Institutions and Government Controls

This paper develops a model of government policy toward industrial control and regulation that sheds light on the determinants of differential country experiences in terms of organizational arrangement and enterprise performance. In contrast to the model developed by Shleifer and Vishny (1994 and 1998), which suggests that government controls over firms come about when politicians can use public funds to buy off the managers and solicit their cooperation in politically-motivated redistribution of rents, the present model shows that it may be the ability to use the government's regulatory powers at discretion that encourages politicians to impose controls on firms and redistribute their rents. The model implies that the politicians' appetite for intervention tends to be greater when the cost of collecting and using public funds is higher, which is the opposite of what the Shleifer-Vishny model predicts. The present model helps explain the puzzling observation that countries with poor institutions are more likely to impose extensive controls on production and maintain large and inefficient public sectors. The model also sheds light on a variety of other stylized facts and puzzles and offers new hypotheses to be tested.