Many state-owned enterprises benefit from tax reductions or exemptions, distorting competition and further reducing the income to government. Containing corruption and making government more effective Until recently a preoccupation with shrinking the size of the state led many development economists to neglect the vital task of understanding how to improve the state. One lesson from successful states is that they use market-like mechanisms to improve their efficiency. The World Bank s World Development Report 1997 showed that an effective state is vital for development. Using data from 94 countries over three decades, the study shows that it is not just economic policies and human capital but the quality of a country s institutions that determines economic outcomes.
Institutions determine the environment in which markets operate.
A weak institutional environment allows greater arbitrariness on the part of state agencies and public officials. If laws are applied arbitrarily, or not applied at all, the market will consider them irrelevant. Similarly, if rules are changed frequently or unexpectedly, they lose credibility. The wider the discretionary controls of politicians and bureaucrats, the greater the opportunities for bribery. In these circumstances, noncompliant behavior may be the most efficient way to operate.