Corruption, market quality, and entry deterrence in emerging economies

• DOI: http://doi.org/10.1111/ijet.12265
• Published date: 01 March 2021
• Date: 01 March 2021
• Author: Krishnendu Ghosh Dastidar,Makoto Yano

Int J Econ Theory. 2021;17:101–117. wileyonlinelibrary.com/journal/ijet © 2020 IAET

|

101

DOI: 10.1111/ijet.12265

ORIGINAL ARTICLE

Corruption, market quality, and entry

deterrence in emerging economies

Krishnendu Ghosh Dastidar

1

|Makoto Yano

2

1

Centre for Economic Studies and

Planning, Jawaharlal Nehru University,

Delhi, India

2

Research Institute of Economy, Trade and

Industry (RIETI), Tokyo, Japan

Correspondence

Krishnendu Ghosh Dastidar, Centre for

Economic Studies and Planning, Jawaharlal

Nehru University, Delhi 110067, India.

Email: krishnendu.dastidar@gmail.com

Funding information

JSPS, Grant/Award Numbers: #23000001,

#16H02015

Abstract

In many emerging economies incumbent firms of-

ten use dubious means to deter entry of other firms.

We analyze this scenario in a three‐stage game of

entry deterrence. The incumbent has incomplete

information about the entrant's costs but can in-

crease this cost by resorting to unfair means (e.g.

bribing a politician who harms the entrant). We

completely characterize the optimal bribe and show

that this depends on the “fairness index”and the

“differentiation”parameter. We also show that zero

bribes need not maximize welfare and market

quality. Our results seem to be compatible with

anecdotal evidence from emerging economies such

as India.

KEYWORDS

bribe, Cournot, entry deterrence, market quality

JEL CLASSIFICATION

L11; L13; O16; O17

1|INTRODUCTION

In many emerging economies corruption and poor governance lead to restricted entry.

Established firms often use dubious means to deter entry of other firms that are

perhaps more efficient than the incumbent. A similar phenomenon is observed in devel-

oped economies where lobbying leads to restricted entry. The common perception is that

firms in developing countries are more likely to pay bribes to get their desired objective,

whereas firms in developed countries are more prone to lobby the government to change

the rules.

1

It may be noted that imposing higher costs on a rival can tame it as effectively as predatory

pricing. In many emerging economies, an established firm often can bribe government officials to

impose large costs on a potential entrant. In such countries, where the law and order machinery is

very weak, this increase in rivals' costs can be achieved through the abuse of government proce-

dures, including sham litigation and the misuse of licensing and regulatory authorities.

2

In the present paper we analyze the above scenario by using a three‐stage game of entry

deterrence in a horizontally differentiated duopoly where the incumbent decides on the level of

“bribe”to prevent a technologically superior potential competitor from entering the market.

The term “bribe”includes lobbying expenses that are used to influence policy decisions in such

a way as to increase the cost of any potential entrant. The effectiveness of the bribe depends on

the “fairness index”prevailing in the economy. The lower the fairness index, the higher will be

the effectiveness of such a bribe. This paper demonstrates how the equilibrium outcome cru-

cially depends on the “fairness”index and the “differentiation”parameter (whether goods are

substitutes or complement) and how the “market quality”is endogenously determined.

1.1 |Efficiency, fairness, and market quality

This study is the first attempt to deal with the endogenous determination of “market quality”as

defined by Yano (2009), who refers to “market quality”as a measure of “efficiency in alloca-

tion”and “fairness in pricing”in a market.

3

Here efficiency refers to Pareto efficiency. Fairness may be stated as fairness in dealing or in the

process in which the terms of trade are formed. A price formed through fair dealing is a fair price.

4

In this paper we follow Yano (2009) and define market quality to be a weighted average of

total “welfare”(consumer surplus plus producer surplus) and total “fairness.”Total fairness is

defined to be the product of the “fairness index”and the “bribe”paid.

5

1

In 2016, under pressure from the hotel industry and a populace concerned with the surge in the number of foreigners

in their neighborhoods, the government in Japan released guidelines for home sharing –called minpaku in Japanese –

that made most Airbnb rentals in the country illegal. Under these guidelines Airbnb hosts were only allowed to rent to

guests who would stay for a week or longer, a minuscule slice of the market. This is clearly a case where lobbying by the

incumbent industry successfully created entry barriers for the new entrant, Airbnb (for details, see Nakamura and

Takahashi, 2016).

2

See Salop and Scheffman (1983,1987) for the idea of “raising rivals' costs.”Martin (2010, pp. 253–255) provides specific

real‐life examples of such cost‐raising strategies chosen by the incumbent.

3

There are a couple of papers that study the endogenous determination of market quality (although in a much looser

sense). Dei (2011) analyses the dynamic development of a high‐quality labor market where unskilled and skilled

workers are properly distinguished. Furukawa and Yano (2014) study market quality by focusing on fairness in

handling intellectual property.

4

“Actions in a particular market are competitively fair if they are conducted in compliance with the set of ‘generally

accepted’rules. Moreover, a state of that market is competitively fair if it is formed through competitively fair actions

and if there are no profit opportunities left available for competitively fair actions”(Yano, 2009). However, such fairness

cannot be guaranteed when one party (say, one seller) has significant and unilateral powers (e.g. the power to use

violence) enabling it to unilaterally set the terms and change the rules of the game. This is often observed in emerging

economies.

5

Some Scandinavian countries (e.g. Denmark) may have a very high fairness index. However, when the governance is

relatively poor (which is very likely in emerging economies such as India, Pakistan, and Bangladesh), the fairness index

is low.

102

|

DASTIDAR AND YANO