Optimal Government Regulations And Red Tape In An Economy With Corruption

We study an economy where agents are heterogeneous in entrepreneurial ability, and may decide to become workers or entrepreneurs. The government is motivated by a production externality to impose regulations on entrepreneurship, and sets a level of red tape to test regulation compliance. In an environment where some officials are corrupt, we characterize the optimal levels of regulations and red tape, and to what extent such policies reduce the welfare losses created by corruption. For each level of externalities, high and lowlevels of corruption create qualitatively different distortions, which in turn hanges the nature and reach of optimal policies.