Are Autocratic Rulers Also Inside Traders? Cross-Country Evidence

I. INTRODUCTION This article explores one aspect of the relation between a country's political structure and its regulation of economic activity. The central premise is that authoritarian governments operate, at least in part, for the purpose of enriching their rulers. Consequently, economic regulations are enforced (or not) so as to benefit the autocrats and their supporters. By its nature, insider trading is clandestine. It is therefore unobservable, and its existence must be inferred from indirect evidence. My approach is to examine the enforcement of insider trading regulation. More than 100 countries have stock markets. Most also have laws ostensibly designed to protect the general investing public from trading with insiders possessing superior material information regarding the value of particular firms. Enforcement has occurred, however, in less than one-half of the countries with laws. My key hypothesis is that enforcement is less likely in autocracies, where government officials and their supporters both control the regulatory and judicial systems and are likely to engage in inside trading. Put simply, they will be disinclined to prosecute themselves. Data are available that identify countries with stock markets, those with insider trading laws, and those that enforce them. Also available are indexes that gauge levels of political freedom, economic freedom, and corruption for almost all countries. These serve as measures of the degree of autocratic rule. My statistical analysis indicates a strong correlation between the presence of autocratic government and the absence of insider-law enforcement, supporting the main hypothesis. II. BACKGROUND The economic theories of regulation and public choice presume that government officials are self-interested utility maximizers whose behavior is substantially affected by the personal costs and benefits of exercising their political power. (1) In autocracies, officials generally have significant control over economic activity and are unconstrained by democratic institutions, such as political competition (elections), the rule of law, an independent judiciary, and a free press. Opportunities for personal aggrandizement are therefore more readily available, including in particular financial enrichment. All such behavior amounts to wealth transfers from the population at large and a tax on productive economic activity. (2) Government regulation of the economy is ostensibly about rectifying market failure. For example, market entry restrictions are justified by arguments that consumers are protected from incompetent, unstable, or dishonest firms. Various other government-imposed requirements and permits for the conduct of business are justified under the guise of protecting workers, saving the environment, nurturing infant industries, earning foreign exchange, and a variety of other public interest grounds. All such regulation, however, can be viewed alternatively as creating "tollgates" through which entrepreneurs must pass to (legally) conduct business. (3) Unrestrained government officials charged with regulatory enforcement can extract tolls (bribes) for personal gain. Given this potential, autocratic rulers have an incentive to impose numerous regulations simply to create opportunities to enrich themselves and their supporters. (4) If a law or regulation is to serve as a tollgate, enforcement must occur. The threat of prosecution must be real to create the incentive for market participants to pay bribes. Autocrats must establish that attempts at circumvention without payment (or compliance) involve real costs that are greater. Through their control of government regulatory agencies and the judicial system, they can exempt bribe payers while others are subject to prosecution, that is, enforcement occurs but is selective. More generally, autocrats might view all types of economic activity within their country as providing opportunities for personal economic gain. …