One of the big themes about development is the transition to institutions that allow for individuals to reliably cooperate across time and space in creating value. From Adam Smith onward the idea of specialization as a path to higher productivity has been part of economics and specialization requires cooperation among various actors in the value chain. One important strain of thought in economics is that “institutions” (in quotes as a reference, not use) are important and that the institutions that sustain prosperity need to be “open” and reliable (e.g. can secure expectations across time and space). North, Wallis and Weingast 2009 Violence and Social Orders and Acemoglu and Robinson 2012 Why Nations Fail are two (of many) influential expositions of ideas about “institutions.”
My work has been about trying to reconcile the idea of “institutions” (by which authors often mean long-standing, slowly changing, characteristics of countries/societies) to explain long-run outcomes with the episodic and volatile nature of growth in developing countries. One can distinguishes between “rules” as environments in which strong institutions create a reliable environment for economic actors irrespective of their personal characteristics (e.g. kinship) or affiliations (e.g. politic group) or influence actions (e.g. bribes). Whereas in “deals” conditions what you expect to happen to you depends on who you are. In “deals” conditions the de jure laws and policies may have little or no relevance to outcomes. As one Latin American president is said to have said: “For my friends, anything, for my enemies, the law” (while various countries claim this saying as their own, at least its Latin American origin is plausible as amigos and enemigos rhyme in Spanish (Por mis amigos, todo; por mis enemigos, la ley).
This idea of “deals” raises three lines of research. One, can one document the gap between rules and deals in practice? Two, is there a typology of “deals” such that shifts in the type “deals” available to investors can account for growth accelerations or decelerations? Three, while it is obvious there are paths to episodes of rapid growth via a more conducive “deals” environment (without change in “institutions” or “policies”), but which of these lead to sustained growth episodes and, possibly, a gradual transition from “deals” to “rules”?
Evidence about deals and rules
Before the papers, a story, which illustrates the gestation of ideas.
A story about the structure of import protection. Even before I joined the World Bank I was part of a team doing analytical work as part of a structural adjustment loan for Argentina. Argentina, like many countries of the time, had tariffs and also a variety of non-tariff barriers. Also like many countries at the time Argentina has a system of licensing imports. Each specific category in the tariff schedule was allocated to either a list: “open, freely imported” “requires a license” or “banned.” The “tariff equivalent” (the ad valorem tariff rate that would produce the same realized demand) of an item being on the “requires a license” was completely opaque as (i) whether you would get the license (in the quantity you requested) was a discretionary decision of a bureaucratic (hence potentially political) process, and (ii) the overall imports brough in under “requires license” was financing constrained so if there wasn’t enough FEX then the licenses would be rationed or delayed (over and above their “protectionism” of domestic industry).
Since one of the proposed conditionalities of the trade reform component of the adjustment loan was moving goods from the “requires license” to the “open” list. But since the overall macro balances were supposed to “close” (in that the IMF program had adequate financing so that debts could be paid and imports did not need to be rationed) the magnitude of the Bank/IMF financing should be set at a level adequate to cover the additional imports that the licensing deregulation might cause. That meant somebody has to estimate (guess) how much that would be and I, PhD student though I was, was that somebody.
My idea was to get the detailed imports for each item in the tariff nomenclature (of which, at the time, there were, I think, over 10,000 separate items) over time and compare the value of imports on the “requires license” list in the latest period (in which FEX for imports was super scarce) to a period earlier when FEX was (relatively) abundant–and maybe adjust this for changed levels of GDP and Investment–and have a baseline of “Okay, if imports rose back to their pre-restricted baseline, imports would be higher by X.” And from that I could maybe add some additional amount for the difference between the protectionist tariff equivalent and the tariff. (This experience taught me very quickly, and at a young age, that, for lots of practical situations, there was no canned formula that I knew of for a specific situation, even having received a pretty good economics training. This led to the realization that many academic papers set up a problem in just such a way they had a tractable solution, but that made them less, rather than more, useful.)
Now, after a couple of paragraphs of set up, is the of the story. When I went to compare the data I discovered there were hundreds more items in the recent tariff code than in the code of just five years previously. This led me to the Gazette which communicated to Customs officers the recent changes in either tariff rates, licensing status, or, the creation of a new tariff item, splitting it off from a previous code. As I went through the Gazettes to find these new items I quickly realized that the classification of items in the tariff code was itself endogenous to lobbying. That is, an example I remember that a new code split small plastic cards that had electronic encoding (e.g. an ATM card) from small plastic cards that did not (e.g. a driver’s license (at the time)). This new item was in the “open” list while the old code remained in the “requires license” list. The politics of this seem obvious: rather that fight domestic producers of all similar cards, if I want to import something I create a new code that identifies an item that has no domestic producers (at least yet) and then get that item out of the discretionary license regime. This led me to several thoughts. One, I realized that I had been thinking about trade at a level of aggregation that was far, far, too aggregate. So, one might think about a political economic model of tariffs that differentiated “consumer” from “capital” goods, or perhaps even “shoes” from other imported items. But looking at actual tariff codes there were something like 20 different tariff items for what seemed a pretty homogenous item like “cotton thread” (differentiated, for instance, by thickness). Two, I realized that I thought too much about the setting of rules assuming the playing field was fixed, but in actuality the categories were up for grabs. Three, ideas that aggregates of firms, like “domestic producers” were a homogenous class about which meaningful statements could be made, like “domestic producers prefer protection from imports” has to be much more nuanced as if the regulatory structure was flexible each firm has the incentive to get the best possible deal.
In the first instance, this led to do ask “how much of the variance of tariff rates is across categories (say, the four-digit level) and how much is within categories?” In the longer run it left me curious what “for a specific firm, what is the achievable deal?”
“How Business is Done in the Development World: Deals versus Rules.” 2015. Journal of Economic Perspectives. (with Mary Hallward-Driemeier).
“How Business is Done and ‘Doing Business’: Measuring the Investment Climate when Firms have Climate Control.” World Bank Working Paper 5563. 2011.(with Mary Hallward-Driemeier).
These two papers (one is more detailed, one is shorter for the JEP) lays out some basic (and striking) facts about comparing the Doing Business reports (which are a report by an expert about de jure conditions of doing business) and the Enterprise Survey (which are a survey of firms who are actually doing business). Some of the indicators are close enough in the two sources, such as time it takes to get permits to construct a building, that one can compare. So one can compare the Doing Business reported time it takes to get a permit for construction (of a specified type, in a specified location to be comparable across countries) with the time firms who built a building report it took them to get a permit. The basic result (illustrated across a number of facts about the comparison) is that the de facto of how business is done has very near zero to do with the de jure rules of Doing Business. This is a one measure of just how much firms face a “deals” environment (which varies from firm to firm) and how little the rules matter.
A simple analogy. One can compare the actual weather, or climate of Minneapolis Minnesota and Phoenix Arizona by measuring the outdoor temperature. The average January daily high in Minneapolis is 25 F and in Phoenix is 68 F–a 43 F difference. But, if one did a survey of people at 2 pm on January 15th and the temperature they were actually experiencing the average would likely be very close as most people in Minneapolis would be inside a heated building or vehicle. So the variance of temperature experienced would be huge–people outside would be cold, inside warm but the average about the same as Phoenix. (And of course roughly the same in the summer, people in Phoenix would be nearly all in an air conditioned enclosed space).
This just illustrates that people talk about the “climate” or “environment” for doing business, and this matters, but we should not imagine that in countries with restrictive laws and policies this affects all firms equally because they all have to follow the rules, rather the combination of the laws and rules and the organizations and institutions of enforcement pattern the available deals and “who you are” can be as important to the costs and benefits of regulation (as lax regulation of me and strict regulation of competitors is a benefit to my firm) as “where you are” as measured by the de jure laws/regulations.
“Deals versus Rules: Policy Implementation Uncertainty and why Firms Hate it” NBER Working Paper 16001, 2010. (with Mary Hallward-Driemeier and Gita Khun-Jush). There is a kind of funny story with this paper. In early versions of the World Bank Enterprise Survey they asked firms about the “biggest obstacle” their firm faces with a prompted list of 15 or so items, including “tax rates” “corruption” “business licensing and regulation.” One of the options was “policy uncertainty.” In the early surveys this tended to be a common response. But if we think of a “policy” as a mapping from facts to actions (e.g. a sales tax is a mapping from sales of an item to a tax owed) then there are three conceptually distinct ideas about “policy uncertainty.” One is that the “policy” itself, the mapping, will change, so say, tax rates go up or down. Two is that variables thought to be determined by policy, like inflation or exchange rates are uncertain because of policy imbalances. Three is that there is uncertainty of policy implementation for each specific firm–that is, I know the sales tax is 5 percent and expect that will be stable but don’t know the degree of under-declaration I can get away with given the “deals” nature of actual interactions with the tax authorities or, alternatively, I may be tightly connected politically and hence be certain I can get away with massive under-declaration of sales. I was really intrigued by this aspect of “policy implementation uncertainty” and wanted to do research on it, but I learned that the fact that “policy uncertainty” was a common answer but they didn’t know how to interpret it (into “recommendations”) was a (mild) embarrassment so, rather than fixing the survey to investigate the phenomena more precisely, they did the bureaucratically obvious thing and just dropped the question from future surveys. So we did the best we could to argue that the “policy uncertainty” that firms complained about was about the “deals” driven firm-specific uncertainty about how policy would be implemented for them.
“Doing business in a deals world: the doubly false premise of rules reform“ (with S. Kar, S. Roy, and K. Sen). There is a lot of debate that is premised on the idea there is a tradeoff between achieving goals via regulation (e.g. reducing air pollution, improving worker safety) and the costs of compliance to firms. People envision a world in which people want to accomplish good things (“good seekers”) lobby/act politically to have stricter rules and “the private sector” acts politically to resist stricter rules. This, however, is only true in a “rules” world in which the policy or law or regulation is routinely enforced neutrally across firms. However, in a deals world with weak organizations of policy implementation firms expect and receive differential treatment depending on their characteristics (e.g. political affiliations, kinship) and influence actions. In that world both highly influential firms and “good seekers” will want de jure stricter rules with higher costs for firms, conditional on compliance but for completely opposite reasons. The “good seekers” want stricter rules because they believe this will lead to greater compliance and hence greater achievement of public purposes (e.g. less air pollution). The “influential firms” (or “power brokers” or “cronies” or “insiders”) want stricter rules because they believe it will lead to less compliance costs for them, but potentially higher compliance costs for other firms (and deter new entry from, say, foreign firms). With weak and politically permeable regulatory organizations tighter regulations could lead marginal firms to switch from a “compliance” strategy to an “influence” strategy and hence actually reduce the achievement of public purposes. This means the “tradeoff” debate is wrong in that “tougher” regulation could lead to less of the good thing and less private sector investment inhibiting costs of compliance overall, exactly the opposite of the expected impact under the assumption of compliance.
This uses data from the Enterprise Surveys, the Doing Business rating, and country rankings of “state capability” to show that (in cross section) countries with tougher rules and weak state capability have more firms getting “fast” deals (which we use as a proxy for non-compliance). So “tougher” rules lead to more compliance in strong state capability countries but less in weak state capability countries.
This can obviously create a situation in which countries get locked into unenforceable rules because (i) governments gain additional rents from tougher rules, (ii) connected firms and firms paying for influence activities to evade compliance don’t want relaxed rules (a better Doing Business de jure law) as they have a comparative advantage in non-compliance, and (ii) “good seekers” find it very difficult to position themselves in favor of “weaker” laws, even if they realize that non-compliance is thwarting their efforts.
“Tariff Rates, Tariff Revenue, and Tariff Reform: Some New Facts.” World Bank Economic Review, vol. 8 no.1, January 1994. (with Geeta Sethi). In my PhD training and my early career at the World Bank I was a trade economist. This was a period of lots of “trade reform” as a component of Bank/IMF “structural adjustment” programs and this occasioned a lot of research into specific, pretty practical questions. Before describing this paper a story that gave me a lot of insight.
Deals and Growth Episodes
“Developing the guts of a GUT (Grand Unified Theory): Elite Commitment and Inclusive Growth.” ESID Working Paper Series 16/12. 2012. (with Eric Werker).
Deals and Development: The Political Dynamics of Growth Episodes. 2018. Oxford University Press. Edited with Kunal Sen and Eric Werker.
Transition from Deals Growth Episodes