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priately included in national income accounts, accounting conventions are violated, creating an unrecorded economy. Corruption, extortion, financial fraud, smuggling, organized crime, and theft of state property are examples of illegal economy activities.

Consequences of Noncompliance

There is a growing literature expressing concern about the prevalence of illegal activities and their corrosive effects. However, Leitzel (in this volume) reminds us that the consequences of various noncompliant behaviors depend critically on the nature of the rules being violated. The violation of "bad" rules, "those that prohibit voluntary exchanges—in the absence of negative third party effects," may actually have positive economic consequences. (Similar arguments can be found in Leff, 1964, and Huntington, 1968.) De Soto (1989) argues that noncompliant behaviors that circumvent onerous regulations in developing countries effectively reduce transaction costs and therefore should be encouraged and legitimated. Corruption can also be viewed as a means of circumventing bureaucratic obstacles with ''speed money," and even organized crime has been cited as a means of providing enforcement of property rights when the state is weak and ineffectual.

The evasion, circumvention, and violation of "good" rules—those that prohibit and regulate coercive behaviors—are likely to make society worse off. In the parlance of institutional analysis, whenever noncompliance increases uncertainty and the costs of measuring and monitoring behavior, it raises transaction costs and is likely to have damaging social consequences. Indeed, the weight of the evidence appears to be shifting in the direction of uncovering the long-term damage that results from pervasive noncompliance, particularly in the form of corruption and organized crime (see Benham and Benham [in this volume] on the role of the Sicilian mafia). Bribery and corruption often encourage the bureaucracy simply to create additional artificial administrative hurdles in order to receive side payments for their removal. At the same time, organized crime and corruption are seen as a growing menace to new business establishments and as a major barrier discouraging foreign capital investments.

The extent of noncompliance is also an important factor when threshold effects dominate the dynamics of institutional change. Low levels of noncompliance with bad rules might provide a useful buffer against the negative effects of the bad rules, but widespread noncompliance can undermine the social fabric, thereby jeopardizing the fundamental principle of the rule of law.

There is now an ongoing debate concerning the consequences of various types of noncompliant behaviors (see Grossman, 1992; de Soto, 1989; Klitgaard, 1988; Leitzel et al., 1995; Trang, 1994; Alexeev, 1997; Lotspeich,



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