Building Regulations, Enforcement, and Real Estate Developer Behavior in Developing Countries

In many developing countries, weak institutional strength, excessive regulatory costs and limited enforcement capacity have led to presence of unauthorized or illegal buildings in cities. Such illegality – resulting from noncompliance to the prevailing regulations, implies lack of safety and hazard risk for the occupants. Governments across the world have tried to come up with mechanisms to address the issue, either by legalizing these buildings or by imposing structural changes. There has been dearth of studies analyzing developer behavior toward compliance with building regulations, and the resulting impact on the real estate industry structure. We bridge this gap in literature, by developing a firm-level micro-economic model, of a local real estate market, to examine developer’s profit-maximizing decisions in the presence of high compliance costs, and low enforcement intensity. We further show how a low probability of detection and low penalty regime results in production inefficiencies, prevalence of smaller and localized firms, and presence of complaint and noncomplaint supply. This work shows the discourse on illegality in building construction in two major ways, one, we highlight the trade-off faced by regulatory authorities between a preventive strong enforcement or a curative secondary regime with high penalties. Also, we present the economic rationale for prevalence of small, localized real estate firms, producing at lower than optimum quantity, in developing countries. Rationalization of regulations to bring the compliance costs down, strong enforcement and high penalty for noncompliance are measures that would support a competitive real estate market.