Essays on rent-seeking, corruption and informality
Flochel, Thomas Robert Kenneth Lawrence Arthur
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This thesis compiles three essays on corruption and informality in the developing world. The first chapter focuses on the industrial organisation effects of favouritism in public procurement in the context of Paraguay. It is the first empirical microeconomic study to illustrate the fact that rent-seeking is costly for development by showing how entrepreneurs’ economic incentives are distorted toward unproductive activities as the result of favouritism in the allocation of public contracts in Paraguay. Our findings highlight the importance of tackling corruption by shedding light on some of the large dynamic “hidden” costs of corruption over and above the static costs of bribery and embezzlement. We find that in Paraguay institutions with an important procurement activity are more likely to engage in corrupt dealings. As for firms, they have a greater probability of obtaining a contract directly through an exceptional procedure from an institution with which they have a strong contractual relation, both in terms of the total value and frequency of transactions, particularly when dealing with more corrupt State entities. Finally firms trading more with the public sectoi aie found to be more profitable, even when controlling for their unobserved characteristics, reflecting the misallocation of talent towards this largely unproductive sector induced by favouritism. Large rents linked to the resale of impoited goods to the State and the historical absence of an import-substitution strategy have contributed to make Paraguay one of the least industrialised economies in South America as, apart from the soybean and meat sectors, its entrepreneurs have systematically specialised in commercial intermediation, often with the public sector as sole client, rather than in production. The costs of this productive atrophy and biased specialisation are reflected in the poor record of economic growth. Several policy implications emerge from this chapter. First, whilst the existence of an exceptional purchase mechanism is clearly needed to deal with cases of emergency, it is also important that a mechanism of checks and balances ensure its use remains exceptional. Second, more transparency in the allocation of contracts can be achieved by putting together a registry of State providers, including the names of the firm owners and members of the administration board. Third, the move towards greater transparency also includes better data keeping and diffusion. Provided good quality data, an analysis like this one could assess the state of competition in public contracts more frequently, which could also help to target monitoring efforts. These proposals were put to the Paraguayan government in a report which I wrote for Transparency International (Paraguay) and presented to the newly elected government in September 2008.The second chapter analyses the political economy of labour regulatory enforcement in Brazil. In the context of the empirical political economy literature in Brazil, the analysis reveals that, contrary to other areas of the public sector, the work of the labour inspectorate in Brazil is not subject to political manipulation. I test firstly for electoral cycles in the imposition of labour fines, secondly whether labour regulations are selectively enforced according to political motivations and finally, I assess whether “pork barrel” strategies are used in order to sway voters. Electoral results are matched with a novel dataset of fines imposed on firms for labour infractions to test these considerations. First, the analysis finds that mayors’ and the president’s political interests are not significantly correlated with the distribution of fines, neither is the alignment of local politicians with governors or the president. Second, the appointment of a new governor is found to be a highly disruptive event for the inspectorate, as evidenced by the steep rise in the number of fines issues in governors’ second term. Third, towns where the governor received strong support in the last election have marginally fewer fines on average. This corroborates the evidence from the institutional analysis of the inspectorate, namely that a key channel for political influence on regulatory enforcement is through the regional inspectorate superintendents who are appointed by the state governors. However fourthly, in contrast with Ferraz (2007)’s findings in the context of environmental regulations in Brazil, the pattern of targeting does not vary significantly along the electoral cycle making it unlikely to be an electoral clientelism strategy.The important reforms in the organisation of the labour inspectorate in Brazil since the mid-1990s to guarantee more autonomy to the inspectors have probably had a positive effect in protecting them from the influence of powerful politicians. In this sense, the significant correlation between governors’ political interests and the issuance of fines suggests that the appointment of the regional inspectorate director should also be kept independent of the political preferences of the governor. Nonetheless, the availability of other, more efficient and more effective means to sway voters in Brazil suggests that labour inspections are not so much at risk of clientelistic manipulation. In fact, fiscal transfers have received far more attention in the political economy literature precisely for this reason.Finally, the fourth chapter builds a voting model in a dual sector economy to explain the relation between taxation and informality in cross-country data. Voters in countries with high informality rates tend to vote for lower redistribution and taxation rates. This is explained in the model by the poor quality of institutions in such countries, which cause the relative premium from formalising to be low. The elasticity of formal production to taxation is therefore lower where institutional quality is poor: For a given increase in the tax rate, more individuals will hide in the shadow economy. As a consequence, the welfare maximising tax rate is found to be lower than in countries where there are more benefits from formalising. Moreover, comparative statics on the level of labour productivity show that improvements in institutional quality are more important in countries with a less productive labour force, as they lead to greater increases in redistribution and reductions in the informality share.The model integrates political mechanisms as well as economic features and in doing so shows the non-trivial interaction between informality and policy choice. More attention should be paid to this interaction when studying the determinants of informality, instead of taking policy choice as exogenous. Moreover, this chapter contributes a theoretical framework that is well adapted to studying political economy features of developing countries, where informality is a key characteristic of the economy.Several projects and ideas for further research have germinated from work on this thesis. One in particular focuses on the relationship between informality and corruption, which has drawn increasing amounts of research interest lately. One aspect that has however eluded the literature to date is the impact of informality on voting behaviour. In a democratic setting, I argue that widespread informality weakens the effectiveness of elections as a mechanism for selecting and disciplining politicians, essentially because informal voters receive an imperfect signal on politicians types. This research would contribute to explaining the persistence of corruption alongside widespread informality in much of the developing world.