Barriers to Entry and Economic Growth in Transition Economies

Some believe that temporary governmental policies are likely to have no permanent consequences. In this paper, we develop a mathematical model of crime and corruption. We show that even temporary imposition of the barriers to entry to a competitive industry may lead to permanent extortion development and substantial slow-down in the economic growth. Entry restrictions, if binding, lead to the excess profits, which create an incentive to extort. Emergence of the extorters reduces the expected profit from production, making the producers expect to get extorted in the future. If, after this adaptation of expectations, the government removes the barriers to entry, only few new firms enter the market. Hence, the total number of firms on the market is lower that it would have been under no barriers to entry. The low number of firms on the market allows each producer to earn relatively high pre-extortion profits which reinforces the desire of racketeers to take part on their wealth. Consequently, the part of the population is permanently diverted from the production to rent-seeking activities, which is likely slow down economic growth even in the long run.