39242 January 2007 · Number 99 A regular series of notes highlighting recent lessons emerging from the operational and analytical program of the World Bank`s Latin America and Caribbean Region. Cutting Red Tape in Lima How Municipal Simplification Improves Investment Climate David Sislen, Taimur Samad, Sarah Anthony, Luke Haggarty, Igor Artemiev Regulatory simplification has become a part of many small and medium size enterprises ­ SMEs ­ which cannot countries' efforts to improve the investment climate and the afford to hire a third party to handle the paperwork), overall economy. Reducing "red tape" can lift constraints causing businesses to evade regulation rather than comply on private sector development and foster economic growth. with it. The result is a growing informal sector. Figure 1 In Latin America, where decentralization has advanced shows that countries with more efficient regulatory systems considerably in recent years, there is emerging consensus have the lowest shares of informal sector-generated GDP. as to the need to focus reforms at the municipal level, where barriers tend to be especially high. The experience There is some evidence of a link between a country's GDP of Lima, Peru shows how streamlining municipal business per capita and efficiency in regulation, but the direction in registration and licensing procedures can lead to positive which causality runs is unclear. Doing Business in 2006 economic outcomes. reports that rich countries impose the least regulation and have recently made greater strides in streamlining than What is red tape reduction, and why? the rest of the world, increasing the business start-up gap Regulatory simplification reduces or eliminates unnecessary between rich and poor nations. The cost to start a business administrative requirements, affording businesses greater in poor countries is 113% of income per capita, compared efficiency and productivity. The benefits of such reform to 7% in high income countries, and the average minimum include increased formalization of the local economy, capital requirement in poor countries is 299% of income per improved regulatory supervision, increased compliance with capita ­ 10 times the level of OECD countries. laws and norms, and decreased opportunities for corruption. Figure 1 - Heavier Regulation, More Informality1 Simplifying business regulations has recently come to the forefront of development discourse, highlighting the important roles of the private sector and a sound investment climate in countries' economic growth and development. Governments across the globe are taking action: in 2004, 99 countries introduced 185 reform programs to ease doing business. Efficient business regulation is beneficial for both the public and private sectors. Gains within the public sphere include orderly development (e.g. city planning) and firms' compliance with health and safety norms and tax obligations (a main source of funding for public services). As for the private sector, simplified rules stimulate the transfer of small businesses to The importance of sub-national simplification the formal sector, resulting in more opportunities for accessing In many countries sub-national political entities (states, capital, contract enforcement, and overall growth. provinces, regional governments and municipalities) have an important function in fostering a sound business On the other hand, when regulation is inefficient and climate. Local government is often the first point of cumbersome, costs become prohibitive for firms (especially interaction for businesses and, at least in the LAC region, Table 1 - Starting a Business2 (data applies to largest city) where the highest administrative burden is concentrated. Country Number of Steps Number of Days Traditionally, reform efforts have been applied at the Peru 10 102 national level. Given recent decentralization trends Ecuador 14 69 (worldwide, and especially in Latin America) and Bolivia 15 50 the greater responsibility of municipalities to apply Colombia 12 43 regulations, however, local reform is becoming ever more Chile 9 27 important. Local governments generally face capacity constraints in this area and need assistance and training to Most of the regulatory bottlenecks contributing to effectively carry out their increased responsibility. economic informality are concentrated at the local level. In the case of Lima, Peru's capital city, although Key components for successful municipal red tape reduction municipal level procedures made up only 3 of the 10 Based upon recent work by the World Bank Group on required steps to start a firm (pre-reform), they represented municipal simplification, a number of characteristics for 60% of the total time required to do so. This is in line with a successful reform program have been identified: the finding that 65% of legal complaints about red tape were directed at municipal level procedures. · Political will ­ demonstrated by municipalities signing a public agreement to reform and providing space and Given the city's demographic and economic importance, technical counterparts for the reform team. the predominance of SMEs (99% of all firms in the capital), · Stakeholder engagement ­ to avoid paralysis and and a dire need for standardized procedures across districts breakdown of reform efforts, usually due to changes (the metropolitan area contains 43 semi-autonomous district in administration. Public-private roundtables of ben- governments, each applying its own set of requirements), eficiaries can oversee the progress of reform, ensure a Lima was a prime candidate for municipal level reform. comprehensive approach in project design, and eventu- ally expand the reform agenda with the municipality. Generating consensus on the need for municipal level reform A stakeholder-managed public information campaign A body of work by the World Bank Group identified raises awareness of reform efforts. Institutional support the need to cut red tape in Lima. The red tape reduction and coordination enable inter-governmental support initiative was designed as part of an ongoing program of and partnerships among government, private sector, technical assistance between the Bank and the Metropolitan NGOs and multilateral organizations. Municipality of Lima (MML). This city development · Integrated strategies ­ outlining the role of all actors at strategy effort, focused on metropolitan-level strategic each stage in the process. planning and targeted interventions for poverty reduction · Building local expertise ­ to ensure sustainability and and fostering economic growth, was complemented by a work on future reforms. 2004 Investment Climate Assessment which pinpointed red tape reduction as a critical component for Lima's growth, The case of Lima, Peru in 2005 and an Administrative Barriers Assessment, conducted to Business regulations in Peru in 2005 were among examine urban development procedures in 6 districts of the the most time-consuming in the region. Starting a city. The latter found that processes for obtaining operating business, for example, required 102 days (the LAC licenses and construction permits were the main obstacles for regional average was 63 days) and cost about 38% of investors. These processes were quite slow and there were the average income per capita. The regulatory process considerable backlogs in many districts. Several agencies associated with a standard construction permit ("building often required identical information from the entrepreneur a warehouse"), averaged 321 days and 366% of income and even performed reviews of the same documents. per capita. It does not come as a surprise, then, that 60% of Peru's economic activity in 2005 was informal. Based on these findings, the MML committed to Relative to its neighboring countries, the Peruvian improving the situation and asked for the Bank Group's regulatory framework was particularly onerous (Table 1). assistance. The IFC LAC Technical Assistance Facility started a project with the municipality on operating license reform, and also worked jointly with the 2 · January 2007 · Number 99 IFC's Foreign Investment Advisory Service (FIAS) to the categorization of sectors and established four "risk improve the construction permit process and to adopt a categories" to differentiate licensing requirements and cost methodology for municipal red tape reduction. according to a firm's complexity and size. Early results of the program, reported below, are very encouraging. Implementing reform Construction permit reform: Work on reforming the The MML applied the following methodology for reform construction permit process started in Spring 2005. By implementation, comprising a four-step strategy: December the metropolitan authority approved an ordi- nance to simplify zoning, and in 2006 work began on the 1) A detailed diagnostic to precisely identify problem areas in application review process. municipal level procedures; The latter consists of dividing applications into 2) Development of a specific reform proposal with detailed categories according to the complexity and urban solutions; impact of the proposed works, affording beneficiaries a quicker, simpler route to obtaining a permit (thereby 3) Implementation of this proposal, including the approval improving the current application approval rate of only of laws/ordinances by the local legislature; assessment and 30%). The design of the reform has also considered training of staff in new processes; publication of a new the historic value of many of the city center's structures operating manual; and implementation of a workflow system and incorporated the input of various stakeholders. The that includes a monitoring and evaluation framework; objective of the new process is to bring new investment and employment opportunities without changing the 4) Introduction of sustainability mechanisms, such as appearance of the historic district. continuous training programs within the municipality; a communications campaign to raise the target population's Outcomes: Changes to the operating license process awareness of the reforms; and the creation of a private- include vast reductions in the number of requirements public advisory council to oversee the implementation and (e.g. certified copies of documents), inspections, visits continuity of reforms across changes in administration. to the municipality, and days to obtain a permit (Figure 2). Data collection on firms registering their activities The operating license reform has been implemented is ongoing, and the initial numbers are promising: more and revisions to the construction permit process are than twice as many licenses were issued in 2006 than currently in the implementation stage. Each step of the during the entire 2002-2005 period (Figure 3). reforms involves municipal counterparts to ensure that the proposal reflects the reality of the municipality and its Not only did the reform of inspections combine several administrative capabilities. steps into a single multi-purpose inspection; it also made Operating license reform: Prior to the reform Figure 2 - Obtaining an Operating License in Lima, Peru package only 34% of applicants seeking to open a business in central Lima completed the process, indicating the need for a more streamlined system. The objectives of the reforms were to institute a single window for applicants (eliminating numerous trips to various agencies); ensure better, more personalized client service; implement a workflow void of redundancies; install a fully electronic approval process; build the capacity of municipal officials to manage the new system; and ensure continuous improvements by incorporating reform beneficiaries into the advisory council. Additionally, the municipality adopted the standard international industry classifications (SIIC) for January 2007 · Number 99 · tion through a communications campaign; Figure 3 - Operating Licenses in Municipality of Lima3 · Creating a single methodology for municipal simplification (based on experiences in Lima), disseminated by a toolkit, "Simplification of Business Regulations at the Sub-National Level," created by the IFC; · Forming a cadre of trained consultants to replicate these reforms across a wide set of interested municipalities. Train- ing is conducted with a specially-designed toolkit for Peru: Herramientas para la Simplificación de Trámites Munici- pales ­ TRAMIFACIL. This toolkit was also designed by IFC, along with others with experience in the field. The Municipal Scorecard is a project designed by the Facility to enable comparison of key indicators for bureaucratic efficiency across municipalities in the the process more objective, with clear criteria and simple region. In 2007 the Scorecard will measure the efficiency yes-or-no answers. The reduction in visits is particularly of operating license and construction permit processes important for SME owners as their costs in both time and and is being applied in Honduras, Nicaragua, Bolivia, transport to the municipality decrease. Simplification of Peru and Brazil. The Scorecard will allow for both these procedures can also reduce levels of corruption, as national and international comparisons of municipal less contact between the entrepreneur and public servants performance in the regulation of the private sector and diminishes opportunities for illicit activity. is expected to expand its coverage of countries and regulatory issues over the next few years. Regarding construction permit reform, once implemented, the process should comprise no more than Conclusion 31 steps (versus 206 today) and 11 documents (versus 40 Municipal level red tape reduction is an effective measure today). With no ex-ante inspections and fewer visits and for improving investment climate and is becoming payments to the municipality, the existing average of 321 increasingly important, given today's decentralization days should drop to between 2 and 30, depending on the trends. Initial results from the Lima experience show that scope and urban impact of the project. government reform paired with beneficiary engagement can indeed induce economic formalization. Ultimately, Scalability and sustainability it is expected that better economic data at the municipal The IFC Facility is now engaged in a program to expand level and more formalized firms will attract private application of these reforms to other municipalities across investment, spur economic growth, and create jobs. Peru, through two main vehicles: the National Municipal Simplification Plan and the Municipal Scorecard. Notes 1 - Out of 155 countries. The ease of doing business averages country The National Municipal Simplification Plan (TramiFácil) rankings across the 10 topics covered in Doing Business. Source: is supported by a consortium of 24 leading institutions Doing Business from Peru's central and local government, the private 2 - Source: Doing Business in 2006 sector, international institutions, and NGOs. TramiFácil 3 - Source: Metropolitan Municipality of Lima seeks to spread municipal simplification by: About the Authors · Applying a workplan with specific targets and responsibili- David Sislen is a Senior Infrastructure Economist, Taimur Samad ties for each institution involved in the reforms, fostering is an Urban Specialist and Sarah Anthony is a Consultant all within cooperation and coordination among municipalities; the Latin America and the Caribbean Region of the World Bank. · Working with local advisory councils to ensure sustainabili- Luke Haggarty is a Senior Operations Officer in the Latin American Technical Assistance Facility of the International Finance Corporation ty of reforms and quality control of work across the country; (IFC). Igor Artemiev is a Senior Private Sector Specialist in the Foreign · Promoting awareness of the issue of Municipal Simplifica- Investment Advisory Service (FIAS) of the World Bank Group. "en breve" is produced by the Knowledge Team of the Operations Services Department of the Latin America and the Caribbean Region of the World Bank - http://www.worldbank.org/lac · January 2007 · Number 99