The Impact of Regulation on Economic Growth in Developing Countries: a Cross-Country Analysis

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THE IMPACT OF REGULATION ON ECONOMIC GROWTH IN DEVELOPING COUNTRIES: A CROSS-COUNTRY ANALYSIS

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ABSTRACT

The role of an effective regulatory regime in promoting economic growth and development has generated considerable interest among researchers and practitioners in recent years. In particular, building effective regulatory structures in developing countries is not simply an issue of the technical design of the most appropriate regulatory instruments, it is also concerned with the quality of supporting regulatory institutions and capacity. This paper explores the role of state regulation using an econometric model of the impact of regulation on growth. The results based on two different techniques of estimation suggest a strong causal link between regulatory quality and economic performance.

Key words - economic growth; regulation; governance; developing countries; institutions. JEL classification: C23,I18, L33, L51, L98, O38, O50

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Acknowledgement

We would like to thank three referees for their perceptive comments on an earlier draft of this paper. The usual disclaimer applies.

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1.

INTRODUCTION

The role of an effective regulatory regime in promoting economic growth and development has generated considerable interest among researchers and practitioners in recent years (e.g. World Bank, 2004). Regulation can take many forms and the form of regulation policy adopted in developing countries has shifted over time (Minogue, 2005). From the 1960s to the 1980s, market failure was used to legitimise direct government involvement in productive activities in developing countries, by promoting industrialisation through import substitution, investing directly in industry and agriculture, and by extending public ownership of enterprises. However, following the apparent success of market liberalisation programmes in some developed countries, and the evidence of the failure of state-led economic planning in developing ones (World Bank, 1995), the role of state regulation was redefined and narrowed to that of ensuring an undistorted policy environment in which efficient markets could operate. Deregulation was widely adopted, often as part of structural adjustment

programmes, with the aim of reducing the “regulatory burden” on the market economy.

Privatisation and the more general process of economic liberalisation in developing countries have produced their own problems and failures and have resulted in the current focus on the regulatory state (Majone, 1994, 1997). The regulatory state model implies leaving

production to the private sector where competitive markets work well and using government regulation where significant market failure exists (World Bank, 2001: 1). Arguably, however, the performance of the new regulatory state remains under researched, especially in the context of developing countries with their own peculiar economic and social problems and institutional characteristics. Building effective regulatory structures in developing countries is not simply an issue of the technical design of the regulatory instruments, it is also concerned

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with the quality of supporting regulatory institutions and capacity (World Bank, 2002: 152). Many of the institutions that support markets are publicly provided, and the effectiveness of these regulatory institutions will be an important determinant of how well markets function. The quality of regulatory governance will affect regulatory outcomes, which in turn can be expected to impact on economic growth.

This paper explores the role of regulation in economic growth using an econometric model. More precisely, it assesses through econometric modelling the impact of variations in the quality of regulation on economic performance. Although earlier studies have looked at governance as a cause of cross-country productivity or income differences (Olson, et al., 1998; Kauffman and Kraay, 2002), this paper differs in concentrating on...
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