Combating Corruption with Bargaining Disruption Fabio Méndez University of Arkansas Department of Economics Business Building Room 402 Fayetteville, AR, 72701
[email protected] May 28, 2007
Abstract This paper presents a theoretical model in which the government regulates economic activity and individuals are able to bypass the regulations by paying bribes to the public o¢ cials who monitor their businesses; where the amount of the bribe is the subject of bargaining. The paper then studies the e¤ects of a policy which disrupts the bribe-bargaining process by rewarding public o¢ cials beyond what they would expect to receive if they accepted a bribe. Throughout the paper, this policy is referred to as "bargaining disruption". The results of the model suggest that bargaining disruption policies are e¤ective in economies without extortion, but their e¤ect is ambiguous in economies where corruption is also used for extortionary motives.
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Introduction
Government regulations on economic activities are designed to enhance welfare and policy makers want to make sure that these regulations are implemented properly.
In addition,
when corruption is part of the economy, policy makers also want to eliminate any corrupt deals designed to bypass the regulations and undermine their e¤ectiveness. Unfortunately, very few policy alternatives exist that would e¤ectively reduce corruption and increase regulation compliance simultaneously. In this regard, the economic literature on corruption and regulation has provided a careful analysis regarding the e¤ects of policy changes a¤ecting, for example, the public o¢ cials compensation, the penalties for giving or taking a bribe, the costs of regulation compliance, and others (recent contributions include Mookherjee and Png (1995), Damania et al. (2004), Çule and Fulton (2005), Mishra (2006), Friedman et al.(2000) and Schneider(2005)). This paper complements that literature, but focuses its attention on an alternative (and much less discussed) mechanism for combating corruption and increasing regulation compliance; namely: the disruption of the bargaining practices through which corrupt agents interact. In speci…c, this paper presents a theoretical model in which the government regulates economic activity and individuals are able to bypass the regulations by paying bribes to the public o¢ cials who monitor their business; where the amount of the bribe is the subject of bargaining.
The paper then studies the e¤ects of a policy which disrupts the bribe-
bargaining process by rewarding public o¢ cials beyond what they would expect to receive if they accepted a bribe. Throughout the paper, this policy is referred to as "bargaining disruption". The model in this paper is closer to that of Mookherjee and Png (1995). They present a model of delegated enforcement in which public o¢ cials monitor the amount of pollution
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released by factories. They use this model to study changes in the inspector’s wages and rewards. They …nd that if the reward to a public o¢ cial is high enough, the o¢ cial’s demand "rises beyond the factory’s willingness to pay"; so that corruption disappears completely and regulation compliance increases unequivocally. There are at least two important di¤erences between the paper by Mookherjee and Png (1995) and this one. First, unlike the paper by Mookherjee and Png (1995), the case of economies with extortion is also considered here. When extortion is present, corrupt public o¢ cials may use their power to threat businesses who have followed the regulations with a …ne or a penalty, which, although unjusti…ed, could only be avoided by paying an extortionary bribe. As it turns out, in economies without extortion the results of the model presented in this paper coincide with those of Mookherjee and Png (1995); but in economies with extortion, the results change signi…cantly. Second, in the paper by Mookherjee and Png (1995) all public o¢ cials are corruptible (they are willing to take a bribe in principle). Instead, in this paper public o¢ cials are of two types: some are corruptible and some are not.
When all o¢ cials are assumed to be
corruptible, one cannot study the frequency of corrupt payments: bribery either takes place all the time or it does not take place at all.
Thus, Mookherjee and Png (1995) measure
corruption by looking at the size of the bribe only.
Instead, in this paper corruption is
measured in three separate dimensions: the frequency of bribery, the size of the bribes, and the di¤erence in the rewards perceived by honest o¢ cials with respect to dishonest ones. As shown below, the e¤ects of bargaining disruption policies on any one of these three measures sometimes di¤ers from its e¤ects on the other two. Other authors like Hindricks, Keen and Muthoo (1999) and Chander and Wilde (1992) have also studied the e¤ects of changing the compensation to public o¢ cials in economies with corruption.
Both of these papers, however, study corruption in the context of tax 2
collections; where o¢ cials are paid a share of the tax collected. In contrast, the o¢ cial’s compensation assumed in this paper is tied to the penalty imposed on infractors. The remaining of the paper is organized as follows: Section 2 presents a basic model in which corrupt o¢ cials take bribes only from agents who failed to comply with regulations and introduces the concept of bargaining disruption. Section 3 expands the basic model to that of an economy with extortion and re-examines the e¤ects of bargaining disruption policies. Finally, Section 4 presents the conclusions and directions for future research.
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An economy with corruption
The object of analysis is an economy in which the government regulates economic activity and individuals decide whether to comply with these regulations in an environment where some public o¢ cials are corrupt. The economy is populated with a continuum of agents of size N. Each agent derives a bene…t Ri from the speci…c economic activity under regulation, where Ri is drawn from a distribution with c.d.f. G(R). The government imposes a set of regulations on economic activity. have a cost Ri to the individual who follows the regulations1 ; where
These regulations
2 (0; 1). Simultane-
ously, the government uses public o¢ cials to randomly monitor the individuals’regulation compliance, but the monitoring e¤orts are not exhaustive so that only a fraction d of all individuals is detected and questioned by public o¢ cials. It is assumed that all public o¢ cials review the same number of projects (n). O¢ cials are of two types. A proportion 1
p is honest and verify that regulations have
been followed. If they have not, the honest o¢ cial issues a penalty f that the individual must pay. The remaining p o¢ cials are corrupt and are willing to take a bribe from agents 1
The costs of regulations could also be modeled as a …xed amount determined exogenously. Althought this alternative is not explicitly pursued in the paper, the intuition behind the results also applies when …xed costs are considered.
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who failed to meet regulations in exchange for not issuing the corresponding penalty f . By taking the values of p, , n, and f as exogenous, one can focus on the e¤ects of bargaining disruption policies alone, and distinguish them from those of other anti-corruption policies which typically target these variables (and others not explicitly modeled here). When an economic agent bribes a corrupt o¢ cial, the amount of the bribe ( ) is determined by Nash bargaining, where the bargaining power of the o¢ cial is
2 (0; 1), the
reservation value for the corrupt o¢ cial is zero, and the reservation value for the investor is the …ne f . The bribe is determined by solving )1 .
max( ) (f
The solution for the bribe follows a simple rule of surplus sharing between corrupt o¢ cials and investors; where the equilibrium bribe is
.
=f
Individuals decide whether to comply with the mandated regulations by maximizing the net bene…ts perceived from the economic activity. Throughout the paper, the net expected value of the economic activity when regulations are followed is denoted by v(1), and the net expected value of the economic activity when regulations are not followed is denoted by v(0). Thus, in choosing whether to follow the regulations, individuals choose v = maxfv(0); v(1)g. Individuals with v(1) > v(0) will choose to follow the regulations and individuals with v(1) < v(0) will choose not to follow the regulations. The payo¤s v(1) and v(0) take the following form: v(1) = d[(1
p)(Ri
v(0) = d[(1
p)(Ri
Ri ) + p(Ri f ) + p(Ri
Ri )] + (1 )] + (1
d)(Ri
Ri )
d)(Ri ).
After some straightforward algebra, it can be shown that whether v(1) is greater than v(0) depends directly on the individual value of Ri relative to a value R 4
df (1 p+p )
. Speci…cally,
it can be shown that individuals with Ri < R will choose to follow the regulations and individuals with Ri > R will choose not to follow the regulations. The intuition behind this result is that agents choose not to follow the regulations when the cost of following the regulations exceeds the expected cost of not following them (in terms of bribes and …nes). Since the cost of regulations Ri increases with Ri and both the …ne f and the bribe
=f
are independent from Ri , the result follows logically.
2.1
Bargaining Disruption
A bargaining disruption policy is now introduced. Under this policy, government o¢ cials are paid an amount f + e for each …ne f that they issue. Where the amount e is small but positive. It is important to note that all other assumptions of the model remain unchanged, including those regarding the exogenous nature of p and n, and the assumption that economic agents encounter public o¢ cials in a random fashion2 . With this policy in place, the value of following regulations (v(1)) remains the same as before, but the value of not following regulations (v(0)) changes because a corrupt o¢ cial is not willing to accept a bribe smaller than f + e and the individual is not willing to pay a bribe greater than f . Under this payment scheme, there is no possible bribe that would mutually bene…t the corrupt o¢ cial and the economic agent. Thus, the payo¤s now take the following form: v(1) = d[(1
p)(Ri
v(0) = d[(1
p)(Ri
Ri ) + p(Ri f ) + p(Ri
Ri )] + (1 f )] + (1
d)(Ri
Ri )
d)(Ri )
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A posible consequence of the policy change is that agents and corrupt o¢ cials collude in a non-random fashion in order to share a payo¤ e/2 per penalty issued. However, if the maximum number of penalties that can be issued is determined exogenously by n, this type of collusion would not arise in equilibrium, because it is less pro…table than the alternative.
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Again, after some algebra it can be shown that the decision to comply with regulations b or not depends on the individual value of the economic activity Ri relative to a value R
df
.
b will choose to follow the regulations and individuals with Ri > R b Individuals with Ri < R will choose not to follow the regulations.
In order to evaluate the results of the bargaining disruption policy, however, one has to be able to measure the extent of corruption and level of regulation compliance precisely. One can measure the level of regulation compliance by looking at the fraction of individuals that follow the regulations. Measuring corruption, however, is more complicated because there is no exact de…nition of corruption. In here, three measures related to corruption are studied. The …rst one measures the frequency of corruption or the number of agents that pay a bribe. The second one measures the rents from corruption or the total amount paid in the form of bribes. Finally, the third one measures the di¤erence between the income perceived by a corrupt o¢ cial and the income perceived by an honest o¢ cial. This di¤erence is referred to as the "corruption incentive". Table 1 compares the measures of corruption and regulation compliance resulting from the model with and without the bargaining disruption policy. As shown before, the value b is greater than the value of R , so that more regulation compliance results from the of R
bargaining disruption policy. At the same time, all three corruption measures are smaller with the bargaining disruption policy. In fact, because there is no opportunity for mutually bene…cial bribes, corrupt agents do not perceive any extra income relative to honest o¢ cials and all three corruption measures go to zero.
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Table 1. Levels of Corruption and Regulation Compliance Without With b Regulation compliance G(R ) G(R) Corruption Rents N dp[1 G(R )] f 0 Corruption Frequency N dp[1 G(R )] 0 Corruption Incentive n[1 G(R )] f 0 Thus, for the case of an economy without extortion as described in this section, the results coincide with those of Mookherjee and Png (1995). That is to say that, after the bargaining disruption policy is implemented, corruption disappears and regulation compliance increases unequivocally. An immediate concern regarding the model presented in this section, however, is that the bargaining disruption policy might generate incentives for dishonest public o¢ cials to extort law abiding individuals by threatening to charge them the penalty f even when all regulations have been followed. In Section 3, the model is modi…ed to account for this possibility.
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An economy with corruption and extortion
In an economy with corruption and extortion, corrupt o¢ cials ask all individuals to pay a bribe
or take the penalty f ; regardless of whether the individuals have followed the
regulations and the penalty is unjusti…ed3 .
It is assumed that those individuals who are
victims of extortion cannot overturn the …ne in court. Typical examples of such situations may include alleged tra¢ c violations, noise violations, violations related to the deforestation of protected areas, and other violations for which the o¢ cial’s subjective judgment is unlikely to be overturned in court. This assumption simpli…es the analysis; but all that would be needed here to conduct the analysis without major changes is that the costs of overturning the penalty are greater than those of paying the extortionary bribe. 3
This is certainly a simpli…ed version of extorsion where individuals have no extra-bargaining power if they had followed the regulations. Allowing for di¤erent bribes for law-abiding individuals and infractors, however, should not modify the qualititative results presented afterwards.
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In this economy, the individual’s payo¤s v(1) and v(0) take the following form: v(1) = d[(1
p)(Ri
v(0) = d[(1
p)(Ri
Ri ) + p(Ri f ) + p(Ri
Ri
)] + (1
)] + (1
d)(Ri )
d)(Ri
Ri )
Notice that since the corrupt public o¢ cial’s threat is the same for those who follow the regulations than for those who do not, the amount of the bribe is also the same. As in the previous section, the bribe that solves the Nash-bargaining problem is
=f :
In turn, in an economy with a bargaining disruption policy and no opportunity for mutually bene…cial bribes, the respective payo¤s become: v(1) = d[(1
p)(Ri
v(0) = d[(1
p)(Ri
Ri ) + p(Ri f ) + p(Ri
Ri f )] + (1
f )] + (1
d)(Ri
Ri )
d)(Ri )
For both alternative scenarios (with and without bargaining disruption), it can be shown that the decision of whether to comply with regulations depends on the individual value e of Ri relative to a value R
df (1 p)
.
e will choose to follow the Individuals with Ri < R
e will choose not to follow the regulations under regulations and individuals with Ri > R both payment schemes. Thus, in an economy with corruption and extortion, the level of regulation compliance is unaltered by bargaining disruption policies. Table 2 presents the speci…c measures of regulation compliance and corruption for an economy with extortion. For clarity, the measures of corruption rents and corruption frequency are disaggregated into extortion bribes (paid by law-abiding individuals) and non-
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extortion bribes (paid by infractors). Table 2. Levels of Corruption and Regulation Compliance Without With e e Regulation compliance G(R) G(R) e Corruption Rents (1+2) Ndpf NdpfG(R) e (1) Non-extortion Bribes N dpf [1 G(R)] 0 e e (2) Extortion Bribes N dpf G(R) N dpf G(R) e Corruption Frequency (3+4) Ndp NdpG(R) e (3) Non-extortion Frequency N dp[1 G(R)] 0 e e (4) Extortion Frequency N dpG(R) N dpG(R) e Corruption Incentive nf n(f + e)G(R) As shown in Table 2, corruption frequency is always lower with bargaining disruption policies because all non-extortionary bribes disappear. These policies, however, do not alter the frequency of extortinary bribes. Notice that whenever a law-abiding individual is forced to pay an unjusti…ed fee, this event is recorded as extortion, and the amount paid (f ) is recorded as an extortionary bribe. With respect to the corruption rents and corruption incentive measures, whether these measures decrease when bargaining disruption policies are implemented depends on the e with respect to . Only in those economies where regulation compliance relative size of G(R)
e is low enough to begin with, a bargaining disruption policy yields smaller values for (G(R)) both of these corruption measures.
In this regard, the empirical evidence is mixed. On the one hand, anecdotal evidence of cases where the level of regulation compliance is notoriously low abound.
Friedman
et al.(2000), for example, estimate the share of uno¢ cial economic activities as share of GDP for a series of countries; their estimates are as high as 76% for the case of Nigeria4 . On the other hand, most empirical evidence points to low or very low values of . 4
See Johnson et al (2000) and Schneider and Enste (2000) for two other related studies
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In a
recent World Bank survey conducted in 22 transition economies where extortion is common5 , individual responders were asked to estimate the bribe as a percentage of revenues.
The
average response was between 1% and 2%, same as the median. Thus, in economies with extortion, the e¤ects of bargaining disruption policies on the level of corruption rents and the corruption incentive are ambiguous.
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Conclusions
The results of the model presented here suggest that bargaining disruption policies would e¤ectively eliminate corruption and increase regulation compliance in economies without extortion.
This result coincides with those of previous literature.
When extortion is also
present in the economy, however, the e¤ects of bargaining disruption policies are ambiguous. This paper makes that point with a simple model where corrupt behavior is imposed exogenously. The type of policies studied here, however, could have additional implications for the behavior of public o¢ cials that need to be taken into account for policy design and future research.
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References
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The Business Environment and Enterprise Performance Survey (BEEPS), developed jointly by the World Bank and the European Bank for Reconstruction and Development, is a survey of over 4000 …rms in 22 transition countries conducted in 1999-2000 that examines a wide range of interactions between …rms and the state. For more information on the survey, the BEEPS research project and related papers, follow the link http://www.worldbank.org/wbi/governance/pubs_statecapture/
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