Transcript L1. Corruption and Market Intervention

Anticorruption and the Design of Institutions 2008/09
Lecture 3
Corruption and
Market Intervention
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: 1-26.
Red Tape
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Red Tape
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 A study of corruption should start with identifying preconditions
which favor corruption.
 Corruption can result from inefficient rules and state intervention.
 We have to distinguish between affluent laws/regulations and red
tape:
– Affluent laws: Immense amount of regulations, laws etc.
Mostly unknown to bureaucrats, judges and private parties;
not enforced; not applied; contradictory
–
Red tape: regulations that are enforced (or threatened to be
enforced). They are communicated and applied.
Red Tape
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 Red tape often arises when the government unduly interferes with
market forces.
 Informal methods are sought to better arrange the delivery of
bureaucratic permits and licenses.
 Such informal methods open the door to corruption.
 The welfare effects of this can be investigated by studying the effects
of state intervention in otherwise well functioning markets.
 Incentives for corruption can easily be depicted in a graphical
analysis.
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
Price Controls
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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
Excess Demand
Quantity
of Housing
Price Controls
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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
Excess Demand
Quantity
of Housing
Price Controls
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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.
 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!
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
Excess Demand
Quantity
of Housing
Price Controls
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 “Inefficient regulation” represents an effective means of generating
corrupt income for public servants.
 Corruption is a symptom that something went wrong.
 Corruption is a mechanism that allocates scarce goods according to
customers willingness to pay.
 Corruption can equate supply and demand.
 The new equilibrium is not the efficient old equilibrium without state
intervention.
 Misallocation costs are diminished.
Price Controls
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 But these findings of the model are valid only in few instances.
“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.
Quantity Restrictions
Price of
Imported Good
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Consumer surplus
with quantity restriction
Supply
p1D
Dead Weight Loss
Producer surplus
with quantity restriction
Demand
0
Effective
Quantity
Restriction
Quantity of
Imported Good
Quantity Restrictions
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
Quantity Restrictions
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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.
Quantity Restrictions
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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 statecontrolled 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.
Quantity Restrictions
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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.
Quantity Restrictions
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 Fighting corruption must embrace its
causes.
 Corruption arises where government
intervention is in conflict with market
forces.
 Quantity restrictions or price ceilings
can create opportunities for corruption;
their potential social benefit must be
evaluated against this drawback.
Quantity Restrictions
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 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.
"The extent to which public procurement is open to foreign bidders"
and "the extent to which there is equal fiscal treatment to all
enterprises" is negatively associated with corruption.
 There is a high correlation between corruption and government
regulation of and involvement in the financial sector.
Discretionary Power
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 In order to obtain bribes bureaucrats need discretionary power.
 Decisions can be sold when bureaucrats have sovereignty with
regard to how rules should be interpreted and applied.
 Subsidies for housing may be available for the needy, but
certification of the requirements may be sold to unqualified.
 Taxes on fine counts of yarn were higher than those on inferior
quality (called coarse) in Pakistan. This lead to the bribing of tax
inspectors to record the production of fine counts as coarse.
Discretionary Power
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Discretionary Power
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 Complaints mechanisms may help in
limiting (extortionate) bureaucratic
discretion.
 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).
Discretionary Power
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 Bureaucratic discretion increases with
the functions a bureaucrat simultaneously
carries out.
 Division of labor limits 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.
Discretionary Power
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 Bureaucratic discretion is on the one hand an unavoidable part of
public administration: Someone must make the decision.
 On the other hand, it can be amplified by market restrictions and
government intervention.
 Finally, organizational features such as a well organized division of
labor may limit the capacity to take bribes.
Appendix
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Discussions:
1) What is the difference between red tape and disregarded rules or
those unknown to bureaucrats?
2) Policy intervention tends to lead to misallocation costs. Why? Are
these always detrimental to welfare?
3) 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.
Appendix
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Case Study
An FBI sting operation videotaped inspectors from the city's
Department of Licenses and Inspections accepting money from
plumbing contractors... For years, one source said, there were tales of
plumbers' offering "tips" to L&I inspectors for a quick approval of jobsite work. L&I has also been dogged by other corruption scandals in
recent years... A standard "tip" was $20, a source said, and it could
grow if a plumber was in a bind of some kind. "A lot of it would occur
when a plumber would need to close an excavation hole where they'd
buried pipe, and it couldn't be closed until an inspector approved it,"
the source said. "So you could stand around with your crew waiting,"
the source said, "or you could page an inspector and get him out there
real quick, and thank him for it.“ ... One government source said that
the payments to inspectors have been suspected for years but that they
were hard to crack since those paying the bribes were happy for the
speedy service. [Philadelphia Daily News, March 14, 2001]
Appendix
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1) What was the plumbers advantage from bribing inspectors?
2) In how far can the incidences of corruption be related to government
regulation?
3) What favors other than speedier delivery might be offered by
inspectors?
4) How would you assess the overall effect of the bribes paid on public
welfare?
5) How would you assess the alternative of abolishing inspections
overall?