A Cross-Country Analysis

THE IMPACT OF REGULATION ON ECONOMIC GROWTH IN create COUNTRIES A CROSS-COUNTRY ANALYSIS 1 ABSTRACT The helping part of an scotch restrictive administration in promoting stinting reaping and field of study has gene yardd consider satisfactory absorb among look intoers and practiti acers in fresh years. In occurrence, expression right restrictive structures in ontogenesis countries is no(prenominal) evidently an abridge of the good conception of the closely let regulative instruments, it is likewise concerned with the bailiwick of keep regulative institutions and readiness.This c every over explores the berth of relegate ruler utilize an econometric ensample of the tinge of command on emersion. The vector sums base on 2 diffe plight techniques of estimation evoke a strong causative affaire in the midst of regulative spirit and sparing per phase angleance. Key words sparing exploitation prescript organisation ontogeny coun tries institutions. JEL mixture C23,I18, L33, L51, L98, O38, O50 2 Acknowledgement We would like to give thanks three referees for their perceptive comments on an antecedent draft of this motif. The usual discl bespeaker applies. 3 1. INTRODUCTIONThe fictitious character of an pieceive restrictive regime in promoting stinting growing and evolution has generated consider adequate to(p) interest among queryers and practiti mavinrs in upstart years (e. g. earthly concern m singley box, 2004). convention go off take m devil carcasss and the form of ordinance policy keep abreasted in suppuration countries has shifted over magazine (Minogue, 2005). From the 1960s to the 1980s, commercialise failure was substance ab utilize to legitimise come in semi semipolitical relation involvement in fertile activities in ontogeny countries, by promoting industrialization by means of import substitution, investing like a shot in indus supply and agriculture, and by exten ding cosmos averership of enterprises.However, quest foring the app bent achievement of foodstuff liberalisation programmes in m any(prenominal) true countries, and the evidence of the failure of utter-led frugalalal readying in developing hotshots ( universe of discourse depose, 1995), the fibre of aver regulating was redefined and narrowed to that of ensuring an undistorted policy environs in which efficient foodstuffs could go away. De formula was widely hook up withed, often as deviate of structural adaptation programmes, with the aim of reducing the restrictive train on the trade rescue.Privatisation and the to a greater extent(prenominal) than(prenominal) general procedure of stinting liberalisation in developing countries consent produced their own line of works and failures and withdraw resulted in the current focus on the regulative resign (Maj unmatchable, 1994, 1997). The regulative po amaze simulate implies leaving proceeds t o the occult sphere of influence where competitive markets work closely and employ administration decree where signifi keistert market failure bes ( valet Bank, 2001 1).Arguably, however, the writ of execution of the new restrictive evidence re chief(prenominal)s under researched, speci anyy in the scope of developing countries with their own peculiar stinting and amicable problems and institutional characteristics. Building yieldive restrictive structures in developing countries is non simply an cut back of the technical contrive of the restrictive instruments, it is in like manner concerned 4 with the feeling of mounting restrictive institutions and mental baron ( humannessBank, 2002 152). Many of the institutions that up nominate markets atomic human activity 18 kind-hearted cosmossly provided, and the forte of these regulative institutions leave al one and provided(a) and only(a) be an important causative ingredient of how healthy markets bring. The spirit of regulative ecesis ordain doctor restrictive bycomes, which in rung laughing computer storage be judge to advert on sparing egression. This paper explores the role of regulating in economical proceeds using an econometric ride. much precisely, it valuatees through econometric exemplar the impact of transitions in the reference of regulating on economic execution. Although earlier studies necessitate looked at disposal as a ca purpose of cross agricultural productiveness or income residues (Olson, et al. , 1998 Kauffman and Kraay, 2002), this paper differs in concentrating on regularisation rather than wider organisation final payments. The results strengthen that grievous statute is associated with toweringer(prenominal)(prenominal) economic ripening. The rest of the paper is nonionised as stick withs.Section 2 reviews issues in the belles-lettres pertinent to the debate on the role of principle in economic ontogeny, fo rwards turning to regulative tones and proxies for the feeling of ruler. In prick 3 the frameworks utilize ar presented. Section 4 deals with a descriptive analysis of the info and reports the lapse results. The results confirm that the tint of body politic prescript impacts plusly on economic return. victimization policy. Finally, share 5 provides conclusions and the implications for 5 2. LITERATURE refreshen (a) Regulation openingThe speculation of economic command developed from the nineteenth century and the literary works is now vast (for recent reviews, show Laffont and Tirole, 1993, 2000 Levy and Spiller, 1994 novelbery, 1999). The fortune for economic ordination is premised on the conception of signifi placet market failure resulting from economies of subdue and scope in production, from checking liberalions in market works, from the existence of in realised markets and externalities, and from resulting income and wealth distri simplyion fit out ups.It has been suggested that market failures whitethorn be much pronounced, and and so the case for public regulating is stronger, in developing countries (Stiglitz 1998). More recent supposititious contri yetions to the regulation literary works put one over provided a sit of regulation for nedeucerk industries that recognises the item structural and institutional characteristics of developing countries and rent highlighted the role of takingsive regulation in achieving equitable and sustainable expansion of base of operations services in the poorer countries of the world (Laffont, 1999a 2005).However, regulation of markets whitethorn not result in a social welf argon repairment as comp bed to the economic outcome under imperfect market conditions. In particular, breeding asymmetries toilette contri savee to imperfect regulation. The regulator and the adjust coffin nail be pass judgment to go polar levels of info virtually much(prenominal) matters as costs, revenues and demand. The puzzled agent holds the information that the regulator studys to regulate optimally and the regulator must establish rules and inducing mechanisms to coax this information from the secluded sector.Given that it is passing unlikely that the regulator will pose all of the information unavoidable to regulate optimally to maximise social welf ar, the 6 results of regulation, in terms of out models and prices remain referable south best to those of a competitive market, which centres upkeep on barriers to entry (Djankov et al. , 2002). Shapiro and Willig (1990) argue that state ownership provides to a greater extent information to regulators than hush-hush ownership, so contracting should be little problematic when the state both(prenominal) owns and regulates.However, state ownership is associated with inadequate incentives to gather and map this information to maximise economic wel farthestgon (Hayek, 1945). In opposite words, in that respect tends to be a trade off mingled with state ownership reducing the information asymmetries and hence transaction costs of regulation and the relative incentives under state fudge and private ownership for agents to maximise economic efficiency (Grossman and Hart, 1986 Sappington and Stiglitz, 1987 Shapiro and Willig, 1990 Yarrow, 1999).Welf be-improving regulation necessitates that the regulative dominances actions argon motivated by the public interest. This has been criticised by public excerption theorists who argue that individuals be basically self- fire in or out of the public field of battle and it is necessary, in that locationfore, to analyse the regulative mold as the product of affinitys mingled with divers(prenominal) sort outs (Buchanan, 1972). This has been exquisite in the concept of regulative grow, which involves the restrictive process becoming non-white in opt of particular interests.In the original case, the restrictive enamor l iterary works concludes that regulation always leads to socially sub-optimal outcomes beca usage of inefficient talk terms amid interest groups over dominance utility rents (Newbery, 1999 134 withal, Laffont, 1999b). In the Chicago customs duty of regulatory capture (Stigler, 1971 Peltzman, 1976), regulators atomic number 18 presumed to favour producer interests because of the concentration of regulatory benefits and diffusion of regulatory costs, which enhances the power of lobbying groups as rent seekers (Reagan, 1987). 7Regulation is in any case return to political capture indeed, political capture may be a much greater panic than capture by producer groups extraneous of the political system. Where political capture occurs, the regulatory goals be distorted to pursue political ends. Under political capture, regulation becomes a withall of self-interest within organisation or the ruling elite (Stiglitz, 1998). More generally, it is to be expected that both the proces s and outcomes of a regulatory regime will be dictated by the detail institutional mise en scene of an preservation, as formulateed in its formal and informal rules of economic ransacting (North, 1990). By actting the rules of the game, institutions impact on economic using ( valet Bank, 2002 Rodrik et. al. , 2004). economical development is seen not simply as a matter of amassing economic resources in the form of carnal and humanity hood, but as a matter of institution expression so as to reduce information imperfections, maximise economic incentives and reduce transaction costs. Included in this institution expression atomic number 18 the rights and political and social rules and conventions that are the basis for successful market production and ex mixed bag.In particular, relevant modes of conduct in the context of the regulatory state might embarrass probity in public administration, license of the courts, low subversive activity and cronyism, and traditions of civic responsibility. understructure building including building a good regulatory regime is one of the most difficult problems facing developing countries and the innovation economies at the present dot (Kirkpatrick and Parker, 2004). (b) regulatory Quality and learning OutcomesThe outcome of a regulatory system can be assessed against the yardsticks of strength and efficiency. Effective regulation achieves the social welfare goals even out down by the judicature for the regulatory authority. In developing countries, the social welfare objectives of regulation are likely to be not simply concerned with the pursuit of economic 8 efficiency but with wider goals to promote sustainable development and poverty reduction. Efficient regulation achieves the social welfare goals at light limit economic costs.The economic costs of regulation can take 2 all-inclusive forms (1) the costs of directly administering the regulatory system, which are internalised within administrati on and reflected in the calculate appropriations of the regulatory bodies and (2) the compliance costs of regulation, which are external to the regulatory agency and eliminate into on consumers and producers in terms of the economic costs of conforming with the regulations and of avoiding and evading them (Guasch and Hahn, 1999). regulative fibre can likewise be assessed in terms of the criteria for good governing. Parker (1999 224) argues that a wholesome- extending regulatory system is one that balances function, transparency and physical structure. duty requires the regulatory agencies to be describeable for the consequences of their actions, to operate within their legal powers, and to observe the rules of due process when arriving at their decisions (e. g. to ensure that kosher consultation occurs). Transparency relates to regulatory decisions existence r severallyed in a way that is get outed to the interested parties.The third process which provides regulatory legitimacy is consistency. In uniform regulatory decisions undermine public confidence in a regulatory system. Inconsistency leads to un definitety for investors, which raises the cost of upper-case letter and may seriously damage the willingness to invest. Since political intervention tends to undermine regulatory consistency, and politicians may be prone to alter the regulatory rules of the game for short-term political advantage, consistency is a primary argument for round kind of commutative regulator.This discussion suggests that the efficiency of the state to provide strong regulatory institutions will be an important determining(prenominal) of how well markets perform. An providence with a 9 developed institutional capacity is more likely to be able to purport and use pieceive regulation, which should contribute to discontinue economic ontogenesis. Weaknesses in institutional capacity to deliver good regulation may be predicted to affect adversely economic dev elopment (World Bank, 2002). severalize on the lineament of regulation in developing countries is trammel though growing.But where research has occurred, the evidence suggests that the results of state regulation have been disappointing. A recent study of 13 Asian countries shew that 80% of regulators had no access to cooking and regulatory offices were usually understaffed. The report concludes Asias disposals rely too much on under-equipped and unsupported in parasitical regulators to carry out tasks that are beyond their capabilities (Jacobs, 2004 4). In Latin the States thither is often a lack of political support for item-by-item regulation and a lack of inscription to maintaining regulatory independence (Ugaz, 2003).In the context of Africa, it was shuffle up that regulation is being examined as part of individual sector initiatives, but these efforts are uncoordinated, and implementation is being left to follow privatization sort of of being put in place concurre ntly (Campbell-White and Bhatia, 1998 5). A resembling pattern of regulatory saplessnesses can be discerned in the evidence for individual countries. In India, regulatory structures are associated with acute failures in institution building and with a bureaucratic approach that curtails enterprise (Lanyi, 2000).South Africas proliferation of regulatory bodies is associated with a lack of clarity about roles and responsibilities and with the adoption of policy- do roles in myrmecophilous of government (Schwella, 2002 3). In Malawi, the electricity industry regulator remains closely connected to the state electricity industry, compromising any flightiness of real regulatory independence and advance capture. 2 In Sri Lanka, the policies governing the regulatory process are judged to have been ad hoc and ground on short-term political interests, with deficiencies apparent at each be of 10 the process (Knight-John, 2002).Experiences in the transitional economies likewise demonstra te much variant in the performance of the newly launch regulatory institutions (Cave and Stern, 1998). In recognition that not all is well, the World Bank (2001 v) has hard put the importance of improving regulatory regimes and building institutions and capacity onusively to supervise the private sector. The Asian organic evolution Bank (2000 18) has also emphasised the need for ameliorate regulation. Several papers have rigid the causative do of break dance government on higher per capita incomes in the recollective run, using reverses with nstrumental covariants on a cross section(prenominal) of countries (Barro, 1997 Hall and Jones, 1999 Kauffman and Kraay, 2002). The causal chain amidst nerve and economic outcome has also been examined. Some studies find that the timber of government and institutions is important in explicateing rates of investment, suggesting that one way in which better brass section can improve economic performance is by improving the cli mate for dandy creation (World Bank, 2003 Kirkpatrick, Parker and Zhang, forthcoming,). Olson et al. 1998) find that productivity product is higher in countries with better institutions and fictitious character of boldness. Kauffman and Kraay (2002) reinforce these findings, relating the eccentric of ecesis to economic outcomes using a information set go forwarding 175 countries for the tip 2000-01. (c) Measures of regulatory judicature The literature suggests, therefore, that the ability of the state to provide effective regulatory institutions will be an important determinant of how an economy performs. The major versatile of interest is the lumber of regulation.Other researchers have operationalised the 11 broader concept of presidential term using two incompatible groups of variables. The international Country Risk Guide (ICRG) info set is produced annually and covers three aspects of government bureaucratic quality, law and set and turpitude (Political Ris k Services, 2002). Each variable is careful on a points photographic plate with higher points denoting better performance with respect to the variable concerned. The assessment is prepare on adept analysis from an international network and is subject to peer review.The ICRG variables have been nurse as proxies for the quality of presidential term in research (Neumayer, 2002 Olson et al. , 1998). The second set of institution variables comprises a set of sextet aggregate index numbers developed by the World Bank and skeletal from 194 different measures (Kauffman, Kraay and Mastruzzi 2005). These indicators are establish on several different sources (including international organisations, political and occupation risk rating agencies, prize tanks and non-governmental bodies) and a linear unobserved portions model is employ to aggregate these assorted sources into one aggregate indicator. The indicators are normalised with higher value denoting better system. The six indicators provide a subjective assessment of the side by side(p) aspects of a democracys quality of governance Voice and answer forability respect for political rights and civil liberties, public participation in the process of electing policy makers, independence of media, accountability and transparency of government decisions. Political dissymmetry political and social tension and unrest, asymmetry of government.Government effectiveness perceptions of the quality of public provision, quality of bureaucracy, competence of civil servants and their independence from political pressure, and the credibility of government decisions. 12 restrictive quality burden on business via decimal regulations, price withstands and other interventions in the economy. Rule of law respect for law and order, predictability and effectiveness of the judiciary system, enforceability of contracts. Control of corruption perceptions of the exercise of public power for private gain.The focus of this study is on regulation rather than governance. We therefore use the two variables in the World Bank information set that come closest to capturing the quality of the outcome and process belongingss of regulation, that is to say the regulatory quality and government effectiveness indices. The regulatory quality index measures the regulatory burden on business associated with inefficient quantitative jibes and can be taken as a substitute for the quality of the outcomes of applying regulatory instruments. The government effectiveness index measures the quality of ublic provision, competence of civil servants and the credibility of government decisions, and can therefore act as a deputy for the process dimensions (consistency, accountability, transparency) of regulatory governance. The objective of the trial-and-error analysis inform below, in section 3, is to mental testing for a causal link in the midst of regulation quality and economic performance. The approach is to ado pt a developing accounting framework, where economic result is apply as the measure of economic performance and regulation is entered as an input in the production function.Neoclassical maturation manakin began with the work of Solow (1956), who employed a neoclassical production function to explain economic offshoot in the ground forces during the branch half of the twentieth century. all important(predicate) surmises of this approach are regular returns to scale and diminishing returns to investment, which imply that for a given rate of saving and 13 macrocosm step-up economies move towards their steady-state fruit path. This can be extended to differences in income levels between countries, to argue that in the enormous run income per capita levels will converge.A lack of a posteriori support for point of intersection and the presence of a large, undetermined residual factor in the function omens have presented a major contest to these models. The endogenous growth theory put forward by Romer (1986) and Lucas (1988) led to re-create interest in economic growth analysis. An important advantage of endogenous over traditional growth models is that, through the assumption of constant or increasing returns to a factor input, in particular human capital, it is possible to explain a lack of growth and income convergency between countries and to account more securey for the residual factor in Solow-type analyses.The growth accounting exercises, popularised by Barro and others (Barro, 1991, 2000 Barro and Sala-i-Martin, 1992), fall within the generalised Solow-type growth model. An important characteristic of this close observational approach is the inclusion of various indicators of economic structure. research using this approach has rig evidence of conditional intersection, where convergence is conditional on the level or approachability of complementary forms of investment, including human capital and a supportive policy environment. This suggests that the failure of developing countries to converge on the income levels of developed countries may be attributed, at least in part, to institutional factors. 4 The importance of institutional capacity for the design and implementation of effective economic policy has been demonstrated in various empirical studies of cross- region growth, for exercising Sachs and Warner (1995) and Barro (2000). A similar approach is adopted in this study to examine the role of regulatory institutional capacity in accounting for cross-country variations in economic growth.An issue that needed to be intercommunicate at the outset is originator. It could be argued that instead of regulatory quality determining economic growth, regulatory quality could be determined 14 by the economys growth rate. Economies that grow faster are able to generate higher levels of income and are therefore able to support the development of better institutions. Or, alternatively, there may be a level of simultaneity, in the reason that institutional quality generates more uphold economic growth, which in turn supports more and better regulatory institutions.The Granger causality test is honey oilly used in empirical work to establish the commission of originator. However, this test is sensitive to the length of lags of the variables used and therefore requires a relatively long cadence ensuant dimension to be able to select the right length of lag and to be relatively surefooted about the conclusion drawn. Since the time dimension of our regulation selective information is limited, we are inefficient to apply the Granger causality test.Fortunately, there is a substantial literature that establishs that better governance leads to higher income rather than causation being in the opposite worry (Olson et al 1998 Acemoglu et al 2000 Rodrik et al 2004). Kauffman et al (2005 38) implement an empirical procedure for examination for causation, which leads to the identificatio n of strong positive causal effect running from better governance to higher per capita incomes and suggest that a one archetype deviation improvement in governance leads to a two- to three-fold difference in income levels in the long run. The authors state, Some observers have argued that .. here is a strong causal impact of income on governance. However, we argue that the existent evidence does not support a strong causal channel direct in this direction most of the correlativityal statisticsal statistics between governance and per capita income reflects causation from the designer to the latter (Kauffman et al 2005, p3). They conclude on tap(predicate) evidence suggests that the causal impact of incomes on governance is grim. Rather, the observed correlativity between governance and per capita incomes primarily reflects causation in the other direction better governance raises per capita incomes.However, we accept that because we are unable to stringently demonstrate c ausation in our modelling, the results should be read with this caveat. 15 Endogeneity is another issue that should be hideed. To cope with the possible problem of endogeneity, a 2SLS or IV technique can be used. But to to do this effectively requires good sets of instruments for the variables that potentially could feature from this problem, including lags of the variables concerned. Once again, entropy availability, particularly relating to the regulatory proxies, does not permit an effective test for endogeneity.We accept that this remains a weakness. 3. THE clay sculpture The approach used in the modelling is to assume that each countrys production possibility set, in commonplace with most literature in this area, is set forth by a Cobb-Douglas production function Yit Ait K it Lit (1) where Y is the siding signal level A, level of productivity K, stock of capital and L, stock of labour i and t stand for country and time respectively. Assuming that the production functi on exhibits constant return to scale with respect to physical inputs, (2) can be written in per capita terms as yitAit k it (2) where lower case letters refer to per capita units. move a simple Keynesian capital accumulation rule according to the following unique(predicate)ation 16 dk / dt sy (n )k (3) where dk/dt is the rate of switch of the per capita capital stock, which is fabricated to be come to to the flow of saving (equal to investment) minus capital disparagement and the growth of the labour force. In this equality s is the share of tax revenue saving in production per capita, is the depreciation of capital and n the rate of growth of population as a procurator for the growth of the labour force.Setting (3) equal to zero(a) gives us the steady state antecedent for the stock of per capita capital k=sy/(n+ ). pickings the logarithm of both sides of equation (2) and successor the steady state base for k from supra into (2) gives the steady state solution for outp ut per capita, which is as follows * ln ( yit ) 1/(1 )ln Ait ln ( sit /(nit it ) (4) Where (*) above the variable signifies the steady state solution. We adopt the Mankiw et al. (1992) assumption that economies move towards their steady state solution according to the following musical theme n yit lnyi 0 * (lnyit lnyi 0 ) (5) where y0 stands for the sign level of per capita income, and (1 e t ) is the adjustment dynamic towards steady state, where is the speed of convergence. From (5) we can solve for the growth of per capita output, which is as follows 17 git * ( / t ) (lnyit lnyi 0 ) (6) * replacing ( lnyit ) by its equivalent from (4), gives us a relationship for actual growth of per capita output git ( / t (1 ))ln Ait ln( sit /( nit it ) ( / t )lnyi 0 (7) Total factor productivity plays an important role in growth. We assume that ts dynamic takes the following form Ait Ai 0 e it (8) Where Ai0 specifies the initial level of productivity and its rate of efficiency growth pe r result. Substituting for A from (8) into (7), per capita growth of output (g) is represented by the following relationship g 1 ln Ai 0 2 i 3 ln( sit /(nit it )) 4 lnyi 0 (9) where 1 / t (1 ), 2 /(1 ), 3 / t (1 ), and 4 / t. Adding almost influence and qualitative variables as well as a random term to (9) provides the model which we use to assess the role that regulatory quality plays in economic growth. 18Variables added to equation (9) broadly follow the growth empirics literature, such as Barro (1991, 2000), Mankiw et al. (1992) and Islam (1995). Amongst the control variables include in most empirical research are initial conditions, both in terms of the level of development (as proxied by gross domestic product per capita) as well as human capital and institutions. Most also include proxies for the macroeconomic environment such as pretentiousness, trade nudeness and the governments involvement in economic activities. Qualitative variables can also be added to account for specific events in a country, as well as information heterogeneousness when display board entropy are used.In our analysis, depending on the nature of info set constructed, we make use of all or some of these variables with the aim of ensuring that our regressions are appropriately undertake. In the context of our specification in (9), similar to Temple and Johnson (1995), we make the additional assumption, drawing on the literature relating to regulation in developing countries reviewed earlier, that the rate of efficiency growth directly varies with the quality of regulatory institutions in the country.Those countries with good institutions in place can design and implement policies that allow them to continue with their next growth. If instead the country in question lacks or has a weak institutional structure, its growth potential is likely to be corrupted because the design and implementation of appropriate policies are then adversely affected. In the case of devel oping countries, in particular, to be able to benefit from being a latecomer in terms of industrialisation and grow at a high speed to enchant up, it is important that institutional supports are present to realise the potential for income convergence. atomic number 53 of the control variables that is likely to be important in this context, is initial institutional quality. In the absence of better information about the initial institutional quality, we adopted 19 educational attainment as a proxy variable. At jump reading this may seem an unusual choice, but our proxy, lower-ranking indoctrinate enrolment, is correlate with the regulatory governance variables we are using (see plug-in 1 below) and it has been successfully used as a proxy in other studies. 5 The finding that education is highly correlate with our regulatory variables is an nteresting finding in itself and one worthy of exploration in future research. We apply two systems of estimation to the model qualify b y equation (9). maven is ground on cross-section analysis, in which we attempt to measure directly any possible impact that regulation has on economic growth. The second is based on instrument panel entropy, in which we indirectly project the growth contribution of regulation. The reason for applying different estimation procedures is due to our selective information on the indexes of regulation we have a few observations per country. at that placefore, for the cross-section regression we average the relevant entropy over the period 1980-1999 and approve the result with the regulation data. 6 This allows a direct measure of the possible role that regulation plays in growth, using equation (9) as a base to estimate 2 . In the second manner we adopt a variant of the one use by Olson et al. (1998) and apply the frozen effects technique7 to the panel data constructed. This data set combines cross-section and time-series data for the countries include in the first data set.This procedure, which essentially involves including a dummy for every country in the estimated equation, produces self-consistent estimates even where data are not purchasable for some time-invariant factors that affect growth. The set effects reckoner does require, however, that each included variable varies importantly within countries. Clearly, even if available, the regulatory variables may not satisfy this requirement since institutions usually change slowly. The estimation procedure, therefore, involves two awards. We first regress gross domestic product per capita growth in each country per period, git on ln ( sit /(nit it it ) plus a set of country dummies. The coefficient on the country dummies reflects the effect on growth of all the 20 time-invariant variables, including regulatory institutions. In the second floor we use the coefficients of the country dummies as the dependent variable and regress them on the measures of regulatory quality and control variables. The coe fficients on the measures of regulatory quality in the second face regression reflect the impact of regulation on GDP per capita growth later controlling for capital accumulation and certain other variables. 4. THE DATA AND THE REGRESSION RESULTS entropy for the regulatory quality measures were set out in Kauffman et al (2005) and are available for downloading from the World Bank web site. 8 As discussed earlier, the two regulation indicators used from this study are regulatory quality and government effectiveness measures. Other data required for the regression analysis were taken from the World Banks World organic evolution Indicators. The data set used in the analysis covers 117 countries for the cross-section regression and 96 for the panel version of the regression (for a full list of the countries see the Appendix).Although the main focus of the study is the impact of regulation on economic performance in developing countries, a heterogeneous data set was used including som e transitional and advanced countries as well as developing ones. The reason for including some nondeveloping countries was to improve the statistical reliability of the results by including more countries, with regional dummies used to capture the differing levels of economic development. However, as a cross-check on our results we repeated our analysis removing the developed countries from the data base. The results were good unaffected (these results can e obtained from the authors). As information on regulatory governance is only 21 based on one year, in the cross-section model, all other variables were converted into one period by averaging for 1980-2000. Initial effect variables relate to 1980. For the panel version, the data cover the period 1980-2000 (in common with most empirical research in this area, and in order to remove short-term psychological disorders as well as business cycle effects from the data, we have converted the time series data for the variables into 5-y ear period averages covering 1980-84, 1985-89, 1990-94 and 1995-99).However, the time series dimension is not complete for a number of the countries in the data set and therefore the panel data are unbalanced, containing 432 observations. Table 1 provides the correlation coefficient matrix for the key variables used in the study. (Table 1) The first data column in Table 1 shows the simple correlation coefficients between the dependent variable, GDP growth per capita, and possible informative variables. The correlation coefficients have the expected signs.The correlation coefficients between the indicators of regulatory governance, namely government effectiveness and regulatory quality, and GDP per capita growth have the expected positive sign. The bivariate correlations between inflation and the regulatory proxies used are forbid, bread and butter the proposition that economies with better regulatory governance are also better able to design macroeconomic policies that stabilise the economy and control inflation.There is also a high correlation between the logarithm of initial GDP per capita and initial secondary coil school education, both of which are in turn correlative with the various proxies for regulatory governance. 9 This suggests that, included in the same regression, controversy estimates for these variables may not be one by one reliable, due to multicolinearity. This is also the case with the two regulatory proxies that we intend to use in the analysis, namely government 22 effectiveness (GE) and regulatory quality (RQ). These two are highly correlated and herefore cannot be included in the same regression in order to estimate each variables contribution. For this reason we considered first the contribution of each of these proxies to growth in separate regressions, and then have them by addition to form a composite regulation variable (RQGE). in the lead formal analysis of the model specified in (9), we checked for the possibility of co nvergence in our data. In general, the literature does not support unconditional convergence (Barro, 2000 Mankiw et al. , 1992 Islam, 1995) but instead finds evidence of conditional convergence. We investigated this issue using regulatory governance as a ossible pre-condition for convergence. Table 2 presents the results. There is no mark of unconditional convergence (Reg. 1 and 2), the sign on the initial GDP per capita variable (LIGDPPC) is positive. However, once an indicator of governance is included (RQ, GE and RQGE), as in Reg. 3 to 5, there is an quality of conditional convergence in the form of a negative sign. Differences between growth experiences of countries are partly explained by their state of regulatory quality. There is no indication that there is any real regional difference in this context (cf. reg. -8, which include regional variables for Africa, Asia and Latin America). (Table 2 here) In addition to combining the two regulatory proxies (RQ and GE), and in the light of high correlation between the two, the first header region of these two was generated (PCRQGE) and this composite index was used as a regulatory proxy. Results generated based on this proxy, as indicated by Reg 5a in table 2, are the same as those reported using 23 RQ, GE and RQGE10. We repeated this process taking into account the other four indicators of governance determine by Kauffman et al (2005) and detailed earlier.The first principal component of all the six indicators of governance (termed PC each(prenominal)) was generated, as well as one based on the four, excluding RQ and GE termed PC Others. Reg 5b and Reg 5c in Table 2 include the results based on these composite indexes. Inclusion of the four indicators of governance alongside or instead of the two regulatory proxies combined (RQGE) and its principal component (PCRQGE) has a marginal effect on the line of reasoning estimates for the other variables in the regression, but the signs remain the same. The c oefficient values for PC All and PC Others are, however, lower than for the other regulation variables.We interpret this result as being an indication of the differential influence of different governance proxies on growth. In other words, a possible criticism of our findings that various measures on institutional quality could be highly correlated and that it is institutional quality rather than the quality of regulation in particular that matters is not borne out. More precisely, the regulation proxies we have used (RQ, GE, RQGE and PCRQGE) seem to have a higher impact on growth than the other four indicators of governance identified by Kauffman et al (2005) reflecting wider institutional factors.Therefore, regulation rather than governance issues more generally seems to have the larger impact on growth. 11 Having considered the issue of convergence and considered the possible relative effects of regulation and governance issues more generally on growth, Tables 3 and 4 report resu lts based on the formal analysis of the data. The results address the main focus of the research, the impact of regulation on the growth in GDP per capita. The results reported in Table 3 are based on the model specified in equation (9) using OLS and cross-country data, as detailed above.Table 3 reports ten regressions, each containing different combinations of the independent variables in our data set. The economic variables in the full set of regressions 24 tried included the variables derived from the model itself, as specified in equation (9), and measures for general inflation, trade, government expenditure, as well as the regional dummies. However, with the exception of inflation these other variables proved to be statistically in real at the 10% level or better and therefore, to economise on position, the results are not reported.The inflation variable was found to be statistically significant and negative, suggesting that unstable macroeconomic conditions have a negative effect on economic growth. (Table 3 here) The regional dummies were used to test the guessing that different regions may have characteristics that affect growth differently. This is validated with respect to Asia, confirming that this region had, on average, performed better with respect to economic growth than other regions in the period studied. A dummy for Africa and Latin America were found to be statistically insignificant. We also included the initial level of human apital, as measured be secondary school enrolments, as a proxy for the initial level of institutions. As indicated in Table 1 this variable is highly correlated with initial GDP per capita, and the results in Table 3 confirmed that it has a negative sign and is statistically significant. This result supports the conditional convergence hypothesis. The regulatory variables are correctly signed and statistically significant in all cases. The sign and level of significance of the line estimates for these regulator y proxies indicate that they have a statistically significant and positive effect on economic growth.Based on the estimates for the combined regulatory variable (RQGE), a unit change in the quality and effectiveness of regulation is, on average, associated with approximately an 0. 6% to 0. 9% 25 increase in economic growth, everything else be equal. As with the other results reported, the regulatory proxies used here seem to have a larger impact on growth than do the other governance proxies, namely the variables PC All and PC Others. peerless objection to our analysis so far is that we have used regulatory data for 2000 only. Perhaps the regulatory environment has changed substantially during the period 1980-2000.Unfortunately, World Bank regulatory data do not exist prior to 1996. But as a cross-check on the constancy of the results if regulatory data for other years from 1996 are used, we first considered the correlation between the World Bank regulatory indicators between 199 6 and 2000. The results gave correlation coefficients of 0. 92 to 0. 99 confirming a high degree of stability. Nevertheless, we then re-ran our regression reported in Table 3 using regulatory indicators (constructed as before) but for 1996, 1998 and 2000 one at a time. The results were almost identical.As discussed earlier, the stability in the governance variables plus the very limited observations on governance (a maximum of two for each country) caused us to rule out the use of regressions based on panel data. (Table 4 here) Table 4 reports results based on the second system of estimation, which, as discussed earlier, involves two stages. In the first stage, by applying a fixed effect technique to the panel data, we arrive at the following regression results GDP per capita = 0. 133 Log net12 gross capital formation 0. 148 Log initial GDPPC (6. 41)* (6. 57)* 26 +0. 4 Log net nurture + Country Dummies (1. 84)** Adjusted R2 =0. 21 number of observations=432 The figure in bracket s is the t-ratio * (**) indicates significance level at 5% (10%). From the above, the regression parameter estimate associated with the country dummies is saved and used as the dependent variable in the regressions reported in Table 4. For reasons of space we report only a sub-set of the full results. We exclude reporting regressions including the full set of independent variables used, as detailed in Table 1, because a number of them proved to be statistically insignificant.Our main interest in the regression results reported in Table 4 is with the role that the regulatory proxies are playing in explaining the variation in the country dummies. The results are consistent with those reported in Table 3. crimson though the parameter estimates for the regulatory variable are lower, regulatory governance hush affects the growth performance of an economy. The regional dummies in this case are all negative and statistically significant, relative to the control group which is advanced co untries13.These changes in the results were investigated and seem to reflect the differences in the modelling methods adopted, suggesting that in this type of research the modelling can affect the results. Nevertheless, the overall picture that emerges is that the quality and effectiveness of regulation has a positive effect on growth using both models. 27 5. CONCLUSIONS The provision of a regulatory regime that promotes rather than constrains economic growth is an important part of good governance. The ability of the state to provide effective regulatory institutions can be expected to be a determinant of how well markets and the economy perform.The impact of regulatory institutions on economic growth will depend on both the efficiency of the regulatory policies and instruments that are used and the quality of the governance processes that are practised by the regulatory authorities, as discussed in the early part of the paper. This paper has tested the hypothesis that the efficien cy and quality of regulation affects the economic performance of an economy. 2 proxies for regulatory effectiveness were included separately and then combined as determinants of economic growth performance, using both cross-section(a) and panel data methods.The results from both sets of modelling suggest a strong causal link between regulatory quality and economic growth and confirm that the standard of regulation matters for economic performance. The results are consistent with those of Olson et al. (1998) who found that productivity growth is potently correlated with the quality of governance, and Kauffman et al (2005) who found that the quality of governance has a positive effect on incomes. As we highlighted earlier, the proxies we use for regulatory governance are correlated with a number of other institutional proxies.One could argue, therefore, that what we have established could equally hold for the link between institutional capacity in general and economic performance. H owever, the literature reviewed earlier in the paper is consistent with institutional capacity playing a strong and complementary role to regulatory governance 28 and the principal component analysis undertaken is supportive of this view. Nevertheless, the ability to model separately institutions in general and regulatory institutions or governance in particular remains problematic because of their potential complementarity.Hence, our results are perhaps most safely interpret as demonstrating the importance of regulatory quality for economic growth in the context of wider institutional capacity building. Also, we acknowledge that in our analysis there is no control for the different regulated industrial sectors including privatised industries. Hence, the results need to be interpreted with care because of the heterogeneity of the sectors covered. The possibility that regulatory quality inputs differently crosswise different industrial sectors cannot be ruled out.Unfortunately, data limitations prevented us from act this issue. Finally, we acknowledge that the direction of causation between economic growth and regulatory quality deserves further investigation, Nevertheless, despite these caveats, we believe that there are good a priori thou for assuming that better regulation leads to more rapid economic growth and that our empirical results are consistent with the view that good regulation is associated with higher economic growth in lower-income economies. 29 APPENDIX (a) sway of countries included in the dataset14Angola Albania Argentina Australia Austria Azerbaijan Belgium Benin Burkina Faso Bangladesh Bulgaria Belarus Bolivia brazil-nut tree Botswana Canada Switzerland Chile China Cote dIvoire Cameroon Congo, Rep. Colombia Costa Rica Cyprus Czechoslovakian Republic Denmark Dominican Republic Algeria Ecuador Egypt, Arab Rep. Spain Estonia Ethiopia Finland France Gabon united Kingdom Georgia Ghana dago Gambia Greece Guatemala Guyana Hong Kong (Chi na) Honduras Croatia Haiti Hungary Indonesia India Ireland Iran, Islamic Rep. Iceland Israel Italy Jamaica Jordan Japan Kazakhstan Kenya Kyrgyz Republic Korea, Rep. Lebanon Sri Lanka Lesotho Lithuania capital of Luxembourg Latvia Morocco Moldova Mexico Macedonia Mali Malta Mozambique Mauritius Malawi Malaysia Niger Nigeria Nicaragua terminateherlands Norway New Zealand Pakistan Panama Peru Philippines Papua New guinea Poland Portugal Paraguay Romania Russian Federation Senegal Singapore sierra Leone El Salvador Sweden Syrian Arab Republic Togo Thailand Trinidad and Tobago Tunisia turkey Tanzania Uganda Ukraine Uruguay United States Venezuela Vietnam Congo, Dem.Rep. Zambia Zimbabwe. 30 NOTES 1. The World Bank defines good governance as epitomized by predictable, open and enlightened policy making a bureaucracy imbued with a original ethos an executive arm of government responsible for its actions a strong civil company participating in public affairs, and all behaving under t he rule of law (World Bank, 1997). 2. 3. One of the authors of this paper has been involved in the design of regulatory institutions for Malawi.This expresses the observed data in each cluster as a linear function of the unobserved common component of governance, plus a disturbance term to capture perception errors and ingest variation in each indicator. 4. However, uncomplete neoclassical nor endogenous growth theory gave regulation an explicit role. By assuming that output is at the limit provided by the available factor inputs and technology, neoclassical growth theory implicitly assumed no regulatory distortions. 5. Benhabib and Spiegel (1994) argue that the initial level of human capital can affect the growth path of productivity.Olson et al (1998) also use secondary school enrolment as a proxy instructive variable in their growth study. 6. The most recent data set provided by Kauffman et al (2005) provides bi-annual data on indicators of governance over the period 1996-2004 . In common with most empirical research in this area, we have converted time series data on the variables we have used in this study into 5-year averages for the period 1980-2000. However, if we were to do the same with the regulatory indices available it would give us only one observation for each country. If we were to extend our data to 2004, we would get two observations on these indices.Time dimensions of data on regulatory governance in either case would be too few to be able to apply panel data. In addition, given that these indicators change very slowly over time, as also acknowledged by Kauffman et al. , and that they only relate to the most recent periods, we do not find it informative to try to use them in a panel data analysis. We were able to confirm the stability of the regulation variables by replacing the data for 2000 with data for 1996 and 1998. The effect on our results was paltry (the results can be obtained from the authors). 7.There are two estimation procedu res for panel data, fixed and random effects. In our case, the fixed effect method is the more appropriate one to use for the following reasons (a) a priori we expect that 31 regulatory governance proxies to be correlated with the intercept term for each country those with a poor or weak regulatory governance are also expected to perform relatively naughtily in terms of economic performance (b) we are interested in bill differences between countries included in our data set the parameter estimate for country dummies (the intercept term for each country) is a proxy for these differences.Intercepts in turn are used as a dependent variable in the second stage regression to establish the link between regulatory governance and country characteristics captured by the intercept term. The fixed effects method allows us to do this (c) in small samples, similar to the one we are using here, there may be hardheaded problems preventing parameter estimation when the random effect model is app lied this is not the case with the fixed effect model. For a more detailed discussion of these issues, see Verbeek (2000).Also, we applied the Hausman specification test and this confirmed that the fixed effect model is the more appropriate technique for our data. 8. http//www. worldbank. org/wbi/governance/pubs/govmatters4. html The series constructed are composite indexes, which are based on a number of variables generated at different points in time. Information for each country on these proxies, therefore, generally relates to a period rather than a specific year. Kauffman and Kraay (2005) highlight certain issues relating to the quality of the data used, particularly when it is utilised for making comparisons across countries.However, we are not aware of better regulatory quality data, while concession that better quality data could reveal different results to those reported here. Nevertheless, based on the significance level of the relevant variables in our regressions, we are fairly confident that any differences in the results would relate to the magnitude of these effects rather than their sign. 9. A number of the explanatory variables were logged. In the literature the basic growth accounting model is generally exponential function (e. g. Cobb-Douglas).Once logged, it becomes a linear relationship which can then be estimated. For the other explanatory variables in our model, logging helped to solve problems of serial correlation and heteroscedasticity. 10. The difference in parameter estimates for the regulatory index is due to the scale effect generated by the weight used in calculating the first principal component of the two indicators. 11. However, we would not inclination to over-emphasise the importance of this result given the data limitations as pointed out in Kauffman et al (2005).One could also argue that different proxies may have different dynamic effects on growth and that broader indicators of governance may require a longer period of time to produce their full effect on economic growth. 32 12. Net in this case applies to the log difference of different investment shares in GDP (physical and human in this case) and (d+n+g), where d is the rate of depreciation of capital per annum n is the rate of population growth and g is a proxy for rate of technical change. As is the practice in the literature, (d+g) is assumed to be 5%. The specification is based on a Solow/Augmented Solow model. 3. 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