Essays in political economy

Abstract

This thesis studies the effect of rent-seeking behavior on entrepreneurial activity, regulation and policy choices. The first chapter investigates the impact of corruption on entrepreneurial activity. Entrepreneurial projects, like innovation or production, can fail to result in a positive profit implying that they entail risk. Using a theoretical framework I show that corruption distorts this risk in different directions depending on the amount of information available to entrepreneurs and bureaucrats. A key finding is that corruption can result in entrepreneurs choosing more risky projects if entrepreneurs are well-informed and bureaucrats are ill-informed. Thereafter, the resulting distortions in volatility and expected output are derived and the model's predictions are tested empirically. The second chapter sheds light on the optimal level of regulation in the presence of corruption. A government sets rules in order to allocate goods only to agents valuing them highly. A corrupt bureaucrat offers agents to circumvent the official rules in exchange for a bribe. Agents are willing to pay higher bribes if they value the goods highly and if the regulation is overly cumbersome. Therefore, an increase in regulation increases both bribes and allocative efficiency because only agents valuing the goods highly pay high bribes. The government increases regulation if the costs of misallocation are high. The third chapter studies the policy impact and formation of interest groups with a large membership base. Provided that the group is sufficiently large to compensate for votes lost from unorganized voters, interest groups can influence a politician's policy choice by conditioning the group's voting behavior on the observed policy. In an equilibrium with the endogenous formation of two groups, the groups occupy positions that are sufficiently moderate to appeal to the politician and sufficiently extreme to benefit from a change in policy. Groups become more extreme the higher the cost of founding and the smaller the share of politicians interested solely in being reelected.