Research Note. Bureaucratic structure, regulatory quality, and entrepreneurship in a comparative perspective: cross-sectional and panel data evidence

Research note by Marina Nistotskaya

Puzzle. It is a commonly held view that vibrant entrepreneurship lies at the root of economic development. International organizations, such as the World Bank and EU, and governments at all levels take action to foster entrepreneurship. A body of critical research has identified regulatory quality, particularly the regulation of entry (Djankov et al 2002), as the key factor explaining variation in the creation of new firms, and this was an stimulus for the influential World Bank’s Ease of Doing Business rating. Yet, recent data reveal the striking differences in entrepreneurship rates across countries: in 2012 the difference between New Zealand and Pakistan was almost 400-fold (15.7 newly incorporated firms per 1,000 working age population versus 0.04). A remarkable variation is observed among countries of the same income category and also among those belonging to the same geographic region. What explains this persisting variation in new business entry rates?

We examine this question in a recent publication in Journal of Public Administration Research and Theory:

  • M. Nistotskaya, L. Cingolani, Bureaucratic Structure, Regulatory Quality, and Entrepreneurship in a Comparative Perspective: Cross-Sectional and Panel Data Evidence, in “Journal of Public Administration Research and Theory”, doi: 10.1093/jopart/muv026. First published online: September 16, 2015

Argument. We argue that the observed variation in new business formation and also regulatory quality can be explained by the extent to which meritocratic recruitment and security of tenure are institutionalised administrative practices.
The positive role of a meritocratic bureaucracy was established in the writings of Hamilton (1788) and Weber (1978 [1922]) but the veracity of this idea came under sustained criticism from the Public Choice and Principal-Agent theory literatures resulting in the emergence of a New Public Management that offered a market led alternative to meritocracy and tenure security. In the 2000’s scholars, such as Peter Evans and James Rauch (1999), Gary Miller (2000) and David Lewis (2007) among others, have breathed new life into this debate by re-examining the positive features offered by Weberian bureaucracy. The neo-Weberian literature argues that the positive impact of meritocratic bureaucracies goes through two channels. The first, more established, line of reasoning is that the merit-based selection of public employees and the “firmness of the tenure” have a positive effect on bureaucratic output, such as regulatory quality, through the improved expertise of administrators, their greater cohesion and commitment to the goals of their organizations. We call it “epistemic effect”, and believe it mostly affects bureaucratic output such as regulatory quality. The second, more recent, argument sees meritocratic recruitment and security of tenure as a firewall against political moral hazard: a propensity of the political elites to use the powers of the state and resources associated with the regulation of the economy in the interests of their key constituencies and/or for self-dealing. We call it “credible commitment effect” and believe that it affects entrepreneurship, independently from the “epistemic effect”. We argue that meritocratic recruitment and tenure protection reduce bureaucratic responsiveness to the morally hazardous preferences of individual politicians, providing a powerful signal to potential and acting entrepreneurs that the risk of political contingency of wealth creation is comparatively low, and facilitating their complex assessment of the expected long-term utility from entrepreneurship and venture creation decisions. If this is the case, then we should be able to empirically observe a positive effect of meritocratic bureaucracies on business entry rates, even when controlling for regulatory quality (which would support the idea that the “credible commitment effect” operates independently from the “epistemic effect”).

Findings. We provide empirical support to the argument in the form of estimates from multivariate regression analyses, featuring novel cross sectional data on the extent of meritocratic recruitment and panel data on tenure protection from politically motivated dismissals of central bankers.  We find that these two features of the organisational structure of public bureaucracy have a positive effect on the regulatory quality of government in a large sample of countries (Figure 1). They also are also robustly linked with higher entrepreneurship rates, even after controlling for major alternative explanatory factors, including regulatory quality. The latter corroborates the proposition of merit affects entrepreneurship directly through the “credible commitment” and indirectly through the “epistemic effect”, which manifests itself in a better regulatory framework.

Policy-implications. The message of our findings is that, as long as the responsiveness of bureaucrats to individual politicians remains high, the number of individuals turning to business will be below some natural limits determined by socioeconomic and other factors. Given that in most of the world’s bureaucracies merit is not a “rule of the game”, one of the policy implications arising from this research is that civil service reform, understood as meritocratic recruitment and tenure protection in practice, should be part and parcel of entrepreneurship-promoting efforts by national governments and international donors.

Caveats. While the general pattern is clear, we also acknowledge the limitations of public bureaucracies insulated from the day-to-day oversight of individual politicians.
First, we warn also against a threshold effect, that is, that at a certain point ‘too much civil service’ may act to the detriment of the economy. Also a legitimate question to ask is: in the absence of tight political oversight what constraints bureaucrats from rent-seeking? Although the relevant literature points at several measures that have been successful in correcting the rent-seeking behaviour of bureaucrats, including legal constraints, transparency, professional norms, public service motivation and the improved civic control, the ultimate message of this literature is rather pessimistic. There is no perfect solution to the problem of moral hazard, no institutional design is a panacea, and we live in a world of second-best solutions in which meritocratic tenured bureaucracy plays an important, but far from perfect, welfare-enhancing role (Miller 2000; Knott and Miller 2006).

Figure 1. Meritocratic Bureaucracy and Regulatory Quality


Note: Regulatory quality is “Regulatory Quality”, 2010-2011, averaged, from the Worldwide Governance Indicators. Merit is based on “When recruiting public sector employees, the skills and merits of the applicants decide who gets the job?’, a 7-point scale: 1 (hardly ever) to 7 (almost always), 2008-2011 from the the QoG Institute Expert Survey I.



About the Author

Marina Nistotskaya is a research fellow at the Quality of Government Institute and the Department of Political Science at Goteborg University. She receivedher MA and PhD in Political Science PhD from Central European University.





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