Transcript L2. Bureacuratic Discretion

Anticorruption and the Design of Institutions 2009/10
Lecture 5
The Maximizing
Bureaucrat
Prof. Dr. Johann Graf Lambsdorff
Literature
ADI 2009/10
 Lambsdorff, J. Graf (2007), The New Institutional Economics of
Corruption and Reform: Theory, Evidence and Policy. Cambridge
University Press: 58-80.
The Request for Bad Regulation
ADI 2009/10
 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 2009/10
 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 2009/10
 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 2009/10
 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
The Vicious Circle
Low quality of institutions; bureaucratic
discretion; improper government intervention
Corruption
ADI 2009/10
The Request for Bad Regulation
ADI 2009/10
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 Maximizing Bureaucrat
ADI 2009/10
Price of
Imported Good
Minimum
Price or
Quantity
Restriction or
Supply
Maximum
Price
Demand
Bribe
Demand for
Entitlements
Optimum
Bribe
Quantity of
Imported Good
Marginal
Revenues of
Monopolistic
Bureaucrat
Optimum Quantity
Quantity of
Entitlements
The Maximizing Bureaucrat
ADI 2009/10
 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 2009/10
The case of beneficial corruption
Price of
Housing
Supply
+Entitlement
Income
from Bribery
Supply
Maximum
Bribe Income
Effective
Maximum
Price
0 Q S
1
Demand
Q1 D
Excess Demand
Quantity
of Housing
The Maximizing Bureaucrat
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 2009/10
The Maximizing Bureaucrat
ADI 2009/10
 It is not easy to detect actual cases of beneficial corruption.
 Around 1997 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 discuss the law.
A Principal Agent Approach
ADI 2009/10
 The principal-agent approach provides an alternative concept to the
adverse welfare effects of corruption.
 Agents may fail to maximize when being capable of maximizing.
 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.
 The agent will suffer from his own corrupt intention.
 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 2009/10
 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 2009/10
 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 increases for otherwise
useful purposes because administration and politics cannot be kept
from embezzling the funds.
 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 – they are jobless.
A Principal Agent Approach
Source: The Wizard of ID, Parker and Hart, April 9 2000
ADI 2009/10
A Principal Agent Approach
ADI 2009/10
 In this perspective, a bureaucrat who tries to maximize with a
willingness to take bribes fails to maximize.
 His actions can be anticipated; his superior (the principal) has no
reason to trust in his loyalty.
 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 2009/10
 Bureaucrats thus often have an intrinsic motivation 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.
 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 2009/10
 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.
 Bureaucrats can be helped by
committing 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.
A Principal Agent Approach
ADI 2009/10
 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 calculus just developed. Citizens
(the principal) prefer tax cuts where bureaucrats (the agents) fail in
committing to honesty.
Appendix
ADI 2009/10
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! Why may it be
difficult to abolish such a system?
3) How does a regulated market compare to one where public servants
maximize income from corruption?
4) Why may a maximizing bureaucrat fail to maximize? Explain by use
of a principal-agent approach!
Appendix
ADI 2009/10
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!