How much does it cost a country like Peru if business owners don't trust its own justice and conflict resolution systems? Somewhere between $65-200 million per year in gross domestic product, according to a recently published IDB study.
Alvaro Herrero and Keith Henderson, co-authors of The Cost of Conflict Resolution for Small Businesses, came up with that estimate after surveying and interviewing owners of medium, small and micro businesses, judicial system officials, economists, bankers and public officials across Peru.
Herrero and Henderson wanted to find out how small and micro business owners use the justice system, how their businesses are affected by inefficiencies in that system, as well as the total economic impact on the productive sector of those inefficiencies.
They found that small and micro business owners think that Peru's justice system is corrupt, slow, too complex and too expensive. “Only 5% of the business owners we surveyed think that the justice system works well or very well,” says Herrero. “But only 15% said that they had ever even used the system.” Thus, small and micro business owners tend to use informal methods for settling disputes, avoiding the courts and the justice system at any cost, the study reports.
The study also finds that when conflict resolution mechanisms are inadequate or perceived to be so, small businesses miss out on business opportunities and become more risk averse, restricting their markets and increasing their business transaction costs.
“In our research, we came across a 2002 study indicating that 73.7% of small and micro business owners don't use contracts with their clients,” Henderson says. “Because they often don't use contracts, these business owners tend to be relatively risk averse in making business decisions. For example, some told us that they would rather sell to clients they already know than market to new clients and risk non-payment, so they sometimes avoid business expansions or investments.”
Herrero adds, “the non-use of contracts also raises business owners' costs, since many would rather use trusted suppliers than risk potential problems that a new supplier may bring, even if the new supplier was less expensive. Among microentrepreneurs, 24% told us that they would never change suppliers, no matter how much cheaper a potential new supplier may be; while another 26% told us they would only change suppliers if the new supplier offered a price reduction of at least 30%.”
The study also shows that business owners are most inclined to ask for a contract when doing business with a state-owned enterprise or the government—81% and 76%, respectively—but that many avoid doing business with the state completely because they don't trust the state to comply with contracts or pay for goods or services provided. This unwillingness to access the public procurement system represents one more limitation on the expansion potential of small and micro business, Herrero and Henderson argue.
Herrero and Henderson propose several procedural and policy recommendations for governments and the IDB to consider, although they point out that several projects aimed at strengthening conciliation and arbitration systems in Peru and several other countries, financed by the IDB's Multilateral Investment Fund, are already having a “very positive impact.”
The study recommends financing training for medium, small and micro business owners, as well as development of “Know Your Rights” toolkits. Herrero and Henderson also recommend creating “Advice Centers” to help business owners with legal transactions related to business development and conflict resolution. Other recommendations include creating a debtors registry that would be made available to the public, improving transparency and standardization of public procurement, reforming judicial enforcement mechanisms, and promoting coalition building for medium, small and micro businesses.
Alvaro Herrero is a consultant specializing in judicial reform and legal affairs programs. He has extensive experience in Latin America, having worked with Argentina's federal justice system and in organizations such as Inter-American Dialogue, IFES and the IDB.
Keith Henderson is a professor at the American University's Washington College of Law as well as a senior legal affairs specialist at IFES. Previously, Mr. Henderson worked with USAID as a specialist in anticorruption policies and as a lawyer at the U.S. White House and with private law firms. He has written many articles on corruption, judicial independence, transparency, legal sentencing and judicial integrity.