www. CEFIR.ru Institutional determinants of deregulation Evgeny Yakovlev and Ekaterina Zhuravskaya

Main question What determines whether deregulation reform started by a central government in a large federation would yield results at the local level? What determines whether deregulation reform started by a central government in a large federation would yield results at the local level? We use: We use: Russia’s deregulation reform - “a natural experiment” Russia’s deregulation reform - “a natural experiment” unique panel data set on regulatory burden on firms from CEFIR’s “Monitoring of administrative barriers to small business development” unique panel data set on regulatory burden on firms from CEFIR’s “Monitoring of administrative barriers to small business development” Analyze regional-level factors that explain variation in: Analyze regional-level factors that explain variation in: 1. Changes in regulatory burden induced by reform 2. The enforcement of deregulation laws

Reform In , Russia undergone a drastic deregulation reform In , Russia undergone a drastic deregulation reform It passed laws that simplified procedures and reduced administrative costs of It passed laws that simplified procedures and reduced administrative costs of Registration, inspections, and licensing to business Registration, inspections, and licensing to business The new laws established clear measurable benchmarks The new laws established clear measurable benchmarks One “window” and no more than a week for registration One “window” and no more than a week for registration No more than one inspection in two years by each agency (e.g., fire, sanitary, certification inspections) No more than one inspection in two years by each agency (e.g., fire, sanitary, certification inspections) No less than 5 years of license validity and reduction the number of activities which require licenses No less than 5 years of license validity and reduction the number of activities which require licenses

CEFIR’s Monitoring project  Measures of regulations Repeated surveys of 2,000 small businesses in 20 regions of Russia (panel data) Repeated surveys of 2,000 small businesses in 20 regions of Russia (panel data) Violations of enforcement of benchmarks in deregulation laws Violations of enforcement of benchmarks in deregulation laws Dummies indicating: too short license validity; an illegitimate license; more than one inspection of any agency in half a year; more than one window for registration; more than one week to register Dummies indicating: too short license validity; an illegitimate license; more than one inspection of any agency in half a year; more than one window for registration; more than one week to register Regulatory burden Regulatory burden number of illegitimate licenses; term of license validity; number of inspections; % time spent on inspections, number of agencies for registration number of illegitimate licenses; term of license validity; number of inspections; % time spent on inspections, number of agencies for registration

Timeline of Reform and the periods covered by Monitoring data 2001 I2001 II2002 I2002 II2003 I2003 II2004 I2004 II 1 st 2 nd 3 rd 4 th 5 th Law on Registration, 1 st reduction (July 2002) Law on Inspections (August 2001) Law on Licenses (February 2002) Data from Survey Rounds: time Law on Registration, 2 nd reduction (June 2004) 5 rounds of Monitoring have taken place in rounds of Monitoring have taken place in Laws took effect at different points in time Laws took effect at different points in time

Enforcement of new reform benchmarks Reform induced improvement in regulatory burden: Monitoring showed immediate positive effect of the enactment of each law on measures of the regulatory burden Reform induced improvement in regulatory burden: Monitoring showed immediate positive effect of the enactment of each law on measures of the regulatory burden For most of the measurable outcomes, however, regulatory burden never reached the level of benchmarks set by deregulation laws For most of the measurable outcomes, however, regulatory burden never reached the level of benchmarks set by deregulation laws Darker bars in each row indicate the period before reforms rounds

Vast regional variation in the levels of regulatory burden and in law enforcement Total number of inspections Main question: What accounts for differential in reform progress across 20 (monitoring) regions Main question: What accounts for differential in reform progress across 20 (monitoring) regions We relate reform progress to different regional institutional characteristics We relate reform progress to different regional institutional characteristics

Potential institutional determinants (initial, pre-reform values) Government transparency Government transparency Fiscal incentives (share of own revenues in regional budget) Fiscal incentives (share of own revenues in regional budget) Lobbying by large business Lobbying by large business Lobbying by small business Lobbying by small business Media freedom Media freedom Resource abundance Resource abundance Political variables (voter turnout, popularty of local leaders) Political variables (voter turnout, popularty of local leaders)

1 st exercise: Methodology Difference-in-differences estimator Difference-in-differences estimator Regress each measure of regulatory burden and of enforcement of a particular deregulation law on Regress each measure of regulatory burden and of enforcement of a particular deregulation law on interaction of “after reform” dummy with institutions (potential determinants of deregulation) – the main variable of interest interaction of “after reform” dummy with institutions (potential determinants of deregulation) – the main variable of interest region and time fixed effects region and time fixed effects Important control: initial level of regulation interacted with “after reform” dummy Important control: initial level of regulation interacted with “after reform” dummy For all regulations – regional level panel For all regulations – regional level panel For inspections and licenses – firm level panel For inspections and licenses – firm level panel

Effect of institutions on selected measures of regulation level, regional level panel Government transparency; fiscal incentives; lobbying by large businesses have beneficial effect on enforcement of deregulation Government transparency; fiscal incentives; lobbying by large businesses have beneficial effect on enforcement of deregulation Resource abundance has some adverse effect on license validity Resource abundance has some adverse effect on license validity Small business prevalence some beneficial effect on license validity Small business prevalence some beneficial effect on license validity Medial freedom and political variables do not have a robust effect Medial freedom and political variables do not have a robust effect Firm-level results are similar, but there are fewer significant results (possibly, because of a measurement error) Firm-level results are similar, but there are fewer significant results (possibly, because of a measurement error)

2 nd exercise: Methodology Different institutions affect progress in different regulatory areas Different institutions affect progress in different regulatory areas Which intuitions have the robust effect on law enforcement and deregulation on average in all areas of regulation? Which intuitions have the robust effect on law enforcement and deregulation on average in all areas of regulation? Construct measures of regulatory burden comparable across types of regulations for each region and round: Construct measures of regulatory burden comparable across types of regulations for each region and round: Rates of violations of benchmarks in each law Rates of violations of benchmarks in each law Z-scores of regulations in each regulatory measure Z-scores of regulations in each regulatory measure Difference-in-differences-in-differences (DDD) estimator Difference-in-differences-in-differences (DDD) estimator Panel with fixed effects for each regulation in each region Panel with fixed effects for each regulation in each region Timing of “after reform” differs across regulations (thus, this is DD already) Timing of “after reform” differs across regulations (thus, this is DD already) Main variable of interest – interaction of “after reform” with institutions Main variable of interest – interaction of “after reform” with institutions

Effect of institutions on the overall level of regulation and violations of laws Government transparency; fiscal incentives; lobbying by large businesses have strong robust effect on all regulations and law enforcement in general

Does deregulation matter? A common problem with figuring out the effect of regulatory burden on small business development is endogeneity of the level of regulatory burden on firms A common problem with figuring out the effect of regulatory burden on small business development is endogeneity of the level of regulatory burden on firms State officials regulate when there is something to regulate (if business grows – bureaucrats prey on it) State officials regulate when there is something to regulate (if business grows – bureaucrats prey on it) We can use our analysis of determinants of regulations as IV We can use our analysis of determinants of regulations as IV Use cross-term AFTER*INST as instruments for regulations Use cross-term AFTER*INST as instruments for regulations

Deregulation caused SME growth Panel OLS and IV regressions of small business on regulatory environment

Conclusions We find that there are three institutional factors that have significant and robust positive effect on reform progress in the regions: We find that there are three institutional factors that have significant and robust positive effect on reform progress in the regions: 1. government transparency in a region 2. the extent to which regional authorities are under influence of powerful industrial groups representing large businesses 3. the extent to which regional budgets are comprised of own revenues rather than transfers from the federal center Thus, our empirical findings confirm the following results of theoretical literature on institutional change: Thus, our empirical findings confirm the following results of theoretical literature on institutional change: The importance of federalism for institutions (fiscal incentives of local governments matter) The importance of federalism for institutions (fiscal incentives of local governments matter) The need for creating demand for institutions (coming from large industrial lobbies) The need for creating demand for institutions (coming from large industrial lobbies) Importance of accountability (since government transparency matter) Importance of accountability (since government transparency matter) We establish causal effect of deregulation on SME growth We establish causal effect of deregulation on SME growth