Transcript L3. Competition and Lobbying - uni

Anticorruption and the Design of Institutions 2010/11
Lecture 6
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):
9-26.
 Shleifer, A. and R.W. Vishny (1993), ”Corruption.” Quarterly Journal
of Economics, Vol. 108: 599–617.
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.
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.
Bureaucratic Competition
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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.
Bureaucratic Competition
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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.
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.
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
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.
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
bribe-taking among lower levels in the public service.
Political Competition
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Parker and Hart,
December 8, 2001
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.
Political Competition
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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.
Competitive Lobbying
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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
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
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).
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
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
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
Competitive Lobbying
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x
R/4
0
1
2
3
4
5
6
7
8
9
10
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
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.
Competitive Lobbying
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.
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 rentseeking expenses.
 Public servants’ will create rents (R) when they are induced to do so
— primarily by bribes.
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 rent-seeking activities.
 As opposed to lobbying, corruption is more forceful in motivating
distorting rents.
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 is often wrong.
Competitive Lobbying
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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.
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.
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?
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.
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 rentseeking theory?
7) What are the pros and cons of independent courts and political veto
powers?
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 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?