COSTS OF BUSINESS FORMALIZATION: MEASURING TRANSACTION COSTS IN BRAZIL

Decio Zylbersztajn1

School of Economics and Business – University of São Paulo

dzilbers@usp.br

Carolina T. Graça

School of Economics and Business – University of São Paulo

ctgraca@usp.br

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

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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

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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.

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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.

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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;

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• 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);

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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-

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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.

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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.

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< 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.

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<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.

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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.

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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

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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

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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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Cambridge University Press, Cambridge. 1996.

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www.montesiao.com.br/index.html. Acesso em: 27 jul. 2001.

BARZEL, Y. Measurement Cost and the Organization of Markets. In: Journal of Law and

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BENHAM, A., BENHAM, L. Measuring the Costs of Exchange. In: Second Annual

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COASE, Ronald. The Problem of Social Cost. The Journal of Law and Economics 3.

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De SOTO, Hernando. The Other Path. New York,NY:Harper and Row.1990.

De SOTO,Hernando. The Mystery of Capital. Basic Books.New York, USA. 275 pp. 2000.

Djankov.S,La Porta.R,López-de-Silanes.F,Shleifer.A .2001. The Regulation of Entry.

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INSTITUTO Brasileiro de Geografia e Estatística. Disponível em: www.ibge.gov.br.

Acesso em: 30 jul. 2001.

KLAES, M. The Birth of the Concept of Transaction Costs: Issues and Controversies. In:

Oxford University Press. V. 9, n. 4, p. 567-593, 2000.

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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