Lecture 4 Corruption and Market Intervention Prof. Dr. Johann Graf Lambsdorff Anticorruption and the...
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Transcript of Lecture 4 Corruption and Market Intervention Prof. Dr. Johann Graf Lambsdorff Anticorruption and the...
Lecture 4
Corruption and Market Intervention
Prof. Dr. Johann Graf Lambsdorff
Anticorruption and the Design of Institutions 2010/11
ADI 2010/11
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
Lambsdorff, J. Graf (2007), The New Institutional Economics of
Corruption and Reform: Theory, Evidence and Policy. Cambridge
University Press: 1-26.
Literature
ADI 2010/11Red Tape
ADI 2010/11
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
ADI 2010/11
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.
Red Tape
ADI 2010/11Price Controls
Priceof Housing
0 Quantityof Housing
Supply
Demand
Consumer surplusbefore maximum price
Producer surplusbefore maximum price
ADI 2010/11Price Controls
Effective Maximum
Price
Priceof Housing
0 Quantityof Housing
Supply
Demand
Q1D
Excess Demand
Q1S
Dead Weight Loss
Consumer surpluswith maximum price
Producer surpluswith maximum price
ADI 2010/11Price Controls
Consumer surpluswith maximum price
Effective Maximum
Price
Priceof Housing
0 Quantityof Housing
Supply
Demand
Q1D
Excess Demand
Q1S
Dead Weight Loss
Producer surpluswith maximum price
Demand
Misallocation Costs
ADI 2010/11
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 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!
Price Controls
ADI 2010/11Price Controls
Effective Maximum
Price
Priceof Housing
0 Quantityof Housing
Supply
Demand
Q1D
Excess Demand
Q1S
Dead Weight Loss
Consumer surpluswith maximum price
Producer surpluswith maximum price
Income from Bribery
Supply+Entitlement
ADI 2010/11
“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
ADI 2010/11
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.
Price Controls
ADI 2010/11Quantity Restrictions
Producer surpluswith quantity restriction
Effective Quantity
Restriction
Price of Imported Good
0 Quantity ofImported Good
Supply
Demand
p1D
Dead Weight Loss
Consumer surpluswith quantity restriction
ADI 2010/11Quantity Restrictions
0
Supply
Demand
Dead Weight Loss
Consumer surpluswith maximum price
Producer surpluswith maximum price
Income from Bribery
Price of Imported Good
Quantity ofImported Good
Effective Quantity
Restriction
p1S
p1D
ADI 2010/11
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
ADI 2010/11
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.
Quantity Restrictions
ADI 2010/11
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
ADI 2010/11
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.
Hints for Reform
Quantity Restrictions
ADI 2010/11
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.
Quantity Restrictions
ADI 2010/11
Countries with uniform tariffs are better capable of limiting
corruption (Gatti 1997).
Discretionary Power
ADI 2010/11
In order to obtain bribes bureaucrats need discretionary power, the
ability to act or decide according to their own judgment.
To the contrary, where bureaucrats must abide by clear rules they
have little to sell.
Discretionary power is particularly strong where rules are vague.
This assigns bureaucrats the sovereignty to interpret and apply rules.
Empirical Evidence from a cross-section of countries reveals that
vague rules are associated with corruption.
For example, subsidies for housing may be designated for the needy,
but certification of the requirements may be sold to unqualified if
bureaucrats have discretion to determine qualification.
Taxes on fine counts of yarn were higher than those on inferior
quality in Pakistan. Bureaucrats took bribes and misused their
discretionary power to record the production of fine counts as coarse.
Discretionary Power
ADI 2010/11Discretionary Power
ADI 2010/11
Discretion is on the one hand an unavoidable part of public
administration: Someone must make the decision. Limiting
bureaucratic discretion by increasing political discretion is not a
convincing approach.
Total discretionary power can be amplified by market restrictions and
badly designed government intervention.
But bureaucratic discretion can also be reduced by help of
organizational features.
Public decision-making commonly involves many actors: heads of
state, cabinet, parliament, local government, bidders, tender board,
auditors, technical experts, … Each actor acts as a balance to the
power of others.
If power is concentrated among one actor, this increases discretion.
Discretionary Power
ADI 2010/11
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).
Hints for Reform
Discretionary Power
ADI 2010/11
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.
Hints for Reform
Discretionary Power
ADI 2010/11
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
ADI 2010/11
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 job-
site 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
ADI 2010/11
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?
Appendix