lecture 6 competition and lobbying prof. dr. johann graf lambsdorff anticorruption and the design of...

Lecture 6

Competition and Lobbying

Prof. Dr. Johann Graf Lambsdorff

Anticorruption and the Design of Institutions 2010/11

ADI 2010/11

Lambsdorff, J. Graf (2007), The New Institutional Economics of

Corruption and Reform: Theory, Evidence and Policy. Cambridge

University Press: 109-135.

Rose-Ackerman, S. (1999), Corruption and Government. Causes,

Consequences and Reform, (Cambridge: Cambridge University Press):

9-26.

Shleifer, A. and R.W. Vishny (1993), ”Corruption.” Quarterly Journal

of Economics, Vol. 108: 599–617.

Literature

ADI 2010/11

One of the inspiring economic principles is that of competition.

Competition is assumed to act like an invisible hand, allowing for

public welfare to prosper in the absence of individuals’ social

mindedness.

Can competition also help fighting corruption and limiting the

resulting welfare losses?

Unfortunately, the answer is less straightforward.

We will consecutively investigate competition among bureaucrats,

politicians and private firms.

Bureaucratic Competition

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Misusing ones office as a maximizing unit is particularly troublesome

when bureaucrats are in a monopoly position.

Competition between bureaucrats might drive down bribes and bring

the outcome closer to the initial equilibrium.

Departments could be given the right to issue licenses and permits

also in areas that belong (geographically or functionally) to other

departments. Their jurisdiction would overlap. This suggestion has

thus been labeled “overlapping jurisdiction”.

This solution appears attractive when bureaucrats extort payments in

exchange for licenses and permits. Payments for extortion would be

reduced to zero.


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But it fails in many other areas of the public sector:

In public procurement contracts can be awarded only once. There is

a natural monopoly in the awarding of a contract and the principle is of

no use.

Whenever corruption involves also the defrauding of the state (e.g.

tax collectors underreporting due taxes in exchange for a bribe),

competition would ensure that the most fraudulent bureaucrats are

preferred by customers.

Whenever truthful inspection of application requirements is needed,

competition would no longer ensure that the best qualified

bureaucrats are selected by clients.

Similar problems are observed with regulators and inspectors: a race

towards the lowest standards may arise.


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An approach of “overlapping

jurisdictions” would effectively decrease

bribes in areas where bureaucrats

formerly extorted businesspeople.

But the concept runs counter to other

legitimate tasks of the bureaucracy such

as tax collection, inspection and

regulation.

Hints for Reform


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Some economic models assume benevolence among policymakers.

This assumption is sometimes overemphasized.

Politicians may not be primarily motivated by productive efficiency

or the public interest.

How does competition affect the goals pursued by politicians?

Competition for votes is commonly seen to reduce corruption.

This effect is parallel to that of the invisible hand in private markets:

even self-seeking politicians must convince voters by effectively

containing corruption among bureaucrats and among their own ranks.

Political Competition

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Competition among politicians thus enables society to get rid of

those performing poorly.

Competition acts as a disciplining device. Politicians fear for their

office when losing votes.

This effect becomes

stronger if votes are

pivotal for staying in

office.

A political leader who

loses or wins anyways

is little disciplined by

elections.


vote

income

50%

A politician‘s indifference curve

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However, this effect can be undermined by various forces:

1. Promises to reduce corruption may not be credible.

Crucial for sound competition is not the amount of political parties, because these might be founded ad hoc and may be unable to make credible commitments.

Crucial is also whether political parties have a long-standing tradition that keeps them from disappointing their voters.

2. A politician can share his corrupt income with influential actors (media, trade union leaders, senior bureaucrats) whose recommendation is estimated by voters. Honest politicians have fewer such resources at their disposal and fail to obtain the respective support.

This represents another type of “political corruption”, not aimed at generating income for politicians but subverting the electoral process.


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3. Another downside effect of competition relates to the subordinates

(agents) of politicians (the principal).

Agents may obtain bargaining power when they can choose

between different principals, politicians who are standing for

election.

Competition may weaken politician’s control over agents (e.g.

departments, regulation authorities).

In return for political support politicians may turn a blind eye to

bribe-taking among lower levels in the public service.


ADI 2010/11Political Competition

Parker and Hart,December 8, 2001

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Empirical results from a cross-section of countries reveal that

democracy and levels of corruption do not correlate well, once

regressions are controlled for income.

Only those democracies that are in place for decades exhibit

systematically lower levels of corruption.

Investigating non-linear influences is revealing. An ambiguous

impact is obtained for countries scoring between 7 and 2 in the

Freedom House index. Only the good score of 1 brings about

decreased corruption.

Higher participation in general election is important for containing

corruption.

Fighting corruption by introducing political freedom is possible, but

it is a thorny road where in transition corruption may even increase.


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Political competition can in the long run

lower levels of corruption.

Political parties and candidates must

establish long-term oriented programs

that can be identified by voters and must

seek ways to commit to their

announcements.

Clear rules on party and election finance

appear indispensable for democratic

systems to reduce political corruption.

Hints for Reform


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Public servants have ample opportunities to sell preferential

treatment to private parties. They can protect firms by hindering

competition, impose import quotas or tariffs, grant tax privileges,

give subsidies, award profitable contracts, privatize industries.

These activities are valuable to private parties. We call the

associated value “rent”: a surplus that accrues to a firm beyond

what would be needed to maintain a resource’s current service flow.

Once rents are created private firms attempt to get hold of them.

They compete with the help of lobbying and corruption.

This type of “rent-seeking” differs from (normal microeconomic)

“profit-seeking” where investments into production bring about

profit only if someone else is better off buying a superior product.

Competitive Lobbying

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Wizard of ID, Parker and Hart, March 9, 2000


ADI 2010/11Competitive Lobbying

Price

0 Quantity

Supply= Marginal

Costs

Demand

Q1S

Dead Weight Loss

Consumer surpluswith maximum price

Rent

Marginal Revenue

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Only one out of n firms can win the competition for a monopolistic position created by the state, worth an exogenously given value R. The probability for winning the competition (pi) is proportional to a firm's

investments into rent-seeking (xi). A single firms'

probability decreases with the investments undertaken by its competitors (xj). Expenses for rent-seeking have no

value to any of the firms or the state.

jj

ii

x

xp , i, j = 1, ..., n

Firms are risk-neutral, face identical (profit and probability) functions and are unable to influence their competitors' level of rent-seeking xj. They maximize the expected profit, E(piR-xi).


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01)(

2

j

i

ji

ij

i

i

ii

x

Rx

x

R

dx

xx

Rxd

dx

xRpd

The first order condition is:

Introducing symmetry, xi=xj=x. This brings about the

Cournot-Nash-equilibrium:

Rn

nxxnRnR

xn

Rx

nx

R2

222

11


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Symmetry (xi=xj=x) brings about:

.

)()(01 22

jji

jiiji

ji

i

ji

xRxx

xxRxRxxxx

Rx

xx

R

.04

4 2 xR

xxRxxxRx

In the case of two players, the first order condition simplifies and the following reaction function is obtained:


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Figure 1: Rent-seeking with two players

xj

0

xi

xj=xj(xi)

xi=xi(xj)

R/4

R/4

R


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0 1 2 3 4 5 6 7 8 9 10

Total expenses (S) for rent-seeking then sum up to: Rn

nnxS

1

x

0 1 2 3 4 5 6 7 8 9 10

S

R/4

R


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What are the consequences for welfare?

The creation of rents not only distorts private markets, leading to

inefficient outcomes (for example due to monopolistic dominance).

There are additional costs because firms pay for bribes and

lobbying. They devote resources without creating a social surplus.

Devoting resources that fail to create social surplus immediately

produce welfare losses – let us call them “waste”.

Waste only arises in case of competition.

Waste increases with the number of competitors.

In case of lacking competition the monopolist can be sure to obtain

the rent and will not expend these resources.


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If you two behave like this while sharing every item, I'm going to unilaterally decide which state should have what!

Laxman, Times of India,

December 7, 2000


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Corruption versus lobbying – what is the difference?

Public decisions are for sale in both cases, but:

As opposed to lobbying, corruption is intransparent and entails

little competition.

Politicians profit from corrupt payments (bribes) but not from

lobbying, which may entail harassment instead.

Bribes are thus a mere transfer. Only lobbying is wasteful.

The conclusion by rent-seeking theory is most unusual: Corruption

is better than lobbying because it entails little competition and

resources are not wasted but merely transferred to politicians.


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One key shortcoming of the model: Rent-seeking theory provides

no adequate description for the causes of policy distortions and the

creation of rents.

Rent-seeking theory fails to observe that corruption can cause the

creation of rents.

Politicians will weight the welfare losses of the rent R against

political benefits from imposing the relevant market restrictions.

Thus, is competition really bad?

Not necessarily when the size of rents is itself a function of rent-

seeking expenses.

Public servants’ will create rents (R) when they are induced to do so

— primarily by bribes.


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The positive impact of rent-seeking expenses (S) on the rent (R) will

be felt more when few competitors exist. For competing firms the

overall size of the rent is a public good which they will hardly lobby

for.

For a monopolist the total rent is not a public good but his own

private good. A monopolist may thus be willing to devote resources

to rent-seeking activities.

As opposed to lobbying, corruption is more forceful in motivating

distorting rents.


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Finally, lobbies represent “broader” interests while corruptors

represent only their own interest. A rent created for broad interests

will have more difficulties organizing a joint willingness to pay.

Such rents are thus less likely to be generated with a corrupt

intention.

Overall, lobbying is more transparent and includes broader

segments of society. It can represent a form of participation where

not narrow defined interests are exchanged but responsibility for

broader interests emerges.

The idea that corruption is better than lobbying is often wrong.


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Lobbies have an interest in reducing the

disorganized bribery by their members.

Lobbies can help in ordering

communication between business and

politics.

The behavior of all lobbies might be

further improved by registration,

accountability and codes of conduct for

lobbies and their representatives.

Hindering lobbyism may backfire.

Hints for Reform


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Lobbies face organizational difficulties: they strive to obtain a rent

for a whole sector, even if the individual firms do not contribute to

the functioning of the lobby.

Members face a prisoner’s dilemma, which may hinder the

foundation and functioning of a lobby.

Is this good or bad?

Some researchers argue that this is good, because lobbies

intervene in otherwise undistorted decisions.

I would argue that it is bad, because lobbies balance the various

interests of their members to form broader interest that are pursued

transparently; only those striving for narrow interests will survive if

lobbies are hindered.


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Independent courts and Presidents with veto power restrict the

parliament’s capacity to “sell” laws.

Courts have discretionary power in interpreting law; courts check

the consistency of laws against older legislation and the

constitution, setting preferences in case of conflict; courts have the

power to reject the enforcement of new laws.

In case of a veto power, two parties must be paid for passing

favorable laws.

Both institutions introduce continuity in the otherwise unbound and

potentially arbitrary laws enacted by parliament.

Are veto powers helpful in containing corruption?


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Some would argue that this is bad, because the value of rents

increases. Laws, once passed, assign long-term income streams to

those who were able to influence legislation in their favor. The

judiciary helps to enforce the 'deals' made by effective interest

groups with earlier legislatures.

I would argue, instead, that this is good. Laws that are valid over a

longer period will be fought for by larger lobbies which promote

broader interests. Quickly changing laws and ad hoc decisions are

lobbied for by those striving for narrow interests.

Still, the overall judgment on the usefulness of veto powers is more

complex, in particular, because there might be intransparent

collusion among veto powers.


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Discussions

1) What is the concept of “overlapping jurisdictions”? Where may it

help in reducing corruption, where not?

2) Does competition for political positions increase or decrease

corruption? Explain the diverging positions!

3) What is rent-seeking as opposed to profit-seeking?

4) What determines the extent of “waste”?

5) Why is competition regarded to be harmful by rent-seeking theory?

6) Why is competition for rents not as bad as suggested by rent-

seeking theory?

7) What are the pros and cons of independent courts and political veto

powers?

Appendix

ADI 2010/11

Exercise Three firms compete for a monopoly license for gambling. The total rent is US$ 180 Mio. a) One firm assumes that each of its competitors will spend US $ 10 Mio. for bribes and lobbying. Determine its optimum probability to win the contest, assuming that its probability to win the contest is proportional to its own rent-seeking expenses, divided by all firms’ expenses!b) If all firms expect their competitors to optimize their rent-seeking expenses (Cournot-Nash solution), how much will each spend for this purpose? c) Rent-Seeking theory concludes total rent-seeking expenses increase with the number of firms. What is the economic reason for this conclusion? d) Why may this relationship not arise in reality?

Appendix

lecture 6 competition and lobbying prof. dr. johann graf lambsdorff anticorruption and the design of...

Documents

fraudulent bureaucrats

literature slide

public welfare

best qualified bureaucrats

public sector

cambridge university

public procurement contracts

invisible hand