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Bureaucratic Discretion and the Regulatory Burden: Business Environments under Alternative Regulatory Regimes

Published online by Cambridge University Press:  05 January 2012

Abstract

While theoretical arguments distinguish regulatory policies from the institutional mechanisms of their implementation, empirical accounts often conflate the official regulatory policies of the government with the unofficial regulatory burden emanating from corruption and red tape. Building on the literature that emphasizes a separate and non-trivial effect of regulatory enforcement, this article identifies bureaucratic discretion as an important institutional factor that conditions the effects of regulatory policy on the business environment. An analysis of cross-sectional data covering 119 economies demonstrates that, under high levels of bureaucratic discretion, state regulatory involvement has no effect on the business environment. Low levels of bureaucratic discretion, however, accentuate the link between light regulatory burden and a business-friendly economic environment.

Type
Research Article
Copyright
Copyright © Cambridge University Press 2012

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References

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2 For a discussion of different approaches to the regulatory state, see Moran, Michael, ‘Review Article: Understanding the Regulatory State’, British Journal of Political Science, 32 (2002), 391413CrossRefGoogle Scholar. The literature often distinguishes three types of regulations: economic (price and entry), social (environment, social cohesion, health, occupational safety), and bureaucratic (red tape, government information collection). These regulations have different purposes but in practice are closely interrelated. For instance, the government may restrict entry into the chemical sector to better enforce environmental regulations, or it may impose price controls on the telecommunication industry in pursuit of its goals of social cohesion. Unlike other works that explicitly distinguish between these types, this analysis applies to all regulatory hurdles, irrespective of their purpose.

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6 Dellepiane-Avellaneda, ‘Review Article: Good Governance, Institutions and Economic Development: Beyond the Conventional Wisdom’, offers a thorough critique along these lines.

7 The concept of ‘business environment’ is central to the neo-liberal political economy that tends to see government regulations and taxation as imposing costs on businesses. This approach associates low taxes and few regulations with a business-friendly environment. Examples of empirical indicators inspired by the neo-liberal approach include the Heritage Foundation Index, the World Bank Governance Indicators, and Business Environment Risk Intelligence. The transaction costs economics and varieties-of-capitalism approach challenge this perspective, arguing that well-designed regulations may underpin firms’ co-ordination strategies and hence promote investment and growth. Hall, Peter A. and Gingerich, Daniel W., ‘Varieties of Capitalism and Institutional Complementarities in the Political Economy: An Empirical Analysis’, British Journal of Political Science, 39 (2009), 449482CrossRefGoogle Scholar, provide empirical evidence to support this argument. Acknowledging conceptual bias of the neo-liberal perspective, I consider infrastructure, macroeconomic stability, health, education, skill levels, technological readiness and innovation as part of the operational definition of ‘business environment’.

8 A number of game-theoretic and empirical studies analyse bureaucratic discretion as a crucial factor in policy implementation, e.g., Kydland, Finn E. and Prescott, Edward C., ‘Rules Rather Than Discretion – Inconsistency of Optimal Plans’, Journal of Political Economy, 85 (1977), 473491CrossRefGoogle Scholar; Epstein, David and O'Halloran, Sharyn, ‘Divided Government and the Design of Administrative Procedures: A Formal Model and Empirical Test’, Journal of Politics, 58 (1996), 373397CrossRefGoogle Scholar; Bendor, Jonathan and Meirowitz, Adam, ‘Spatial Models of Delegation’, American Political Science Review, 98 (2004), 293310CrossRefGoogle Scholar; Frye, Timothy, ‘Credible Commitment and Property Rights: Evidence from Russia’, American Political Science Review, 98 (2004), 453466CrossRefGoogle Scholar; Gordon, Sanford C. and Hafer, Catherine, ‘Flexing Muscle: Corporate Political Expenditures as Signals to the Bureaucracy’, American Political Science Review, 99 (2005), 245261CrossRefGoogle Scholar.

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27 Francis, John G., The Politics of Regulation: A Comparative Perspective (Oxford: Blackwell, 1993), p. 43Google Scholar.

28 Francis specifically contrasts the fusion of rule making and rule enforcement in the hands of the ministerial bureaucrats with the separation of the ministerial functions of designing regulatory regimes and the delegation of the task of implementation to specialized agencies with different levels of autonomy from the ministries.

29 For a review, see Bendor, Jonathan, Glazer, Ami and Hammond, Thomas H., ‘Theories of Delegation’, Annual Review of Political Science, 4 (2001), 235269CrossRefGoogle Scholar.

30 Yet, we should credit the studies exploring the effects of political institutions on bureaucratic incentives for providing a clear set of theoretical expectations about sources of bureaucratic discretion. Huber and Shipan, Deliberate Discretion; Brehm, John O. and Gates, Scott, ‘Working, Shirking, and Sabotage: Bureaucratic Response to a Democratic Public’ (Ann Arbor: University of Michigan Press, 1999)Google Scholar; and Epstein and O'Halloran, ‘Divided Government and the Design of Administrative Procedures’, among other works, point to institutional sources of constraints on bureaucratic behaviour (e.g. veto players, federalism, separation of powers, institutional capacity). Additionally, political variables, such as the level of policy conflict, alter political incentives for constraining bureaucracy. Authoritarian regimes show even greater divergence in the sources of bureaucratic constraint. Elite cohesion, clientelism, regionalism, political repression, type of elite recruitment and many other features that may serve as a source of bureaucratic constraint vary across military dictatorships, one-party rule or bureaucratic-authoritarian regimes. Bureaucratic preferences and behaviour are likely to vary depending on the specific institutional and political sources of constraint. The theoretical argument of this article, however, makes no assumptions about sources of discretionary power and, hence, should apply to the analysis of different institutional and political environments. It would be interesting to explore how the types of bureaucratic constraint affect the nature of discretion and the resulting policy outcomes, though I leave this to future research.

31 Gordon and Hafer, ‘Flexing Muscle’, p. 245Google Scholar.

32 The fact that in the first case the official regulatory regime is five times as costly as in the former case might be irrelevant from the point of view of myopic business, but might prove consequential for the long-term prospects of business–state relations.

33 For a theoretical model that links corruption to the discretionary use of resources, see Dal Bo, Ernesto, Dal Bo, Pedro and Di Tella, Rafael, ‘ “Plata O Plomo?”: Bribe and Punishment in a Theory of Political Influence’, American Political Science Review, 100 (2006), 4153CrossRefGoogle Scholar.

34 McChesney, Money for Nothing; Shleifer and Vishny, ‘Corruption’.

35 The way it is formulated here, the argument is an extension of the ‘corruption with theft’ analytical framework proposed by Shleifer and Vishny. Corruption in this formulation allows the agency to pocket the entire amount of the bribe and not collect the official compliance fees, taxes or other transfers due to the state coffers. The proposed argument can be extended, however, to a ‘corruption without theft’ situation by breaking down the cost of compliance into the official costs to be collected for the agency coffers and the processing cost, which includes time, queuing and external clerical service fees.

36 Federal Law No. 222-Fz of 29 December 1995, ‘On a Simplified System of Taxation, Accounting and Reporting for the Entities of Small Business’.

37 Murray, Matthew H., Small Business: A Response to Corruption in Russia. U.S. House of Representatives, Committee on International Relations, Testimony, 7 October 1999Google Scholar.

38 Center for Economic and Financial Research (CEFIR), Press release, 17 November 2005, available at http://www.cefir.ru/index.php?l=eng&id=25; see also Yakovlev, Evgeny and Zhuravskaya, Ekaterina, ‘Reforms in Business Regulation: Evidence from Russia’, CEFIR Working Paper, w0097 (CEFIR, 2010)Google Scholar.

39 I conceptualize bribery and compliance as mutually exclusive strategies. Bribery allows firms to forgo the cost of compliance altogether. When a firm chooses to bribe, it pays no regulatory cost. To simplify the presentation, I assume that on any given issue, the firm either bribes or complies. This does not mean that the firms cannot pursue a mixed strategy over a range of issues.

40 A third strategy, in fact, exists. The total profit constraint means that if the cost of regulatory compliance exceeds a firm's revenue minus the cost of production, and other strategies are not available, the firm might be forced to go under. Operating illegally, the firm runs the risk of being prosecuted; thus, private protection mechanisms, including mafia-type organizations, are going to ensure firms’ continuing operation in the illegal sector. The firm's activity per se is not illegal – it might continue producing legal products and providing legal services. What makes the firm's operations illegal is that it exits regular regulatory relations with the state, such as paying taxes, obtaining permits and licences, and submitting its practices and products to state regulation. Such a strategy, however, goes beyond the scope of this investigation. For an analysis of entrance into the unofficial economy, see Hibbs, Douglas A. and Piculescu, Violeta, ‘Tax Toleration and Tax Compliance: How Government Affects the Propensity of Firms to Enter the Unofficial Economy’, American Journal of Political Science, 54 (2010), 1833CrossRefGoogle Scholar.

41 This political utility function is consistent with Levi's revenue maximization objective of the ruler, see Levi, Margaret, Of Rule and Revenue (Berkeley: University of California Press, 1988)Google Scholar.

42 The bribe should simultaneously satisfy IF(bribe) > IF(comply), so that b < cr + pf.

43 Huber, John D. and McCarty, Nolan, ‘Bureaucratic Capacity, Delegation, and Political Reform’, American Political Science Review, 98 (2004), 481494CrossRefGoogle Scholar.

44 Schiantarelli, Fabio, ‘Product Market Regulation and Macroeconomic Performance: A Review of Cross-Country Evidence’, World Bank Policy Research Papers (Washington, D.C.: World Bank, 2005)Google Scholar.

45 Most objections to cross-national measures of the business-friendly institutional environment are directed at their subjective, perception-based nature, volatility and ideological biases ( Glaeser, Edward L., La Porta, Rafael, Lopez-de-Silanes, Florencio and Shleifer, Andrei, ‘Do Institutions Cause Growth?’ Journal of Economic Growth, 9 (2004), 271303CrossRefGoogle Scholar; Kurtz, Marcus J. and Schrank, Andrew, ‘Growth and Governance: Models, Measures, and Mechanisms’, Journal of Politics, 69 (2007), 538554CrossRefGoogle Scholar). The subjectivity concern is also valid in relation to the Corruption Perception Index, used to capture the extent of corruption. It has been argued that the measurement error is likely to be distributed non-randomly and is influenced by the observable levels of economic performance, past values and political factors. Such non-randomness is particularly harmful for studies considering corruption and other governance measures as causes of economic performance. Kurtz and Schrank suspect reverse causation between economic performance and governance indicators, while Glaeser et al. are concerned with the volatility that undermines the notion of institutional stability. Kurtz and Schrank's arguments are not harmful to the empirical strategy adopted here, because I make no claims about a causal relationship between corruption and the business environment on the one hand and economic performance on the other. The volatility objection cannot be dismissed, but the inclusion of economic controls should make it harder to find a statistical link between perception-based measures of governance quality and institutional variables. In addition to the perception-based data, I also use the World Economic Forum Economic Competitiveness Index that in part relies on ‘hard’ data.

46 Lopez-Claros, Augusto, ‘Executive Summary’, in Klaus Schwab and Michael E. Porter, eds, The Global Competitiveness Report 2006–2007 (Geneva: World Economic Forum, 2006), p. xiiiGoogle Scholar.

47 Doing Business data are available from http://www.doingbusiness.org.

48 Djankov et al., ‘The Regulation of Entry’.

49 Global Integrity 2006, ‘Global Integrity Indicators’ [online database], 〈http://www.globalintegrity.org/〉, accessed May 2010.

50 Appendix B contains an analysis based on the measure of central bureaucratic control developed by Rauch, James E. and Evans, Peter B., ‘Bureaucratic Structure and Bureaucratic Performance in Less Developed Countries’, Journal of Public Economics, 75 (2000), 4971CrossRefGoogle Scholar.

51 Kaufmann, Daniel, Kraay, Aart and Mastruzzi, Massimo, ‘Governance Matters VIII. Aggregate and Individual Governance Indicators, 1996–2008’ (Washington, D.C.: World Bank, 2009)Google Scholar.

52 Heston, Alan, Summers, Robert and Aten, Bettina, Penn World Table Version 6.3 (Center for International Comparisons of Production, Income and Prices at the University of Pennsylvania, 2009)Google Scholar.

53 Facing strong multicollinearity among attributes of good governance, I strived for the most parsimonious model. As with much of the extant cross-sectional analysis, there is a trade-off between omitted variables and multicollinearity. The omitted variable concern, however, is mitigated by the fact that the key explanatory variables exhibit variation across income groups, political regimes, economic openness and stability. The results of empirical analysis are not sensitive to the inclusion of political variables, e.g. Polity IV, Freedom House, and Voice and Accountability Index. Results are available upon request.

54 Models 1 and 2 are not sensitive to the inclusion of the Rule of Law control. The direction and statistical significance of the remaining coefficients does not change with the exclusion of this variable.

55 Hall and Gingerich, ‘Varieties of Capitalism and Institutional Complementarities in the Political Economy’.

56 Persson, Torsten and Tabellini, Guido, The Economic Effects of Constitutions (Cambridge, Mass.: MIT Press, 2003)Google Scholar; Acemoglu, Johnson, Querubin and Robinson, ‘When Does Policy Reform Work’; Hallerberg, Strauch and von Hagen, Fiscal Governance in Europe.

57 Rodrik, Dani, ‘Institutions for High-Quality Growth: What They Are and How to Acquire Them’, Studies in Comparative International Development, 35 (2000), 331CrossRefGoogle Scholar.

58 Loayza, Oviedo and Serven, ‘Regulation and Macroeconomic Performance’.

59 Evans, Peter, ‘The State as Problem and Solution: Predation, Embedded Autonomy, and Structural Change’, in Stephan Haggard and Robert Kaufman, eds, The Politics of Economic Adjustment (Princeton, N.J.: Princeton University Press, 1992), pp. 139181Google Scholar.

60 Acemoglu et al. explain: ‘one would not expect a society with a functioning system of accountability and with checks on politicians to be pursuing highly distortionary policies in the first place’ ( Acemoglu, Johnson, Querubin and Robinson, ‘When Does Policy Reform Work’, p. 355Google Scholar).

61 For example, see Rhee Baum, Jeeyang, ‘Presidents Have Problems Too: The Logic of Intra-Branch Delegation in East Asian Democracies’, British Journal of Political Science, 37 (2007), 659684Google Scholar.

62 For example, see Glaeser et al., ‘Do Institutions Cause Growth?’ and Kurtz and Schrank, ‘Growth and Governance’.

63 Gordon and Hafer, ‘Flexing Muscle’; Naoi, Megumi and Krauss, Ellis, ‘Who Lobbies Whom? Special Interest Politics under Alternative Electoral Systems’, American Journal of Political Science, 53 (2009), 874892CrossRefGoogle Scholar; Slinko, Irina, Yakovle, Evgeny and Zhuravskaya, Ekaterina, ‘Effects of State Capture: Evidence from Russian Regions’, in János Kornai and Susan Rose-Ackerman, eds, Building a Trustworthy State: Problems of Post-Socialist Transition (New York: Palgrave Macmillan, 2004), pp. 119132CrossRefGoogle Scholar; Guriev, Sergey, Zhuravskaya, Ekaterina and Yakovlev, Evgeny, ‘Interest Group Politics in a Federation’, Journal of Public Economics, 94 (2010), 730748CrossRefGoogle Scholar.

64 Rauch and Evans, ‘Bureaucratic Structure and Bureaucratic Performance in Less Developed Countries’.

65 Djankov et al., ‘The Regulation of Entry’.

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