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IMT Institute for Advanced Studies, Lucca

Lucca, Italy

The Interplay between Bureaucracy and Globalization

PhD Program in Political Systems

and Institutional Change

XXV Cycle

By

Irina Mirkina

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The dissertation of Irina Mirkina is

approved.

Program me Coord inator: Giovanni Orsina, LUISS–Guid o Carli Free International University for Social Stud ies

Supervisor: And reas Bergh, Lund University

Tutor: Antonio Masala, IMT Institute for Ad vanced Stud ies, Lucca

The d issertation of Irina Mirkina has been reviewed by: James Melton, University College Lond on

Martin Rod e, University of Cantabria

IMT Institute for Advanced Studies, Lucca

2013

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v

Table of content

Table of content v

List of figures and tables vi

Acknowled gements vii

Vita ix

Publications and presentations ix

Abstract xii

1. Introd uction 1

2. Institutions in the Era of Globalization: Literature Review 4

2.1 Governance and the features of bureaucracy 4

2.2 Measuring quality of bu reaucracy 6

2.3 Globalization: terms, factors, ind icators 11

2.4 Bureaucracy and globalization 13

3. Globalization and Institu tional Qu ality: A Panel Data Analysis 16

3.1 Scope of research 16

3.2 Theoretical framew ork and previous empirical evid ence 17

3.2.1 Theoretical expectations 17

3.2.2 Previous stud ies 20

3.2.3 Sum mary 22

3.3 Data and method s 24

3.3.1 Data on institutional quality and globalization 24

3.3.2 Method 28

3.4 Results 29

3.4.1 Main results 29

3.4.2 Robustness tests 33

3.5 Conclud ing d iscu ssion 35

4. Fiscal Incentives and Foreign Direct Investment: A Causal Inference

Approach 38

4.1 Scope of research 38

4.2 Review of literature on fiscal incentives and FDI 39

4.3 Effect of tax concession on FDI in Ru ssian regions: a natural

experiment d esign 40

4.4 Parametric id entification strategy 46

4.4.1 Difference in d ifferences estim ation 46

4.4.2 Results of the d ifference in d ifferences estimation 51

4.5 N on-p arametric id entification strategy 54

4.5.1 Synthetic controls method 54

4.5.2 Results of the synthetic controls method 57

4.5.3 Main find ings 60

4.6 Conclusion 63

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vi

References 102

Special p ages 120

List of figures and tables

Figure 1 Scores for government effectiveness and regulatory quality

from the WGI in 1996 and 2010 10

Figure 2 Change in economic globalization and change in government effectiveness for high-income and low-income countries, 1996-2009 26 Figure 3 The marginal effect of economic and social globalization on control of corrup tion at d ifferent levels of GPD per cap ita 34 Figure 4 FDI inflows in Russian regions in 2002 and 2008 41 Figure 5 Balance of relevant covariates between treatment and control

groups in the pre-treatment period 45

Figure 6 Orange regions that attracted more FDI after tax concession 58 Figure 7 Orange regions that d id not attract more FDI after tax

concession 59

Figure 8 Yellow regions that attracted m ore FDI after tax concession 60 Figure 9 Balance of confou nd ing factors for orange regions 61 Figure 10 Balance of confou nd ing factors for yellow regions 62

Table 1 Concep ts, questions and d efinitions 7

Table 2 Descrip tive statistics 26

Table 3 Econom ic globalization: baseline m od els; full samp le 29 Table 4 Social globalization: baseline m od els; full samp le 30 Table 5 Different types of globalization; sub-sample of low -income

countries 31

Table 6 Different types of globalization; sub-sample of high-income

countries 32

Table 7 Tax rates on investment profit in Russian regions, per cent 42

Table 8 Descrip tive statistics 49

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vii

Acknowledgements

Preparing a thesis is a long journey in time and sp ace, and in the last three years I have travelled a lot, collecting new experiences and gaining new id eas. During this journey, I was lucky to meet and to work with m any great p eople. I would like to express my sincere gratitud e to all those w ho have inspired me, whom I have had a pleasure to w ork w ith, and who have m ad e this thesis possible.

First and foremost, my d eepest gratitud e goes to my su pervisor, Prof. And reas Bergh, who has su pp orted me with his great knowled ge and enthusiastic encouragement w hilst allow ing me free rein to work in m y ow n w ay. One simply could not w ish for a better supervisor. Profou nd gratitud e goes to my tutor, Prof. Antonio Masala. He gave me freed om, courage, and the priceless practical assistance d uring the planning and d evelopment of my w ork.

This thesis would not have been possible without the help, supp ort , and p atience of Dr Leonard o Baccini, not to mention his ad vice and unsurp assed knowled ge of the m ost sophisticated statistical method s. I wou ld like to especially thank Dr Therese Nilsson. Our collaboration and vivid d iscussions brought my research skills to the new level. Moreover, chapter 3 of this thesis is largely based on the project that we have carried out together w ith Prof. Bergh and Dr Nilsson.

I am end lessly grateful to Prof. Leonard o Morlino for sharing his immense knowled ge and remarkable expertise and inspiring w ith his personal examp le of an ind efatigable scholar.

My thesis has also benefited from the proficiency and authority of Prof. Qu an Li. Chapter 4 is based on the stud y that we have d one together with Prof. Baccini and Prof. Li.

I am very thankful to my external reviewers, Dr James Melton and Dr Martin Rod e, for their precious com ments and suggestions that allowed me to improve significantly this thesis.

I wou ld like to express my appreciation to the researchers and staff at the Institu t Barcelona d ‘Estud is Internacionals for giving me the opportunity to carry out m y research project as a visiting fellow . I am personally thankful to Prof. Juan Díez Med rano, Matthias vom H au , Martijn Vlaskamp, Benjamin Kienzle, and Carlos Sánchez Moya.

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viii

I d eeply appreciate the research opportu nities provid ed by the Department of Economics at the School of Economics and Management at Lu nd University and by the Research Institute of Ind ustrial Economics. My sincere and profou nd thanks go to Prof. David Ed gerton and Prof. Magnu s Henrekson.

I have greatly benefited from the institu tional, acad emic, and personal support from the people at IMT; particu larly, I owe a debt of gratitude to Prof. Giovanni Orsina. I also w ould like to express my thanks to Serena Argentieri and Daniela Giorgetti for excellent assistance and the highest effectiveness in every single m atter. I am also grateful for kind ness and courtesy of Antonella Barbu ti and Barbara Iakobino. I am d elighted to have great classm ates, a tireless source of supp ort, critique, and joy. I w ish them all the best of luck in their fu ture end eavours.

Albert Schweitzer once said that, ―At times our own light goes ou t and is rekind led by a spark from another person. Each of us has cause to think with d eep gratitud e of those who have lighted the flame within us.‖ My utmost thanks to Alexand er Mironov are beyond word s. I am also ind ebted to Svetlana Lepeshkina, Oksana Butakova, and Olga Sleptsova for being with m e in the right place at the right time.

Special thanks should be given to Marta Palacín Mejías for her lovely hosp itality, contagious enthusiasm, and for her role as my prim ary contact in Barcelona.

I wou ld have not mad e this journey without Enrico De Angelis. His warm supp ort and affectionate encouragement brighten up both my life and my research.

Last bu t not least, I w ish to thank my p arents for everything they have ever d one for me. I d eeply appreciate their end less care and countenance.

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ix Vita September 24, 1980 Born, Barnau l, Ru ssia

2002 M.Sc. in Economics

Diplom a with d istinction

All-Russian State Distance Institute of Finance and Economics, Moscow, Russia

2002–2008 Lecturer

Department of Finance and Cred it

All-Russian State Distance Institute of Finance and Economics, Barnaul, Russia

2004–2008 Research associate

Department of Econom ics

Novosibirsk State University of Econom ics and Management, N ovosibirsk, Russia

2007–2010 Lecturer

Department of Econom ic Science

Altai Institute of Financial Ad ministration, Barnaul, Russia

2010–2013 Ph.D. stud ent in Political System s and Institutional Change

IMT Institute for Ad vanced Stud ies, Lucca, Italy

2010–2011 Research assistant

Department of Econom ics and Institutional Change

IMT Institute for Ad vanced Stud ies, Lucca, Italy

2011–2012 Visiting scholar

Institut Barcelona d ‘Estud is Internacionals, Spain

2013 Visiting research fellow

School of Econom ics and Management Lund University, Swed en

Publications and presentations

I. Mirkina (2013) 15 Y ears of the Federal Target Programs in Russia: Good

Intentions and Cruel Reality [Kind le Ed ition]. Retrieved from

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x

L. Baccini, Q. Li, and I. Mirkina (2013) Tax Cut and Foreign Direct

Investment: A Causal Inference A pproach. Paper presented at the

International Stud ies Association Convention, San Francisco, USA . A. Bergh, I. Mirkina, and T. Nilsson (2013) Globalization and Institutional

Quality: A Panel Data A nalysis. Paper presented at the 15th World

Economy Meeting, Santand er, Spain.

I. Mirkina (2011) The Impact of Institutions on the International Relations of

a Country. Paper presented at the 8th Convention of the Central and

East European International Stud ies Association, Istanbul, Turkey. I. Mirkina (2011) The Interplay between Bureaucracy and Globalization. Paper presented at the 3rd Grad u ate Conference of the Italian Political Science Association (Società Italiana d i Scienza Politica), Turin, Italy. Y. Shvetsov, I. Mirkina (2009) Fed eral'nye tselevye programm y kak instru ment upravleniya gosud arstvennymi raskhod ami [Fed eral Target Program s as an Instrument for the State Expenses]. Finansy, 2009-4. Y. Shvetsov, I. Mirkina (2007) Gosu d arstvennye investitsii i razvitie regional‘noi economiki [State Investment and the Regional Develop ment]. Federativnye otnoshenia i regional’naya

social’no-economicheskaya politika, 2007-5.

Y. Shvetsov, I. Mirkina (2007) K voprosu ob effektivnosti fed eral'nyh tselevyh program m v bud zhetnoy sfere [On the Effectiveness of the Fed eral Target Programs in Public Economy]. Finansy, 2007-6.

I. Mirkina (2007) Vned renie bud getirovania, orientirovannogo na resultat [Introd ucing Goal-Oriented Bud geting], in: Management of

Organizations and Financial Markets for Economic Growth: conference proceedings, Barnaul: International Acad em y for Ind ustrial Management.

I. Mirkina (2006) Finansovoe obespechenie social‘nyh reform [Financial Basis of the Social Reforms], in: Strategy and Tactic of Russia’s

Development for the Socially Oriented Economics: conference proceedings,

Barnaul: AltGTU.

Y. Shvetsov, I. Mirkina (2005) Problemy realizatsii fed eral‘nyh tselevyh program m na regional‘nom urovne [Problems in Im plementation of the Fed eral Target Programs at the Regional Level]. Finansy, 2005-5. I. Mirkina (2005) Problemy vned reniya bud getnogo u cheta [Problems of the Bud geting Reform s]. V ZFEI Discussion Papers Series, 2005-8.

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I. Mirkina, I. Rud enko (2004) N alogovaya nagru zka i ee v liyanie na chistuyu pribyl firm y [Tax Assessment and Net Profit of the Firm].

V ZFEI Discussion Papers Series, 2004-7.

I. Mirkina (2003) Aspecty sovmestnoi realizatsii fed eral'nyh tselevyh program m regional'nymi i fed eral'nymi organami vlasti [Cooperative Investment through the Fed eral Target Programs]. V ZFEI Discussion

Papers Series, 2003-6.

I. Mirkina, E. Kolobova (2002) Problem y realizacii i finansirovaniya

gosud arstvnnyh investicionnyh program m [Problem s of

Implementation and Financing of the State Investment Program s].

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xii Abstract

This research focuses on a tw ofold issue: 1) the challenges that globalization creates to institutions, having to d eal with a new international ord er; 2) the challenges that state governan ce creates for global actors, having to ad apt themselves to the national and sub -national peculiarities. The globalization –bureaucracy interplay is a politically contested p henomenon, in which d ifferent mod els of interactions am ong states, firms, and citizens ap pear and transform both nationally and internationally.

At the national level, the impact of globalization on qu ality of governance is examined empirically across countries. The analysis with fixed effects mod els is based on a panel d ataset, covering over 100 countries in the period 1992–2010. The stud y exam ines an effect from both economic and social globalization factors on d ifferent governance features, includ ing governance effectiveness, regulatory qu ality, control of corruption, accou ntability, p olitical stability, and rule of law. The find ings show that various governance features seem to d iverge in how easily they respond to the new state of affairs that follows with m ore globalization. Moreover, in line with the theoretical pred ictions, globalization affects institutions d ifferently d epend ing on the cou ntry‘s level of d evelopment. The results thus suggest that the previous find ings on positive effects of international economic flow s on institutional qu ality are likely d riven by changes in rich countries. The imp act of institutional policies on globalization factors is analyzed at the sub-national level, u sing a panel d ataset of 82 Russian regions in the period 1995–2010. The stud y takes an ad vantage of exam ining d ifferent types of fiscal incentives, introd uced in some regions of Russia in 2003, treating them as a natural experiment and estim ating the causal effect of tax concessions on foreign d irect investment inflow s with two causal inference techniques: d ifference in d ifferences estim ation and synthetic controls method . The find ings confirm that tax concessions for investment lead to more foreign d irect investment inflows. H owever, selective tax concessions for the government sanctioned imp ortant investment projects d o not have the expected effect, or the effect is sporad ic and weak at best. As governments seek to increase the national and sub-national attractiveness for foreign investors, these find ings have imp ortant im plications for the d esign of institutional p olicies.

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1. Introduction

Globalization transforms mod ern society and economy. The states, therefore, face a challenge in ad ap ting them selves to the global factors and netw orks. They ought to implement new policies or to change existing ones, seeking integration into the international o rd er. However, one generally sees the governmental stru ctures as highly inertial and slow to change. Once their form al method s and proced ures are established , they tend to use the same method s and rules, whether the situation changes or not. And even if bu reaucratic structures d o change u nd er an external pressure, it is u nclear how far the d evelopment w ould go. Thus, one might wond er about the effect that the rigid and slu ggish state bureaucracies have on globalization factors. In some cases, extensive ad ministrative burd ens and form alities restrain the d evelopment of international trad e, investment, and migration. On the other hand , in those cou ntries w here m any of the ad ministrative proced ures and bureaucratic institutions are weak or unspecified , global actors wou ld find neither field to act, nor rules to follow. The question is on a mutual effect of bureaucracy and globalization in this interp lay. Does globalization red uce bureaucratic barriers through, for exam ple, multilateral agreements or internationa l norms? Or d oes it create just the opp osite, a new kind of ―internationally w id espread ‖ bureaucracy? Does bureaucracy support international cooperation by provid ing the legal and institu tional framew ork? Or on the contrary, d oes it fight with the global features, trying to keep its purely national p ower?

This research focuses on a tw ofold issue: 1) the challenges that globalization creates to the existing national and sub -national institutions, having to d eal with an expand ing international ord er; 2) the challenges that state governance creates for global actors, having to ad ap t them selves to the d omestic form al and informal peculiarities. Globalization–bureaucracy interplay is a politically contested phenomenon, in w hich d ifferent m od els of interactions a m ong states, firms, and citizens app ear and transform both nationally and internationally.

Each state keeps its national interests above all. But globalization comes, to a large extent, as the weakening or even removal of the institutional buffers between d omestic econom y and global m arkets. (Ó Riain, 2000) States, therefore, should respond to pressures from local societies and global m arkets simu ltaneously that lead s to the changes

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2

not only in the state-markets interaction but also in the state structures them selves.

States are interconnected , and none cou ld be totally isolated from the global ord er. States are integrated into global m arkets throu gh, for instance, international trad e and prod uction d istribution (Wallerstein, 2011). Besid es, states comp ete w ith one another to attract m obile capital (Arrighi, 1994). Moreover, business exp ansion requires m ore bureaucratic work on creating and ad apting regulations, which lead s to the expansion of the state apparatus (Chase-Dunn and Grimes, 1995). Different m od els of state's reaction to globalization might spread throu gh the interaction of states or throu gh the influence of international and su pranational organizations. Globalization may pose new problems for states, but it also m ay reinforce states to id entify an d to m anage those problems on behalf of their societies (Meyer et al., 1997). Contem porary theories both in political science and in economics emphasize the ways in which national and global actors interact with each other (Block, 1994; Evans, 1997). The relations am ong them are essentially tense, and com petition fights can often result in a zero -sum game. The d irection and pace of the cou ntry's d evelopment are d etermined by how institu tions regulate these tensions, creating basis for both national actors, going global, and foreign actors, coming into the country. This d evelopment is p ath -d epend ent and reflects the mutu al effect of state and private actors at the subnational, national, and international levels. In this respect, Band elj (2009) argues that the global econom y can be conceptualized as an instituted process1

. States contribute to the institu tionalization of globalization by ad apting formal policies, as well as inform al norms, by provid ing both d omestic and foreign actors with organizational resour ces, and by supp orting real economic and social interactions (Band elj, 2009).

The globalization–institutions interactions have received some attention am ong the p olitical theorists, but so far have not been examined empirically. Does good governance actually promote international cooperation? Does globalization itself support better governance? Do the available measures of globalization and institutional qu ality provid e a reliable tool to answer these questions? The answers to these qu estions have both theoretical and p olicy implications. If globalization or its variou s sub -comp onents are able to

1 She uses Polanyi's (1957 [1944]) id ea about "economy as instituted process," meaning

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improve quality of governance, then international factors shou ld be taken into account not only in cross-cou ntry comparisons but also in implementation and analysis of d omestic p olicies.

Before examining the strength and d irection of the relationship between d omestic bureaucracies and globalization factors, one should d efine how to conceptualize both bureaucracy and globalization and how to assess them. Hence, the th esis proceed s as follows. Chapter 2 d iscusses institutional features of bureaucracy and their reflection in the existing measures of governance qu ality. Then it proceed s to d escribing globalization as a process and as a historical p henomenon, and to exp laining how bureaucracy and globalization shape and reshape each other. Chapter 3 d iscusses the imp act of various types of globalization on institutional qu ality at the national level and then examines this imp act emp irically with the analysis of a panel d ata set, covering over 100 cou ntries in the period 1992–2010. Chapter 4 d iscusses the effect from the fiscal elements of institutional policies on globalization factors at the sub-national level. The effect is tested empirically, using a p anel d ataset of 82 regions of Ru ssia in the period 1995–2010.

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4

2. Institutions in the Era of Globalization: Literature Review

2.1 Governance and the features of bureaucracy

One of the most imp ortant roles of the state in m arket economy is in d etermining the rules of d omestic–international interaction by creating, implementing, and ad apting variou s types of regulations. This role, as well as many others, heavily d epend s on the qu ality of government, i.e. the functioning of executive branches and their bureaucracies. Importance of bureaucratic work is d efined by the ability of public officials a) to d eliver services both to m arket actors and to society, and b) to create and enforce ru les and regulations (Olsen, 1988; Fu kuyam a, 2013).

Many sound theoretical m od els, created in th e XX century, contributed to the analysis and u nd erstand ing of bureaucratic structures (Weber, 1978 [1946]; Blau, 1955; Tullock, 1965; Crozier, 2009[1964]; Lipsky, 1980; Mises, 1983 [1944]; Dow ns, 1994 [1966]; Niskanen, 1994 [1971]).

Weber's classical analysis provid es systematic arguments on the genesis and features of bureaucracy. Weber d escribed in d etails the fund amental role of bu reaucracy for a cou ntry's d evelop ment. Particularly, he listed several features of bureau cratic structures, includ ing the follow ing (Weber, 1978: 196-203):

- There are some fixed jurisd ictional areas, ord ered by laws and ad ministrative regulations,

- There is a hierarchy within a fixed system of super - and subord ination,

- The officials und ergo thorough and expert training , - There are some general ru les, stable and exhaustive, - The officials are appointed by a superior au thority , - There is a career p ath within the office,

- *The officials get a fixed salary.

- *The office constitutes tenure for life, and - *Job requires full w orking capacity of the official

Last three of the listed features d o not reflect m od ern reality, though. As Fukuyama (2013) points out, fixed salaries are not compatible w ith the market-like incentives often offered to bureaucrats und er New

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Public Management. Moreover, it is com mon for talented ind ivid uals from the private sector or the acad emy in m any cou ntries to serve in government for period s of time.

Many stud ies d ealt with the other Weberian features later on, having come, however, to rather d ifferent conclu sions.

Austrian School of economics sees bureaucracy mainly as an instru ment, the tool for executing laws and regulations. State function could not be realized w ithout bureaucratic work: ―There is a field , namely, the hand ling of the app aratus of government, in w hich bureaucratic method s are required by necessity‖ (Mises, 1983: 48). Minim al bureaucracy is required for the protection of property rights, physical property, and the people, as well as for insuring social cooperation among the members of society and market actors (Mises, 1983: 20).

However, there is always a d anger of overwhelming bureaucracy, unable to correct its own errors, that w ould requ ire some external (market or social) factors to intervene. ―The bureaucrats see in the failure of their preced ing m easures a proof that further inroad s into the market system are necessary‖ (Mises, 1983: 35).

Public choice theorists concentrate on problems of bureaucratic accou ntability. This school of research analyzes the pathologies of overwhelming institutions, their implications, and the possible method s of control from society. Tullock (1965) investigated harmful effects of m isinformation that cou ld be channeled w ithin the hierarchy of ad ministrative structures. Crozier (2009) later conclud es that the lack of accou ntability, be it before elected officials, citizens, or pressure groups, is attributable to bureaucratic inertia (see Meier and Krause (2003) for d iscu ssion). Niskanen (1994) extend ed this view, claiming that bureaucracy is preoccu pied with its ow n bud get maximization and its interests contrad ict the interests of society, thu s, making bureaucrats unresp onsive to society d emand s. Downs (1994) argued that the ind ivid u al preferences of bureaucrats m ight d iffer, thus policy m aking and coord inating process could become d ifficult. Finally, Olson (2000) claimed that the main aim of p olitical d evelop ment shou ld be the creation of instru ments like rule of law and accou ntability that could limit the state‘s d iscretion.

The scholars w ithin a principal–agent framew ork look for the method s of corruption control and better accountability through m anipulation of

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6

incentives, e.g. competition, manipu lation of w age scales, shortening of accou ntability rou tes, etc. (see Fukuyama (2013) for d iscussion). Many stud ies, app lying the principal–agent views, found various incentives and m onitoring activities being effective in controlling the behavio ur of bureaucrats (Miller and Moe, 1983; Moe, 1990; Scholz and Wei, 1986; Scholz, Twombly, and Head rick, 1991; Weingast and Moran, 1983). Other stud ies of bureaucracy and bureaucratic performance examined the imp ortance of the bureaucrats‘ values and its impact on public policy outputs (Eisner, 1991; Khad em ian, 1992). Several researches showed how attemp ts to impose var iou s bud geting system s have been altered and even sabotaged by bureaucrats in the implementation process (Wild avsky, 1984 [1964]; Meier and Krau se, 2003). Finally, open systems theories of bureau cracy focus on how organizations cope w ith the political environment (Keiser, 1999), as well as on a general framew ork for assessing political control (Meier, 2000; Meier and Krau se, 2003).

2.2 Measuring quality of bureaucracy

To assess emp irically the mu tual impact of bureaucracy and globalization, one shou ld be able to measure the quality of governance with a reliable, cross-nationally comp arable tool. Existing measures typically rely, in w hole or in p art, on surveys of either expert op inions, either market actors (international and d omestic firms), or citizens. Questions in such surveys involve national laws and regulations, the level of ―red tape‖ and ad ministrative burd ens, or perceptions of corruption (Chong and Cald erón, 2000; Mauro, 1995).

These measures, however, have a number of limitations. First, as the und erstand ing of governance features d iffers am ong the field s and theories, d ifferent experts m ay intend d ifferent things when respond ing to the same survey question (Fu kuyam a, 2013). Another issue is the assump tion that the interests of firm s (either foreign or d omestic) and the interests of the nation are similar (Kurtz and Schrank, 2007). For instance, some regu lations, imp osed by the state (e.g. labor laws, environm ental controls, or antitrust actions) m ay be assessed as ―burd ensome‖ and ―growth -inhibiting‖ by the m arket actors. If, however, such controls d o not exist, states might be jud ged less severely by the firms (Kurtz and Schrank, 2007). Moreover, as Rothstein (2011) p oints out, the existing ind icators of governance qu ality presu me some strong norm ative p olicy preferences (e.g., less rather than more regu lation), which m ight skew their values. Finally,

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since the d irect assessment of m any governance aspects is not possible, most of the ind icators ap proxim ate them (with, for example, input – output evaluations), i.e. ―measure w hat is measurable‖ (Fu kuyam a, 2013).

Taking into account the listed limitations, it is worth d iscussing the ind icators from three well-known sources: the World wid e Governance Ind icators prod uced by the World Bank (WGI), the Global Competitiveness Rep ort by the World Economic Foru m (GCS), and the Risk Briefing assessment as well as the Democracy Ind ex by the Economist Intelligence Unit (EIU) (table 1).

These measures have a number of ad vantages. First, they includ e d ifferent types of measures: aggregate ind icators (WGI), survey (GCS), and experts‘ assessment (EIU)2

. Second ly, unlike some other ind icators, these sources cover a consid erable number of countries. The WGI ha s started w ith 185 countries in 1996 and offered the scores for alread y 210 countries in 2010. The EIU observes 170 countries in the Democracy Ind ex (issued early from 2006) and 179 countries in the Risk Briefing assessments (this number has increased from 120 countries in 1996). The biggest d evelopment occurred in the GCS: from 58 countries in 1996 up to 133 countries in 2010. Third ly, they concentrate, again u nlike some others, not only on one aspect of governance, e.g. corruption, but on m any d ifferent features of the government functioning, includ ing political representation, stability and balance of powers, red tape, corruption, liberal p olicies and their imp lementation, etc.

This broad range of featu res, however, creates also some conceptu al and method ological problems. First of them is related to the end uring d ebate on w hat is governance. Due to the lack of agreement in d efinitions even am ong the political theorists, the sources of nu merous ―institutional‖ ind exes and ind icators try to avoid giving their own d efinitions. Instead , they offer a variety of questions and / or marks to d escribe certain aspects of the government‘s work. And although it looks sometimes like touching d ifferent parts of an elephant in the d ark, the resu lts seem qu ite encouraging as long as one takes into accou nt their comp lexity and interd epend ence (table 1 and ap pend ix A).

2 The WGI as a set of the aggregate ind icators rely on the GCS and the EIU among the

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8 Table 1 Concep ts, questions and d efinitions

Governance feature

World w id e Governance Ind icators (WGI)

Global

Competitiveness Report (GCS)

Economist Intelligence Unit‘s Risk Briefing assessments (EIU)

Definition of governance

Trad itions and institutions by w hich authority in a country is exercised Legal and ad ministrative framew ork w ithin w hich ind ivid uals, firms, and governments interact to generate w ealth - Government effectiveness The quality of public services, the capacity of the civil service and its ind epend ence from political pressures; the quality of policy formulation and implementation, and the cred ibility of the government's commitment to such policies - Wastefulness of government spend ing - Burd en of government regulation - Efficiency of legal framew ork in settling d isputes - Efficiency of legal framew ork in challenging regulations - Transparency of government policymaking

- Is the government likely to open, liberal and pro-business policies for nationals and foreigners? - What is the quality of the bureaucracy in terms of overall competency/ training, morale/ d ed ication? -H ow pervasive is red tape? - H ow pervasive is

corruption?

- H ow accountable are public officials?

- Is there a risk that this country could be accused of human rights abuses? Regulatory

quality

The ability of the government to provid e sound policies and regulations that enable and promote private sector d evelopment

- - Is the tax regime clear and

pred ictable? - What is the risk that corporations w ill face d iscriminatory taxes? - What is the risk from retroactive taxation? - What is the risk of d iscriminatory tariffs? - What is the risk of excessive protection (tariff and non-tariff) in the next two years? Control of

corruption

The extent to w hich public pow er is exercised for private gain, includ ing both corruption and ―capture‖ of the state - Diversion of public fund s - Public trust of politicians - Irregular payments and bribes -

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One can see from comparisons in table 1 that the lim its of all categories are highly ambigu ous and could lead to confu sion. Marks of government (in)effectiveness in the GCS cou ld be compared with the regulatory qu ality in terms of the WGI, w hile the EIU‘s assessment of the government effectiveness includ es hu man rights, bureaucratic competency, red tape, corruption, and accountability all at once. Some questions for the ind ivid ual ind icators are excessively precise (for examp le, the GCS d istinguishes seven types of bribes), some others, however, are rather vague (e.g. ―How accountable are public officials?‖ in the EIU).

The second conceptu al problem refers to the id ea that Putnam et al. (1993) state as ―d ifferent governments m ight be simp ly good at d ifferent things.‖ Concentrating only on government effectiveness o r control of corruption w ould be by no means enough for a full analysis; one should not skip any of the governance features. Moreover, it m ight be necessary to keep in mind possible existence of some other governance features, not listed explicitly in the institutional ind exes. Comp aring two or m ore d imensions of governance gives some insights about possible internal factors that might affect the country‘s institutional quality (figure 1). On the one hand , there are some ou tliers scoring relatively well for one feature of governance but not for the others. For instance, Bhu tan w as assessed much higher for government effectiveness and political stability than for regu latory qu ality and accou ntability over the whole period . On the other hand , clear improvement or worsening of the institutional quality in general cou ld be seen only in few cases. More often, the countries manage to improve certain aspects of governance, while having a little success in the other aspects.

The last method ological problem occurs her e. Since the ind icators certainly measure d ifferent things with d ifferent method s, it might well be that only the m ost evid ent cases receive reliable scores. That is: in those cases w here m any ind icators agree on a country‘s institu tional qu ality, it happens because its improvement or worsening is unquestionable. However, for many other cou ntries fallen ―in the mid d le,‖ the scores and ranks are somewhat relative that cou ld make any d irect country comp arisons vague and d isp utable. For this m atter, for instance, the au thors of the WGI, besid e the estim ation of governance ind icators, report also the m argins of error, highlighting their importance. While taking this into account, many significant

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10

d ifferences among cou ntries can in fact be assessed using these ind icators (Kaufm ann et al., 2010). It is, therefore, preferable using the WGI instead of either alternative. In ad d ition to its growing p olicy relevance (World Bank, 2000), it d isplays reasonable reliability and has a broad coverage, avoid ing samp le selection problems at the cou ntry-level (Kurtz and Schrank, 2007).

Figure 1 Scores for government effectiveness and regulatory quality from the WGI in 1996 and 2010

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2.3 Globalization: terms, factors, indicators

Globalization may be d efined as a process, a historical period , or as a political and economic p henomenon.

In the first und erstand ing, globalization reveals itself throu gh a variety of links and interconnections between the states. ―It d efines a process throu gh w hich events, d ecisions and activities in one part of the w orld can come to have a significant consequence for ind ivid u als and com munities in quite d istant parts of the globe‖ (McGrew, 1990). This view is shared by m any scholars, d efining globalization as a set of ―processes d eriving from the chan ging character of the good s and assets that comprise the base of the international political econom y‖ (Cerny, 1995: 596).

In the second u nd erstand ing, the term ‗globalization‘ might serve for d escribing a context in which events occur (Reich, 1998). The globalization period might be d escribed as one that began in the m id -1970s3

. Other interpretations d ate globalization from the end of the 1970s and the beginning of the 1980s, becau se of a series of events that clustered within a limited time period : spread of technologies, international d ebt crises, the second oil crisis; rise in inflation rates; rise of capital movement, etc.4

Finally, globalization is m ost often characterized as a complex system of political and economic phenomena. These includ e d iffusion of technology, m oving of prod uction and capital, integration of cap ital markets, and the changes in the international d ivision of labour (Reich, 1998). All these phenomena certainly have had historical preced ents; nonetheless, these events have no preced en ts in terms of speed and intensity. Globalization thus characterizes the escalation of existing processes rather than the d evelopment of a new one (Reich, 1998). Such intensification creates new challenges and opportunities for international and d omestic actors, as well as for the states (Jones, 1995). The impact of globalization varies across cou ntries, d epend ing on many socio-economic factors. Great expectations abou t global p olitical convergence based on liberal d em ocratic institutions across nations (Fukuyama, 1992; Mand elbau m, 2005) d id not fully come into reality.

3 For d iscussion, see H irst, P. and Thompson, G. (1996). Globalization in Question: The

International Economy and the Possibilities of Governance. Cambrid ge: Polity Press.

4 For d iscussion on this view, see Solomon, R. (1994). The Transformation of the World

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12

However, there is some evid ence in support of the neoliberal concep t of globalization, w hich expects that the cou ntries wou ld red efine their national interests to achieve greater openness to the world economy (Ohm ae, 1991; Fried m an, 2005; Rod e and Gwartney, 2012). Critique of globalization regard s some und esired consequences of such openness, includ ing the increase of poverty and socio-economic d ivisions (Murphy, 2001), cultural conflicts and ethnic nationalism (Mansfield and Snyd er, 2007), and rise of protectionist p olicies (Stalling s, 1995; Mansfield and Milner, 1997; Helleiner and Pickel, 2005). Such consequences were especially evid ent in the less d eveloped cou ntries, as globalization cou ld und ermine national sovereignty in variou s areas, from finance to labour mobility (Strange, 1996).

To analyse the effect and consequences of globalization, m ost stud ies use variou s economic ind icators, w hich allow reliable cross-cou ntry comp arisons. Such ind icators includ e:

- Foreign d irect investment inflow s (Blomström et al., 1994; Garrett, 2001; Borensztein et al., 1998; Carkovic and Levine, 2002),

- International trad e flows (Frankel and Romer, 1996; Dollar and Kraay, 2004; Greenaw ay et al., 1999), and

- Measures of openness of trad e (Dollar, 1992) and of capital (Chand a, 2005; Rod rik, 1998; Alesina et al., 1994).

While those ind ivid u al ind icators might provid e a proxy for some sub -d imensions of globalization, it is necessary to assess several globalization factors together, as they are strongly related to each other. For a long time, the only overall–globalization stud y w as the Globalization Ind ex by A.T. Kearney/ Foreign Policy Magazine (2002). There were several attemp ts to upd ate this ind ex after 2005, e.g. CSGR Globalization Ind ex by the University of Warwick5

and GlobalInd ex by the TransEurope Research Network6

.

Recent KOF Ind ex of Globalization took some of the previous approaches, but with improved method ology and the expand ed list of und erlying factors.

5 CSGR Globalisation Ind ex is used in Joyce, J. P. (2006). Promises Mad e, Promises

Broken: A Mod el of IMF Program Implementation, Economics and Politics, 18(3): 339-365.

6 The authors d escribe GlobalInd ex in Raab, M., Ruland , M., Schönberger, B., Blossfeld ,

H ., Hofäcker, D., Buchholz, S., and Schmelzer, P. (2008): GlobalInd ex – A sociological approach to globalization measurement, International Sociology, 23(4): 596-631.

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In the KOF Ind ex of Globalization, globalization is d efined as ―the process of creating netw orks of connections am ong actors at multi-continental d istances, med iated through a variety of flows includ ing people, inform ation and id eas, cap ital and good s. Globalization is conceptu alized as a process that erod es national bou nd aries, integrates national economies, cultures, technologies and governance, and prod uces comp lex relations of m utu al interd epend ence‖ (Dreher et al., 2008).

The KOF Ind ex of Globalization takes account of economic, social, and political globalization (see Append ix C for d etails). Econom ic globalization is measured by trad e, foreign investment, as well as the tariff restrictions. Social globalization, meaning movement of id eas, information, and peop le, is estim ated , am ong other factors, by tourism, foreign population, use of the Internet, and the number of both McDonald ‘s restaurants and Ikea stores. Political globalization is meant to approximate political cooperation and is measured by such factors, as the nu mber of embassies and membership of international organizations (Dreher et al., 2008).

2.4 Bureaucracy and globalization

Each state reacts to globalization in its own, national-specific w ay. Und erlying factors for the reaction m ight includ e the level of social and political d evelop ment, structure of ind u stries, as well as cultural, ed ucational, and ethnic structure of the society. Among all the factors, qu ality of institutions is of a great imp ortance. Imp lementation and enforcement of regulations can become a crucial factor for a foreign or d omestic investor, tourist, trad er, or migrant.

Since the 1980s, the value of world trad e has increased enormously and ind ustrial capital has become u ncond itionally globalized (Ruggie, 1995). These factors affected governments‘ ability to control their national financial p olicies (Ó Riain, 2000). Migration has become a significant feature of m any open econom ies (Held et al., 1999). Moreover, globalization has had some social implications (e.g. in its imp act on gend er equality and income d istribution groups).

Some stud ies find that these changes have und ermined the role of the state, replacing or complementing national institutions with global norms and structures (Sklair, 1991; Robinson, 1998; Mittelm an, 1997). Many scholars, however, pred ict that globalization makes the role of the state more imp ortant, since effective governance is crucial for

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14

national interests w ithin the global ord er (Cerny, 1995; Rod e and Gw artney, 2012). The governments med iate the connections between the d omestic and global actors, therefore, affecting the way, in which the national interests and assets are used w ithin the range of opportunities available in the global economy (Ó Riain, 2000). Globalization m ight change lin ks and authority of institutions across the levels of governance (Castells, 1997). This would mean reconfiguration of the state and form ation of new relations both between states and the local actors and between states and the global actors.

A number of policies and regulations, u sed to p rom ote d omestic d evelopment, ought to be reshaped und er the imp act of globalization. Multilateral agreements change tariff rules and simp lify cu stom proced ures. Currency unions change m onetary p olicies, banking regulations, and control of capital. Migration changes labour regulations and sup ports, to some extent, anti-d iscriminatory p olicies. Foreign investment may serve as a stimulu s for ad op ting more liberal financial policies and even for prom oting d em ocratization. The fo rmer happens because investors seek for mild er fiscal policies (e.g. in the form of tax concessions), w hich d ecrease costs for investors, instead of protectionist policies, which increase costs (Bhagw ati et al., 1992; Brewer, 1993; Ellingsen and Wärneryd , 1999). Moreover, investors d o expect that d emocratic governments can more cred ibly com mit to market friend ly p olicies than authoritarian governments can; hence, foreign investment could affect the p ath of p olitical d evelopment of a country and provid e a su pport for d emocratization reforms (Jensen, 2008; Band elj, 2009; but see Rod e and Gw artney, 2012). Some stud ies und erline the role of foreign capital for d em ocratic transition and global integration of a cou ntry (Bevan and Estrin, 2004; Meyer, 1998; Schmid t, 1995). Some even argued that those countries were m ore successful that built ―capitalism from outsid e‖ (King and Szelényi, 2005; Eyal et al., 1998). Some other stud ies, however, d emonstrated controversial imp act of foreign investment. While stimu lating a country‘s d evelop ment in a short-run, it could create d epend ence on foreign capital, curbing the long-ru n d evelopment (Dixon and Boswell, 1997; Firebaugh, 1997).

As all institutional areas are being reshaped by globalization, there is a strong need in an empirical analysis of those changes and their consequences. Globalization brings to test the strength, autonomy, and legitimacy of national institutions. At the same time, institutions

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d etermine, to w hat extent various globalization factors wou ld be able to affect the d omestic ord er. Their interplay creates a new global ord er, where national-specific norms and institutions might become m ore important than ever.

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16

3. Globalization and Institutional Quality: A Panel D ata Analysis

3.1 Scope of research

In Moscow, Ru ssia, the Swed ish furniture retailer IKEA w as asked to pay a bribe only weeks before the opening of its flagship store in 2000. Refusal to p ay w ould lead to electricity being shut d ow n. IKEA respond ed , not by paying the bribe, but by renting d iesel g enerators large enou gh to p ower the entire shopp ing m all. Later, in 2006, it was revealed that the Russian executive hired to m anage the d iesel generators for another store, in St. Petersburg, took kickbacks from the rental company to inflate the price. IKEA‘s expansion in Ru ssia w as halted , and tw o years later senior executives were d ismissed for allowing bribes.

The story about IKEA in Russia, told by among m any others The New York Times7

, illustrates im portant aspects of globalization. Trad e and foreign d irect investments can p otentially im prove economic d evelopment, benefitting both consumers and cap ital owners. At the same time, d ysfunctional institutions, such as corrup tion, m ay thw art these potential benefits. The establishment of and actions taken by firms operating in foreign cou ntries may also affect norm s and behavior. On the one hand , IKEA‘s refusal to p ay bribes m ay facilitate the fight against corruption in Russia. On the other hand , the profits generated by IKEA increase the p otential gains from engaging in corrupt behavior. It is therefore not clear how the d egree of corruption in Ru ssia would change as a result of IKEA‘s ventures. More generally, little is known about the effects of globalization on institutional qu ality. This p art of research aims to shed light on one particular question: Is increasing globalization on average followed by improving or d eteriorating institutional quality?

Changing institutions w ill generally involve trad e-offs between short- and long run benefits. Consequently, the time horizon and expectations of those w ho influence institutions—executive authorities and their bureaucracies—will be cru cial in d etermining the effects of increased globalization. As the time horizon often is d eterm ined by the level of economic d evelop ment, it is imp ortant to examine w hether the globalization effect on institutional qu ality varies across levels of d evelopment.

7 Kramer, A. (2009). Ikea Tries to Build Public Case Against Russian Corruption. The New

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The analysis employs the World Bank‘s World w id e Governance Ind icators (WGI) to capture several aspects of institutional qu a lity and the KOF Globalization Ind ex to measure economic and social globalization. The stud y also avoid s what Blonigen and Wang (2005) call ―inappropriate pooling of wealthy and p oor countries‖ by u sing both sample splits and interaction effects. Accord ing to the theoretical pred ictions, globalization should be typically follow ed by im proved institutional qu ality in rich cou ntries, but in poor countries this relationship wou ld be the opposite. Despite institutions changing slowly over time, the d ifference between rich and poor countries should allow to d raw significant conclusions.

This chap ter proceed s as follows. The next section d iscusses theoretically how globalization and economic openness is expected to affect institutions and reviews recent research. Section 3.3 d iscusses the measurement of institutions and presents the d ata, while section 3.4 contains the empirical analysis, includ ing several robustness checks and tests of the relationship between globalization and institutional qu ality across levels of d evelopment. Section 3.5 conclud es the analysis by sum m arizing the resu lts and d iscusses how to interpret the find ings.

3.2 Theoretical framework and previous empirical evidence 3.2.1 Theoretical expectations

North (1990) d efined institutions as ―ru les of the game‖ that shape hum an interaction and argued that ―third w orld countries are p oor because the institu tional constraints d efine a set of payoffs to political/ economic activity that d oes not encou rage prod uctive activity‖ (N orth, 1990: 3, 110). A large following literature has empirically confirmed quality of institutions as an imp ortant d eterminant of economic growth: Knack and Keefer (1995), Rod rik et al. (2004), Abd iweli (2003) and Doucouliagos and Ulu basoglu (2006) to mention ju st a few.8

There is no complete agreement on what institutions m atter the most, thou gh the survey by Du rlauf et al. (2005) points to low corru ption, p olitical stability, property rights, and ru le of law all being imp ortant for d evelopment. The im portance of low corruption for growth is also confirmed by H aggard and Tied e (2011). As the evid ence of the imp ortance of institu tional qu ality accum ulates, it is natural to examine if and how institutions change. Institutions

8 H ow ever, Richter and Timmons (2012) argue that the siz e of the effect institutions have

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18

shape hu m an interaction, but at the same time institutions are enforced and up held by hu m an interaction. Accord ing to North (1998), institutional change is incremental and occurs when influential agents perceive they could d o better by altering the existing institutional framew ork. Typically, institutions are assu med to change slowly over time (Acem oglu et al., 2005; Kingston and Caballero, 2009). Nevertheless, as d iscussed in the previou s chapter, there are several reasons w hy increasing globalization may foster institutional change, many of w hich suggest that at least some aspects of globalization should be beneficial for institutional quality.

A fund amental reason to expect trad e and economic openness to improve institu tional qu ality is Montesquieu‘s id ea that m arket interactions act as a civilizing force.9

The survey by Hirschm an (1982) emphasizes that the practice of com mercial transactions generates feelings of trust and empathy for others. Later, experimental research in East Africa reported by Ensm inger (2004) ind icates a strong relationship between m arket exchange and fairness. Ensm inger notes several possible explanations, such as the id ea that people are learning in the m arket that fair-m ind ed ness is reward ed . Another possibility is that market experiences help people learn how to coord inate successfully with other anonym ou s ind ivid u als using conventions based on fairness (cf. Young, 1993).

Differences in institutional qu ality across countries can also be seen as a source of comp arative ad vantage. As d iscussed in Bergh and Höijer (2008), globalization can increase the competition between cou ntries with d ifferent institutions, fostering institu tional reforms in countries with low institutional quality. An examp le is provid ed by Al-Marhubi (2005), who notes that the cost associated w ith bad policies such as unexpected m onetary exp ansions m ay be higher (and the benefits sm aller) in the countries that are open to w orld markets. As a result, openness generates incentives to create governance structures such as ind epend ent central banks and autonomous tax agencies to free monetary policy and tax collection from p olitical influ ence.

Finally, as also d iscussed by Al-Marhubi (2005), globalization may also affect institutions throu gh closer integration and openness, coming with an increasing global flow of inform ation that provid es alternative sources for knowled ge and id eas. Such inform ation spillovers m ay

9 ―[w ]herever manners are gentle there is commerce, and w herever there is commerce,

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make citizens more d em and ing and help nurture civil institutions. As d iscussed by Ostrom (2005), the fact that inefficient institutions persist, can be p artly explained by people being misinformed or having biased view abou t the outcomes of various institu tional arrangements. Many aspects of globalization can potentially mitigate such misinform ation and bias, thereby fostering institutional reform.

While the OECD focu s sp ecifically on citizens‘ role in policym aking (OECD, 2009), inform ation spillovers are also likely to affect institutional quality in a low -income setting. A recent illustrative examp le is the initiatives to tackle corruption in d eveloping countries by encouraging anonymous reports of bribe-p aying using p ublic websites.10

Such activities may improve governance systems and proced ures and red uce the scope for corrup tion.

Other mechanisms d o not necessarily su ggest that institutions improve as a result of globalization. While generally sympathetic to the id ea of market integration as a civilizing force, H irschm an (1982) also noted as a counteracting force the tend ency of commerce to ind uce an element of calcu lation and instrumental reason in m any sp heres of life.

Another likely consequence of globalization is that the d istribution of power within cou ntries will change through, for example, the transmission of technology (Romer, 1990). Along these lines, Acem oglu and Robinson (2006) show that the trad e ind uced transfers of skill-biased technology increase the income share of the mid d le class, in turn improving their p olitical power and u ltimately generating better protected property rights. Similarly, Acem oglu et al. (2005a) argue that the Atlantic trad e strengthened commercial interests in Western Europe.

Hard y and Maguire (2008) d efine institutional entrep reneurs as actors who have an interest in p articular institu tional arrangements and w ho leverage resources to create new institutions or to transform existin g ones, and provid e several examp les of how institutions such as labour regulation, entry barriers and property rights have been changed as a result of such ind ivid u al initiatives. Imp ortantly, it is not necessarily the case that the changes following glob alization strengthen the incentives for institutional entrepreneurs to im prove institutions.

10 See e.g. w w w.ipaid abribe.com—a w ebsite covering information reported by

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Changing institu tions will in m any cases involve trad e-offs between short ru n and long ru n benefits. For examp le, both violations of rule of law and of property rights are likely to bring short run gains to those involved , while harming the long run economic d evelopment. The same goes for corruption and several policy ru les as well, such as inflationary m onetary policies, which m ay bring substantial benefits to sm all elite groups in the short run while being d evastating for long ru n economic d evelopment.

For this reason, the time horizon and expectations of those w ho influence institutions will be crucial in d etermining the effects of increased globalization. Referring again to the case of IKEA in Russia, it may well be the case that those who engage in corru pt activity realize that corruption is likely to d iminish the long run benefits from having IKEA expand ing in Russia, but w hen future benefits are heavily d iscou nted , the short run benefits of increased corruption are higher. In the latter case, the presence of IKEA creates an incentive for bureaucracies to alter institutions in ord er to easier be able to reap short run benefits from corruption, property rights violations, and similar activities. If, however, m ore weight is put on long run economic d evelopment, the effect of IKEA would be to increase the return to institutional improvements.

In poor countries, uncertainty and instability is typically higher, and life expectancy is shorter. Consequently, the incentives to improve institutions to foster long run economic d evelopment are lower, and the incentives to w orsen institutions (through, for examp le, accepting corruption) are likely to be higher (see Acemoglu an d Verd ier, 2000; Fjeld stad and Tu ngod d en, 2003; and Altind ag and Xu , 2009 for further d iscussions). Thu s, the correlation between globalization and subsequent improvements in institutional qu ality when examined using p anel d ata w ith cou ntry fixed effects is expected to be sm aller (and possibly negative) in poor countries than in rich countries.

3.2.2 Previous studies

In the wake of increasing globalization, several stud ies have examined whether factors such as trad e and econom ic openness affect institutions, especially rule of law and the level of corruption. Most of these stud ies find a positive effect of openness on institutional qu ality, but none has so far exam ined how the effect varies with the level of d evelopment.

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Recently, Bhattacharyya (2012) find s a p ositive effect of openness on property rights. Openness is quantified as the nu mber of years a country has been open, as d efined by the Sachs and Warner openness ind ex, upd ated by Wacziarg and Welch (2003). The institutional ind icator used is expropriation risk and repud iation of contracts as measured by the International Cou ntry Risk Gu id e. The stud y uses panel d ata, covering between 65 and 103 cou ntries from 1980 to 2000. Results ind icate that a one sample stand ard d eviation increase in the fraction of years a country has rem ained open since 1950 lead s to a 2.2 point increase in the property rights institu tions ind ex. To accou nt for potential end ogeneity, Bhattacharyya (2012) verifies the results by instru menting trad e openness using export partners‘ gr owth rate. In a limited sample of 31 cou ntries, he find s a similar relationship between tariffs and executive constraints over the period 1865 to 1940.

Levchenko (2011) find s that the countries w hose exogenous geographical characteristics pred ispose them to exporting in so-called institutionally intensive sectors have significantly higher institutional qu ality. The conclusion is reached by pred icting the institutional intensity of exports u sing geograp hic characteristics and exam ining the relationship with the rule of law ind ex from Kaufm ann et al. (2005) averaged across 1996–2000 for a cross section of 141 countries.

The Kaufm ann ind icators (Kaufmann et al., 1999, which are the same as in Knack and Keefer, 1995) are also used by Al-Marhubi (2005), w here the average of the six d imensions are exp lained using several ind icators of econom ic openness: trad e flows, the Sachs and Warner ind ex, the D-ind ex (Dollar, 1992) and the fourth d imension of the economic freed om ind ex, freed om to trad e internationally (Gwartn ey and Lawson, 2002). Regressions includ ing 81 to 125 countries ind icate that openness (all measures except the D-ind ex) in 1985 is associated with im proved governance in 2000 and 2001.

A positive relationship is also found by Wei (2000) using corruption (taken from Business International and Transparency International) and trad e flows as a share of GDP in a cross section of 169 cou ntries in 1978–1980 and 184 cou ntries in 1994–1996. Similar results are reached by Bonaglia et al. (2001), who have fou nd corruption (from Transparency International and International Cou ntry Risk Guid e) being related to the GDP share of imports in 53 to 119 cou ntries, using pooled OLS regressions for various period s between 1980 and 1998. The negative effect of imp ort openness on corruption is confirmed by

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IV-regressions where pop ulation, an English -speaking d u mmy, area, and rem oteness are used as instru ments for openness.

While the stud ies reviewed above all tend to find a positive relationship between openness and institu tional qu ality, these results are not confirmed by Nicolini and Paccagnini (2011). Their stud y uses political rights and civil liberties (from Freed om hou se) as well as trad e flows/ GDP in a p anel d ata setting with 197 countries from 1976 to 2004 period . Using Granger causality tests, they fail to find a cau sal relationship between trad e and institu tions in any d irection. Their use of yearly d ata is in contrast to other stud ies and m ay bias the results tow ard s 0 if there are measurement errors in the d ata and institutions change only little from year to year.

The mechanisms d iscu ssed in previous stud ies are sim ilar to those d escribed in section 3.2.1. For example, Bhattacharyya (2012) d ep arts from N orth (1990) by noting that N orth d oes not mention the imp act of international trad e on technological progress via technology transfer. The most theoretically elaborated paper is Levchenko (2011), w here institutions play d u al roles: they generate rents for some p arties within the economy and they are a source of comparative ad vantage in trad e. The d u al role of institutions means that d ifferent consequences of increasing trad e openness are possible. In technologically similar countries, trad e will lead to a ―race to the top ‖ in institutional qu ality (similar to the perspective in Bergh and H öijer, 2008). However, w hen technological d ifferences are bigger, trad e flows are d riven by other than institutional sources of comp arative ad vantage. In this case, trad e d oes not create an incentive to improve institutions but rather increases the incentives for the parties earning rents to make institutions w orse. The em pirical results ind icate that institutions d o ind eed improve as a result of trad e openness in cou ntries that can expect to capture the institutionally intensive sectors after trad e opening. The theoretical possibility that some countries w ill actually m ake institutions w orse as a result of trad e openness is not supported by the empirical analysis. Levchenko (2011) su ggests that the presence of the OECD countries with very high institutional qu ality means that no other cou ntry will find it optim al to red uce its quality of institutions after trad e opening.

3.2.3 Summary

Research so far lend s some support to the view that economic openness

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recent find ings fit well w ith old er stud ies such as Wei (2000) and Bonaglia et al. (2001) w here more open econom ies are shown to exhibit less corruption. Institutional improvements can therefore be seen as a potential mechanism in the emp irical relationship between globalization and econom ic growth (Dreher, 2006; Rod e and Coll, 2012).

Several questions are how ever left open. Previou s stud ies, relying on cross-sectional variation among countries, d o not teach u s anything about variation over time. Imp ortantly, this also hold s w hen instru mental variables are used in cross sections. When Levchenko (2011) shows that cou ntries, which geographical characteristics pred ispose them to exp ort in institutionally intensive sectors, have higher institutional qu ality, this find ing d oes not imply that an increase in trad e flows wou ld be followed by institutional improvement.

The two existing panel d ata stud ies arrive at d ifferent results. Bhattacharyya (2012) find s a positive relationship b etween openness and better protected are private property, w hereas Nicolini and Paccagnini (2011) d o not find any relationship between trad e and institutions using yearly bilateral trad e flow d ata and the Freed om House ind ex for political rights and civil liberties. Given that institutions change slowly over time, the result m ay be explained by their use of yearly d ata.

It is also clear from previous research that m ost of the economic gains that can be expected from institutional improvement d o take some time to m aterialize, while the gains from breaches of contracts, corruption , and other form s of institutional d eterioration are more or less immed iate for those involved in these activities. Thu s institutions m ay well change for the w orse in less d eveloped cou ntries w here the bureaucrats who shape institutions have shorter time horizons. So far, however, no stud y has noted that the effect of globalization on institutions is likely to d epend on the level of d evelopment as suggested by the time horizon argu ment, and thus p otentially suffers from inappropriate p ooling of low -income and high-income countries, as d iscussed by Blonigen and Wang (2005).

Finally, the literature on globalization and institutional qu ality has so far employed strict economic measures of globalization, such as trad e flows or the Sachs Warner ind ex that classifies a cou ntry as either open or not. The process of globalization, however, is a broad and multid imensional phenom enon w ith economic, social, and political

References

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