of inspections and licensing, which for the most part were sustained in the third round. The third round also showed that the introduction of the law on registration had both a positive and a negative impact on the complexity of this procedure, and the new simplified tax system for small business has stimulated firms to adopt this system in 2003 more intensively than before. The fourth and the fifth rounds demonstrated further changes in the level of most of the administrative barriers for small firms, such as further simplification in the procedure of registration, lower frequency of inspections, and a smaller share of illegitimate licenses among the permissive documents given to firms. Moreover, in each round the respondents perceived the level of fair competition as a more challenging problem than they did in the previous round, which implies that business is starting to worry about the “right” problems. In the fifth round respondents named competition as a more severe problem than the tax level – a clear leader of the previous four rounds. At the same time, responses to quantitative questions demonstrate that many guidelines spelled out in the laws continue to be violated. Thus, registration frequently takes longer than the prescribed five days, firms are required to obtain excessive number of permissive documents, and inspections are administered more frequently that is allowed and with violations of the law. Inspections: The new law on inspections came in force in August 2001. Prior to the introduction of the law many small enterprises were subjected to frequent visits by inspecting agencies. With the introduction of the new law the number of visits by all the government agencies decreased significantly. Correspondingly, the amount of time spent on inspections by the management of small enterprises and monetary costs involved diminished. But the results of the second and the third rounds indicated that in 2002, substantial abuses continued on the part of inspecting agencies: many firms were subject to several planned inspections by a single agency, which is a direct violation of the new law. Then, in 2003 and 2004, the frequency of inspections by the agencies, which conduct the most frequent inspections, declined. However, the enterprises also reported frequent unplanned inspections carried out without a warrant. Furthermore, the decrease in financial costs, noted in each of the last three rounds, was accompanied by an increase in the share of firms, which suffered financial losses, as well as the share of the firms, which were “fined” not in the correspondence with the official scale. In the fifth round, the share of firms that had to pay bribes significantly increased. Licensing: Although there were tangible improvements in the field of licensing after five rounds, overall results are ambiguous. After the adoption of the new law in February 2002 the 2

percentage of the enterprises that applied for licenses and permits dropped by a third. The process of obtaining licenses became simpler and less time-consuming in the first half of 2002 but in the second half the costs of obtaining permissive documents rebounded to the former levels, and sustained almost at that level throughout the later rounds. The average monetary cost of acquiring a license was twice as high as the fee announced in the law. In the fifth round, for the first time, the share of licenses, which look legitimate, exceeded one half of all permissive documents. Yet, about half of such documents are either permits with dubious legitimacy or licenses for types of activities that are formally not subject to licensing. Registration: After the introduction of the new law on registration in 2002 the procedure became simpler and faster, but more expensive, as was noted in the third round, which followed the reform. But in the next rounds both the time spent on registration and its cost substantially decreased. The procedure became faster because the registering firms stopped visiting the local administrations and registration chambers, which used to take up the bulk of their time. Instead, the greater part of the registration procedure was relocated to the divisions of the Ministry of Taxation, where now firms spend more time on average than they did before. Land and Premises: The procedures of buying/leasing land/premise are quite problematic for small enterprises. Interviews suggest that while some firms manage to grow through the procedure relatively fast (2-3 months), other firms get stuck, and then finishing the task may easily take more than a year. Thus, in 2003, as was reported in the fourth round, more than one third of the firms trying to purchase premises had to spend over half a year on that procedure; about 90% of the firms trying to purchase land failed to finish the procedure in half a year In the fifth round, the length of these procedures decreased only slightly. Among them, buying premises from the government seems to be the most costly, time-consuming, and the least transparent. Moreover, the length of this particular procedure went up 15 fold for a median firm in the fifth round. Simplified tax system for small business: The results of the monitoring show that the simplified taxation system for small enterprises indeed simplifies tax administration. Thus, firms, which switched to the simplified system (the biggest shift took place in 2003, when the new law came into effect) are paying fewer taxes, spend less time on their administration, and in general view taxes as a smaller problem than firms, which adhere to the standard procedures. Overall assessment:: On the whole, the results give grounds for cautious optimism, although progress slowed down between the second and third rounds. In terms of subjective perceptions of business climate, the marked improvement in the first four rounds was not uniformly followed in the fifth and some factors significantly worsened. The immediate effect of the new laws was positive, but progress did not persist, and the level of administrative burden on small firms remains high. The observed situation does not fully correspond to the norms spelled out in the laws. Thus, the government still has to do a great deal to enforce the new legislation.

The Goal of the Study The Center for Economic and Financial Research (CEFIR), an independent Moscow think tank, in collaboration with the World Bank and financial support of USAID is monitoring the level of the regulatory burden imposed by the Russian government agencies on small businesses. The purpose is to measure changes over time in 3

administrative costs of doing business and document the progress of deregulation reform recently started by the Russian government. The reform comprises a package of laws that significantly simplify the procedures and reduce the costs to the firms related to administrative regulation in the fields of licensing, certification, registration and various kinds of inspections. In addition, the “simplified system of taxation” for small business is being reformed to further cut the tax burden and enable a wider range of firms to adopt the simplified system. Four laws have come into force: the law on inspections in August 2001, the law on licensing in February 2002, the law on registration in July 2002, and the law on the simplified taxation system in January 2003. In June 2003,, the law on technical regulation came into force. The monitoring is being conducted by regular repeated surveying of 2,000 firms in 20 regions of the Russian Federation (see Figure 1 for the regional coverage of the sample) with questions asked about actual quantifiable costs associated with inspections, licensing, certification, registration, and tax administration, as well as subjective perceptions of business climate by the respondents. At present, the results of five rounds are available. The rounds took place respectively in the spring and the fall of 2002, and in the spring of 2003, 2004 and 2005. During the first round initial information was gathered on the situation in 2001, that is, prior to the introduction of the deregulation laws. The data of the second stage made possible the assessment of the course of reform after the introduction of two new laws: on inspections and on licenses. The third stage took place in the spring of 2003 and it permits an assessment of the effect of the new law on registration and simplified tax system. Data of the fourth and the fifth stages give the possibility to evaluate further progress of the reforms.

Survey Design Two primary survey instruments are used in this project, one for firms established more than a year ago, and one for the recent start-ups. The first one inquires about the burden imposed on firms by inspections by different government agencies, licensing and certification regulations, and tax administration as well as about the general perceptions of business climate. The second instrument is designed specially for the newly registered firms in order to monitor entry costs; it contains questions about the registration procedures, licensing, and certification for new firms. Thus, panel data are collected to monitor administrative burden on existing firms and repeated cross-section data are collected to monitor the regulatory costs of entry.

The Findings The primary result of the first round of monitoring was that in all areas of governmental regulation the situation in 2001 was far from the goals declared in the new laws from the deregulation package. The second round has revealed significant improvements in the areas of inspections and licensing, in which new laws were introduced in between the first two rounds of monitoring. Before the third round the law about the registration took effect. The results of the survey showed that the procedure became faster but more expensive. In the fourth round further improvement in all directions was noted, although the progress slowed down. The most remarkable drop in the number of inspections of firms occurred during the period between autumn 2001 and the spring of 2002, but the following decrease was much less intensive. Despite the rapid growth of small business sector, the number of licenses and other permits issued to firms participating in the survey dropped in 2002-2003. Although registration of enterprises became more expensive in the fall of 2002 after the new law came into force, in 2003 and 2004, both the time and the cost of registration significantly declined.

4

1. Inspections The new law came in force in August 2001. According to the new law, any state agency can carry out no more than one inspection in one firm within two years. Although the number of unplanned inspections remains unlimited, the procedure of carrying them out has been streamlined. Prior to the introduction of the law many small enterprises were subject to repeated inspections by several supervisory agencies. But with the introduction of the new law the number of inspections by all of the government agencies dropped substantially, as was confirmed by the results of the second round of surveys. Table 1: Average number of inspections by agencies 1 2001 - II Tax inspection 0.74 Fire inspections 0.90 Sanitary inspection 0.70 Police 0.57 Social security . AT inspection 0.36 Labor protection 0.25 Licensing inspections 0.26 Certification 0.20 inspection Environmental 0.26 protection Trade inspection .

2 2002-I 0.53 ** 0.63 ** 0.51 ** 0.37 ** 0.26 ** 0.25 ** 0.20 * 0.13 **

3 2002-II 0.53 0.54 * 0.47 0.35 0.25 0.26 0.15 * 0.11

4 2003-II 0.49 0.48 0.35 * 0.28 0.22 0.22 0.16 0.12

5 2004-II 0.48 0.46 0.32 0.28 0.21 0.20 0.13 0.12

0.12 **

0.09

0.08

0.10

0.14 **

0.11

0.10

0.09

0.15

0.12 *

0.12

0.09 *

On average, the number of inspections per enterprise dropped by 33% in the first half of 2002 compared with the second half of 2001 and by 25% compared with the first half of 2001. The third round of surveys revealed a further drop in the number of inspections, but at a much slower rate, by 12% in the second half of 2002 compared with the first half of the year. After a substantial fall in the number of inspections in 2002 comparing to 2001 for all inspecting agencies, the rate of reduction has decreased in the next two years.. The number of inspections in 2004 was still significantly less than in 2001-2002, but there was no statistically significant change comparing to 2003. The average number of inspections per firm during a half a year period declined to two, according to the results from the fifth round of the survey. The most frequently inspecting agencies are tax, fire, sanitary, and police inspections.

Figure 2: Share of time spent on inspections by management During the five rounds of monitoring the amount of time spent by management of small firms on inspections has diminished. In the first round only in half of the small firms, management spent less than 5% of its time on

Round 5

0

1-5

6-10

Round 4

0

1-5

6-10

Round 3

0

Round 2

0

Round 1 0%

1-5 1-5

0

1-5 20%

5 0

1-5

6-10

10-20

6-10

6-10

40%

60% 20-30

10-20

6-10

30-40

10-20

10-20 80% 40-50

100% 50+

inspections. In the fifth round the share of such enterprises grew to 73%. Differences between regions are big, for example, in Primorskiy Krai, management of 70% of all small firms spends less than 5% of its time on inspections, while in Moscow oblast this is true only for 30% of firms. On the other hand, the decrease in financial losses experienced by small firms during inspections, noted in the first three rounds, was followed by its increase in the fifth round. In addition, the share of firms share of firms, which had to pay “fines” not based on the official scale (or simply bribes) in the last two rounds significantly increased. In the fifth round the share of firms, having financial losses, increased for the following inspecting agencies - environmental protection, AT inspection, fire inspection. The frequency of the penalties, which are not based on the official scale, increased for the majority of inspections. As before, the most frequent unofficial penalties come from police inspection (68% of firms). Moreover, the share of unofficial penalties by licensing inspection has rapidly increased from 35% in Round 4 to 56% in Round 5. For other inspecting agencies this share of firms varies from 16 % (tax inspection, social security) to 40% (certification). Table 2: Multiple inspections Share of firms inspected by this Share of these firms inspected by this agency more than once *) agency Police

1 2 3 4 5 1 2 3 4 5 0.17 0.15 0.13 0.12 0.13 0.55 0.41 0.47 0.39 0.44

Sanitation dept.

0.33 0.26

0.25

0.21

0.20

0.37

0.34

0.30

0.30

0.32

AT inspection

0.17 0.14

0.14

0.13

0.12

0.35

0.29

0.29

0.28

0.31

Tax inspection

0.46 0.36

0.35

0.32

0.32

0.32

0.27

0.25

0.26

0.22

Fire inspection

0.50 0.39

0.36

0.33

0.32

0.32

0.28

0.25

0.20

0.19

Certification

0.13 0.09

0.07

0.06

0.05

0.18

0.17

0.19

0.20

0.17

0.14 0.09

0.05

0.07

0.07

0.22

0.24

0.26

0.09

0.16

Environmental ins.

Po lic e in En s pe vir ct on io m n en ta Tr l ad pr e ot in . sp ec Fi t io re n in sp ec Ta tio x n in s pe La ct bo io rp n ro t e Li ct ce io ns n in g in Sa sp ni . ra ty So in sp cia . lS ec ur it y AT

Ce rti f

ica

tio n

Furthermore, there are also some persistent violations of law on part of inspecting agencies, as in the previous rounds. Although for most of the agencies the frequency of inspections corresponds to legal requirements (not more than once in 2 years, i.e., 25% of firms in half a year), still tax and fire inspectors act against the law (33%). As before, firms continue to Ratio of unplanned inspections to total inspections complain about multiple and 0.7 unplanned inspections. Some of the 0.6 agencies - police, AT, certification, 0.5 sanitary inspections - primarily 0.4 administer repeated inspections (in 0.3 more than half of all cases). 0.2 Besides, about half of all police 0.1 and certification inspections are 0 unplanned. A significant share of all unplanned inspections - more than one half for the majority of the inspecting agencies- are administered without a warrant. Round 2 Round 3 Round 4 Round 5 6

Especially, all inspecting agencies, except police, licensing, tax and sanitary inspection agencies, started to violate the laws more often and administer inspections without warrants in 2004. The most frequently unplanned inspections without a warrant are administered by police, AT, environmental protection and certification agencies with the share of such inspections being above 60%. During the period covered by the monitoring study, the transparency of rules and procedures during inspection has improved to a certain extent. There was a particularly significant improvement in 2002, but the overall perception by small firms on this issue is ambiguous. While 30% of the firms consider the rules to be transparent, an equal share thinks the opposite.

2. Licensing The new law on licensing was introduced in February 2002. It significantly reduced the number of activities subject to licensing, cut down the license fee to 1400 rubles and extended the term of validity of a license to at least 5 years (under the old law the charge was 3000 rubles and the required term of validity was 3 years). In 2002, immediately after the adoption of the new law, improvements in the field of licensing was observed. The share of firms, which applied for licenses and permits, indeed dropped from 31% in the second half of 2001 to 14% in the first half of 2004. However, further development in the later years have been less clear-cut. Table 3: Licenses Round 2 Round 3 Round 4 Round 5 2002:I 2002:II 2003:II 2004:II Share of firms applying Payment, rubles (mean) Payment, rubles (median) Waiting time, days (mean) Waiting time, days (med.) Effort, persondays (mean) Effort, persondays (median) Term of validity, months (mean) Term of validity, months (median)

21% 13525 3000 39 30 19 9 32.7 36

21% 24346 4000 44 30 20 7 30 36

15% 56611 5000 54 30 25 10 35 36

14% 25778 6750 61 30 29 10 34 36

The process of obtaining a license became simpler and cheaper in the second round, but the situation worsened in the later rounds as the monetary and non-monetary costs of obtaining a license increased again. Such comparisons of costs across rounds, however, should not be regarded very seriously, because the cost of obtaining different licenses differs greatly. A more promising finding is that a larger share of all permissive documents reported in round 5 look like legitimate licenses. Almost a half, on the other hand, are either for types of activities not specified in the law, or are some kind of permits, frequently given out by local governments, with dubious legitimacy. In the first four rounds, about 40% of all licenses and permits looked legitimate, and this number grew to above 50% in the fifth round. However, a significant share of all licenses, even seeming legitimate ones, have their term of validity shorter than the prescribed five years.

7

Table 4: Term of validity: Licenses and other permits License legitimate according to new law

Term of validi ty

Less than 3 years 3 to 5 years 5 years or more Avg. (months) Median

Round 2 16.0% 28.6% 55.3% 45 60

Round 3 13.2% 25.9% 61.0% 48 60

Round 4 16.2% 24.8% 59.0% 46 60

Round 5 17.7% 20.2% 62.1% 46 60

Other licenses and permits Round 5 68.4% 14.5% 17.1% 23 12

Local authorities seem to give out less legitimate licenses and permits, but also less costly ones.. Thus, about 70% of the licenses issued by local authorities do not look legitimate – many of them are permits for retail, which is not supposed to be a licensed type of activity.. The overall conclusion is that most of the problems in the field of licensing and inspections stem not from the nature of federal legislation, but from the way it is applied, especially on the regional and municipal level.

3. Registration According to the new law that came into force in July 2002 the process of registration of a new enterprise should take no more than five days and should not cost the enterprise more than 2000 rubles. Besides, the declared aim of the law was to introduce the “single window” principle whereby an entrepreneur seeking to obtain registration should deal with only one government agency. These new rules came into effect between the second and the third rounds. The first two rounds of monitoring were carried out before the new law on registration was introduced. The results of these rounds indicated that the cost of registration was much higher than the level targeted by the new law, and that these costs did not change between the two rounds: on average registration took one month and cost about 3500 rubles. The third round revealed that in the second half of 2002 registration became faster and simpler, but also costlier. The fourth and the fifth rounds demonstrated that in 2003 and 2004 the situation became better. That is, the number of agencies that have to be visited during the procedure decreased and the procedure itself became faster and cheaper. However, one of the key principles of the reform – the “single window” rule – was not observed, although the majority of entrepreneurs (85%) no longer visited local administrations and registration chambers whose functions were handed over to the Ministry of Taxation. Entrepreneurs still had to visit some other government agencies such as the Pension Fund, the social and medical insurance funds, fire and sanitary epidemiological services. Thus, the average number of “windows” declined by one initially, and then by one yet again. An average firm that previously visited five government agencies during registration had to visit four in the second half of 2002, and then only three in 2003 and 2004.

8

Round 1 Time to register Less than a week Week to a month More than month

17 65 18

22 60 18

Round 1 Payment

2000 rubles or less More than 2000 rubles

Round 2

Round 3

Round 4

w/o w/ w/o w/ w/o w/ w/o w/ interm. interm. interm. interm. interm. interm. interm. interm. % % % % % % % %

20 64 16

17 68 15

19 67 15

Round 2

25 60 15

47 47 6

Round 3

42 54 4

Round 4

w/o w/ w/o w/ w/o w/ w/o w/ interm. interm. interm. interm. interm. interm. interm. interm. % % % % % % % %

Round 5 w/o interm. %

w/ interm. %

49 46 5

24 69 7

Round 5 w/o interm. %

w/ interm. %

33

51

45

58

18

26

39

11

35

10

67

49

55

42

82

74

61

89

65

90

Being relieved of the need to visit local administrations and registration chambers was the main factor that reduced the time required to go through the procedure. In the preceding rounds it was the local administration and registration chambers that took the most time, 11-14 days on average. Instead, the time spent at the departments of the Ministry of Taxation increased from 6 days in the first round to 10 days in the third and then declined to 8 and 7 in the fourth and fifth round, respectively. Apparently, immediately after the reform, the ministry divisions could not cope with the inflow of entrepreneurs seeking to register new firms. This may account for the increased cost of the procedure in 2002 and the decrease in 2003. Table 5: Time elapsed to register

Tax agencies Pension fund Statistical agency Social security Local administration Medical insurance Bank Fire department Registration chamber Sanitation department

Round 1

Round 2

Round 3

Round 4

Round 5

6

8

10

8

7

3

4

2

2

1

2

3

3

3

2

3

4

2

2

2

11

11

9

10

4

3

3

2

3

2

5

5

3

7

3

4

2

3

6

13

13

14

4

7

6

14

9 2

5

Firms are hiring intermediaries more frequently, and on average, they spend more time and money on registration than the firms that register without intermediaries. Apparently, firms hire intermediaries in cases when registration is especially difficult. Or, they are willing to pay extra and wait longer in order to avoid the necessity of standing in the lines themselves. Consequently, after the adoption of law situation in the field of registration has changed positively, but still it does not correspond to the guidelines spelled out in the law.

9

4. Simplified System of Taxation In January 2003, the new law on the simplified system of taxation for small enterprises came in force. The first two rounds of monitoring were carried out before the new simplified tax system was introduced, although there was already a simplified system adopted back in 1997. The new law was meant to simplify the transition to this system substantially and broaden the base of the enterprises entitled to use it. For example, previously enterprise employing no more than 20 people could use the system, and beginning 2003 firms up to 100 employees became eligible. According to the answers of the respondents, the simplified system does indeed seem to simplify tax administration. This prompted a fairly large number of enterprises to adopt the system. While in the second round only 40% of the surveyed firms that were eligible to use the simplified system actually exercised that right, in the later rounds the share of such firms went up to 62%. Table 6: Usage of the simplified tax system 2002 - II 2003-I 2004-I 2005-I Share of eligible firms

64%

70%

69%

70%

Of them use the system

40%

50%

59%

62%

38%

22%

16%

Share of firms switching from the new tax system during the year

The firms that adopted the simplified system in 2003 paid, on average, 5.72 different types of taxes and levies, compared with 9.56 types of taxes they paid in 2002. The reduction in the number of taxes by four accords with the parameters of the law, as the single income tax or profit tax replaces five other taxes. So it is worth noting that the simplified system was adopted mainly by the firms for which tax administration was more complicated than the average. The firms that use such a system gave much more optimistic subjective assessments of the efforts they spent on tax administration in 2004. Indeed, in all three rounds after adoption of the new law, they named the level of taxes as being less of a problem than the other firms did. It remains puzzling thatmore insufficient information than half of the eligible firms did 0.5 not adopt the simplified system 0.4 when the new law was introduced and 38% of them still have not 0.3 switched, although this system 0.2 enables firms to reduce their the standard system is easier t others costs. Moreover, a significant use 0.1 share of the firms using the new system is switching back to the 0 standard system in each round. Among the explanations offered in the last three rounds the most popular one was that the standard system of taxation was simpler and clearer to use. The second simplified tax system implies business partners don't use this higher tax level system most popular explanation was that Round 3

10

Round 4

Round 5

“business partners do not use this system”.

5. Land and Premises In the fourth round, with the initiative and financial support of the Foreign Investment Advisory Service (FIAS), a section of questions related to purchasing and renting of the land and premises was added to the monitoring. The results of the monitoring showed that about half of the firms have to deal with such issues, and this issue has been named the most serious problem connected to regulation. The procedures of purchasing both land and premises seems to be a gamble: in some cases, it finishes relatively fast (taking between 1 and 3 months), but in some cases gets stalled, and then takes more than half a year. Table 7: Length of procedure (days) related to the acquisition of premises. Procedure finished Procedure not finished *) 62% of firms 74% of firms 38% of firms 16% of firms Procedure Round 4 Round 5 Round 4 Round 5 mean 58 301 255 576 Purchase from government median 22 180 365 363 mean 111 219 84 246 Purchase from private party median 60 180 45 180 mean 55 212 45 370 Rent from government median 30 120 30 180 mean 25 213 17 142 Rent from private party median 7 150 3 95 The results from the fifth round show that in the fifth round, the length of a procedure is rather short if the procedure was started and finished within the half-a-year period prior to the interview. The only outlier is purchase of premises from government – the time needed to get premises from government increased 15 fold for a median firm between the fourth and the fifth rounds (this is inline with recent TI and INDEM report that documents substantial rise incorruption). On the other hand, if the procedure was not finished at the time of the interview, then in most cases it had been going on for a much longer time. It is also clear that obtaining premises from government takes much longer than obtaining them from a private party. Therefore, about half of the firms prefer to rent premises from private parties. Additionally, purchasing/leasing costs of the premises both from the government and a private party have significantly decreased between the fourth and the fifth rounds. The firms also assess the situation to be more transparent in the fifth round compared with the fourth round. Furthermore, , while buying premises from government seems to be the most costly, difficult and the least transparent procedure, buying premises from a private party was evaluated by respondents to be relatively transparent and quick. . Thus, it is possible to assert that there are serious problems in the procedures, related to the premises and land. A significant number of firms are prevented from doing business because of these difficulties. Simplification of these procedures is necessary in order to decrease the arbitrariness of local officials, and will serve as a powerful stimulus for the development of small business in the regions of Russia.

11

6. Subjective Perception of Problems Related to Regulation Following a continuous decrease in the seriousness of problems related to regulation in the first four rounds, as viewed by the respondents, some indicators worsened in the fifth. The most significant improvement took place between the first and second halves of 2002. Subsequently, the sharpness of the problems declined very slowly. Among the problems related to regulation, the most significant ones are excessive volume of the paper work, inspections in general, and tax inspections in particular. Table 8: Main problems related to the regulation 3

4

5

2001 - II 2002-I

2002-II

2003-II 2.88

2004-II 3.00

share of firms *) 5 round 0.49

2,99

2.72 **

2.66

2.69

0.99

2.52

2.68 *

0.53

1 Regulations on buying land General documentation requirements Regulations on renting land Regulation on buying premises Licensing and obtaining permits Inspections in general Certification Tax inspection

2

2.83 **

2.49

2.31 **

2.30

2.39

2.56

0.64

2.46

2.34 *

2.29

2.23

2.22

0.75

2.37 2.29

2.32 2.25 * 2.23

2.18 2.13 * 2.15 *

2.14 * 2.08 2.05 **

2.11 2.09 2.09

0.98 0.66 0.99

*) Share of firms, for which this problem is relevant. 5 – threatens the existence of the firm, 4- a very serious problem, 3 –a serious problem, 2 – a slight problem, 1 – not a problemThere are also some “specific problems”, such as regulations on buying and leasing of

premises and land that have been named the most severe problems by those firms, for which these problems are relevant, whose share is about one half of all firms in the sample. Although on average, none of the problems related to Number of very significant problems of a firm regulation has been evaluated as "very significant" Round 5 0 1 2 3 4 5+ approximately half of all firms have at least one "very 0 1 2 3 4 5+ Round 4 significant" problem, which creates serious difficulties with Round 3 0 1 2 3 4 5+ the functioning of the 0 1 2 3 4 5+ Round 2 enterprise. This observation demonstrates a very important 0 1 2 3 4 5+ Round 1 point that problems related to regulation have very 0% 20% 40% 60% 80% 100% individualistic nature, and % of firms many be very specific for each firm. But no one singular problem seems to be very severe on average.,.

12

0 1 2 3 4 5+

7. Subjective Perception of Business Climate Although the monitoring focuses on the real objective costs of small enterprises arising from state regulation, the importance of the overall perceptions among entrepreneurs should not be underestimated. During the first four rounds the mood improved markedly, with the biggest changes occurring between the first and the second rounds, and slower rate of improvements in the fourth round. In the fifth round, the situation became somewhat worse - there were no significant improvements, and some factors significantly worsened. Table 9: General perception of business climate 1 2001 - II

2 2002-I

3 2002-II

4 2003-II

Frequent change in laws Macro instability Competition Tax level Tax administration Regulation Difficulties with access to capital Anticompetitive barriers Corruption Racket

5 2004-II 2.99

3.28 2.62 3.52 3.10 2.90

3.00 ** 2.73 ** 3.30 ** 2.82 ** 2.64 **

2.78 * 2.69 3.06 ** 2.67 * 2.51 *

2.60 ** 2.78 ** 2.80 ** 2.59 * 2.52

2.89 ** 2.86 ** 2.78 2.59 2.45

2.63

2.40 **

2.39

2.33

2.42 *

2.26

2.17 **

2.09

2.19 *

2.3 **

2.10 1.34

1.87 ** 1.27 **

1.87 1.21 *

1.93 1.25 *

2.03 ** 1.21

5 – threatens the existence of the firm, 4- a very serious problem, 3 –a serious problem, 2 – a slight problem, 1 – not a problem

In the period since the second half of 2001 and until the second half of 2002 such problems of small enterprises as high taxes, macroeconomic instability, tax administration, state regulation, difficulties raising capital, anticompetitive barriers, corruption, and racketeering, came to be seen as being less acute. The most remarkable development is that competition, the only problem on the list that firms in a free market economy are meant to worry about, was indeed becoming more and more serious in each round. Thus, in the second round, in the first half of 2002, small enterprises assessed competition as a more serious problem than state regulation. In the third round the problem of competition outstripped, in terms of significance, that of tax administration, which also has to do with administrative barriers. The latter change is mainly due to the firms, which have switched to a simplified taxation system. In the fourth round, problem of competition came, in its degree of sharpness, closer to the most serious problem - the level of taxes. In the fifth round, competition tightened yet more, and this problem became more severe than the previous leader, the tax level. Surprisingly, however, macroeconomic instability made a big jump as well, becoming the number one problem among the incumbent ones, even though no major cataclysms seemed to take place at the macroeconomic level in 2004. A new potential problem was added to the list in the fifth round, frequent changes in legislature. Since this problem actually was named the most severe, in the future studies, we aim at understanding the nature of this problem.

13

8. Main Conclusions from the Fifth Round The overall result from the 5th Round is ambiguous. Although there are some significant improvements in certain fields of regulation, in the majority of the cases the reform so far had not reached the desired level of deregulation. • Improvements in the fifth round: – For the first time the share of legitimate licenses exceeded one half. – Number of agencies that have to be visited during registration decreased and the procedure itself became faster and cheaper. – Competition is becoming more and more important for small business. • Failures: – Still a significant share of licenses has short term of validity and they are still difficult and costly to obtain. – Business climate has worsened in Round 5 – although competition is becoming more challenging for firms, some other factors, such as economic instability, difficulties with access to capital, anti-competitive barriers and corruption have significantly worsened. – Firms consider frequent changes in law and economic instability as the most significant problems. – There is an increase both in the share of firms, which suffered financial losses and share of firms, which were fined not in the correspondence with the official scale during the inspections. – Buying premises from government is the most costly, time-consuming procedure. Moreover, the length of this procedure went up 15 fold for a median firm in the Round 5.

14