lecture 4 the maximizing bureaucrat prof. dr. johann graf lambsdorff anticorruption and the design...

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.


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.


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.


ADI 2008/09

The Vicious Circle


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.”


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.


ADI 2008/09

The case of beneficial corruption


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


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.


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.


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.


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.


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.


ADI 2008/09

Source: The Wizard of ID, Parker and Hart, April 9 2000


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.


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.


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


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.


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

lecture 4 the maximizing bureaucrat prof. dr. johann graf lambsdorff anticorruption and the design...

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