Transcript 2. Definitions and Opportunities - uni

Anticorruption and the Design of Institutions 2012/13
Lecture 5
Competition and
Lobbying
Prof. Dr. Johann Graf Lambsdorff
Literature
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 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): 926.
 Shleifer, A. and R.W. Vishny (1993), ”Corruption.” Quarterly Journal of
Economics, Vol. 108: 599–617.
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Bureaucratic Competition
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 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.
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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 been first proposed by
Rose-Ackerman (1978: 137-166) and later 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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Bureaucratic Competition
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 In Germany competition exists between TÜV and DEKRA on certifying car
safety. Similarly between private auditors on certifying bookkeeping.
 Such competition can work properly if inspectors are controlled and run
financial risks if misbehavior is detected.
 But the suggestion fails in other areas of the public sector:
 If misbehaving inspectors cannot be sanctioned competition would ensure
that the most fraudulent bureaucrats are preferred by customers. For
example, when tax collectors underreport due taxes in exchange for a bribe
there might not be an independent authority that might detect the
malfeasance.
 In public procurement contracts can be awarded only once. There is a
natural monopoly in the awarding of a contract and “overlapping jurisdiction”
is not applicable.
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Political Competition
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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.
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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.
vote
A politician‘s
indifference
curve
50%
 A political leader who
loses or wins anyways
is little disciplined by
elections.
income
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Political Competition
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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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Political Competition
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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 bribetaking among lower levels in the public service.
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Political Competition
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Parker and Hart,
December 8, 2001
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Political Competition
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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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Competitive Lobbying
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 Politicians have ample opportunities to sell preferential treatment to
private parties. They can protect markets 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) “profitseeking” where investments into production bring about profit only if
someone else is better off buying a superior product.
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Competitive Lobbying
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Wizard of ID,
Parker and Hart,
March 9, 2000
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Competitive Lobbying
Price
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Consumer surplus
with maximum price
Rent
Supply=
Marginal
Costs
Dead Weight Loss
Marginal
Revenue
0
Q1S
Demand
Quantity
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Competitive Lobbying
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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.
xi
pi 
 xj
, i, j = 1, ..., n
j
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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Competitive Lobbying
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The first order condition is:
 Rxi

d
 xi 
x

d ( pi R  xi )
Rxi
R
j





1  0
2
dxi
dxi
 x j  x j 
Introducing symmetry, xi=xj=x. This brings about the Cournot-Nashequilibrium:
R
Rx
n 1
2
 2 2  1  nR  R  n x  x  2 R
nx n x
n
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Competitive Lobbying
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In the case of two players, the first order condition simplifies and the following
reaction function is obtained:
Rxi
R
2


1

0

(
x

x
)
R

Rx

(
x

x
)
i
j
i
i
j
xi  x j xi  x j 2
 xi  x j R  x j .
Symmetry (xi=xj=x) brings about:
R
x  xR  x  4 x  xR  x   x  0.
4
2
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Competitive Lobbying
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Figure 1: Rent-seeking with two players
xj
xi=xi(xj)
R/4
xj=xj(xi)
xi
0
R/4
R
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Competitive Lobbying
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x
R/4
0
1
2
3
4
5
6
7
8
9
10
n
n 1
S  nx 
R
n
Total expenses (S) for rent-seeking then sum up to:
S
R
0
1
2
3
4
5
6
7
8
9
10
n
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Competitive Lobbying
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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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Competitive Lobbying
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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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Competitive Lobbying
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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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Competitive Lobbying
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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 Request for Bad Regulation
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 Office holders have an incentive to maintain the existence of rents and will
oppose attempts to get rid of them.
 Market distortions that give rise to rents may even be initiated with the
purpose of creating corrupt income.
 Corruption and market distortions 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 market distortions and rents.
 An office holder then regards his office as a business, the income of which
he will seek to maximize.
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The Request for Bad Regulation
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 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.
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The Request for Bad Regulation
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 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.
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The Request for Bad Regulation
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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
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Competitive Lobbying
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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 rentseeking activities.
 As opposed to lobbying, corruption is more forceful in motivating
distorting rents.
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Competitive Lobbying
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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 can be misleading.
o Lobbies have an interest in reducing the disorganized bribery by
their members.
o Lobbies can help in ordering communication between business and
politics.
o The behavior of all lobbies might be further improved by registration,
accountability and codes of conduct for lobbies and their
representatives.
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Competitive Lobbying
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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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Competitive Lobbying
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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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Competitive Lobbying
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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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Appendix
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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?
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Appendix
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8) 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.
Discuss how this system may have developed if
a) the government is benevolent,
b) the government is naïve and driven by interests of lobbies,
c) if the government is maximizing!
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Appendix
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 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 rentseeking 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?
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