Transcript 2. Definitions and Opportunities

Anticorruption and the Design of Institutions 2012/13
Lecture 4
Market Intervention
and Discretion
Prof. Dr. Johann Graf Lambsdorff
Literature
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 Bandiera, O., A. Prat, and T. Valletti (2009), “Active and Passive Waste in
Government Spending: Evidence from a Policy Experiment,” American
Economic Review, Vol. 99:4, 1278–1308
 Gatti, R. (1997), Corruption and Trade Tariffs, or a Case for Uniform Tariffs,
World Bank policy research working paper No. 2216,
http://siteresources.worldbank.org/INTWBIGOVANTCOR/Resources/wps2216.pdf
 Glaeser, E. and E. Luttmer (2003), The Misallocation of Housing under Rent
Control, American Economic Review,
http://www.nber.org/~luttmer/rentcontrol.pdf
 Kelman, St., (2002), “Remaking Federal Procurement,” The John F.
Kennedy School of Government Working Paper No. 3 (Cambridge, MA).
 Lambsdorff, J. Graf (2009), “The Organization of Anticorruption – Getting
Incentives Right,” in: Corruption, Global Security, and World Order, ed. by
Robert I. Rotberg, (Harvard Kennedy School and the Brookings Institution
Press: Washington, D.C., 2009): 389-415.
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Price Controls
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 The government often interferes into markets. The common justification
provided by economists is related to market failure, for example due to
externalities. In other cases, market outcomes are seen to be unjust and
governments seek to help disadvantaged groups and insure its citizens
against the risks of degradation.
 At the same time, such government activities may open the door to
corruption.
 The welfare effects of this can be investigated by studying state
intervention in otherwise well functioning markets.
 Incentives for corruption can easily be depicted in a graphical analysis.
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Price Controls
Price
of Housing
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Consumer surplus
before maximum price
Supply
Producer surplus
before maximum price
Demand
0
Quantity
of Housing
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Price
of Housing
Consumer surplus
with maximum price
Supply
Dead Weight Loss
Producer surplus
with maximum price
Effective
Maximum
Price
Demand
0
Q1 S
Q1 D
Quantity
of Housing
Excess Demand
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Price
of Housing
Misallocation Costs
Consumer surplus
with maximum price
Supply
Dead Weight Loss
Producer surplus
with maximum price
Effective
Maximum
Price
Demand
0
Q1 S
Q1D
Quantity
of Housing
Excess Demand
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 With demand exceeding supply we are short of a mechanism that
determines which customers are served.
 This produces a misallocation cost. Clients are randomly assigned the
scarce good, rather than according to their willingness to pay.
 As a result, some clients who little value a good (housing in our example)
are served while others with a high preference are disregarded. Glaeser and
Luttmer (2003) find the characteristics of renters in a controlled market such
as New York to differ from those in other markets, revealing misallocation.
 In an economy with free exchange of goods and services this is unlikely to
be the equilibrium.
 Bureaucrats can sell entitlements to the scarce goods!
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Price Controls
Price
of Housing
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Consumer surplus
with maximum price
Supply
+Entitlement
Supply
Income from
Bribery
Dead Weight Loss
Producer surplus
with maximum price
Effective
Maximum
Price
Demand
0
Q1 S
Q1 D
Quantity
of Housing
Excess Demand
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 Corruption is a symptom that something went wrong. The “good” side of
corruption is that the market is cleared, supply and demand are equalized.
 Corruption does not bring equilibrium back to the efficient equilibrium that
would persist without state intervention.
 But misallocation costs are avoided.
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 But whether these “misallocation costs” are a bad thing can be up to
debate. The “willingness to pay” may not be the allocation preferred by
society.
 This criterion disregards concerns related to equality (giving to the needy)
or security (handing out licenses to the qualified).
 A good test whether misallocation costs arise would be by charging an
official fee for the scarce good.
 Selling import licenses to the high bidder will usually be the efficient
strategy. But how about driving licenses to a blind person? How about a job
as a judge to the highest bidder? Or import licenses to those who trade with
poisonous products? This strategy would be rejected due to concerns
related to security or equality.
 In this case, the misallocation costs are dominated by other concerns.
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Quantity Restrictions
Price of
Imported Good
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Consumer surplus
with quantity restriction
Supply
p1D
Dead Weight Loss
Misallocation
Costs
Producer surplus
with quantity restriction
Demand
0
Effective
Quantity
Restriction
Quantity of
Imported Good
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Price of
Imported Good
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Consumer surplus
with maximum price
Supply
p1D
Income from
Bribery
Dead Weight Loss
Producer surplus
with maximum price
p1S
Demand
0
Effective
Quantity
Restriction
Quantity of
Imported Good
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 Producers excessively request the right to import goods. Bureaucrats must
allocate this right.
 Producers are willing to pay for the right to import.
 Bureaucrats can obtain corrupt income.
 Corruption functions as a market mechanism which brings supply and
demand back into balance.
 The welfare loss resulting from a misallocation is avoided with the help of
corruption.
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Wall Street Journal, 15 September 2004
Two Vietnamese officials have been arrested for allegedly forcing companies to pay bribes
to secure textile and garment exports to the U.S., officials and state-controlled media
reported Thursday. Le Van Thang, 50, deputy director of the Ministry of Trade's Import
and Export Department and staff member Bui Hong Minh, 33, were arrested in Hanoi
Wednesday, said Nguyen Thanh Bien, chief administrator at the Trade Ministry.
Thursday's Thanh Nien (Young People) newspaper said police also seized documents
relating to the case from their houses. The two men were flown to southern Ho Chi Minh
City Wednesday night for further police investigations, it said. It was unclear how much
money they allegedly collected in bribes.
The newspaper reported that Thang and Minh required companies to pay bribes to ensure
that textile and garments were included in shipments designated for the U.S. The case
was exposed when some of the companies came forward to police, it said.
Last year, the U.S. imposed quotas of $1.7 billion a year on 38 textile and garment
categories shipped from Vietnam to curb a surge in exports that began after the two
former foes signed a landmark bilateral trade agreement in 2001.
Thang was responsible for selecting the local textile and garment companies to meet the
quotas.
The arrests come at a time when the ruling Communist Party is stepping up efforts to
fight graft . Several senior executives at the state-owned oil and gas monopoly,
PetroVietnam, have been arrested over the past two months.
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One of the biggest cases of systematic corruption also related to market distortions: In the
Iraqi Oil-for-Food program between 1995 and 2003 oil was allowed to be sold only in
exchange for humanitarian goods. The extreme public desire for much needed goods did
not only provide ample opportunities to mark up prices, it also lead to high ranking UN
officials to turn a blind eye to massive corruption. According to an estimate, Saddam
Hussein’s regime was able to collect as much as 1.8 billion US $. From the 4500 private
firms involved in the program close to half were involved in the payment of bribes. One
paradigmatic case relates to a truck being sold by Daimler Chrysler. While the regular
price would have been 130,000 US$, the company charged 143,000 US$ and to passed
on 13,000 US$ to other Iraqi bank accounts. Likewise, oil left the country too cheaply and
kickbacks were paid in exchange. This case well fits standard economic modeling on the
distortionary effects imposed by market restrictions. Such restrictions create opportunities
for systematic corruption. But at the same time, the common economic advice to abolish
market restrictions is far from obvious. The standard economic recipe would be to disallow
the UN Security Council to impose trade restrictions as a way of sanctioning countries –
this is not at all a suggestion that will gain undisputed approval.
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 Due to the risks of corruption governments should not completely correct
for market failure. This is the argument advanced by Acemoglu and Verdier
(AER 2000).
 Government intervention is more costly due to the increased risks of
corruption. Optimal policy would thus involve allowing some market failure to
persist rather than “costly” correcting for all failures.
 For example, empirical evidence from cross sections of countries reveals
that high barriers to market entry are strongly associated with corruption.
There is a higher level of corruption in countries with many procedures
required for starting a new business and much time needed and high official
costs involved. This appears to be an area where government excessively
intervenes and easier market entry appears to be justified.
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 Countries with uniform tariffs are better capable of limiting corruption (Gatti
1997).
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 In order to obtain bribes bureaucrats need discretionary power, the ability
to act or decide according to their own judgment.
 The government may limit discretion by downsizing government itself, less
delegating the task to correct for market failure to its bureaucrats .
 Another option arises if the government can also limit the bureaucrats’
discretionary power. It might then continue with its intervention.
 Discretionary power is particularly strong where rules are vague. This
assigns bureaucrats the sovereignty to interpret and apply rules. Keeping
laws comprehensible and simple is a straightforward recommendation that
will find few opponents.
 Some further organizational methods for limiting discretion have become
prominent:
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 Division of labor
If power is concentrated among one actor this increases discretion. E.g.
in public procurement writing invitation documents, carrying out the
bidding, deciding on the winning bid, executing the contract, inspecting
the procured quality and carrying out financial transactions should be
assigned to different public servants/departments.
 Automatic processes
Instead of leaving decisions to bureaucrats a randomized mechanism
(e.g. with the help of computers) can be employed. Customs checks
might invite for bribes in exchange for being disregarded. Instead, a
computer based system of random checks can be employed (as was
done in Mexico).
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 Complaints mechanisms
Allowing citizens to complain limits the misuse of bureaucratic
discretion. Disadvantaged competitors or extorted citizens have an
incentive to complain. To the extent that investigators are independent
they impede official malfeasance.
 Rotation of staff
Discretionary power may build up over time. Officials learn the rules
quickly and need more time to understand how to circumvent them. For
further reasons in favor of staff rotation see the script to the Economics
of Corruption. Rose-Ackerman (1999) notes, however, that superiors
may obtain discretion when rotating their subordinates.
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The costs of limiting discretion
 There can be costs of limited discretion. Imagine, for example, that a
bureaucrat enjoys discretion when the government employs procedure A but
less so with procedure B. But procedure is the more efficient one. Which
procedure should be preferred?
 To illustrate, tale an example from procurement.
 Procurement officials are mostly required to award contracts to the lowest
bidder. This reduces discretion in judging on quality or experience related to
the past performance of contractors.
 The latter recommendation, however, has produced poor results, (Kelman
2002). Strict rules divert officers away from the actual goal of acquiring bestvalue products and services for the government.
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 Procurement officers observe the performance of contractors over time.
They gather experience with respect to the quality procured in the past. But,
due to fears of biased judgments, procurement guidelines often discourage
the use of this experience.
 Procurement officers’ tasks are limited to awarding to the lowest bidder
and checking whether official specifications are fulfilled. But contractors look
out for incomplete specifications and similar loopholes as a method for
making extra profits. In an attempt to avoid this, the bid inviter and the
procurement officials are supposed to add more detailed specifications.
Take the example of a 26-page description for cookies procured by the US
army. This increasing burden of specifications acts as a deterrent to bidders
and suffocates competition.
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 Procurement officials are often prohibited to carry out pre-bid talks, as
these may allow for collusion. But this limitation disallows them to profit from
contractors experience with respect to current prices and available qualities.
 We can thus conclude that policymakers must find a balance between the
reducing corruption and the avoidance of inefficiencies. The former may
have dominated lately.
 In a field study Bandiera, Prat and Valletti (AER 2009) investigate these
inefficiencies (called passive waste) for Italy and assess their magnitude
relative to corruption (called active waste).
 They investigate purchases of 21 generic goods, such as printers and
gasoline, by 208 Italian public bodies between 2000 and 2005. These
bodies can purchase generic goods through two channels: either on their
own or through a central procurement agency (Consip), which establishes
agreements with suppliers of generic goods which commit to selling a
specified product at given price to any Italian public body.
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 When a Consip agreement is not active, the price increases with active
waste and passive waste.
 When Consip is available, the willingness to employ this mechanism is a
decreasing function of active waste (because it does not allow for bribery),
but an increasing function of passive waste (because it avoids the
inefficiency that result from own procurement efforts).
 The existence of Consip thus serves as an instrument that helps
disentangle active and passive waste.
 The authors conclude that on average, at least 82 percent of estimated
waste is passive (1279): “Fighting this kind of passive waste requires giving
public officials more discretion, not less.” and (1305) “… our results about
the importance of passive waste also indicate that economists should not
limit their attention to active waste: they should view sheer inefficiency as a
problem which is potentially even more important than corruption.”
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Appendix
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Discussions:
1) Policy intervention tends to lead to misallocation costs. Why? Are these
always detrimental to welfare?
2) Imagine a country imposing a minimum price on agricultural products so
as to protect the income of farmers. Use a graphical illustration to describe
why this may result in misallocation costs and subsequently in corruption.
3) Why may governments abstain from correcting for market failures?
4) What are the methods available to governments to reduce discretion?
5) What can be the costs of reducing discretion?
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