Abstract | Business

The rules of the game

For some time now, retrospective taxation has been a major issue of concern for foreign investors thinking about doing business in India. The confiscation of dividends belonging to Cairn Energy by the Income Tax Department in June is the latest event to highlight the significant risk faced by foreign investors due to the unreliable nature of laws in the country.

Economists, for long, have emphasised the need for institutions that can provide sound and stable rules to oversee the proper conduct of commerce. American economist Douglass C. North, for instance, characterised institutions as setting “the rules of the game” in any economy. After all, investors seeking profit will not risk their capital in building a business until they can foresee — to a reasonable extent — the likely returns they could earn on their investment. A government that changes the tax — or any other — law arbitrarily obviously will not instil any sense of confidence in investors about the future.

How they deal with it

“A Theory of Entrepreneurship and Institutional Uncertainty,” a 2017 paper by Per L. Bylund and Matthew McCaffrey, explores the various kinds of institutional uncertainty that affect entrepreneurs, and how they react to them. Entrepreneurs, they argue, can deal with institutional uncertainties in four ways: by abiding by the rules, by evading the rules, by altering the rules through institutional entrepreneurship, and, finally, by exiting the system if the rules prove too hard to change.

The authors base their analysis primarily on the hierarchical model of institutions developed by economist Oliver Williamson, and the concept of “regime uncertainty” proposed by economist Robert Higgs in his 1997 paper “Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed After the War.”

Regime uncertainty, where entrepreneurs believe that top-level institutions offer very little protection for their economic rights, represents the worst kind of institutional uncertainty.

The authors offer the slump in private investment and other entrepreneurial actions after the Great Depression of the 1930s as an example of the negative effects of regime uncertainty. It may be a useful exercise to explore the extent to which regime uncertainty explains the slump in private investment in India in recent years.

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Printable version | May 1, 2021 11:36:05 PM | https://www.thehindu.com/business/the-rules-of-the-game/article19205429.ece

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