Svetlana Avdasheva and Paulina Kryuchkova, Deputy Director and Senior Researcher, respectively, of the HSE Institute for Industrial and Market Studies, presented their paper ‘Why the Costs of Oversight Go Up As Compliance Goes Down: An Economic Analysis of Administrative Law Enforcement in Russia’ during an academic seminar held on April 11, 2013, at the HSE Center for Institutional Studies.
According to Kryuchkova, more than three million companies and solo entrepreneurs were audited in Russia in 2011 alone. Oversight authorities paid 47 billion roubles in direct costs to carry out these audits. The approximate combined cost to the government and businesses for oversight and monitoring could reach about 800 billion roubles, or 1.5% of the country's 2011 GDP.
Despite the fact that the government is spending increasingly more to oversee businesses, compliance with the country’s laws is decreasing. The researchers found that almost two-thirds of the audits held in 2011 resulted in findings of noncompliance with business regulations. In fact, one would expect higher spending on oversight to result in better compliance, in contrast to 'less expensive' oversight systems allowing instances of noncompliance to go undetected.
Avdasheva and Kryuchkova seek to understand and explain this paradox. The traditionally poor performance of Russia’s oversight authorities can be explained by corruption, arbitrary enforcement (which turns into an instrument for redistributing property rights), and low-skilled supervisors. All these causes exist; however, Kryuchkova argues that even if the above problems are effectively addressed, compliance is unlikely to improve significantly.
The reason behind this paradox, the researchers argue, has to do with the specific incentives given to the oversight authorities. In practical terms, it makes no difference to them whether they punish the guilty or the innocent. Thus, the risk of being fined or arrested is virtually the same for an honest entrepreneur as it is for a violator. The high probability for error destroys any incentive to comply with legal requirements. Instead, businesses act according to the principle ‘what will be will be’ and are guided only by their desire to squeeze the maximum profit from any transaction.
Currently in Russia, oversight is triggered mainly by complaints filed with the authorities. That means that anyone can file a complaint against anyone else and keep filing complaints until the authorities respond by initiating an audit. The authorities cannot refuse to respond even if the complaining party is clearly abusing the right to complain (ie a complaint is filed with the Federal Antimonopoly Service to get rid of a competitor).
As a result, oversight authorities have to handle too many cases with fewer resources available per case, which increases the likelihood of errors such as punishing the innocent and allowing the guilty to get away. The increased probability for error destroys any incentive to comply with legal requirements.
'The high likelihood of the innocent and guilty alike being punished erroneously fails to discourage potential violators', the authors conclude. However, the lack of a deterrent effect does not prevent people from exercising their right to complain. But the reason alleged victims keep complaining is not because they have suffered damages; instead, they see the complaint mechanism as an opportunity to affect the other party's economic situation.
As a striking example, Avdasheva refers to RUSAL's complaints to the Federal Antimonopoly Service (FAS) against producers of caustic soda for allegedly overpricing their products to the detriment of consumers. As a result, the FAS determined that there was a cartel in the liquid caustic soda market and decided to impose turnover fines on participating companies and to prosecute the individuals involved in building the cartel.
For administrative law to be effective, the authors argue, the likelihood of innocent people being punished erroneously must decrease. Avdasheva and Kryuchkova propose a number of steps towards this goal:
'Introducing punitive damage awards (proportional to the proven level of damage) and redistributing the caseload between government regulators and courts in favour of the latter may produce a good effect, since people litigate for damages rather than to restrict their 'offender' or ‘competitor', argue the authors. These steps, they believe, are not too difficult to take. 'A reform of government supervision and oversight does not require drastic and painful measures', says Avdasheva.