Good Intentions and Bad Consequences: How Overregulation Impedes Uzbekistan's Growth

In 2001, Uzbekistan embarked on a self-proclaimed economic reform program aimed at accelerating its transition to a market economy that better complied to international standards.

In 2001, Uzbekistan embarked on a self-proclaimed economic reform program aimed at accelerating its transition to a market economy that better complied to international standards.  A key goal of the Uzbek government was to decrease the share of the economy operating outside the formal system of licensing, taxation, certification, and other administrative barriers to business. 

By the end of 2003, however, the government's ambitious program had unnecessarily damaged the Uzbek private sector.  The good intention of increasing the number of legitimate small- and medium-sized enterprises (SMEs) succumbed to the ill effects of poorly designed legislation and overregulation.

Promising steps have taken place in recent months as the Uzbek government has reconsidered several onerous measures, but many barriers to enterprise development and economic growth remain firmly in place.

With roughly half of the private economy operating outside the law, the Uzbek government's interest in formalizing more enterprises is evident.  However, despite the government's efforts aimed at helping business, new SME registration has drastically dropped from 40,000 in January 2001 to 15,000 in June of that year, according to the World Bank.  Businesses in the informal sector do not pay taxes, yet have very high operating costs aimed at bypassing the law.  These costs are directly passed on to the consumers.   Such a large share of informal business activity not only deprives government of revenue, but undermines its very authority. 

Informal businessmen sacrifice legal title of their property, the protections of the courts, the ability to contract, and the use of their property, as collateral for bank loans.  The price is steep. Why do so many small-scale entrepreneurs make that trade-off?

 

While operating in the shadow economy is not cheap for businesses, it can be significantly less expensive than entering the formal sector, say entrepreneurs.  Bribe-seeking Uzbek government officials regularly make it clear that paying them under the table is more advantageous than paying the full burden of official taxes or fines.  While remaining in the shadow is costly, emerging into the official economy is even more so.  The complicated documentation procedures for obtaining official licenses require businessmen to run through a bureaucratic maze.  The exorbitant costs expended in pursuit of legal requirements directly subtract from time spent on gainful and productive business activities.

 

Any cursory examination of the informal sector quickly reveals that it is merely the symptom of a much more serious disease: overregulation.  Regulations that set excessively high barriers to property ownership and its use by its rightful owner tie down the wealth of the country.  Bureaucratic overregulation in the form of taxation, licensing, certification, registration, and other numerous administrative procedures that require mandatory permission at every step places a heavy burden on the entrepreneur.  Government-made barriers to the establishment of valid property rights trap assets in less than fully productive uses. 

Recent legislation has choked much business activity, particularly that of small and medium enterprises.  Wholesale operations with strong political connections were boosted by new decrees, while significantly reducing competition from smaller wholesalers and traders.  When passing these new decrees, legislators proclaimed their commitment to spurring the economy through the promotion of SMEs and the creation of badly needed jobs by fostering a healthier business environment, increasing economic growth, and generating much needed tax revenue. 

However, rather than providing incentives for informal businesses to enter the formal economy, the government imposed regulations of control and protectionism that habitually infringe on property rights. In addition, the local business community believes that these regulations were designed with a short-term vision and were intentionally written in vague and often contradictory language.   In addition, when businesses are not encouraged to expand, they are unable to provide employment opportunity which is badly needed in Uzbekistan.  Consequently, the new regulatory framework that emerged has practically devastated local businesses, sharply increased informal sector activity, and has traumatized the local economy.

 

Restricted access to cash, hampered by a crippled banking system, has significantly curtailed the amount of business activity in Uzbekistan.  Withdrawing money from the bank is now only permitted under a narrow set of circumstances that is closely monitored by bank staff.  Despite the fact that entrepreneurs are withdrawing their own money from their own bank account, if the reasons sited for withdrawal are incompatible with the narrow categories under which withdrawal is permitted, cash is not distributed.  Despite more recent legislation adopted in August 2002, stating that cash should be made available to the account bearer on his or her first request, banks continue to dispense cash according to outdated legislation.  Entrepreneurs believe that this is due to a lack of an enforcement mechanism within the new law itself; hence, banks follow the only procedure ever provided, which belongs to the "superceded" legislation.  Even though most basic transactions must be executed via a bank transfer mechanism, buyers and sellers still frequently arrange supplemental cash payments outside the legal system in order to avoid documenting the true value of goods and services, and thus reducing their formal tax liability.  This type of "banking system" encourages SMEs to maintain their "accounts" as cash sitting unproductively in their private safes.

 

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