Self-interests often influence the development of the very rules of the game in the economy. Furthermore, all regional laws are in the public domain, which allowed us to construct a reliable measure of institutional subversion by counting preferences. We consider both cases as cases of institutional subversion (since both lead to unequal treatment of companies by regional institutions), but with a different distribution of bargaining power in the bargain between politicians and companies. 8.
Since the measurement of institutional undermining plays the central role in the whole exercise, we begin by describing it. Second, we searched the comprehensive database of Russia's regional laws for any preferential treatment for each of these enterprises in the regional legislation in each year between 1992 and 2000. At the firm level, we take the share of regional preferential treatment granted to a particular firm in the total number of preferential treatment for five largest recipients as a proxy for the size of the firm's political influence.
The results are robust to changes in the number of firms included in the concentration measure. We test whether regional differences in any budget item can be partially explained by differences in the degree of regional institutional subversion. In addition, we expect tax arrears to be higher in politically connected firms, as discussed in the previous subsection.
To avoid social unrest, regional politicians may grant preferential treatment to the firm, which in turn may lead to performance improvements in the firm.
Empirical methodology
Regional–level regressions
Firm-level regressions
To examine the microeconomic effects of institutional subversion on acquiring firms, we use the sample of firms for which we have legislative data. In the micro-level regressions, PTC and NPT are very strongly correlated, so we orthogonalize them before including them in the regression.19 Thus, the RPTC controls for regional-level conquest and the NPT controls for regional paternalism. In short-run fixed effects regressions (3), we restrict the sample to observations in regions and years for which the total number of regional preferential treatments is greater than zero.
This is because only in this case our instrument is strongly correlated with the share of preferential treatments. In the case where the regional number of preferential treatments is zero, the value of the share of preferential treatments is constant across firms, while employment shares vary widely. 18 In panel regressions with fixed effects (short run), the share of firms' preferential treatments is instrumented with a lagged employment share.
In between effect regressions (long run), the initial employment rate is used as an instrument for all dependent variables except employment.
Results
Regional-level effects of institutional subversion
The fact that retail trade turnover is not significantly affected by institutional subversion suggests the possibility that some are small. Overall, our hypothesis that vested interests hinder small business growth finds support in the data. As discussed in the hypotheses section, the theoretical prediction of the effect of state capture on growth and investment is ambiguous.
Panel A of Table 4 shows that annual changes in GRP per capita are significantly positively related to changes in the concentration of preferential treatment. Thus, in the short term, the positive effect of institutional subversion on growth within interest groups dominates the negative effect on the remaining producers. Panel B of Table 4 presents the long-run results: We find no statistically significant effect of legislative subversion on growth or investment.
The fact that the short-term positive effect on growth disappears in the long-term is consistent with the view that the rent-seeking activities of privateering firms destroy value in the long-term, and that we just have an insufficient horizon to observe negative correlation (reliable GRP data is only available for six years 1995-2000, the first year of which we take as a baseline). 22 We find a strong negative relationship between changes in regional size concentration, on the one hand, and the share of small business employment and the number of small businesses, on the other hand, as reported in table 2A. A one standard deviation increase in the output concentration among ten largest firms reduces the number of small businesses per capita by 14% and the share of small business employment by 23%.
23 Table 2A shows the results: Employment concentration among the ten largest private firms has a strong positive effect on concurrent private and total investment and has no significant effect on GRP. Changes in production concentration have a significant positive effect on GRP growth and have no effect on investments. A one standard deviation increase in the concentration of preferential treatment reduces regional total net income and tax revenue by 1.2%, federal and total tax arrears by 2.7%.
Our findings are consistent with Friebel and Guriev's story, as well as with the story of federal tax evasion (Lavrov et al., 2001): holding other things constant, legislative reversal is significantly negatively related to construction spending. and some social services facilities. A standard deviation increase in the concentration of preferential treatment reduces spending on new housing construction by 5%, and cultural facilities by 14%.25. There is no evidence of significant correlation in any other budget item with our measures of institutional subversion.
Firm-level effects of institutional subversion
There is a statistically significant and robust relationship between regional tax collection and institutional subversion, holding other things constant. We find that, holding other things constant, hijackers continue to outperform non-hackers in terms of sales and employment growth, fixed asset investment, national and regional market shares. Moreover, in the long run, hijackers have higher profits and higher bargaining power vis-à-vis employees, suppliers and the government which allows them to pay higher wages, trade and back taxes.
An important finding is that firms that engage in institutional undermining in the long run have significantly lower labor productivity growth compared to their peers despite their higher profitability. Thus, long-run profits for firms that are abducted are the result of rent-seeking activities and not driven by efficiency improvements. The economic significance of the long-term results is as follows: A one percent increase in the average share of preferred treatments in eight years (from the average equal to 0.1) increases average sales by approximately 1.7%, average employment by 0.5%, average fixed assets by 3.6%, profitability by 1.4%, arrears to suppliers by 1.4%, arrears of wages by 2%, and arrears of taxes by 3%, but lowers labor productivity by one percent.
It also results in one tenth of a percentage point increase in the regional market share and two hundredths of a percentage point increase in the national market share.
Comparison with BEEPS
Conclusions
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Litwack and Douglas Sutherland 2001, Fiscal Federalist Relations in Russia: A Case for Subnational Autonomy, OECD Center for Non-Member Cooperation Working Paper. Ponomareva, Maria and Ekaterina Zhuravskaya 2001, Do Governors Protect Firms from Paying Federal Taxes?, CEFIR Working Doper #10. Sala-i-Martin, Xavier 1997, Empirics of Economic Growth: Cross-Sectional Analysis, Zagreb Journal of Economics, Vol.
Sonin, Konstantin 2003a, Why the Rich May Favor Poor Protection of Property Rights?, forthcoming in The Journal of Comparative Economics. Zhuravskaya, Ekaterina 2000, Incentives to Provide Public Goods: Fiscal Federalism, Russian Style, Journal of Public Economics, Volume 76, Issue 3: 337-368. Growth in small businesses - Log number of small businesses per inhabitant - Log share of small businesses employment - Log retail turnover per inhabitant.
Log level of total revenues net of transfers per capita - Log level of regional tax arrears per capita - Log level of federal tax arrears per capita - Log level of total tax arrears per capita. Log GRP per capita (instrumented by lagged values) - Log population size (instrumented by lagged values) - Dummy for the regional election year. Variable share of expenditure items per capita Construction expenditure per capita culture education health care housing new housing.
In regression with employment, the share of preferential treatment is instrumented by the initial sales share.
