The Impact of Institutional Friction Cost on Economic Growth: Evidence from OECD Countries

Abstract

The institutional environment is critical to economic growth. A favorable business environment can reduce unnecessary transaction costs. This study examined the impact of institutional friction costs on economic growth, based on panel data for 38 OECD countries from 2004 to 2020. The contribution of this paper is that, first, we explore methods to measure the cost of institutional friction, and the measurements show that the total cost of institutional friction tends to be lower in high-income countries than in upper-middle-income countries. Second, we find that reducing the cost of institutional friction helps to promote economic growth through an empirical fixed-effects analysis approach with panel data. The empirical results remain significant after robustness and endogeneity tests. Third, we find that the effect of institutional friction costs on economic growth is more pronounced in high-income countries and even more pronounced in countries with inefficient governments. Fourth, the mediation effect test finds that institutional friction costs affect economic growth by increasing firm innovation. Overall, reducing the costs of institutional friction helps promote economic growth, and this study suggests that policy makers in each country should develop measures to reduce the costs of institutional friction to improve efficiency and economic development.

1. Introduction

The business environment is critical to economic growth. A good business environment helps to stimulate market vitality and social creativity, achieve rational allocation of factors and promote economic growth. However, the construction of the business environment cannot be separated from the improvement of the system. According to the 2020 Doing Business Report released by the World Bank, among 190 economies in the world, China’s business environment ranking jumped from 46th in 2018 to 31st, an increase of 15 places. However, there is still a large gap compared to the international advanced level. Haidar used World Bank DB report data to show that each additional commercial system shift in a country or region can increase economic growth rates by 0.15 percentage points [1]. Market players are facing challenges such as transformation and upgrading, increasing factor costs and operational difficulties. It is crucial to enhance the competitiveness of enterprises by effectively controlling and reducing their institutional transaction costs.

The institutional environment, especially the institutional friction cost, plays an influential role in economic growth. The implementation of some systems is extremely bureaucratic, which increases the cost of doing business. On the one hand, the government has stimulated market vitality and enthusiasm for innovation by reducing market access restrictions, administrative approvals and licensing system restrictions to optimize a more efficient business environment. On the other hand, system optimization, system improvement and other administrative means, such as using modern information technologies to reduce administrative costs, are still needed [2]. A more efficient institutional environment can promote economic growth by reducing unnecessary friction losses, such as redundant approval processes and waiting lists for enterprises. A looser commercial system and a more convenient access environment can facilitate enterprises to enter the market and enhance their market competitiveness [3].

This paper attempts to contribute in the following ways: First, the main contribution of this paper is to propose the concept of institutional friction cost. Institutional transaction costs do not explain the problem very effectively, hence we propose the concept of institutional frictional costs. The institutional friction cost can be understood as any unnecessary or redundant institutional transaction cost incurred in the implementation of the system. It can lower barriers to entry in the industry and reduce excess costs in market transactions. Reducing the cost of institutional friction can promote a country’s long-term economic development and market prosperity. Second, in contrast to the existing literature, which mostly discusses the impact on economic growth in terms of institutional quality and business environment, this paper investigates the impact of business environment optimization on economic growth in terms of institutional friction costs. Third, we discuss the role of institutional frictional costs on economic growth in terms of two aspects of heterogeneity across countries, namely income levels and institutional quality.

Therefore, this paper first calculates the cost of institutional friction and then tests whether reducing the cost of institutional friction can stimulate market vitality and improve the ability of businesses to operate, thereby promoting overall economic growth and hence economic growth mechanisms. The paper includes the following subsections: Section 2 gives a brief review of the literature on the institutional friction cost to economic growth and the study of the hypothesis. Section 3 presents the data and methodology used in this paper. Section 4 shows the empirical results and additional discussions. Section 5 is devoted to concluding remarks.

2. Literature Review

2.1. Economic Growth

Neoclassical economists believe that early economic growth mainly depends on the accumulation of capital factors, and that increasing capital input can improve output efficiency, which is beneficial to the output of enterprise value [4]. As the marginal contribution rate of the economy begins to slow down, the driving force of economic development turns to technology investment and R&D scale [5]. Improving the utilization rate of production factors such as capital, labor, land and technology is a stable driver of a country’s economic growth. We believe that the key reasons for economic growth are the development of human capital, material increase, efficiency and technological progress.

However, the institutional environment as a “hidden” factor is easy to ignore. The institutional context is particularly striking. Grasping institutions and inclusive institutions will have different effects on a country’s level of economic growth and social welfare [6,7]. At the same time, the institutional environment and the business environment play the role of invisible hands in the economy. Optimizing the business environment is key to dealing with the relationship between the government and the market so that the decisive role of the market in resource allocation can be better played. Reducing direct government intervention in market activities, such as reducing links, materials, time limits and expenses, can effectively reduce institutional transaction costs for enterprises. At the same time, lowering the market entry threshold can allow additional companies with innovative potential to enter the market [8,9]. Thus, the institutional environment can also act as a driver for economic growth.

2.2. Institutional Transaction Costs

Institutional transaction costs can be traced back to the discussion of transaction costs in current institutional economics. Transaction costs are the costs of conducting transactions in contrast to friction, which increases the expense and delay of exchange [10]. Transaction costs are the costs incurred by people for economic activities, including economic exchange costs and the costs of monitoring the execution of contracts. Measurement and implementation costs are the sources of social, political, and economic transaction costs in institutions [11]. Exploratory studies have shown that in the absence of institutional mechanisms to reduce transaction costs, excessive transaction costs lead to firm isolation from the market. We divide the cost of an enterprise into production factor cost and transaction cost, of which transaction cost includes market transaction cost, internal management transaction cost, and administrative system transaction cost [12]. Institutional transaction cost is the non-productive operating cost generated by institutional factors in the process of enterprise operation, which has a highly influential impact on the establishment, production, operation, and innovation of enterprises [13].

A positive institutional environment and a relaxed regulatory environment can promote output growth, and increase employment and job creation [14,15]. Bourlès et al. used data from 20 industries from the Organization for Economic Co-operation and Development (OECD) between 1985 and 2007 to show that more regulation has had a negative indirect impact on total factor productivity over time [16]. The reduction of institutional transaction costs is an important mechanism of administrative approval reform to affect enterprise productivity [17]. Using a sample of 19 OECD countries, Aldieri et al. found that the quality of institutions is crucial to enhance employment [18]. Business environment optimization and relaxation of government regulations can promote output growth [14].

However, administrative approvals and regulations that are onerous can increase transaction costs and damage economic growth [19]. Institutional costs can increase the burden on companies and hinder their development and performance. Cumbersome and inappropriate regulations have hampered the development of numerous private companies, resulting in low-productivity operations and slowing economic growth. Chambers and Munemo believe that the increase in the cost of institutional friction will make enterprises allocate limited resources to non-production activities; t will increase the financing gap of enterprises’ production activities, which is not conducive to the improvement of enterprise production efficiency [20,21]. The reduction of institutional costs saves social costs [19], but periodically increases transaction costs for firms and hinders firms’ market entry. Continued relaxation of institutional environment and access approvals is a process to reduce transaction costs for enterprises. The essence of improving the business environment is to reduce the cost of institutional transactions or, more precisely, the cost of institutional friction rather than the cost of institutional compliance. Therefore, we propose splitting the institutional transaction cost into two parts. One is the cost of compliance, that is, the cost that enterprises must pay when facing a series of formal institutional arrangements such as laws and regulations formulated by the government; the other is the friction cost, that is, the redundant and unnecessary time costs and expenses caused by the unreasonableness or lack of scientificity of some laws and regulations and alternative systems to the operation of enterprises. The cost of a compliant system has a positive impact on economic growth, while the cost of a frictional system hurts it. With this in mind, we propose Hypothesis 1.

Hypothesis 1.

Optimization of the business environment promotes economic growth, which essentially reduces institutional friction costs.

2.3. Innovation

Kolasinski believes that the business environment is the overall investment environment for a region, and includes survival and development [22]. The business environment also influences enterprises’ performance [23]. Business environment optimization will also provide more opportunities for companies to obtain funds and more living space, which can stimulate the innovation vitality of enterprises, and is also a sustainable driving force for economic growth in the current era. Reforms to the business system have created more convenient conditions for enterprises to establish and operate, improved their enthusiasm for entrepreneurship and innovation [24,25,26], and stimulated market vitality, thus boosting economic growth. Policymakers can improve the business environment through structural reforms to better capitalize on capital inflows [27]. Institutional reforms can increase the entry rate of firms and business innovation [28,29,30,31,32], which is conducive to increasing employment and job creation [9,29]. Kerr et al. argue that a looser corporate entry regulatory environment can promote corporate innovation activities while increasing the assurance that firms can compete on a level playing field [33,34]. However, overly intensive entry rules restrict entrepreneurial activities, increase transaction costs in the process of starting a business, and affect entrepreneurs’ grasp of business opportunities [35,36]. As a result, increased institutional friction costs will affect the enthusiasm of companies to innovate. Therefore, we propose the following Hypothesis.

Hypothesis 2.

Reducing the cost of institutional friction can promote business entrepreneurship and innovation, and thus economic growth.

3. Methodology

The empirical analysis in this study uses economic growth data mainly from the World Bank database and institutional friction cost data from the World Bank’s Doing Business 2004–2020 report. We compiled the data manually and used Stata17 for data analysis and empirical testing.

3.1. Method of Calculation of Institutional Friction Cost

To better explain economic growth, this paper proposes an institutional friction cost to define this attrition. First, the processes that operate the economic system must incur costs, which are part of the institutional costs that firms have to pay; these can also be referred to as institutional operating costs. Second, the reform of the policy system, including the phase transition between the current system and the original system, also generates some institutional cost loss, which we will refer to as the cost of institutional shift. The cost of institutional friction, however, is the superfluous cost and expense incurred in the operation of a business by unreasonable or unscientific laws and regulations. The process of continuous optimization and improvement of institutional systems also incurs some frictional costs, and improving the efficiency of resource allocation is essential for reducing institutional frictional costs.

We screened the World Bank database for indicators that measure the cost of institutional friction. The World Bank’s Doing Business report assesses entrepreneurship, construction contracts, electricity supply, property registration, credit, minority investor protection, taxation, cross-border trade, contract enforcement, insolvency and labor market regulation. We evaluated economic indicators not including construction quality control, access to power quality indicators, quality indicators of land administration, evaluation of the legitimate rights and interests of credit parties in access to credit, credit information facilitation index, protection of small and medium investors, and judicial process quality index and the strength of the legal framework. The World Bank uses a distance-to-frontline score for the assessment. First, the score indicates how close an economy is to the top score. This score is then used to calculate the frontier distance score of institutional friction cost, whereby frontier distance score = 100 − (current value − optimal value)/(worst value − optimal value) × 100.

This paper refers to the method of Djankov et al., including the four basic factors of the number of procedures, time, cost, and minimum real capital required to register a new enterprise [37]. The institutional friction cost is indicated in

Table 1. The Framework of Institutional friction Costs.

Field	Institutional Friction Cost Content
Starting a business	procedures, time, cost, paid-in minimum capital
Dealing with construction permits	procedures, time, cost
Getting electricity	procedures, time, cost
Registering property	procedures, time, cost
Getting credit	Not included
Protecting minority investors	Not included
Paying taxes	procedures, time, total tax, VAT refund
Trading across borders	Time, cost
Enforcing contracts	Time, cost
Resolving insolvency	Time, cost

.

3.2. Data

This paper calculates OECD institutional friction cost data based on the World Bank’s Doing Business 2004–2020 report.

Institutional Friction Cost Index = 100-Institutional Friction Cost Front Distance Score. The results are then averaged over. To remove the effect of extreme outliers, we define it as the 95th percentile across OECD economies.

Figure 1 shows that the overall cost of institutional friction is on a downward trend. The cost of institutional friction is lower in high-income countries than in upper-middle-income countries.

Figure 2 illustrates the mean institutional friction cost by country from 2004 to 2020. As we can see from the scatter plot, several countries have low institutional friction costs, including Denmark (DNK) with 14.83, New Zealand (NZL) with 14.6, Japan (JAP) with 16.87, and Australia (AUS) with 18.97. Among the countries with higher institutional friction costs, Colombia (COL) scored 39.22, and Greece (GRC) scored 38.02. We find that the cost of institutional friction is lower in high-income countries and higher in upper-middle-income countries.

We have plotted additional detailed breakdowns of the trend changes in institutional friction costs. Figure 3 shows the trend of frictional cost per institution as a function of time. We can see that the institutional frictional cost of contract enforcement was the lowest in 2008. Institutional frictional costs for contract enforcement are next on the rise. Among the total institutional friction costs, we can see that processes dealing with construction permits, registering property, enforcing contracts and resolving insolvencies have higher institutional friction costs. In contrast, there are fewer costs associated with paying taxes and trading across borders. In addition to the institutional friction costs of paying taxes and trading across borders, the institutional friction costs in other parts of the economy are already on a downward trend.

3.3. Empirical model

We constructed empirical models to estimate the impact of institutional friction costs on economic growth, and we started by estimating the following baseline model.

$$GD{P}_{it}={\alpha }_0+{\alpha }_{1}IF{C}_{it}+{\displaystyle \sum }\eta X_{it}+{\theta }_i+{\mu }_t+{\epsilon }_{it}$$

(1)

where $i$ refers to economies and $t$ refers to time. The parameters ${\alpha }_0$ and ${\alpha }_1$ are scalars, which capture intercept and the effects of GDP per capita ($GD{P}_{it}$) and choose the logarithmic form to eliminate systematic errors. The explanatory variable represents the institutional friction cost ($IF{C}_{it}$) at the time $t$ for the country $i$. The coefficients of the key explanatory variables represent the impact of institutional friction cost on economic growth, ${\theta }_i$ and ${\mu }_t,$ which are fixed effects at the national level and fixed effects at the time, and ${\epsilon }_{it}$ is a random error term.

$$M_{it}={\beta }_0+{\beta }_{1}IF{C}_{it}+{\displaystyle \sum }\eta X_{it}+{\theta }_i+{\mu }_t+{\epsilon }_{it}$$

(2)

$$GD{P}_{it}={\omega }_0+{\omega }_{1}IF{C}_{it}+{\omega }_1{M}_{it}+{\displaystyle \sum }\eta X_{it}+{\theta }_i+{\mu }_t+{\epsilon }_{it}$$

(3)

$X_{it}$ is a control variable which includes the following: Foreign direct investment (FDI) uses net inflows of foreign direct investment (current dollars), and FDI can lower market entry barriers in host countries [38]. Capital (CAP) calculates gross capital formation in local currency units using constant prices. Trade (TRADE) uses total merchandise trade as a percentage of GDP. Labor (LAB) and government spending (GOV) data are from the World Bank database. $M_{it}$ is the intermediary variable; we use Entrepreneurship. The data are from the World Bank Open Database and Global Entrepreneurship Monitor (The GEM) database.

4. Results and Discussions

4.1. Descriptive Statistics

Table 2. Descriptive statistics.

Variables	Num. Obs.	Mean	Sd	Min	Max
GDP	608	10.26	0.723	7.931	11.69
IFC	612	3.146	0.356	2.334	3.960
CAP	627	26.58	2.784	21.93	33.99
FDI	551	23.19	1.645	17.33	27.32
LAB	646	15.66	1.489	12.06	18.94
GOV	568	3.493	0.290	2.757	4.133
TRADE	646	72.65	39.44	18.34	182.1

shows the descriptive statistics of the main variables. The average GDP per capita for the explained variables in the sample interval is 10.26, with a maximum of 11.69, a minimum of 7.931 and a standard deviation of 0.723, indicating some variation between countries. The average value of variable institutional friction cost (IFC) is 3.146, the maximum value is 3.96, and the minimum value is 2.334. We reduced the numerical gap between countries by using the method of computing border distances. The descriptive statistics of the other variables are shown in Table 2.

4.2. Correlation Analysis

The correlation analysis of the main variables in this paper shows in

Table 3. Correlation analysis.

	GDP	IFC	CAP	LAB	FDI	GOV	TRADE
GDP	1
IFC	−0.592 ***	1
CAP	−0.198 ***	0.0190	1
LAB	−0.116 ***	0.096 **	0.582 ***	1
FDI	0.355 ***	−0.087 **	0.292 ***	0.596 ***	1
GOV	0.0330	0.145 ***	−0.509 ***	−0.278 ***	−0.235 ***	1
TRADE	−0.133 ***	0.108 ***	−0.368 ***	−0.415 ***	−0.212 ***	0.272 ***	1

Notes: Statistical significance: *** p < 0.01, ** p < 0.05.

that there is a significant negative correlation between institutional friction cost (IFC) and economic growth (GDP), with a correlation coefficient of −0.592. This is consistent with the research hypothesis in this paper, thus providing preliminary empirical evidence for the research hypothesis. The correlation coefficient between the key explanatory variables is less than 0.8, which helps to reduce concerns about multicollinearity among the variables. Correlation analysis results provide preliminary data support for the following empirical analysis.

4.3. The Impact of Institutional Friction Cost on Economic Growth

The estimated results for the impact of institutional friction costs on economic growth are reported in

Table 4. Estimation results.

	(1)	(2)	(3)	(4)	(5)	(6)	(7)
IFC	−0.275 ***	−0.314 ***	−0.267 ***	−0.267 ***	−0.291 ***	−0.287 ***	−0.218 **
	(−2.97)	(−4.67)	(−3.32)	(−3.32)	(−3.43)	(−3.89)	(−2.72)
CAP		0.452 ***	0.379 ***	0.379 ***	0.387 ***	0.540 ***	0.563 ***
		(7.21)	(6.58)	(6.58)	(6.99)	(7.10)	(7.40)
LAB			0.519	0.519	0.546	−0.062	0.059
			(1.57)	(1.57)	(1.55)	(−0.14)	(0.13)
FDI					0.007	0.010	0.010
					(0.87)	(1.20)	(1.14)
GOV						0.589 ***	0.618 ***
						(3.49)	(3.44)
TRADE							0.003 *
							(1.78)
Constant	−9.037 *	−0.688	−6.975	−6.975	−7.813	−4.462	−7.432
	(−1.70)	(−0.41)	(−1.50)	(−1.50)	(−1.55)	(−0.79)	(−1.32)
Country FE	yes	yes	yes	yes	yes	yes	yes
Year FE	yes	yes	yes	yes	yes	yes	yes
Number of id	38	37	37	37	37	36	36
Observations	574	558	558	558	504	477	477
R-squared	0.3	0.4	0.5	0.5	0.5	0.5	0.5

Notes: Statistical significance: *** p < 0.01, ** p < 0.05, * p < 0.1.

. The regression results of the FE regression show that the coefficient of the IFC is highly negative, indicating that it can effectively improve the GDP performance. These results remain significant and similar in size when various control variables are added (p < 0.01).

We also found that some of the control variables have a significant effect. These effects arise, most likely, because different control variables react differently to GDP. Capital, government spending, and trade are all significantly positive, and they reduce the negative impact of institutional friction processes on economic growth.

To gain additional insight and determine the robustness of our findings, we regressed the total, institutional friction cost sub-divided into eight categories from a cost partitioning perspective and present the calculated results in

Table 5. Estimation results in detail of IFC.

	(1)	(2)	(3)	(4)	(5)	(6)	(7)	(8)
	Starting a Business	Dealing with Construction Permits	Getting Electricity	Registering Property	Paying Taxes	Trading Across Borders	Enforcing Contracts	Resolving Insolvency
IFC	−0.094 ***	−0.062	0.041	−0.188 **	0.071	0.054	0.203	−0.150 *
	(−2.89)	(−0.65)	(1.30)	(−2.69)	(0.92)	(0.35)	(1.18)	(−2.00)
CAP	0.610 ***	0.463 ***	0.509 ***	0.502 ***	0.665 ***	0.580 **	0.608 ***	0.594 ***
	(7.19)	(9.62)	(6.79)	(7.57)	(5.21)	(2.69)	(6.36)	(6.40)
LAB	−0.080	0.056	−0.694 **	0.191	0.798	0.496	0.272	0.161
	(−0.17)	(0.16)	(−2.39)	(0.52)	(1.57)	(0.98)	(0.62)	(0.37)
FDI	0.009	−0.004	−0.004	−0.001	−0.000	0.007	0.007	0.008
	(1.08)	(−0.66)	(−0.74)	(−0.08)	(−0.07)	(0.75)	(0.80)	(0.90)
GOV	0.593 ***	0.404 ***	0.151	0.502 ***	−0.438	−0.289	0.648 ***	0.657 ***
	(3.03)	(2.78)	(1.32)	(3.39)	(−1.34)	(−1.10)	(3.23)	(3.19)
TRADE	0.003 **	0.001	−0.001	0.001	0.001	−0.002	0.004 ***	0.003 *
	(2.30)	(0.62)	(−0.89)	(0.70)	(0.41)	(−0.68)	(2.94)	(1.96)
Constant	−6.926	−4.004	7.141	−7.209	−18.857 ***	−12.570 **	−13.475 **	−10.154 *
	(−1.18)	(−0.82)	(1.59)	(−1.47)	(−3.06)	(−2.69)	(−2.45)	(−1.79)
Country FE	yes	yes	yes	yes	yes	yes	yes	yes
Year FE	yes	yes	yes	yes	yes	yes	yes	yes
Number of id	36	36	36	36	35	22	36	36
Observations	477	421	302	451	121	98	477	477
R-squared	0.5	0.4	0.3	0.5	0.5	0.4	0.5	0.5

Notes: Statistical significance: *** p < 0.01, ** p < 0.05, * p < 0.1.

. The regression results for the eight dimensions show that the reduction of institutional friction costs such as starting a business, registering property and resolving insolvency has a significant impact on economic growth. The reform of the business system has been effective in the entry and exit of enterprises. However, the coefficients of institutional friction costs in the segments of “dealing with construction permits”, “getting electricity”, “paying taxes”, “trading across borders”, and “enforcing contracts”, are not significant. We have seen that the institutional friction cost is weak in explaining economic growth during the actual economic operation. It provides some breakthroughs in the optimization of business environments.

4.4. Heterogeneity Analysis

The impact on economic growth varies across different types of countries. Lee and Kim found that there is heterogeneity in policy and institutional variables such as technological innovation and higher education in countries with different income levels [39]. Regarding other factors affecting economic growth, the business environment can affect the amount of foreign direct investment it attracts, changes in infrastructure, political stability, or spillovers from neighboring countries [40,41]. The economic development levels of different types of countries are quite different. Developed countries and regions have comparative advantages in terms of resources, human capital, institutional environment and level of technology. In a five-year group study, Eifert found that low-income countries that implemented business reforms experienced a 0.4% increase in growth in the second year [42]. Castellacci et al. analyzed data from 18 Latin American countries from 1970 to 2010 and found that different types of government policies, innovation policies, and imitation systems are more conducive to economic growth [43]. Correspondingly, we examined heterogeneity in the following two aspects:

First, we analyzed the heterogeneity of income levels within countries, and divided OECD countries into different levels: upper middle-income countries and high-income countries. The results are shown in

Table 6. Heterogeneity Analysis.

	Income Level		Government Effectiveness Index
	(1)	(2)	(3)	(4)
IFC	−0.298	−0.152 ***	−0.339 ***	−0.0454
	(0.343)	(0.0384)	(0.0630)	(0.0463)
CAP	−0.0241	0.540 ***	0.785 ***	0.455 ***
	(0.259)	(0.0444)	(0.0707)	(0.0560)
LAB	0.0249	0.369 **	−1.171 ***	0.966 ***
	(0.566)	(0.172)	(0.288)	(0.178)
FDI	0.347 ***	0.00556	0.0111	0.00745
	(0.0833)	(0.00735)	(0.0144)	(0.00794)
GOV	−0.0440	0.553 ***	1.537 ***	0.347 ***
	(0.246)	(0.0854)	(0.192)	(0.0843)
TRADE	−0.0133 ***	0.00433 ***	0.00172 *	0.00316 ***
	(0.00285)	(0.000675)	(0.00103)	(0.000833)
Constant	3.315	−11.36 ***	2.824	−17.81 ***
	(8.158)	(2.286)	(3.845)	(2.324)
Country FE	yes	yes	yes	yes
Year FE	yes	yes	yes	yes
Number of id	4	32	13	22
Observations	46	431	171	294
R-squared	0.8	0.5	0.6	0.6

Notes: Statistical significance: *** p < 0.01, ** p < 0.05, * p < 0.1.

, where column (1) is upper middle-income countries, and column (2) is high-income countries. According to the country’s income level, we found that the institutional friction cost (IFC) of high-income countries has a more significant impact on GDP. Secondly, we analyzed heterogeneity from the perspective of institutional quality, referring to Laura et al., which is measured by the government effectiveness index [44]. The data comes from The Worldwide Government Indicators (WGI) database. The WGI database is a research dataset summarizing perceptions of the quality of governance among a large group of business, civic and expert survey respondents, and has been expanded into six main areas: voice and accountability, political stability and absence of violence/terrorism, government effectiveness, regulatory quality, rule of law, and corruption control. We selected performance scores for government effectiveness to assess the quality of the effectiveness of the system.

In Table 6, we can see that column (3) is the low government-effectiveness index and column (4) is the high government-effectiveness index. From the third and fourth columns, we can see that countries with high governance index have less institutional friction cost because of their higher government governance efficiency, while countries with a low government-effectiveness index have more institutional friction costs (IFC) and a more serious impact on the GDP, indicating that the friction cost problem in the economic operation of countries with low government efficiency is more prominent.

4.5. Robustness Test

We ran the same model as the baseline model by controlling for the full set of capital and other control variables. In

Table 7. Robustness test.

	(1)	(2)	(3)	(4)
IFC	−0.218 ***	−1.079 ***	−1.079 ***	−1.079 ***
	(-2.79)	(−17.47)	(−17.47)	(−17.47)
CAP	0.577 ***	−0.057 ***	−0.057 ***	−0.057 ***
	(6.72)	(−5.75)	(−5.75)	(−5.75)
LAB	0.025	−0.162 ***	−0.162 ***	−0.162 ***
	(0.05)	(−7.13)	(−7.13)	(−7.13)
FDI	0.013	0.261 ***	0.261 ***	0.261 ***
	(1.39)	(14.17)	(14.17)	(14.17)
GOV	0.665 ***	0.199 **	0.199 **	0.199 **
	(3.73)	(2.17)	(2.17)	(2.17)
TRADE	0.003 *	−0.004 ***	−0.004 ***	−0.004 ***
	(1.95)	(−8.65)	(−8.65)	(−8.65)
Constant	−7.524	11.276 ***	11.298 ***	11.298 ***
	(−1.33)	(19.11)	(19.60)	(19.60)
Country FE	no	yes	yes	yes
Year FE	no	yes	yes	yes
Number of id	36	36	36	36
Observations	477	477	477	477
R-squared	0.5	0.6	0.6	0.6

Notes: Statistical significance: *** p < 0.01, ** p < 0.05, * p < 0.1.

, we performed robustness tests using various methods. First, we used OLS regression and the results are shown in the first column. This paper found outliers in the values of institutional friction costs for some OECD countries, which may affect the estimation results. Second, in this paper, samples with quotient ambient values less than 1 percent and greater than 99 percent w binned to shrink. We dealt with sample data and found that the results are still robust. Third, in the third and fourth columns, we tested the previous results using LSDV regression and multidimensional fixed effect linear regression. We varied the regression method and the results remained significant.

4.6. Endogeneity Test

In this paper, we consider that regression results can suffer from endogeneity issues, mainly from the following two aspects. On the one hand, an increase in the economic growth rate itself implies that the business environment is optimized, and the continued optimization of the business environment also represents a reduction in the cost of institutional friction, i.e., there is a reverse causality. On the other hand, measurements of institutional friction costs may not truly reflect non-essential costs in economic operations due to data availability and measurement errors. Therefore, in order to further verify the robustness of the empirical results, this paper used the instrumental variable approach to weaken this endogeneity problem. For the choice of instrumental variables, two conditions need to be satisfied, namely that the instrumental variables are exogenous and that the instrumental variables are heavily correlated with the endogenous variables.

Referring to Acemoglu, et al. 2015, this paper adopted a one-period lag for the explanatory variable institutional frictional cost (IFC), an approach that effectively avoids possible reverse causality due to the lag in the impact of cost factors during the economic operation. In

Table 8. Endogeneity test.

	(1)	(2)	(3)	(4)
IFC	−0.978 ***	−0.978 ***	−0.978 ***	−0.978 ***
	(−15.25)	(−15.25)	(−16.27)	(−16.27)
CAP	−0.055 ***	−0.055 ***	−0.055 ***	−0.055 ***
	(−5.07)	(−5.07)	(−5.00)	(−5.00)
LAB	−0.174 ***	−0.174 ***	−0.174 ***	−0.174 ***
	(−7.62)	(−7.62)	(−6.28)	(−6.28)
FDI	0.242 ***	0.242 ***	0.242 ***	0.242 ***
	(15.14)	(15.14)	(10.17)	(10.17)
GOV	0.221 **	0.221 **	0.221 **	0.221 **
	(2.54)	(2.54)	(2.21)	(2.21)
TRADE	−0.004 ***	−0.004 ***	−0.004 ***	−0.004 ***
	(−7.09)	(−7.09)	(−8.24)	(−8.24)
Constant	11.440 ***	11.440 ***	11.440 ***	11.440 ***
	(20.20)	(20.20)	(17.94)	(17.94)
Country FE	yes	yes	yes	yes
Year FE	yes	yes	yes	yes
Number of id	36	36	36	36
Observations	448	448	448	448
R-squared	0.6	0.6	0.6	0.6

Notes: Statistical significance: *** p < 0.01, ** p < 0.05.

, we performed robustness tests using various methods. First, we used 2SLS regression and the results are shown in the first column. Second, we chose the LIML regression in the second column to test for endogeneity issues, and the results are still robust. Finally, in the third and fourth columns, we tested the previous results using GMM regression and IGMM regression. From the regression results, we can see that the coefficient of institutional friction cost (IFC) is negative and at the 1% significance level, indicating that lower institutional friction cost is beneficial to economic growth, which is essentially consistent with the theoretical expectation of this paper.

4.7. Analysis of Mechanism Effect

A large number of empirical studies have shown that reform of the administrative approval system and the relaxation of government supervision can promote output growth, increase the entry rate of enterprises, and help increase employment and create jobs [5,9,32,45,46]. At the micro level, Ardagna et al. have found that commercial systems have some influence on the entrepreneurial behavior of commercial entities [47]. Klapper et al. conducted an empirical analysis of the establishment of limited liability companies, the size of market entrants, and the growth of existing firms, based on data from the European Comprehensive Company Database [8]. Onerous regulations have been found to increase the cost of entry into the market, which will hinder the establishment of new companies, especially in sectors where there is a higher degree of freedom of entry. At the same time, it also forces current entrants to increase their size, resulting in slower growth for incumbents entering industries with higher degrees of freedom.

To test the mechanism of institutional friction cost on economic growth, we also improved the empirical analysis. We chose Entrepreneurial Intentions (APS4) and Established Business Ownership (APS6) as intermediary variables, and the data were obtained from the Global Entrepreneurship Monitor (GEM) database. Entrepreneurial Intentions (APS4) is a percentage of the 18–64 population (individuals involved in any stage of entrepreneurial activity excluded) who are latent entrepreneurs and who intend to start a business within three years. Established Business Ownership (APS6) is a percentage of the 18–64 population who are currently an owner–manager of an established business, i.e., owning and managing a running business that has paid salaries, wages, or any other payments to the owners for more than 42 months.

Table 9. Mechanism effect analysis.

	Entrepreneurial Intention			Established Business Ownership
	(1)	(2)	(3)	(4)	(5)	(6)
IFC	−0.407 ***	−5.136 ***	−0.243 ***	−0.407 ***	−0.301 ***	−0.244 ***
	(−10.28)	(−3.44)	(−4.94)	(−10.28)	(−2.76)	(−4.94)
APS4			0.006 ***
			(3.02)
APS6						0.063 ***
						(2.59)
Constant	7.801 ***	−53.313 **	9.439 ***	7.801 ***	1.446	8.841 ***
	(7.44)	(−2.51)	(8.58)	(7.44)	(1.09)	(8.00)
Country FE	yes	yes	yes	yes	yes	yes
Year FE	yes	yes	yes	yes	yes	yes
Number of id	36	34	34	36	34	34
Observations	477	318	318	477	318	318

Notes: Statistical significance: *** p < 0.01, ** p < 0.05.

shows the results of the mechanism tests. The regression results show that the mediating variables are significant, and that reducing the cost of institutional friction can promote entrepreneurship and innovation among firms, which then contribute to economic growth. Reducing the cost of institutional friction can significantly increase the incidence of entrepreneurship in countries with higher income levels and higher aggregate income levels. The per capita income level of entrepreneurs in these countries is generally high; however, capital is not the only reason for limiting entrepreneurial activity, and entrepreneurs value time savings and process simplification.

5. Concluding Remarks

5.1. Summary

A positive business environment is key to long-term strong economic growth. Reducing government approval of enterprises and their independent decision-making on entry and exit can stimulate the vitality and creativity of market players, and promote steady economic and social growth and rational allocation of resources. This paper cuts through the micro-level perspective of institutional friction costs to better validate the impact on economic growth. The reform of the commercial system did not happen overnight. By simplifying the approval process and optimizing the business environment, we can improve the overall economic operation efficiency of society, fundamentally reduce the cost of institutional friction, reduce unnecessary friction losses and lower business operating costs.

Since previous studies have neglected the impact of institutional friction costs on economic growth, this paper systematically analyzes the relations based on mediation effects. The findings are as follows: (1) Through the calculation of institutional friction costs in OECD countries from 2004 to 2020, we found that the overall trend of institutional friction costs is declining; (2) Institutional friction cost hurts economic growth; thus, reducing institutional friction cost can promote economic growth. Among others, the reduction of institutional friction costs in setting up a business, registering a property and resolving insolvency has had a significant impact on growth. This conclusion remains valid after considering endowments and extensive robustness tests; (3) Institutional frictional costs have heterogeneity in the regression results of economic growth, and institutional frictional costs in high-income countries have a relatively slight resistance to economic growth; (4) We choose innovation as an intermediary variable, and the reduction of institutional friction costs can stimulate entrepreneurial enthusiasm to promote economic growth.

5.2. Concluding Remarks

In this paper, we discuss the impact of institutional friction costs on economic growth. Reducing unnecessary frictional losses in society can promote businesses to reduce their operating costs, thereby improving the overall efficiency of economic operations in society and promoting economic growth. At the same time, reducing the cost of institutional friction can promote the innovation and development of enterprises and create a level playing field, which is a prerequisite for market mechanisms to function.

The findings of this paper provide the following policy implications for creating a favorable business environment and promoting economic growth: (1) Promote the reform of the commercial system. Capital market construction is relatively lagging, with institutional friction costs hindering the free flow of labor, land, capital, technology, information and other factors. Reforming the administrative approval system can reduce corrupt rent-seeking, guide market players from rent-seeking to profit-seeking, improve the overall efficiency of economic operations, and promote the innovative development of enterprises by reducing the cost of institutional friction in the factor market; (2) Create a level playing field. We can additionally eliminate industrial monopolies and lower market access thresholds to create a level playing field. A level playing field is a prerequisite for market mechanisms to function, and the development of negative market access lists is also conducive to maintaining a level playing field; (3) Strengthen the follow-up market supervision. We can build public government information sharing and supervision platforms for taxation, customs, industry and commerce, share information on resources on time, improve corporate information disclosure systems and enhance the efficiency of government services.

5.3. Propositions for Future Research

Our future research will extend this further in the following way. First, we will use more detailed city-level data for our analysis, based on the availability of data. Second, we will further analyze the impact of institutional friction costs on economic growth and business environment performance. Third, we will measure institutional friction costs and economic growth in different ways.