Development and the Interaction of Enforcement Institutions
World Bank, East Asia and Pacific Region, Human Development Sector Department, 2006 - Corruption - 21 pages
The authors examine how institutions that enforce contracts between two parties, producers and consumers, interact in a competitive market with one-sided asymmetric information and productivity shocks. They compare an informal enforcement mechanism, reputation, the efficacy of which is enhanced by consumers investing in "connectedness," with a formal mechanism, legal enforcement, the effectiveness of which can be reduced by producers by means of bribes. When legal enforcement is poor, consumers connect more with one another to improve informal enforcement. In contrast, a well-connected network of consumers reduces producers' incentives to bribe. In equilibrium, the model predicts a positive relationship between the frequency of productivity shocks, bribing, and the use of informal enforcement, providing a physical explanation of why developing countries often fail to have efficient legal systems. Firm-level estimations confirm the partial equilibrium implication of the model.
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Application to Natural Asia asymmetric information bad firms bad productivity shock business associations capture connectedness Q consumers and firms consumers invest contract enforcement December 2006 December decreases delivered low quality developing countries Dummy variable Economic Economist Intelligence Unit End of Proof equilibrium level exogenous Fioravante Patrone firm identifies Firm-level firms produce Greif high effort implicit function theorem incentives to bribe informal enforcement mechanisms institutional mix interaction investing in connectedness Investment Climate Assessments Jamele Rigolini judicial efficiency Kranton legal efficiency legal enforcement marginal costs maximization problem membership to business November 2006 November order conditions partial equilibrium payoff Perfect Bayesian equilibrium period price at pNM price pNM Probit produce high quality produced bad quality production process Proof of Proposition put in high reaction functions relationship relevant business constraint reliability reputation Research Working Paper Sub-Saharan Africa sumers sunk cost uncertainty index University of Warwick variable with value World Bank