Essays on the cause and consequences of market distortions
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University of Cape Town
In contrast to past literature on competitive bribery, the thesis demonstrates that competitive bribery for rents generated from market distortions is inefficient. However, self enriching policy makers have incentives for implementing these distortions in order to maximize the appropriation of rents. Their success in raising distortions is higher when the electoral process is easily manipulated. Thus distortions are higher and last longer in the absence of electoral accountability. Such distortions worsen the deprivation of human capabilities and functionings, as evidenced by worsening health outcomes among children in Zimbabwe after the policy changes since 2000. Market distortions are sub-optimal and attract bribery. Given arguments in the literature that competitive bribery is efficient, this thesis investigates whether this 'efficiency outcome' extends to bribery for rents generated from distortions. This analysis questions the generalization of the 'efficiency outcome' from models of competitive bribery. The thesis applies auction theory to demonstrate that a symmetric model of competitive bribery can produce an inefficient outcome. In particular, it shows that efficiency in competitive bribery models is sensitive to the source of rents. If the valuation of rents is misaligned to society's preferences, then competitive bribery produces an inefficient outcome. The generalization that competitive bribery is efficient is therefore misleading. This is illustrated using rents generated from market distortions hence the outcome confirms the inefficiency of bribery for rents generated from market distortions. Bribes for rents generated by market distortions accrue to office bearers. Therefore, self enriching policy makers find rent generating distortions attractive despite their negative impact on efficiency and social outcomes. These policy makers seek to extract maximum rents from distortions subject to constraints imposed by considerations for political survival. The political considerations are determined by the quality of electoral institutions. When electoral institutions are weak, incumbents can use electoral fraud to circumvent political pressure generated by the negative effects of high distortions. They maximize on financial rents by raising the level of distortions even when large welfare losses arise. Uni democratic regimes will therefore choose higher levels of distortions. They are less likely to adjust high distortions too. The thesis demonstrates this argument using a model of electoral accountability to compare distortions chosen by an incumbent with and without the possibility of electoral manipulation. The model shows that an incumbent chooses higher distortions when electoral manipulation is feasible. This theory is confirmed on exchange rate distortions in Sub-Saharan Africa. Dictatorships overvalue by between 22.4 and 26.6 percentage points more than complete democracies. These estimates are obtained from dynamic panel GMM estimation using data for non CFA Sub-Saharan countries. The quality of democracy is measured by the polity 2 score from the Polity IV data and exchange rate overvaluation by the black market to official exchange rate ratio. Further confirmation of the hypothesis comes from conditional logit estimation results. They show that undemocratic regimes are more likely to excessively overvalue the exchange rate than democratic regimes. This explains the persistence of excessive distortions in countries with weak institutions. Such distortions can not be wholly attributed to lobbying by special interest groups or to the political use of economic inefficiency as generally argued in the literature. Zimbabwe offers a practical example of distortions which are implemented or sustained for maximizing the appropriation of rents by the incumbent. The government stepped up its intervention in markets since 2000. The resulting distortions shifted command over resources and placed them in the hands of the elite while their intensity and persistence had devastating effects on the economy. Elections over this period have been accompanied by electoral intimidation and manipulation. Thus the incumbent government relied on electoral manipulation to continue the appropriation of rents from market distortions. Zimbabwe provides a good case study of the consequences of market distortions that are sustained to benefit the incumbent in the presence of weak democratic institutions. The thesis uses the 1999 and 2005/06 DHS data to make a comparative analysis of changes in social outcomes after the policy shift in Zimbabwe. This analysis sheds light on the social costs of market distortions that are sustained to benefit the incumbent. The average number of items consumed by under 5 year old children declined by 34%, mean height for age by 19% and mean weight for age by 16%. The biggest declines were on outcomes for children living in poor and middle class households. Children in richer households were the least affected. The significant negative coefficient of food consumption in the height and weight for age regressions show that food consumptions worsened child health outcomes. The decline in food consumption contributed to 37% and 57% decline in means of height and weight for age respectively. ii Wealth inequality in 2005/06 was 16% relatively higher than inequality in 1999. Wealth is measured by an asset index derived from principle component analysis and its inequality by the McKenzie 2005 index. Inequality in food consumption increased as evidenced by a change in the Kakwani concentration index for food consumption by 48% of the 1999 value. A decomposition of changes in health inequality shows that increased inequality in food consumption contributed to increased nutrition inequality by a magnitude of 11% and 6% of stunting and underweight concentration indices in 1999. These results indicate that market distortions worsened social outcomes in Zimbabwe. Yet the distortions persisted for almost a decade due to weak electoral accountability in that period. This shows that a weak intuitional environment which erodes electoral accountability promotes policies that are costly to society. Distortions that arise from such policies have an impact that extends beyond efficiency in allocation. They affect outcomes which are intrinsically important aspects of well-being. iii
Pimhidzai, O. 2010. Essays on the cause and consequences of market distortions. University of Cape Town.