Sunday, March 16, 2014

Regulations and Corruption

"That government is best which governs least." 
 Thomas Jefferson

The recent global financial crisis ignited a new wave of debate about the need for more regulations and government interventions. More regulations might very well be necessary. But it’s unclear how much regulations are needed and where. And there are always questions of over and under regulation, their efficacy, and the effects on the working of the markets. It’s quite conceivable that more regulations can lead to more corruptions and more corrupt countries can in fact have more regulations already. Here are some empirical cross-sectional correlations, which seem alarming.

Measuring corruption

Transparency International publishes a Bribe Paying Index. It involves twenty eight of the world's largest economies - they represent 80 percent of the world total outflow of goods, services and investments. It is supposed to measure the perceived likelihood of companies in these countries to pay bribes abroad. The scale is 0 to 10, where the maximum score corresponds with the view that the companies from that country never pays bribes, and zero corresponds with the view that they always do. We do not have data on bribes paid or perceived to be paid in own country. I use this index as a proxy measure of corruption. The index was published for the years 1999, 2002, 2008 and 2011. 

Measuring regulations

The World Bank publishes data on the ease (difficulty) of doing business. I chose The Number of Procedures required to establishing a business, the Number of Procedures to Deal with Constructions and the Number of Procedures to Enforce Contracts as measures of regulations. The assumption is that the longer these procedures are the more regulations the country has. There is no particular reason for me to choose these indices and I could have easily chosen other data such as getting credit, paying taxes etc.

Both indexes are for the year 2011 because the bribe index is not available for more recent years.

Putting them together

I invert the bribe paying index before I plot it, separately, against the three numbers of procedures above, which measure regulations. Figures 1, 2 and 3 show a clear positive correlation between regulations and corruption. Obviously I cannot pin down the direction of causality. But I would argue that causality is not really important. There could be bi-directional causality running from regulations to corruption or vice versa. But what matters the most is the close association between these two indices, which are constructed by two different and independent institutions.

Countries which have relatively less regulations have companies which do not anticipate paying bribes abroad. It would not be very wrong to argue that that they are also less likely to pay bribes in their own countries. Countries which are relatively highly regulated have companies, which have a propensity to paying bribes abroad, and most likely they would do so in their own countries. Further, it may well be the case that relatively more corrupt countries are also countries that probably tend to regulate more to extract more bribes.

I conjecture that a country which is characterized to be a difficult one to do business in, difficult to register a property and difficult to enforce a contract is also a country were bribes are anticipated to be paid. While countries like Canada and Australia are ones which are relatively less regulated and relatively less corrupt, countries like China, Russia, the UAE and Argentina represent the other polar side. Majority of countries are in between.

I would ague that one should be very wary of over-regulation as much as being wary of under-regulation. Too many regulations could be just as bad as no or fewer regulations. Striking the right amount is important, such as the marginal benefit must equal the marginal cost.

Figure 1

Figure 2

Figure 3 

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