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COSTS OF BUSINESS FORMALIZATION: MEASURING TRANSACTION COSTS IN BRAZIL
Decio Zylbersztajn1
School of Economics and Business – University of São Paulo
Carolina T. Graça
School of Economics and Business – University of São Paulo
Abstract
The problem that originates the present study is that of institutional improvement. In the presence of positive
transaction costs, institutions and the architecture of organizations take on fundamental importance. The
contribution is to measure costs of opening firms in the Brazilian garment industry. The study is structured
in the following sections:
The introduction presents the problem. In the second part the objectives are described. In the third section,
the theoretical references are presented and following, in the fourth section, the methodology is outlined as
well as the description of the data and definition of the variables to be studied. The fifth part presents the
descriptive statistical results, followed by conclusions in part six.
The measure of costs to start up a new business in the garment industry in Brazil has shown a large variation
between regions in the same city and between different areas in the country. The average cost of 11.3% of the
GDP per capita, 9 procedures and the time span of 64 days have been found. Also 39% of the firms declared
that they operated informally for some time.
Key Words: entry costs, transaction costs measurement
Version : July 2002
1 The authors would like to thank Alexandra Benham and Lee Benham for their extensive comments on earlier versions. Also thanks to the research assistants for their support. Special contribution was made by the participants at the workshop organized by the Ronald Coase Institute at the Washington University in Saint Louis. We thank the Ronald Coase Institute, whose support made the collection of data possible. The authors keep well-defined property rights for any errors.
COSTS OF BUSINESS FORMALIZATION: MEASURING TRANSACTION COSTS IN
BRAZIL
1. INTRODUCTION
The concept of transaction costs is central to the New Institutional Economics, having
opened the path to different lines of thought both on the study of organizations as well as
the genesis and development of institutions.
One of the most common questions that scholars dedicated to the new institutional
economics, or critics of it, tend to ask, is how does one measure transaction costs and why.
Critics say that it is impossible to measure transaction costs because empirical tests cannot
be performed. This question is certainly pertinent, but perhaps not for the reasons
proclaimed by the critics. Drawing a parallel with neoclassical economics, it is perfectly
possible to estimate demand functions without measuring utility. Similarly, it is perfectly
possible to test hypotheses of transaction cost economics, without actually measuring
transaction costs. At the micro institutional level there is significant literature from the 80s
and 90s giving growing support to the theses of alignment of the transaction cost-
economizing forms of governance.
In the macro-institutional level, the studies of institutional evolution, and particularly, the
studies concerned with the obstacles to the development of “market-augmenting
institutions”, suggest that efforts to measure transaction costs can shed light on the way to
conduct institutional reforms. Central to the study and the pursuit of institutional
improvement is, therefore, the measurement of transaction costs. If, on one hand, it is
2
unnecessary to measure transaction costs in order that the theory be validated, on the other
hand, if measurements could be taken and done in a comparative fashion among different
countries, important signaling could be offered to the State and to the agents in society, in
an effort to define programs of institutional improvement. In-depth measurement efforts are
necessary in order to disclose the implicit costs that preclude market growth. The nature of
transaction costs differs among countries, regions within a country, and even among
different groups in the same city.
The problem that originates the present study is that of institutional improvement. In the
presence of positive transaction costs, institutions and the architecture of organizations take
on fundamental importance. The motivation of the study is also associated to the fact that
similar studies are being made in different countries adopting similar methodologies with
the potential of leading to signaling comparative results for the governments and private
agents.2
The contribution of the present study is to measure costs of opening new firms in the
Brazilian garment industry, and compare the results with other similar efforts. The basic
hypothesis is that the implicit prices paid by agents to transact with the government differ
from one location to the next. This study aims to disclose this variability.
The study is organized in the following sections:
This introduction expresses the problem. In the second part the objectives are described. In
the third section, the theoretical references are presented and following, in the fourth
section, the methodology is outlined as well as the description of the data and definition of
2 The effort is being led by the Ronald Coase Institute and has contributions from scholars of different countries. See Gancheva,Yonkova and Stanchev(2000).
3
the variables to be studied. The fifth part presents the descriptive statistical results,
followed by conclusions in part six, stressing the contrast with recent literature.
2. OBJECTIVES
The overall objective of the present study is to study the transaction between government
and private sector. The specific transaction chosen for the study is the start up of new
formal businesses in the small garment industry in Brazil. The several steps necessary to
start a new business provide the empirical background to describe and measure the costs of
transaction between government and private sector based on one single transaction.
The garment industry is the target since it has been studied in other countries. Also an
exploratory study in Brazil has been found so the results can be compared. The
comparative measurement of the transaction costs may open the path for studies that relate
the nature and dimension of the transaction costs to the institutional development.
Because transaction costs are not as explicit as the price of merchandise is, it is necessary to
unbundle them and define measures that approximate their values, since they are defined as
the costs of designing and monitoring contracts in the economy.
The specific objective of the study is to find the average and the variation of the implicit
price paid by the small garment companies in Brazil, in the transactions carried out with
government agents, to enter the formal business.
The specific objective is to study the dispersion of the results - particularly the regularity of
the costs measured in different social groups (regions) contrasting the results with
aggregated analysis (and international literature).
3. THEORETICAL REFERENCES
4
Different definitions of transaction costs can be found in the literature. Kenneth Arrow
(1969 in Furubotn and Richter, 1997) defines transaction costs as being “the costs of
running the economic system”. Yoram Barzel (1997) defines the concept as “the costs
associated with the transfer, capture, and protection of rights”.
Eggerstsson (1990, p.14) states that: “….[I]n general, transaction costs are the costs that
arise when individuals exchange ownership rights to economic assets and enforce their
exclusive rights. When information is costly, various activities related to the exchange of
property rights between individuals give rise to transaction costs
The protection of property rights against third-party encroachment – for example,
protection against pirates or even against the government in the case of illegitimate trade.”
Transactions between private agents or between private and public agents raise signals on
how to architect micro institutions (organizations) and how to shape macro institutions, in
order to economize in costs of transactions. Failures in both purposes, at the micro and
macro levels, will bring sub optimal results.
Furubotn and Richter (1997, apud Benham and Benham, 1998) state, “transaction costs
include the costs of resources utilized for the creation, maintenance, use, change, and so on
of institutions and organizations. When considered in relation to existing property and
contractual rights, transaction costs consist of the costs of defining and measuring resources
or claims, plus the costs of utilizing and enforcing the rights specified. Applied to the
transfer of existing property rights and the establishment or transfer of contract rights
5
between individuals (or legal entities), transaction costs include the costs of information,
negotiation, and enforcement”. 3
Especially important is the measurement of the costs of a transaction between private and
public agents, since that transaction is affected by all sorts of incentives that public agents
are exposed to and that can create inefficiencies in the economy. The theoretical
background that serves as support for the present study is based on the original
contributions of De Soto (1990, 2000), measuring transaction costs based on the actual
costs identified for the opening of firms in Peru. Following this study, others appeared,
such as Djankov, La Porta, Silanes, and Shleifer (2000), who observe the costs from the
viewpoint of regulation of access to the markets.
The authors do a comparative study between different countries, situating three different
perspectives in terms of the consequences and causes of regulation. The first, denominated
“helping hand view”, observes the existence of barriers associated to the improvement of
the quality of the goods produced (for example, environmental regulation). The second
perspective is the theory of capture, according to which the agents that act in the market
raise regulatory barriers, making it difficult for new producers to enter. According to this
perspective, the costs of access to the market function as protection for the incumbents.
The third line of thought in the literature focuses on the tollbooth view, which explains the
barriers as a regulation that benefits the regulatory agents alone. That is, entry is regulated
because it benefits the regulators. Djankov studies 75 countries comparatively, contrasting
the three explanatory lines of thought mentioned, concluding that higher regulation and
higher corruption are related to larger informal economies, supporting the hypothesis that
3 Benham,A and Benham,L. Measuring the Costs of Exchange. Paper presented at the Second Annual Meeting of International Society for the New Institutional Economics, 17 - 19 September, 1998, Université de
6
entry regulation benefits politicians and bureaucrats. Most of the comparative studies
among countries did not perform direct interviews with entrepreneurs but only described
the bureaucratic steps to start up companies. We consider that this is not enough to uncover
the real implicit costs prevailing in the economy.
The study of Stone, Levy, and Paredes (in Alston, Eggertsson and North,1996) focuses only
on two countries, Brazil and Chile, seeking to contrast four basic areas where regulatory
institutions could create costs, namely: the start up of new business, the regulation of
business, orders by customers, and sales with credit. The study covers transactions between
enterprises and the government as well as transactions between different firms. The field
studies were done in the garment industry in the cities of São Paulo and Santiago, with
interviews conducted in 42 firms of varying sizes in each country. The conclusions found
in this study are very relevant for the present paper. First the authors conclude that the
Brazilian system is more costly than its Chilean counterpart. Stone also says that there are
substitutes for institutions like the accountants and “despachantes” operating in the city of
São Paulo. The study also concludes that transaction-specific investments are burdened
more strongly than small and non-specific investments. This conclusion is aligned with the
theory since the need for institutions is related to the protection of specific investments
from hold up appropriation of quasi-rents. In the absence or specific investments, no
specific quasi-rents emerge.
The study of Benham and Benham (1998)4 follows the line of uncovering simple measures
that can identify and compare transaction costs between different countries. It focuses on
the costs of acquisition and operation of telephone lines and opening of firms between
Paris I.
7
countries. Basic conclusions point to the inadequacy of price data usually reported. This
information focuses only on average prices and does not explore its dispersion. This
conclusion is particularly important for the purpose of the present study, because it is
focused on the gathering of primary data of transaction cost measurements and the
dispersion of the results is expected to be relevant.
Finally, it is worth mentioning the study of Gancheva (op. cit.) conducted in Bulgaria,
through interviews with 120 small and medium firms in 21 cities. The study, in the line of
de Soto’s, explores the problem of the shadow economy, as a result of the existence of high
transaction costs to operate formally. The same problem exists in Peru and in Brazil.
4. METHODOLOGY
The analysis of the costs of starting up companies is designed as a qualitative and
quantitative exploratory study. In order to delimit its scope, the garment industry was
chosen, defined as small and micro firms that employ up to 10 employees in the activity.
We have included only firms established between January 1999 and July 2001.
The objective is to focus on the entry costs, ignoring, therefore, costs associated to
regulated activities, as well as focusing on small companies without the support of legal
4 Benham,ª and Benham,L. Measuring the Costs of Exchange, presented at the second annual meeting of ISNIE. September 17-19, 1998, Université de Paris..
8
departments, whose effort to start up can represent a proxy for the transaction costs
involved in accessing the formal market.
Costs are reported in terms of percentage of per capita gross domestic product, which is a
standard measure found in the literature, and have been calculated based on direct costs and
also on the measurement of the opportunity cost of time of the entrepreneur, allocated to the
specific negotiation with governmental agencies.
As an instrument of primary data collection, interviews were developed, structured around
a questionnaire. The selection of the interviewees was by random sampling departing from
pre-defined areas with high concentration of the activity. The design of the questionnaire is
aligned with the basic script proposed by the international team mentoring the project. In
addition, some questions were added with the purpose of adapting the questions on the
process of start up firms to the peculiarities encountered in Brazil. An illustrative example
is the question referring to the utilization of an accountant (facilitator) during the process of
starting up the firms, having been cited also in the study of Stone, Levy, and Paredes (op.
cit.).
The target population was defined as being representative of firms with up to 10
employees, in the garment-manufacturing business, and with at most two years of
existence. The garment sector was chosen in order to permit the contrast with other studies
of an activity that has a very homogeneous technological base, no extra governmental
controls, and has also been studied by other authors.
In the city of São Paulo, 4 field visits were made to the districts of Brás (an old Italian
district), 2 to the district of Bom Retiro (old Jewish district which today is occupied by
Korean immigrants), 1 to a shopping center characterized by small firms working in the
garment sector, and 1 to Itaim Paulista, on the outskirts of the city, mostly populated by
9
immigrants from Brazil’s northeastern states. It should be emphasized that the
metropolitan area of Sao Paulo has 17 million inhabitants, and is characterized by more or
less autonomous regions with specialized activities.
With the objective of providing a contrast for the environment of the metropolitan area, the
sample included interviews from the cities of Americana, Santa Bárbara do Oeste, and
Campinas, all in the State of São Paulo, and the city of Monte Sião in the State of Minas
Gerais, all known centers of the garment industry.
In the city of São Paulo 30 establishments were interviewed and the total number of
interviews was 48. In contrast with the study of Stone, Levy, and Paredes (op. cit;), which
focused on a sample of 42 firms of different sizes in the city of São Paulo, the present study
sought to expand the geographic area of data collection, while controlling for the scale of
production.
In the case of interviews conducted in the cities of Americana, and Santa Bárbara do
Oeste,11 more firms were interviewed.
In Monte Sião, contact was made with the Commercial and Industrial Association, which
prepared a list of 10 firms affiliated to the entity that filled the requirements of the research
study. Adding this list to the information attained from the Legal Department of City Hall,
the interviewer sought out the firms to have them answer the questionnaire. In total, 7
firms were interviewed in Monte Sião.
10
5. DATA ANALYSIS:
5.1. Starting New Companies in Brazil
According to reports from de Soto (1989), in Peru the process of starting new companies is
made up of 11 stages. In Brazil Djankov et al. report 15 different procedures for firms that
operate in regulated sectors, while we found 9 procedures and the need to visit at least 4
different agencies to obtain all the legal licenses for a firm.
• The procedures for opening a company in Brazil depend on the type of activity, the
geographical region where the company intends to establish itself, whether the sector is
regulated or not, among others.
The list of formal licenses needed to start up a company includes:
• Contributor’s Information Register – CIC and General Register – Identification card
(RG) of each partner, 3 notarized copies of each;
• Proof of residence of each of the partners: original and 2 notarized copies;
• Urban Land and Building Tax – (IPTU) of the firm’s headquarters for the year in
effect: 3 notarized copies;
• For limited firms: Social Contract signed by a lawyer or Individual Firm Form for
partner-less companies;
• Proof of register of the partner or licensed professional by the Regional Council’s
office that regulates the different professions in the country including 1 notarized copy;
11
• Building lease registered at the notary office;
• Should the enterprise be located within a residence, a declaration is required from the
owner yielding part of the building (with notarized signature) along with a declaration
from the main firm owner with a sketch on the back (with notarized signature);
• Income tax declaration of the owners, from the last 5 years (notarized copies) or
declarations of exemption.
• Federal Revenue and Social Security;
• Secretary of Finance and Accounting Council.
The legal path for opening a firm that is either an industry or commerce, with or without
service provision, requires the following steps:
STEP 1: Visit to the notary office to notarize signature of the partners and register the
Social Contract and Lease or owner’s declaration yielding the property;
STEP 2: Opening of the firm at the State Board of Trade by obtaining a register number -
NIRE. In the case of São Paulo, the office is called the Junta Comercial do Estado de São
Paulo - JUCESP;
STEP 3: Fiscal register of the company at the Federal Revenue office through the National
Register of Companies (CNPJ), for federal tax collection;
STEP 4: Fiscal register of the firm at the Secretary of Finance for issuing of the State
Register (I. E.) for state tax collection;
STEP 5: City (county) register of the firm and issuing of the Property Contributor Register
(CCM) and payment of the Location, Installation, and Functioning Tax (TLIF);
12
STEP 6: Enrollment of the company in the Social Security Institute;
STEP 7: Printing of formal book of sale registration (bills) to be used as proof of each
transaction. This document can be provided as soon as the CNPJ and IE are in hand;
STEP 8: In case of firms that wish to advertise with storefront signs, they must obtain an
advertiser’s register;
STEP 9: Joining the Union is not mandatory, but highly recommended.
In the case of service providers, the steps for opening the firm are the same as described
above, except for step 2, in which one needs to visit the Notary Office of Civil Registry of
Firms.
For regulated sectors, some other steps must be added, which are unnecessary for the case
of small garment manufacturers. For instance, activities that have potential environmental
impacts require a special license.
The negotiation process is costly and includes visits to several agencies. The figure of the
accountant is justified to act as a facilitator, as reported in Stone (op. cit.). The negotiation
costs do not affect all companies in the same way. Companies that have several businesses
and a specialized legal department to deal with the transactions are expected to have an
advantage.
There are institutional reactions to this picture. One example is in progress, with the
organization of a specialized bureau that provides support to small businesses with private
funds collected from the workers’ payroll. SEBRAE´s officers, accountants (facilitators)5,
and businesspeople are unanimous in advising against following the path described above
without the assistance of a facilitator. Otherwise, the process can be extremely time-
13
consuming due to lack of adequate documentation and having to obtain the relevant
information from the various public agencies, not to mention the exposure to bribes
solicited to accelerate the process.
<Figure1- insert about here>
Figure 1 shows the accumulated time to accomplish four steps to start a new business in the
city of São Paulo, which is close to 40 days. The time spans mentioned above are not
infrequently accelerated through payment of bribes. This practice is extremely common and
known by everyone, having been reported during the interviews conducted in this study.
In São Paulo there is a proposal to concentrate the negotiation with the Board of Trade,
Federal Reserve, and the Secretary of Finance in a single agency to help business people to
start their own businesses. The intention is to dispense with the accountant. However, the
process in practice is only abbreviated for companies that are located in the proximity of
the bureau offices, not reaching the small units that are located far from São Paulo’s
downtown area. The procedures in the new streamlined agency in terms of documentation,
forms, collection of fees, and others are identical to those units geographically farther apart.
Some public agencies are organizing a network of interconnectivity, adopting information
technology whose purpose is to better monitor the situation of the petitioners (to know
whether the individuals or firms are in a lawful situation). Most potential users still do not
benefit from this communication network and have a hard time following the situation of
their requests and the status of their accountants via Internet.
5 The Portuguese word despachante means a facilitator, and is usually but not necessarily an accountant.
14
5.2. Descriptive Statistics:
The data present descriptive statistics on the location of the firms, their legal form, the time
allocated to start-up in months, the cost of accountants’ (facilitator) services, the existence
of bribes, identification of firms that operated informally, perception as to the exit costs and
investments in specific assets (equipment).
To allow the contrast of the results with the international literature, the cost of opening was
indexed by the value of the per capita gross domestic product.6 The data were discriminated
among the different cities and different districts within the metropolitan São Paulo area.
Location and Nature of the Firms
The profile of the sample, as to geographic disposition of the firms, was identified as
follows: 40% were found in the districts of Brás, 8% in Bom Retiro, 17% in the city of
Americana (state of São Paulo), 15% in Monte Sião ( state of Minas Gerais), and 20% in
other districts in the city of São Paulo. Figure 2 shows the number of interviews per
location and figure three shows the relevance of two districts in the population, in terms of
the total number of start-ups in 2000-2001.
6 The per-capita GDP for the purpose of the study is R$ 6560.00.
15
<Figure 2 – insert about here >
The choice of locations for the research was based on information obtained from the São
Paulo State Board of Trade, which furnished a list of the total number of firms opened in
the State of São Paulo in the years 2000 and 2001. Of this total, 22% and 8% of the firms
are located in the districts of Brás and Bom Retiro, respectively, which demonstrates the
importance of these cartiers in the scenario of the state small garment industry, in addition
to justifying the composition of the sample surveyed.
< Figure 3 – insert about here>
The data present the legal nature of the firms, being classified as civil societies (2%),
individual firms (28%), and limited liability societies (70%). Indeed there are different
procedures for each of the legal forms chosen, both for opening the firms as well as
differences in taxation and costs of controls. Figure 4 indicates the participation of the
different forms observed in the sample with the predominance of limited liability firms.
< Figure 4 – insert about here>
Similarly, the firms can be classified according to the nature of the activity. Brazilian
legislation allows the categorization between service providers, industries, and industries
and commerce. This information is represented in figure 5, showing that most of the firms
in the sample are classified as industry and commerce, but not allowed to provide services.
16
< figure 5 – insert about here>
5.3. Start-Up Costs
Figure 6 indicates the time lag the entrepreneur spent following the nine steps described
previously to start up a firm considering the full sample and by location. The town of
Monte Sião presents the shortest time. In the district of Bom Retiro the longest time was
observed, though it should be stressed that there was no access to the Korean-owned firms,
which may have affected the result.
<figure 6 – insert about here>
Figure 7 indicates the fees of the accountant’s package . The data suggest that the lowest
amount observed was in the city of Americana. Monte Sião, which presented the shortest
time devoted to opening, presents costs close to the average of the sample, explained by the
distance of the city from district headquarters where firms must be registered. So the
different fees might reflect the implicit costs related to location, distance from the city
offices and also the implicit bribery costs demanded by government agents.
<figure 7 – insert about here>
Among the firms interviewed, 39.0% informed that they operated informally prior to
fulfilling all the steps for legal start-up. The results also show that 62% of the firms
17
interviewed informed that it was possible to bribe the public employees (but not necessarily
that they did it), and 67% considered that the exit costs could be even larger than the start-
up costs.
The start-up costs have been classified as direct bureaucratic costs (city, state, and federal
fees and specialized services), added to the opportunity cost of the time allocated to the
activity of negotiation with governmental agencies. Complementary, direct investments in
assets allocated to the new business are informed but not considered in the calculation of
start-up costs.
The bureaucratic costs could not be unbundled since the data available was the full bundle
of services charged by the facilitator. The opportunity cost of the time allocated has been
defined as the legally defined minimum wage of R$ 180.00 per month7. In spite of the fact
that this procedure might undervalue the real opportunity cost of time, this follows the same
procedure as followed by De Soto (1989) in Peru. In order to overcome possible
underestimation, the procedure to calculate the start-up costs considered two scenarios,
taking one and two minimum salaries as proxies for the opportunity cost of time.
Measurement of Costs
Table 1 presents the average start-up costs considering the opportunity cost of time, total
time span to follow the negotiation, the bureaucratic costs and the direct investments. Also
a measure of dispersion and the range of values for the whole sample are presented. The
results are reported in terms of the standard measure, the percentage of GDP.
18
<table 1 – insert about here>
Opportunity Cost of Time
This proxy measures the effort to start up the firm in terms of the time the entrepreneur
devoted to following the bureaucratic steps. On average, the partners devoted 27.15
weekly working hours to start up the business, with a standard deviation of 37.33 hours,
showing how this implicit price varies among regions. The extremes are also important,
since there were cases in which the partners did not cease working for this purpose, as well
as cases in which the time devoted to opening the company was significant (full time
devotion of the partners).
In relation to the time to follow all steps to start up and register the firm, on average, it took
2.14 months with a standard deviation of 1.54 months, ranging from 0.33 to 9 months.
Based on the lead-time in months to open the business and the weekly hours devoted to the
process, the opportunity cost of time to the partners for opening the business has been
determined. Thus, if the partners spent, on average, 27.15 weekly hours to finalize the
opening and the span was 2.14 months, approximately 9.17 weeks, then the total average
time of the partners devoted to the legal paths was 248.96 hours. As the monthly minimum
wage is R$180.00, the total cost of opportunity was on average R$254.68.8 In relation to
per capita income, the cost of time opportunity represents on average 3.9% of the per capita
GDP ranging from 79% to zero, in the cases where no time was allocated.
The Facilitator
7 The minimum wage is used as an index for salaries in labor contracts.
19
The analysis of the accountant services shows that, on average, this professional charged
R$488.64 with a standard deviation of R$391.00. This amount includes all the costs of
fees and services of the professional, basically, to go through the following agencies: State
Board of Trade (obtainment of NIRE), Federal Revenue (obtainment of CNPJ), Secretary
of Finance (IE), Municipal Register (TLIF), enrollment of the firm in the National Institute
of Social Security, and obtainment of a lawyer’s signature on the Social Contract of the
firm.
The cost of the facilitator is 7.4% of the standard measure ranging from a maximum of
30.5% to a minimum of 2.1%.
8 For purposes of calculation, the work week was considered to have 44 hours, 4 weeks of work a month, minimum salary of R$180,00, coming to R$ 1,023/hours worked.
20
To conclude this section it can be reported that the start-up costs excluding the investments
and including the opportunity cost of time and the costs of the facilitator is 11.3% on
average ranging from a maximum value of 109.9% and a minimum of 2.1%, measured as
percentage of per capita GDP.
5.4. Results by Region
For a more detailed assessment, the data on time to start the company and the amount of the
package charged by the accountant were calculated for the different locations.
In addition to allowing the contrast between regions, the objective is to evaluate the
contrasts between a large metropolitan center where impersonal relationships are the rule,
with small communities, where interpersonal relationships are present.
The motivation for the disaggregated analysis comes from the results obtained by Stone,
Levy and Paredes (op. cit.), who contrasted aggregated data between Brazil and Chile and
found significant disparities but focused the study only on the city of São Paulo.
<<< table 2 – insert about here>>>
Table 2 presents the average time span to start up the company in each region. In the city of
São Paulo the average time in months is 2.25, longer than the average, reported as 2.14
months. The city of Americana shows the highest figure with 2.37 months and Monte Sião,
the lower average with 1.46 months.
The extreme values for the number of months also vary between locations. In the city of
São Paulo a maximum of 9 months was found, while in Monte Sião, the smallest value was
21
found, namely 3 months. The minimum span was found in São Paulo, being 0.33 of a
month.
A more detailed analysis of the responses allows us to mention that the district of Bras is
the region with the largest observed range, where the longest and shortest start-up times
were found. It was also in that region where most reports of bribes paid to public officers
were found.
<<< table 3 – insert about here >>>
Table 3 reports the opportunity cost of time of the entrepreneur. It shows that larger figures
are reported in the district of Brás, above the average for the city of São Paulo. In the city
of Monte Sião no time was reported as allocated in start-up activities, as the process was
totally carried out by the accountants, and the entrepreneurs did not stop their usual activity.
On average, 3.9% of the standard measure is spent in this activity, ranging from zero to
8.8%.
<<< table 4 – insert about here>>>
The accountant’s fee was R$ 488.00 on average, or 7.4% of GDP/capita, as reported in
table 1, with a negative correlation of 0.15 estimated between this variable and the time
span. The value of the correlation reaches a positive 0.64 in Americana and – 0.32 in the
metropolitan area, excluding Brás and Bom Retiro, thus not allowing conclusive findings.
Americana presents the lowest costs for accountant’s services, or 3.3% of the GDP/capita,
perhaps indicating a greater number of professionals competing in the market, because it is
a larger center and close to other urban centers. The second lowest value observed was in
22
the city of São Paulo, but outside the districts of Brás and Bom Retiro. Brás showed the
highest value, corresponding to 9.53% in relation to GDP/capita.
The entrepreneurs from the district of Brás are, comparatively, at a disadvantage in relation
to their competitors because they must pay higher costs to open their businesses and have
longer waiting periods, but possibly the returns on the business are also higher, reflecting
the higher value of the license to operate in that region. It was in this cartier that we found 4
cases of businesspeople who claimed to have paid bribes to accelerate the opening process
of their firms. A total of 11% of the firms interviewed stated that they paid bribes in the
start-up process.
In sum, these are the procedures, costs, time lags, and limitations to opening garment-
manufacturing firms in Brazil, which are an obstacle for small businesses to start up, even
if the market exists and skills are not a problem. Decision makers might perceive an
incentive to start the business informally, running extra risks of being caught by the tax
office and being exposed to bribes and other harassments.
6. CONCLUSION
The standard measure of costs to start up a new business in the garment industry in Brazil
has shown a large variation between regions in the same city and between different areas in
the country. The average cost of 11.3% of the GDP per capita, 9 procedures and the time
span of 2.14 months (64 days) found in this study can be contrasted with similar
measurement made in the study of Djankov et al. The study reports 6.7% of GDP per capita
(US$ 5,012 in 1997), 15 procedures, and 67 days, very close to the findings presently
reported. Therefore the present result shows a larger cost, a smaller number of steps, and
23
about the same lag time. The differences might be due to the methodological differences,
since Djankov sampled companies of different sizes all of which were located in the city of
São Paulo.
If we double the opportunity cost of time, then the results will change to 15.2% of GDP per
capita, which might be a more realistic measure.
The average amount paid by firms that claimed to have paid bribes in some part of the
process was R$ 3,660.00 (55% of the standard measure). This amount refers to payments
aimed at accelerating the bureaucratic process, liberation of the property, regularization of
the firm, among others. Despite the low incidence of bribes to open firms (11% of
interviews in the city of São Paulo), 62% of those interviewed declared that it is possible to
bribe an official in the day-to-day life of the company. However, the research also shows
that it is in the city of São Paulo that this finding is more widespread. In smaller cities, this
behavior is less frequent and even repudiated by the interviewees, who fear sanctions. The
amount paid varies widely, though it is expected that the interviewees had an information
bias as to this item of the questionnaire.
In Brazil, it is customary for companies to start working in their activity informally without
having fulfilled all the legal procedures to open the company. High costs associated to
formalizing the business added to the typical risk associated with the new business activity
and the exit costs of the business appear to be the main reason for the decision to operate
informally.
In the present study, 39% of the firms declared that they operated informally for some time
prior to having satisfied all the steps. This result contrasts with the report of Stone, Levy,
and Paredes (op. cit, p.114) that claimed “In neither São Paulo or Santiago did we find
unregistered firms.” The authors have pointed to the fact that informality is found primarily
24
in terms of tax evasion in formal business, which seems to be a logical argument, but the
first conclusion is not supported by our findings.
A share of 24% of those companies interviewed declared that they participate in some
group that facilitated access to the activity, of which most were organizations related to the
textile sector. For example, in Monte Sião (MG), the ACIMS (Commercial and Industrial
Association of Monte Sião) is very active and sought frequently by entrepreneurs wishing
to open businesses. Through this affiliation, they obtain necessary information to enter the
business. Possibly, this number would have been higher if Korean businessmen had
participated in the sample, because it is well known that members of this group help
countrymen get set up in the business.
A share of 63% of the firms interviewed had at least one partner with prior experience in
the textile business. This fact seems to be relevant to the success of the endeavor.
During the pilot study of the questionnaire, it was noticed that several entrepreneurs
commented on the relevance of the exit costs. That is why the question was included in the
questionnaire and the results serve as evidence for future studies. Of the total respondents,
67% declared that they believe the cost of closing a firm is higher than the cost of starting
up.
The amount charged by the accountant to close a firm, as a general rule, is double that
charged for opening a company. A possible explanation for this are that the public agencies
make closing difficult since it is not in their best interest to lose contributors; furthermore,
there may be debts and fines that the owner needs to settle before leaving the business,
factors that are time-consuming for the accountant to follow. In many cases it was reported
that the firms simply close their doors and stop their commercial activity, leaving debts
25
with the government and employees to be resolved judicially. This attitude is frequent in
countries where the justice system is slow, so the debt is oftentimes never paid.
It is essential for a conclusion about the start-up process of garment manufacturers in Brazil
to have a view that unifies all the statistical data to the perception formed during the period
of interviews.
Hence, it is concluded that, in Brazil, opening a company is a costly process, whether in
terms of the entrepreneur’s time or in terms of incidental costs. It is also an exceedingly
bureaucratic process, since documentation must travel through at least 4 different public
agencies, taking about 2,14 months, at a cost of 9.8% (GDP/capita). Still, the accountant
functions as a necessary middleman, whose importance tends to decline as society becomes
more organized and the government improves the institutions that control the negotiation
between private and public sectors.
If on one hand, the opening process of a business is very slow, the entrepreneur reacts by
operating informally, as is expected. This logic justifies the statistic that 39% of the firms
interviewed operated informally while they awaited documentation, strengthening the thesis
discussed by Djankov (op. cit), on the role of the public administrator that creates
difficulties in order to collect undue resources (toll booth view). Also in reference to the
public agencies, there is evidence that it is possible to shorten the time period to obtain
licenses for legal functioning by paying bribes. Employees offer to speed up the
bureaucracy and to ignore some irregularity in the installation of the firm or in the
documentation of the partners.
It was noted that the practice of bribery is less frequently reported in smaller cities. No
firm out of São Paulo actually claimed to have incurred this cost and the proportion of
people that believed it is possible to bribe an inspector is also lower outside the capital,
26
being, therefore, one of the facts that reveal that transaction costs are greater in the city of
São Paulo. In relation to the time periods for deliberation of the licenses, it was verified
that they are very particular to each region. In Americana, the time periods were very
similar to those of the capita, whereas in Santa Bárbara d´Oeste (neighboring town) and
Monte Sião (MG), the time periods were much shorter.
A second fact that reveals that transaction costs are higher in the city of São Paulo and
Campinas, is the amount charged by the accountants. Whereas in these places there were
firms that paid as much as 30%, in Americana and Santa Bárbara D´Oeste this amount was
around 3% (GDP/capita) and in Monte Sião, the accountants charge nothing beyond the
cost of the monthly service fee.
An observation in the city of São Paulo is the formation of clans within which the search
for information, credit, and commercial relationships is made viable at a low cost due to the
informality. These are important informal cooperation mechanisms in the communities.
There are also organizations emerging in Brazil whose objective is to inform and facilitate
the start-up of firms. One of these non-governmental organizations is SEBRAE, whose
fundamental purpose is to support the small and medium business.
The profile of the small garment entrepreneurs shows that in general, they had already
worked in the business prior to opening their own firms, a fact that cuts down the costs of
gathering information. As a general rule, these same entrepreneurs have incentives to
cooperate and favor the access to the garment industry. Furthermore, most of the
investments were made with their own capital, given the high cost of credit in the country.
Few of them consulted SEBRAE to open their firms and trusted, basically, the accountants
to provide information on the legal pathways to opening a firm.
27
As a final aspect, it is worth comparing the results obtained with other countries as well as,
and especially, seeking solutions for institutional improvements that can be implemented in
the realities of each country. Some of these measures are: advancing the computerization
process of the public agencies, monitoring the competition and illegal labor, monitoring the
activity of the inspectors and punishment for violators, educating entrepreneurs on the
existing norms as well as facilitating the possibility for their firms to act formally.
We feel that a more in-depth study is needed, with a view to expanding the database of the
interviews, allowing an expansion of the study by covering regions that are representative
of the different institutional realities of Brazil. Certainly the expansion of the data will
bring the possibility of more statistically reliable results, the present study being considered
merely exploratory.
References
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30
FIGURE 1: Cumulative time span to register a new firm in Brazil
0
5
10
15
20
25
30
35
40
State Board of Trade Federal Revenue Municipal Register Social Security Institute
Different regulatory and bureaus
Num
ber o
f day
s
FIGURE 2: Numbers of interviews in each location
0
2
4
6
8
10
12
14
16
18
20
Brás Bom Retiro Otherneighborhoods
Americana Monte Sião
Sam
ple
size
31
FIGURE 3: Importance of the districts of Bras and Bom Retiro in the total number of new
firms opened in the year 2000 and 2001
Brás22%
Bom Retiro8%Others
70%
Source: State Board of Trade (JUCESP)
32
FIGURE 4: Classification of the firm according to its legal nature
Civil Society2%
Individual Firm28%
Limited Liability
70%
33
FIGURE 5: Objective of firms in the sample (%)
Industry9%Services
9%
Industry and Commerce
82%
34
FIGURE 6: Time lag to open a new firm by location (months)
Monte Sião
AmericanaAverage
São Paulo BrásSão Paulo*
0
0,5
1
1,5
2
2,5
3
mes
es
35
* neigborhoods other than Brás and Bom Retiro
FIGURE 7: Accountant´s fee by location
Monte Sião
Americana
São Paulo*
Brás
São Paulo
Average
0
100
200
300
400
500
600
700
Fee
(R$)
36
* neigborhoods other than Brás and Bom Retiro
Table 1:
Costs to start up a business in the garment industry
Lead time
to start up
(months)
Owners´
time to
start up
(hour/wee
k)
Time
opportunit
y cost
index (%)
A
Accountant
s service
cost index
(%)
B
Investme
nt index
(%)
A+B
Average 2,14 27,15 3,9% 7,4% 606% 11,3%
Max 9 132 79,4% 30,5% 3811% 109,9%
Min 0,33 0 0,0% 2,1% 23% 2,1%
s.d. 1,54 37,33 3,8% 6,0% 955% 9,8%
Table 2:
37
Number of months to start up the firm per region
Areas Average Max Min
Brás 2,34 9 0,33
São Paulo 2,25 9 0,33
Americana 2,37 4,5 1,5
Monte Sião 1,46 3 0,75
Average sample 2,14 9 0,33
Table 3:
Opportunity cost of time
Time span
(months)
Time consumed
per week to start
up the business
(hours/week)
Opportunity cost
of time (R$)
Opportunity cost
of time index
Brás 2,84 46,2 575,2534 8,8%
São Paulo 2,25 34,47 340,0342 5,2%
Americana 2,37 24,2 251,4563 3,8%
Monte Sião 1,46 0 0 0,0%
Average 2,14 27,15 254,7314 3,9%
Source: primary data
38
Table 4:
Accountant´s fee
Accountant´s fee
index
Max Min
Brás 9,5% 30,5% 2,1%
São Paulo 8,6% 30,5% 2,1%
Americana 3,3% 4,6% 2,3%
Monte Sião 7,6% 7,6% 7,6%
Average 7,4% 30,5% 2,1%
Table 5:
Opportunity cost of time 2 (double opportunity cost)
Time span
(months)
(hours/week) Opportunity cost
of time (R$)
Opportunity cost
of time index
39
Brás 2,84 46,2 1150,507 17,5%
São Paulo 2,25 34,47 680,0685 10,4%
Americana 2,37 24,2 502,9126 7,7%
Monte Sião 1,46 0 0 0,0%
Average 2,14 27,15 509,4628 7,8%
40