ABSTRACT
This chapter presents a theory explaining why some countries sustain very high costs of doing business. The theory builds on the concept of crony capitalism and investigates the incentive structure of three core agents: politicians, business and bureaucrats. It uses some game theory to explain the equilibrium behind crony capitalism and how it can be broken. The theory can be summarized as follows: High costs of doing business provide politicians and bureaucrats with power resources to manipulate transaction costs by using discretionary regulation, rules and policies. They can switch transaction costs on and off at targeted firms in the business sector. A small group within the business community, the insiders, colludes with government agents to access the loopholes that decrease the cost of doing business, thus gaining a competitive edge over the outsiders, those who cannot access the government.
