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Lecture 4
The Maximizing Bureaucrat
Prof. Dr. Johann Graf Lambsdorff
Anticorruption and the Design of Institutions 2008/09
ADI 2008/09
Lambsdorff, J. Graf (2007), The New Institutional Economics of
Corruption and Reform: Theory, Evidence and Policy. Cambridge
University Press: 58-80.
Literature
ADI 2008/09
Where market distortions exist, public servants seek to make rules
vague and complex so that they are provided with bureaucratic
discretion.
Once market distortion and bureaucratic discretion go hand in hand,
reform becomes a daunting task.
Those who profit from corruption will oppose reform.
Corruption would not be the result of inefficient regulation but its
cause.
The Request for Bad Regulation
ADI 2008/09
Public servants have an incentive to keep inefficient regulation.
They will oppose attempts to get rid of regulation.
Regulation may even be initiated with the purpose of creating corrupt
income.
Corruption and market restrictions can be two sides of the same
coin.
In this case the causality is reversed: Prospects of corrupt income
can be responsible for the creation of inefficient regulation.
A corrupt civil servant then regards his public office as a business,
the income of which he will seek to maximize.
The Request for Bad Regulation
ADI 2008/09
In return for the exclusive right to import gold, a private
businessperson offered bribes to the Pakistani government. In 1994
the payment of US $ 10 million on behalf of Ms Bhutto's husband was
arranged and a license to be the country's sole authorized gold
importer was granted.
The Abacha family was behind the operations of the firm of Delta
Prospectors Ltd., which mines barite, an essential material for oil
production. Shortly after Delta's operations had reached full
production, General Abacha banned the import of barite, turning the
company into a monopoly provider.
The Request for Bad Regulation
ADI 2008/09
Allegations concerning a son of the minister of the interior in Saudi
Arabia: he established a chain of body shops for car repairs.
Afterwards he engaged his father to obtain a decree by the king,
imposing a requirement for the annual inspection of all 5 million cars
registered in Saudi Arabia.
Twin currency system in South Africa was officially aimed at
providing foreign currency to investors. But the parliamentary
commission entitled to distribute the cheaper currencies was said to
request favors in exchange. Abolishing this system was long impeded
by the commission's influence on parliament.
The Request for Bad Regulation
ADI 2008/09
The Vicious Circle
The Request for Bad Regulation
Low quality of instutions; bureaucratic
discretion; improper government intervention
Corruption
ADI 2008/09
Myrdal [1956: 283]:
”In many underdeveloped countries ... the damaging effect [of
quantitative controls] have been serious. The system tends easily to
create cancerous tumors of partiality and corruption in the very center
of the administration, where the sickness is continuously nurtured by
the favors distributed and the grafts realized. Industrialists and
businessmen are tempted to go in for shady deals instead of steady
regular business. Individuals who might have performed useful tasks
in the economic development of their country become idle hangers-on,
watching for loopholes in the decrees and dishonesty in their
implementation.”
The Request for Bad Regulation
ADI 2008/09The Maximizing Bureaucrat
Supply
Demand
Price of Imported Good
Quantity ofImported Good
Demand for Entitlements
Quantity ofEntitlements
Bribe
Ma
xim
um
br ib
eM
ax
imu
m b
r ibe
Marginal Revenues of Monopolistic Bureaucrat
Optimum Quantity
Optimum Bribe
Quantity Restriction or
Maximum Price
Minimum Price or
ADI 2008/09
The bureaucrats and politicians who are helpful in circumventing
regulation may be the same who fight for their endurance or put them
in place.
Corruption can therefore be worse than distorting state intervention
into markets.
It cuts red tape but brings about even larger inefficiencies.
Only in the case of very large pre-existing distortions there is a net
benefit from corruption.
Casual arguments that corruption can be beneficial relate to a rare
incidence: the existence of government intervention that is totally
irrational.
The Maximizing Bureaucrat
ADI 2008/09
The case of beneficial corruption
The Maximizing Bureaucrat
Effective Maximum
Price
Price of Housing
0 Quantity of Housing
Supply
Demand
Q1D
Excess Demand
Q1S
Income from Bribery
Supply+Entitlement
Maximum Bribe Income
ADI 2008/09
Look, I want to announce
some rigid rules and
regulations — so that I may
liberalise them to give relief
to the people!
Laxman,
Times of India
The Maximizing Bureaucrat
ADI 2008/09
After more than 12 years of doing research on corruption the cases
of beneficial corruption I collected are extremely rare.
A prison warden in Nigeria took bribes for passing on a prisoner’s
letter to the international media, describing the inhuman treatment. He
was detained and his further fate not reported.
The movie “Schindler’s list” well illustrates another case: freeing
Jews from Nazi camps sometimes involved the payment of bribes.
These rare cases have been given too much attention by academia
and business.
These cases may be as numerous as cases of beneficial murder –
too little to adjust the law.
The Maximizing Bureaucrat
ADI 2008/09
The principal-agent approach provides an alternative concept of the
adverse welfare effects of corruption.
Fighting corruption can be costly.
The principal must devote resources to the fight against corruption.
There are expenses for detection, enforcement and incentives.
If these costs become too large, a certain level of corruption
becomes unavoidable.
This calculus can be graphically illustrated.
A Principal Agent Approach
ADI 2008/09
Marginal costs of removing corruption are higher where there is little
corruption. This might be due to increased difficulty of detection.
Marginal costs of corruption might have any slope, positive or
negative.
A Principal Agent Approach
Marginal social costs
0 Quantity of Corruption
Marginal cost of
corruption
Marginal cost of removing corruption
Optimum quantity of corruption
Optimum social costs of
corruption
Additional social costs of
eradicatingcorruption
ADI 2008/09
With corruption at an optimum level, should we stop worrying?
No, there are still welfare losses. The principal is in charge of
delegating a task to the agent and may decide against this.
If costs of corruption are too large, they make the whole delegation
unprofitable to the principal. The principal will thus prefer to cancel
the whole project.
Both principal and agent suffer if the optimum level of corruption is
too large.
Corruption implies that potentially beneficial contracts are no longer
tenable.
Those contracts that require honesty and the absence of corruption
will not be sealed when the principal faces an agent who will take
advantage of the arising opportunities.
A Principal Agent Approach
ADI 2008/09
When agents cannot credibly promise to reject side-payments from
clients, they are not trustworthy when writing contracts that require
the absence of such payments. Principals will be reluctant to offer
such contracts in the first place.
An illustrative example on this is provided by Bates [1981]. He argues
that in Sub-Saharan Africa peasant farmers avoided corruption by
taking refuge in subsistence production. They simply avoided
exchange with those who might extort them. The welfare enhancing
profits from a division of labor could not be achieved because farmers
had no guarantee that they would not be cheated.
It may be worthwhile to construct good-quality roads. But principals
may choose to cancel the project if bad quality is expected to result
from unavoidable collusive behavior.
A Principal Agent Approach
ADI 2008/09
A fair and efficient tax system is desirable. If tax collectors cannot be
kept from taking bribes such a system may fall into disfavor and be
terminated by the principal.
The citizenry prefers to vote against tax hikes because
administration and politics cannot be kept from embezzlement.
Supervisors may be unable to guarantee honest reports that are not
influenced by bribes. Their contribution loses value for the principal
and they may not be hired in the first place.
Ultimately, those agents who are willing to take bribes must bear the
burden of the drop in welfare.
Only those jobs survive for the agents where profits for the principal
are huge and where social losses due to corruption small.
A Principal Agent Approach
ADI 2008/09
Source: The Wizard of ID, Parker and Hart, April 9 2000
A Principal Agent Approach
ADI 2008/09
In this perspective, the maximizing bureaucrat is no longer
maximizing.
His actions can be anticipated; his superior (the principal) has no
reason to trust in his loyalty.
The bureaucrat (the agent) will not be hired in the first place.
Any new agent must resist the temptation provided by their
discretionary power.
If an agent can commit to honesty, he will be preferred and given the
job.
Commitment to such a mechanism provides agents with a
competitive advantage.
A Principal Agent Approach
ADI 2008/09
Bureaucrats want to resist temptation. They need help in this desire,
just as anonymous alcoholics need their peer group to support their
integrity. Reform may find support among the bureaucracy, even if it
cuts down on the capacity to take bribes.
We have allies everywhere in the fight against corruption. There is
honest willingness to contain corruption, except among those who
have not adequately thought about the problem.
Some economist’s have suggested that corruption is just as natural
as self-seeking. I suggest the opposite: the quest for integrity is part of
human nature.
A Principal Agent Approach
ADI 2008/09
Even those bureaucrats who are willing
to take bribes have an intrinsic motivation
to commit to honesty. They seek methods
for guaranteeing the absence of
corruption in order to be hired in the first
place.
Anticorruption can cultivate
bureaucrat’s willingness to commit to
honesty by advancing professional ethics
and anticorruption networks.
Ideas for anticorruption need not be
sought by the government, they may be
implemented by bureaucrats themselves.
Hints for Reform
A Principal Agent Approach
ADI 2008/09
Countries with a large public sector (contrary to some economists’
belief) are not characterized by more corruption. Thus, it is not the size
of government that counts. This is largely due to the fact that overall
revenues decline with corruption.
How can declining public revenues in corrupt countries be
explained? This may be due to the rational just developed. Citizens
(the principal) prefer tax cuts where bureaucrats (the agents) fail in
committing to honesty.
A Principal Agent Approach
ADI 2008/09
Discussions:
1) How does bureaucratic discretion affect the behavior of public
servants?
2) On June 20, 2001, Reuters ran the following news: …Argentina now has
two exchange rates -- one for domestic transactions that Argentines will use
when they buy groceries or pay rent where one peso equals one dollar, and
another for trade that applies only to exporters and importers. Under this new
system, for instance, a grain exporter would receive 1.0748 pesos for every dollar
sold abroad, raising the grain exporter's revenues and making his goods more
competitive in markets like Brazil and Europe. But experts say the measure --
which amounts to a 7 percent subsidy for exports and a tax on imports -- is a
form of capital control that creates massive opportunities for corruption.
Explain why this system may invite for corruption!
3) How does a regulated market compare to one where public servants
maximize income from corruption?
4) Explain why corruption may be a cause of market distortions!
5) Why may a maximizing bureaucrat fail to maximize? Explain by use
of a principal-agent approach!
Appendix
ADI 2008/09
Exercise:
The market for import of gold is characterized by customer’s
willingness to pay: p=40-2x and the suppliers’ cost function K=x2.
Assume perfect competition. The market is restricted and bureaucrats
are able to sell entitlements to import, charging a fixed fee (b) relative to
the quantity imported.
a) The bureaucrats provide entitlements for free. Determine the
resulting amount of imports (x)!
b) The bureaucrats determine b so as to maximize their revenue. Show
that imports as determined in a) drop to half the original amount.
c) Show for a more general cost function K=a+fx2 that the fee (b) is
independent of marginal costs. Interpret this outcome economically!
Appendix
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