Corruption and Ethics (2)

7/27/2019 Corruption and Ethics (2)

1/38

ABSTRACTTop of pageINTRODUCTIONTHE SOCIAL COSTS OF BRIBERY: THEORY AND EVIDENCEDETERRING BRIBERY THROUGH THE CRIMINAL LAWCORRUPTION AND ORGANIZATIONAL STRUCTURECONCLUSIONdisclosure statementacknowledgmentsCorruption has serious economic and social costs and can undermine government legitimacy.Economic analysis can help one understand the incentives for bribery and extortion and thedeterrent effect of the law. Such analysis suggests that the law in many jurisdictions ought to beredesigned. Penalties are poorly tied to the marginal benefits of bribery. Small bribes often aremore effectively deterred than larger ones because penalties are not tied to the perpetrators'gains. Economic analysis also highlights the tension between obtaining evidence to bring a caseex post and deterrence ex ante. Furthermore, enforcement programs have not incorporatedbureaucratic structure in a sophisticated way, and in many countries the criminal law onlyapplies to individuals, not firms. In short, economic analysis can help guide the reform debate byproposing workable law enforcement strategies for the control of bribery and extortion.

INTRODUCTIONTop of pageINTRODUCTIONTHE SOCIAL COSTS OF BRIBERY: THEORY AND EVIDENCEDETERRING BRIBERY THROUGH THE CRIMINAL LAWCORRUPTION AND ORGANIZATIONAL STRUCTURECONCLUSIONdisclosure statementacknowledgmentsThe economic analysis of bribery falls into two broad categories. First, economics can help

isolate the underlying factors that produce corrupt incentives, independent of the strength ofbribery laws. Empirical work builds on this theory to produce estimates of the social costs ofcorruption and its impact under a range of conditions. The first section of this reviewsummarizes work in this tradition, both theoretical and empirical. Second, economic principlescan help one assess the laws and policies against bribery to see whether they deter payoffseffectively. The main goal of this review is to summarize and critique research on this secondtopic. Thus, the subsequent section discusses deterrence and argues that the criminal laws ofmost jurisdictions are blunt and ineffective in their efforts to deal with bribery and extortion andwith their accompanying social harms. The final section embeds bribery in an organizationalcontext, both for those who receive and those who pay bribes, and it asks how the law ought totailor deterrence strategies to take account of alternative organizational forms.

THE SOCIAL COSTS OF BRIBERY: THEORY AND EVIDENCE

Top of pageINTRODUCTIONTHE SOCIAL COSTS OF BRIBERY: THEORY AND EVIDENCEDETERRING BRIBERY THROUGH THE CRIMINAL LAWCORRUPTION AND ORGANIZATIONAL STRUCTURECONCLUSIONdisclosure statementacknowledgments


2/38

Private actors frequently make payments to public officials to obtain a benefit or to avoid harm.If these payments are pocketed by the recipient or used for partisan political purposes, mostlegal systems classify some such payments as bribes and can impose criminal penalties onthose who pay and receive them. A few systems, however, treat payers and recipientsdifferently depending on the nature of the benefit.National legal systems differ as to whether business firms or other organizations, as opposed to

individuals, can be guilty of bribery. They also differ in their treatment of payoffs that only involveprivate actors, such as a payment from a salesman to a purchasing agent. In some legalsystems, business firms cannot be guilty of a crime but can be subject to fines, and, in others,commercial bribery is a civil, not a criminal offense.Principal-agent relationships are at the heart of any corrupt transaction. An employee or anotherperson acting as an agent for a government body or a private organization accepts a privatebenefit in return for acting in the payee's interest. The bribe taker may be able to solicit bribessimply by dint of his or her position of authority or may enhance that authority with threats.1Cross-country empirical research demonstrates that corruption is associated with lower levels ofinvestment, productivity, and growth and that corruption discourages both capital inflows andforeign direct investment (Mauro 1995; Wei 2000; Graf Lambsdorff 2007, pp. 7179, 100107).Corruption reduces the effectiveness of industrial policies and encourages business to operate

in the unofficial sector in violation of tax and regulatory laws (Ades & Di Tella 1997, Kaufmann1997). Highly corrupt countries tend to spend less on education, to overinvest in publicinfrastructure, and to have lower levels of environmental quality (Mauro 1998, Esty & Porter2002, Tanzi & Davoodi 2002). Overall, corruption reduces the perceived legitimacy ofdemocratic governments (Anderson & Tverdova 2003, Seligson 2006). Of course, one canquestion the quality of the corruption data as well as the direction of the causal arrow. Doescorruption cause these outcomes or is corruption the result of these underlying conditions? Itseems likely that the causation goes both ways.2Furthermore, macro-level data are not very helpful in designing reform strategies. The socialcosts of corruption differ in different situations (Rose-Ackerman 1978, 1999; Shleifer & Vishny1993). Thus, one needs detailed studies that explore the mechanisms at work in particularsituations. For example, a study of education in Uganda documented how central government

subsidy funds disappeared at the regional level before reaching the village schools. The level oftransfers improved once local parent-teacher associations were given information on fundinglevels. A study of hospital purchasing in Argentina showed how information on the dispersion ofprices across institutions helped rein in corrupt purchasing (these situations are studied inReinikka & Svensson 2004andDi Tella & Schargrodsky 2003; Rose-Ackerman 2004providesadditional references).In doing such analyses, one should distinguish between whether or not the briber is entitled tothe benefit received and whether or not the benefit is scarce. There are four relevant categories:an illegal benefit, a legal but scarce benefit that may be unfairly or inefficiently allocated, a legalbenefit that is not scarce if allocated honestly, and a legal benefit whose corrupt allocation is notinefficient but that generates a wealth transfer.If the benefit provided is illegalfor example, permission to import illegal drugsthe social

harm is the distortion introduced by corrupt payoffs. If the benefit is legal but scarce, the corruptofficial gives preference to bribers over other potential beneficiaries. The social harm is the netcost of allocating by willingness to bribe instead of the stated criteria of the corrupted program.The first two categories might combine in the case of an illegal and scarce benefit. For example,corrupt and budget-constrained police authorities might only arrest those who do not makepayoffs. In the third category, the benefit may be legal and appear scarce only because ofcorrupt public officials. The social cost is then the distortion created by the officials' efforts tocreate scarcity as a way to generate payoffs. Finally, in some cases bribery might have noallocative effects and merely be a transfer from one pocket to another. The only efficiency cost
http://popref%28%27fn1%27%29/http://popref%28%27fn1%27%29/http://popref%28%27fn1%27%29/http://popref%28%27fn2%27%29/http://popref%28%27fn2%27%29/http://popref%28%27fn2%27%29/http://popref%28%27fn2%27%29/http://popref%28%27fn1%27%29/


3/38

would be the time and trouble involved in keeping the transaction secret. Such corrupt systems,however, especially if supported by credible threats, have distributive consequences that arelikely to be viewed as unfair and unjust (Rose-Ackerman 1978, 1999, pp. 926).The social costs of bribery include the inefficiencies introduced by payoffs, the unfair distributionof a public benefit, and the erosion of legal entitlements to act free of threats to person orproperty. Corruption in law enforcement lowers the deterrent effect of sanctioning schemes.

Systemic corruption can undermine state legitimacy over and above its impact on the operationof particular programs. In addition, corrupt schemes and other forms of self-seeking can becostly to implement as public officials and bribe payers spend time and resources in an effort tokeep their actions secret (the literature on this issue is summarized inRose-Ackerman 2004,Graf Lambsdorff 2007).The economic analysis of bribery suggests a way to think about reform strategies. First, do thepayments produce harmful results? If not, the underlying policy environment should bereformed, perhaps by legalizing payments. Second, if there are harmful consequences, whatare the relative merits of redesigning the program to limit bribery, of legalizing a formerly illegalactivity, or of implementing enhanced legal controls to catch and punish those who make andreceive payoffs?Different types of bribery have different costs that depend on background conditions. It is

possible in principle for some bribes to be beneficial, on balance, if they overcome unfair,inhumane, or inefficient practices. For example, bribery might permit someone to escape anoppressive regime, or it might allocate import quotas to the most efficient firms. However,bribery is always a second-best outcome. If bribery overcomes inefficient rules, the best policyis either to repeal the rule or to legalize payments to the state. Official tolerance of briberyleaves in place the transaction costs of corruption, favors those who disrespect the law,encourages officials to create even more red tape and delay to increase incentives for payoffs,and undermines state legitimacy (Bardhan 1997; Rose-Ackerman 1999, pp. 926).If a willingness-to-pay criterion is not itself objectionable, a state can introduce legal priceincentives in some situations. For example, it can sell import quotas, permit applicants to pay forspeedy service (for example, in obtaining a passport or receiving expedited customs clearance),and sell tradable pollution rights. Alternatively, the state can repeal regulatory systems, such as

complex procedures for registering new businesses, that generate bribes, or it can legalizeformerly illegal activities. Whenever a business, such as the drug trade, gambling, orprostitution, is criminalized, this creates corrupt incentives (Andrianova & Melissas 2009). Theworldwide debate over legalizing drugs depends, in part, on the feasibility of controlling theindustry through the criminal law when law enforcement authorities are vulnerable to corruption.Gambling, formerly outlawed in many American jurisdictions, has become a legal business inmany U.S. states, albeit under heavy state supervision and even, at times, state ownership.The bulk of the economics literature on corruption deals with government officials and politicianswho take or solicit payoffs, but corruption also occurs in private institutions. A sales agent maypay off a purchasing agent in a large firm to get business or a labor union leader may extortpayments from corporate managers in return for labor peace. Some private-to-private corruptionoccurs because the police are ineffective or corrupt. Then, organized crime groups may extort

payoffs from shop owners in return for protection from themselves and from rival gangs. See, forexample,Chin (1996)on the operation of gangs in New York City's Chinatowns andVarese(2005)on the operation of mafias in a Russian city.Konrad & Skaperdas (1997, 1998)modelthese situations and analyze how police monitoring can deter payoffs. However, asGambetta &Reuter (1995)demonstrate, businesses may benefit from organized crime connections if theysucceed in frightening away potential entrants and in producing monopoly profits to be sharedbetween mafia members and firms.The debate over anticorruption policy concerns not just the way corruption undermines efforts tocontrol illegal businesses but also the possibility that widespread corruption in one area will spill


4/38

over into other aspects of law enforcement, undermining respect for law enforcement authoritiesgenerally and differentially attracting the potentially corrupt into a career in law enforcement (onthe case of Mexico see, for example,Brophy 2008). If the bureaucracy is highly corrupt, a statemay not be able to take on as many responsibilities as one with more honest and competentofficials. Empirical evidence shows that low levels of corruption are associated with high levelsof public spending, although, of course, the direction of causation is open to debate (Friedman

et al. 2000). In any case, the association is consistent with the hypothesis that the voting publicwill accept high taxes if the government uses them effectively without extensive self-dealing.Modern states, faced with corruption in their ranks and in the private sector, obviously cannotclose down entirely or legalize payoffs wherever they occur. The costs for society would be toohigh. Rather they need to limit the corrupt incentives that produce harmful effects. This can bedone through program redesign, improved public oversight, and more effective lawenforcement. Reform can limit the discretion of officials through a move to clear, simple, andtransparent rules combined with monitoring by superiors and, crucially, a way for those harmedby payoff demands to complain to an independent and honest official such as an ombudsman.3Many bribe payers, however, are better off in a corrupt than in an honest system. The briberobtains a government contract even though his firm is a high-cost producer; a person obtains adriver's license faster than his honest neighbor. In such cases, control must occur throughout

the hierarchy, or the program must be redesigned. For example, the government mightpurchase standardized items that can be bought off the shelf without a specialized biddingprocess, or a government office might streamline procedures to reduce everyone's wait. Inaddition, laws against bribery and extortion must provide a credible deterrent to those whoconsider making and receiving payoffs.Other work discusses the range of policy options besides law enforcement in some detail(Bardhan 1997; Campos & Pradhan 2007; Rose-Ackerman 1978, 1999, 2004, 2006). Here, Ionly wish to highlight their diversity and interconnectedness. A narrowly focused reform may notlimit corruption unless combined with greater overall governmental transparency and outsidemonitoring. Particular laws against bribery, extortion, and self-dealing will never be sufficient todeal with widespread corruption. Fundamental redesign of the relations between the state andsociety will often be the only way to control systemic corruption. Nevertheless, well-designed

and enforced laws against bribery and extortion are a necessary backup to any broader reform,and economic analysis can contribute to the analysis of their operation and effectiveness. Thatis my focus in the remainder of this article.

DETERRING BRIBERY THROUGH THE CRIMINAL LAWTop of pageINTRODUCTIONTHE SOCIAL COSTS OF BRIBERY: THEORY AND EVIDENCEDETERRING BRIBERY THROUGH THE CRIMINAL LAWCORRUPTION AND ORGANIZATIONAL STRUCTURECONCLUSIONdisclosure statementacknowledgments

All countries draw the line somewhere between illegal bribery and acceptable gifts of good will.Here, I take that judgment as given and seek effective deterrence strategies using the criminallaw. The sanctioning strategies that are consistent with economic analysis often differ from theconventional legal penalties, even in developed countries. A law and economics approachfocuses both on improving the deterrent effect of arrest and punishment and on providingincentives for people to come forward with documentation of corrupt deeds. One conundrum foranticorruption efforts is the possible tension between the goals of signaling credible expectedpunishments and using the law to induce perpetrators to provide evidence.
http://popref%28%27fn3%27%29/http://popref%28%27fn3%27%29/http://popref%28%27fn3%27%29/http://popref%28%27fn3%27%29/


5/38

Given the costs of law enforcement, the optimal level of corruption is not zero, even if one givesno value to the benefits received by bribers.4Once one takes the costs of prevention intoaccount, the level of deterrence expenditures should be set where the net benefits aremaximized, that is, where marginal benefits equal the marginal costs (Becker & Stigler 1974;Rose-Ackerman 1978, pp. 10919). A higher level of deterrence would not be worth the extracosts; a lower level would sacrifice the net benefits of increased enforcement. Economic

analysis can aid in this assessment whether or not one includes the benefits of malfeasance inthe policy-analytic calculus.The deterrence of criminal behavior depends on the probability of detection and punishment andon the penalties imposedboth those imposed by the legal system and more subtle costs suchas loss of reputation or shame (Becker 1968). Low penalties upon conviction can still deter if thechance of apprehension is high, and high penalties can compensate for weak enforcement aslong as the enforcement process itself is not unduly biased.Successful detection of corruption depends upon insiders to report wrongdoing. Citizens andbusinesses victimized by extortion demands may report bribery attempts, but they may not beable to offer enough proof for prosecutors to act. Instead, effective law enforcement oftenrequires officials to promise leniency to one of the participants. This creates an importantparadox for law enforcement efforts. High expected punishments ought to deter corruption, but

a high probability of detection may only be possible if some are promised low penalties.I begin by discussing deterrence based on expected punishment, measured by multiplying theprobability of apprehension by the punishment imposed. I then consider strategies that takeaccount of the interaction between punishment and the probability of apprehension. Then, Iconsider bribery and extortion in law enforcement itself that may affect the enforcement of alltypes of law.PunishmentBecause it takes two to enter into a corrupt deal, the transaction will not occur if the law candeter at least one of the parties. Legal language frequently distinguishes between active andpassive bribery where the former refers to the briber and the latter to the bribee (see, forexample,Council of Europe 1999, articles 2 and 3). This language seems to imply that bribepaying is worse than bribe acceptance. However, both are generally criminal offenses, and most

statutes impose parallel punishments. National statutes and international conventions generallyrecognize that the distinction between actively organizing a corrupt transaction and passivelyacquiescing is not a viable one. Neither side is truly passive because both parties must agreebefore corruption can occur. Furthermore, in practice, public officials might actively organize acorrupt bureaucracy that presses citizens or firms to make payoffs.However, in some countries asymmetries do exist. For example, in Taiwan paying off an officialis only a crime when the payment is made to obtain an illegal service. In all other cases, thepayer is not subject to criminal sanction.5Under Romanian law, making a payoff is not a crime ifthe briber has been coerced in any way by the one who received the bribe, and, in addition,such a briber can claim restitution of his payments [Romanian Criminal Code, article 255(3)(5);discussed inSchroth & Bostan 2004, pp. 650, 661]. In other countries the reverse is true. Forexample, in Chile in the 1990s payment of a bribe was a criminal offense, but accepting a bribe

was not unless accompanied by other wrongdoing (Hepkema & Booysen 1997, p. 415).6

Furthermore, the legal distinction between bribery and extortion is not straightforward, and inmany situations a person can be guilty of both (Lindgren 1988, 19921993). Statutes usuallydefine extortion without any specific reference to public officials. Coercive extortion can refer topayments obtained by threats, whether made by an official, a mafia member, or a privateindividual. Violent threats are often punished more severely than other types.7Extortion canoccur in the United States and England under color of office, a condition that need not involvean outright threat but is rather associated with the bargaining power that comes from one's
http://popref%28%27fn4%27%29/http://popref%28%27fn4%27%29/http://popref%28%27fn4%27%29/http://popref%28%27fn5%27%29/http://popref%28%27fn5%27%29/http://popref%28%27fn5%27%29/http://popref%28%27fn6%27%29/http://popref%28%27fn6%27%29/http://popref%28%27fn6%27%29/http://popref%28%27fn7%27%29/http://popref%28%27fn7%27%29/http://popref%28%27fn7%27%29/http://popref%28%27fn7%27%29/http://popref%28%27fn6%27%29/http://popref%28%27fn5%27%29/http://popref%28%27fn4%27%29/


6/38

official position. Thus, in many cases the official can be guilty both of accepting a bribe and ofextortion (Lindgren 1988, 19921993).The law and economics literature recognizes the two-sided nature of corrupt deals and does notrefer to active and passive bribery but rather refers to bribe payers and recipients. Somescholars distinguish between the payer who receives better than fair treatment, on the onehand, or someone who must pay to be treated fairly, on the other(Ayres 1997). More narrowly,

Polinsky & Shavell (2001)categorize extortion as a bribe paid to avoid being framed by anofficial for a trumped-up offense. These bright-line rules are useful for analytic purposes, butthey map imperfectly onto the legal concepts. American law is quite confusing in defining theseconcepts (Lindgren 19921993), and the proposed distinctions would be difficult to implement inpractice. They require a clear benchmark of fair treatment and raise difficulties when the personsubject to extortion has, in fact, violated some other law (Lindgren 1988, 19921993).In deciding how to allocate law enforcement resources, the degree of social harm should be thekey variable, not the location of payoffs in the public or the private sector. In general, highestpriority should be given to preventing the allocation of illegal benefits or the imposition of illegalcosts. For legal benefits, the social costs depend on the damage done by using willingness-to-pay criteria and the inefficiencies and inequities of officials' efforts to create bottlenecks andscarcity. These issues loom especially large when officials or organized crime groups use

threats of physical violence or property damage (Konrad & Skaperdas 1997, 1998). Extortionthat involves organized crime is especially harmful for that reason. These groups seek to shiftthe reversion point for anyone who resists to an outcome that is worse than the original statusquo. Corrupt systems, especially if supported by credible threats, have distributiveconsequences even if resources and services are allocated efficiently. Corrupt officials share inthe profits of private firms, and households may obtain few benefits from a public program. Theeffects may be purely distributive, or they may have long-term impacts on entry into thecorrupted businesses or activities.

A ranking of the social harm of different kinds of corruption, as outlined above, should help setenforcement priorities. However, the penalties actually levied on the convicted need not be tiedto these social harms but rather should concentrate on the benefits received by the corrupt. Todeter bribery, at least one side of the corrupt transaction must face penalties that reflect its own

gains. Because the probability of detection and conviction is far less than 100%, those convictedshould sacrifice a multiple of these gains. From a pure deterrence point of view, either side ofthe corrupt deal can be the focus of law enforcement efforts. From the point of view of publicacceptability, however, bribers who seek legal benefits may arouse public sympathy, not blame.Such offenses may be de facto decriminalized through prosecutorial discretion. Whatever thefocus, actors should face expected penalties tied to their own benefit from corruption.In practice, the briber and the bribee may bargain over the size of the bribe in light of theexpected penalty functions that each one faces. These functions depend both on the chancethat the deal will be uncovered and on the penalty levied on conviction. Most models ofcorruption do not include this aspect of the problem and assume either a fixed bribe price or anequal division of the rents. For example, if the briber faces a fixed maximum penalty X, while thebribee's expected penalty is an ever increasing function of its gains, the division of the benefits

will be affected by these differing conditions. At some point the bribe recipient will reach his orher maximum bribe beyond which the costs outweigh the benefits. In contrast, the briber in thisexample may be willing to contemplate very large corrupt deals because, beyond some point,the penalties are not well tailored to the scale of the deal. The law not only deters some briberyschemes altogether; it can also influence the division of gains from corrupt deals.To deter, officials' penalties should be an increasing function of the payoffs they receive and theprobability of detection. If expected penalties do not depend upon the size of the bribe, ananticorruption drive would quickly confront a paradox. A high fixed penalty will lower theincidence of corruption but increase the average level of bribes paid. Low bribes are not


7/38

accepted, but once the threshold is crossed, the penalty has no deterrent effect. If the penalty ishigh, officials must receive a high return in order to be willing to engage in bribery. Thus, theexpected penalty should increase by more than a dollar for every dollar increase in the size ofthe bribe (Rose-Ackerman 1978, pp. 10935;Shleifer & Vishny 1993). This could be done eitherby tying the penalty levied upon conviction to the size of the bribe or by increasing the risk ofapprehension as the size of the bribe increases. However, if the probability of detection is lower

for small payoffs, the penalty for each detected offense must reflect that fact. This could meanthat those convicted of petty bribery could face more severe penalties than those found to havetaken larger bribes. That outcome, however, is not likely to be politically viable. Hence, twoalternatives are possible: increasing surveillance and redesigning the program to lower corruptincentives by limiting the discretion of officials.On the other side of the corrupt transaction, a fixed penalty levied on bribers will lower both thedemand for corrupt services and the incidence of bribes. However, as long as the probability ofapprehension does not depend on the size of the bribe, it will have no marginal impact once thebribe passes the corruption threshold. If the probability of apprehension and/or the penalty riseswith the size of the bribe, then the level of individual bribes may fall as well. That result does notnecessarily follow, however, if higher bribes provide higher benefits. Suppose, for example, thatthe benefits to bribery are an increasing function of the size of the bribe, such that a bribe of

$1,000 provides benefits of $1,500, but a bribe of $5,000 provides benefits of $20,000. Thenexpected penalties that are set at twice the size of the bribe will deter the smaller bribe but notthe larger one.More fundamentally, bribes represent a cost to those who pay them; penalties for bribers shouldnot be tied to these costs unless they are a good proxy for the briber's benefits. In the example,they are an imperfect proxy. To have a marginal effect, the penalties should be tied to thebriber's gains (their excess profits, for example), not to the size of the bribe. In the contractingarea, if the potentially corrupt firms are repeat players, one option is a disbarment procedurethat prohibits corrupt firms from contracting with the government for a period of years. To have amarginal effect, the disbarment penalty should be tied to the seriousness of the corruptionuncovered.Under American law the maximum penalties are symmetric for those who make and those who

accept corrupt payments. The offender can receive a maximum sentence of three times themonetary equivalent of the thing of value [given or promised to the official]or imprisoned fornot more than fifteen years, or both, and may be disqualified from holding any office of honor,trust, or profit under the United States [18 U.S.C. 201(b)].8Thus, the maximums do notexplicitly recognize the asymmetries in gains between bribe payers and recipients. However, thefederal sentencing guidelines do permit judges to incorporate the benefits received by bribepayers into their calculations. According to the guidelines, the fine levied on an organization forbribery and related offenses should be the greater of the value of the unlawful payment, thevalue of the benefit received or to be received in return for the unlawful payment, and theconsequential damages resulting from the unlawful payment [U.S. Federal SentencingGuidelines, 2C1.1(d)(1)]. Thus, it can either reflect the gain to the firm or the loss to society.This seems a reasonable compromise with the principles outlined above except for one glaring

weakness. It does not account for the fact that, ex ante, the chance of being caught is far lessthan 100%. To properly deter, the penalty should be a multiple of the gain to the firm. Thestatute itself permits a fine that is three times the bribe paid, but it does not mention the benefitto the bribe payers that may far exceed even that total, especially when viewed ex ante.In the sentencing guidelines, the base penalty for individuals is several months in prison and isnot tied directly to the level of benefits received by paying or accepting a bribe. The penalty isincreased if a public official is bribed, if more than one bribe is involved, or if the value exceeds$5,000 [U.S. Federal Sentencing Guidelines, 2C1.1(a)(c)]. In addition, civil fines can beimposed on those convicted of bribery and related offenses. The fine can be either a payment of


8/38

up to $50,000 or the bribe amount if it exceeds $50,000. Thus, individuals can be punished withboth fines and jail time, but it does not seem that the marginal increases exceed the marginalbenefits for large bribes once one takes account of the low probability of apprehension. It maybe that the penalties have little deterrent effect on large bribes.The law, however, does permit the president to rescind any contract or other benefit if there hasbeen a conviction under the statute governing bribery, graft, and conflicts of interest. The United

States can also recover, in addition to any penalties, the amount expended or the thingtransferred or delivered on its behalf, or the reasonable value thereof (18 U.S.C. 218). Thisright of recovery is designed to avoid losses to the government. It is a weak deterrent to corruptpayoffs because the recovery is not multiplied by a factor that reflects the probability ofdetection.Outside the United States, the legal penalties bear only a weak relationship to the deterrencepriorities outlined above. Of the cases examined, admittedly not a comprehensive list, boththose who pay and those who accept bribes face the possibility of fines and imprisonment and,as in the U.S. statute, the maximum penalties are generally symmetric for both groups. Thestatutes fail to link penalties either to the social harm of corruption or to the private benefitsobtained by those who engage in bribery. In some statutes there are special increased penaltiesfor aggravated instances of corruption, but these are trigger strategies not explicitly tied to

marginal gains and losses. It seems quite likely that large-scale corrupt deals are only slightlydeterred by the formal legal penalties.9If expected penalties do not increase along with the benefits of corruption for bribers andbribees, government may be caught in a trap where high corruption levels beget high corruptionlevels. An equilibrium with low corruption may also exist but be unreachable in small steps fromthe status quo. High corruption can be a stable equilibrium when the net rewards of corruptionincrease as the incidence of corruption increases. This might occur, for example, if lawenforcement officials discover a smaller proportion of corrupt deals when the incidence ofcorruption is high and if penalties levied upon conviction are not adjusted to take account of thatfact. Any multiple equilibria case, however, can be converted into a single equilibrium, low-corruption case with the appropriate choice of law enforcement strategy or a change in theinformation conditions. Strategies that tie expected penalties to marginal gains can remove a

society from a high corruption trap. Doing so, however, may require a large increase in lawenforcement resources to tip the system to a low-corruption equilibrium. Fortunately, such asharp increase in enforcement resources need not be permanent. It must simply be sufficient totip the system to a lower corruption level (Lui 1986, pp. 2122). The idea is to changeexpectations. A concentrated cleanup campaign can change expectations about others'cooperation in the corrupt system. Once a new low-corruption equilibrium has been established,it can be maintained with reduced enforcement resources as long as the honest are willing toreport corrupt offers and law enforcement officials follow up on reports of malfeasance they dofind (Andvig & Moene 1990; Bardhan 1997, pp. 133034;Cadot 1987; Rose-Ackerman 1978,pp. 13751). One problem with this optimistic scenario, however, is the possibility that thecorrupt will collude with each other to lie low during the crackdown and reemerge later toresume their corrupt activities. The models summarized here assume, in contrast, that there is

no collusion and that both officials and bribers act on the basis of their most recent pastexperience.Finally, consider efforts to deter private-to-private corruption. Some legal systems criminalizeprivate-to-private bribery, but in many jurisdictions such transactions are not against the lawunless they involve another illegal offense, such as extortion or operation of an illegalbusiness.10One needs to ask if private tort law or employment law is sufficient to deter suchconduct. Is the cost of private-to-private corruption merely the harm to the bribe taker'semployer, and if so, why aren't private law remedies, motivated by the employer's profit motive,sufficient? There are two linked issues. First, the threat of criminal penalties may provide a more


9/38

effective deterrent than civil penalties or a firm's internal disciplinary procedures. The possibilityof a prison sentence and the stigma of a conviction may deter, even if the higher standards forproof and the defendants' greater procedural protections mean that conviction is less likely.Second, some private-to-private bribery can have broader systemic consequences. Ifwidespread, it may spill over into interactions with government bureaucrats, and it may providea way for a firm to cement a monopoly position that harms other customers and suppliers.

Bribes may be paid not just to get business but also to dilute product quality, enforce cartels,and limit entry. Then the motivation for enforcing the law in this area goes beyond its directimpact on private business and merges with the discussion of public sector corruption.Gathering Evidence: Promising Leniency and Rewarding WhistleblowersEffective deterrence is impossible unless law enforcement authorities can obtain relevantevidencea difficult task because often the participants are the only ones who know of thecorrupt deal. In such cases, the probability of detection is a function of whether any of theparticipants has an incentive to report. Those subject to extortion may report attempts, butpolice promises of low penalties or even rewards are often essential. However, such tactics arefrequently criticized by anticorruption commentators as inconsistent with the goals of thecriminal law. For example, the Group of States Against Corruption (GRECO), a Europeangroup, criticized a provision in Romanian law that exempted bribers from punishment if they

inform authorities of their activities before a formal investigation begins [Romanian CriminalCode, article 255(3)(5)]. The GRECO report recognized that this could be a means to gatherevidence and initiate criminal proceedings against officials, but it worried that it would weakenenforcement of the law against active bribery (GRECO 2002).Standard work on the economics of crime does not confront the problem of obtaining evidencefrom perpetrators. Detection is uncertain but independent of criminals' actions. That assumptiondoes not hold for bribery and extortion, for which a prime source of evidence is informationobtained from those engaged in corrupt transactions.Suppose, first, that the benefit obtained in return for a bribe is legal and would be freelyavailable in an honest world to those who now pay bribes. Because the bribers receive benefitsto which they are legally entitled, they believe that they are extortion victims who would bebetter off in an honest world. Such bribe payers are potential allies in an anticorruption effort

and will likely cooperate in efforts to eliminate payoffs. They should not be punished heavilybecause leniency will give them an incentive to report corrupt demands and will encouragebeneficiaries of public programs to demand services that are free of payoff demands.Consider next a scarce but legal benefit that is corruptly allocated to many individuals whowould not qualify if payoffs were eliminated. Neither those who pay nor those who receivebribes will voluntarily report the corrupt transaction. Those shut out of the process, however,have a grievance. For example, disappointed bidders for public contracts can facilitate efforts tolimit corruption (Alam 1995). They should be rewarded for coming forward with evidence even ifthe reason they lost the bid was not moral scruples but their own unwillingness to make a largeenough payoff. The reward offered need not equal their lost benefits from losing the contractbecause one consequence of revealing corruption will be a rebid contract in which thewhistleblower can compete.

Bribes paid to obtain illegal services are likely to be the most difficult to control. Bribers are oftenalso engaged in other illegal activities, and those who fail in their corruption efforts can hardlycome forward to claim that they should have been the ones obtaining the illegal benefit.Nevertheless, the very vulnerability of bribers can be used to uncover corruption. They mayaccept lenient treatment with respect to, say, a violation of the drug laws, in return for providingevidence in a corruption trial. Here, the law with respect to cartels in restraint of trade canprovide useful parallels. Leniency for the first firm that comes forward to report a cartel is acommon feature of the law in the United States and in Europe, and analysts study ways tostructure the rewards to maintain the deterrence effect of punishment. Thus, one study


10/38

recommends increasing average penalties and making leniency conditional on the quality of theevidence provided (Wils 2007).

An alternative system protects and rewards whistleblowers who come forward with evidence ofwrongdoing. Reporting the peculations of others can be dangerous. If corruption is systemic,one risks being disciplined by corrupt superiors and attacked by coworkers. One study ofcorruption in China suggests that this is a serious problem (Manion 2004). The whistleblower

may even end up accused of corruption. The United States has two statutes. The False ClaimsAct rewards those in the private sector who report irregularities in government contracts andprotects whistleblowers from reprisals (31 U.S.C. 37293731,Howse & Daniels 1995,Kovacic 1996). The act pays whistleblowers a share of the total penalties and other damageslevied against firms for wrongdoing that has injured the federal government. The secondprotects whistleblowers inside government agencies from retaliation but does not give them afinancial reward [Whistleblower Protection Act, Public Law No. 101-12, 5 U.S.C. 2302(b)(8)].Such statutes can help prevent malfeasance as long as they do not induce potentialwhistleblowers to create compromising situations and as long as the search for misdeeds doesnot lower the quality of public services. Thus, the value of such statutes depends both on thelikelihood of corruption and on the opportunity cost of whistleblowing activity. (For a somewhatdifferent model of whistleblowing that exploits a similar trade-off between ex ante effort and ex

post revelation, seeTing 2008.)Sometimes public officials claim that firms virtually force bribes upon them. To the extent thisclaim is credible, public officials could come forward with evidence of corrupt offers and seekprotection under the Whistleblower Protection Act. Firms would predictably defend themselvesby arguing that the official demanded the payoff. The distinctions in American law may be usefulhere. Under the False Claims Act, the court can reduce the award for a whistleblower who wasinvolved in wrongdoing, but only if he or she planned or initiated the wrongful conduct. Theaward need not be eliminated, however, unless the whistleblower is convicted of a crime [31U.S.C. 3730(d)(3) (2006)]. Prosecutors with the authority to grant criminal immunity can thusset up a race in which the first to report the corrupt transactions will be rewarded, while theothers are punished. Alternatively, the law might impose penalties on anyone who is part of acorrupt deal and who failed to report it promptly. Then all participants would worry that the other

participants will report their corruption to authorities as a way of avoiding future penalties. Justas with a reward system, the idea is to create a race to the prosecutors that will deter corruptionex ante.11Both carrots and sticks, however, depend on the existence of a credible system of lawenforcement that might discover the corrupt deal on its own. The use of undercover stingoperations can be leveraged into a tool that encourages those offered or pressured for bribes tocome forward. If they do not, they know that the corrupt offer may be a trap set by lawenforcement authorities. Although the defendant may raise the defense of entrapment, this israrely successful in corruption cases, at least in the United States, and is especially unlikely tosucceed when the defendant offers a bribe (69 A.L.R.2d 1397).12The U.S. FBI has made gooduse of sting operations in its efforts to ferret out domestic corruption and has recently done thesame thing under the Foreign Corrupt Practices Act (FCPA, in 15 U.S.C. 78). The most

famous case is probably the Abscam sting, involving an elaborate hoax that snared severalmembers of Congress into corrupt transactions involving a supposed Middle Eastern sheikh (foran overview that cites many of the background documents, seeGrossman 2003, pp. 13). Morerecently, a sting led to 22 arrests in January 2010 for alleged violations of the FCPA. Theassistant attorney general in charge of the case stated that the undercover techniques used inthis case should cause all would-be FCPA fraudsters to pause and to ask: am I really paying offa foreign government official or could this be a federal agent? (quoted inScarcella 2010).Carefully orchestrated sting operations can be a valuable tool as long as the criminal behaviorthey target is relatively clear-cut.


11/38

Corruption in Law EnforcementSo far I have assumed an honest system of law enforcement that can deter corruption.Unfortunately, corruption in law enforcement itself is widespread and can affect the incidence ofall types of crime. Survey evidence from Peru, for example, shows that the incidence of reportedbribery is highest among those who use the judiciary, followed by those who interact with thepolice (Hunt 2006). Obviously, if such corruption reduces the expected costs of breaking other

laws, it will encourage criminal behavior(Becker & Stigler 1974, Bowles & Garoupa 1997,Polinsky & Shavell 2001). The optimal deterrence strategy should take into account and seek todeter the corruption of enforcers, such as the police (Bowles & Garoupa 1997). This could bedone through a mixture of organizational and personnel reforms combined with better oversight.However, it is at least possible that a corrupt system operates so that the cost of breaking thelaw is higher under a corrupted law enforcement system as officials exercise their opportunitiesfor illicit private gain. Potential corrupt payments can be thought of as a common pool in whichthe police all try to fish for private gain. No individual policeman takes account of the fact that hisor her extraction of payoffs limits those available to others. They all race to collect payoffs, andtheir uncoordinated actions may lead them to overfish for corrupt rents, thus deterring otherforms of illegality (Pashigian 1975).Polinsky & Shavell (2001)model law enforcers as having three options: first, soliciting bribes

from offenders not to report a violation (or to reduce the sanction); second, extorting a paymentfrom an innocent person by threatening to frame him; and, third, actually framing the innocent.Thus, their distinction between bribery and extortion, although it is too precise to reflect theactual use of these terms in the criminal law, captures the distinction between potential payerswho are innocent or guilty of the underlying offense. The control of corruption in lawenforcement is justified in their model because corruption limits the deterrent effect of the law.They follow work on the law and economics of crime that recommends the use of maximal finesup to the criminal's wealth constraint (Becker & Stigler 1974). They recommend the use of finesbecause they are much less resource intensive for the government than putting people in prisonand should have equivalent deterrent effects for defendants who are not judgment proof. Becker& Stigler demonstrate the social value of maximally fining both law enforcers and offenders whoengage in bribery as well as enforcers who frame the innocent.13Of course, law enforcement

officials, especially in developing countries, are not well paid and cannot be deterred by finesthat exceed their family's wealth.Their most surprising conclusion is that pure extortion should not be punished. This is becauseits punishment will push corrupt enforcers either to frame the innocent or to demand higherextortion payments from the innocent. This result arises from the structure of their model, inwhich the victims of extortion have no escape route. They are caught in a trap where outsidelaw enforcement can do no more than raise the costs to extortionists, hence encouraging themto demand higher payoffs.ForGaroupa & Klerman (2004), bribery is a second-best way to introduce monetary penaltieswhen nonmonetary sanctions (e.g., imprisonment) predominate. They show that, in thepresence of corruption, nonmonetary sanctions perform the useful function of generating highbribes that are paid to avoid prison. In practice, ordinary crime is deterred by the expectation of

bribe payments. In a fully corrupt system no one goes to prison, and the state benefits from theresulting cost savings. This model, of course, assumes that bribe demands actually deter crimerather than simply being a way of sharing the monopoly profits of criminal activity between thepolice and the criminals. As Garoupa himself recognizes in later work, it neglects the possibilitythat the unequal opportunities for payoffs across different types of policework will distortenforcement priorities (Echazu & Garoupa 2010).The economic models of corruption in law enforcement are also consistent with research thatlooks favorably on privatizing law enforcement. Under this view, tolerating the bribery ofenforcers is worse than policies that legally incentivize enforcers by giving them private


12/38

incentives to work diligently to enforce the law. For example,Becker & Stigler (1974)andPolinsky & Shavell (2001)suggest the potential of bounties paid to enforcers for successful lawenforcement activity. However, privatizing law enforcement through corruption could be adesirable second-best result in a world where enforcers must be paid a fixed salary. Thattolerant view, however, seems extremely optimistic. If penalties are low, bounty hunters mightinduce people to submit to arrest in return for a share of the bounty.14If one adds in the

possibility of coercive extortion and intimidation combined with threats of violence, the quasi-privatization of enforcement, as Polinsky & Shavell recognize, increases the incentives to extortand frame the innocent. Their analysis points to the importance of establishing credible checksso that those subject to extortion or framing have a place to complain. Moves toward a legalbounty system or toleration of corruption could tilt the entire system into a violent, rent-seekingfree-for-all. The system could end up dominated by powerful criminal mafias able to organizecorrupt payoffs and intimidate rank and file officials and ordinary citizens, whether or not theyengage in criminal activity. An extreme alternative, of course, is to legalize the criminal activity,thus removing the incentive to corrupt the police and the courts. More modestly, privatizationdoes not appear to be a desirable option given the downsides highlighted here.

CORRUPTION AND ORGANIZATIONAL STRUCTURETop of pageINTRODUCTIONTHE SOCIAL COSTS OF BRIBERY: THEORY AND EVIDENCEDETERRING BRIBERY THROUGH THE CRIMINAL LAWCORRUPTION AND ORGANIZATIONAL STRUCTURECONCLUSIONdisclosure statementacknowledgmentsBribery frequently occurs in organizational hierarchies and in structures with multiple potentialpayoff sites. These organizational complexities add an important dimension to the analysis. Oneneeds to consider not just the relationship between a single agent, a single honest principal, anda potentially corrupt outsider but also the possibility that individual bribe payments are part of acomplex system. I consider government hierarchies first and then analyze public systems with

multiple potential corruption points. Next, I assess the impact of middlemen who are formallyoutside the public sector but perform an intermediary role. Finally, I consider the organizationalissues that arise in a firm when an employee bribes a public official.Government HierarchiesSome corruption occurs at the top of a government hierarchy where officials sign majorprocurement contracts, award concessions, and privatize state firms. In those cases theanalysis above applies, but deterrence can be especially difficult because the corruptioninvolves high-level political actors with the power to set enforcement priorities and create corruptopportunities (Rose-Ackerman 1978, pp. 10936). Bribe demands not only determine howofficials and firms divide a fixed pool of rents, but also influence firm behavior. The contractingprocess may be less competitive as honest firms stay away and corrupt firms collude to push upthe cost of contracts. Furthermore, firms that face extortionary demands may adjust their

investment choices away from highly capital-intensive techniques that will leave them subject tofuture bribe demands (Rose-Ackerman 1999, pp. 2738;Choi & Thum 2004).In another common pattern, bribes are paid at the bottom of the bureaucratic pyramid, but low-level officials share them with superiors. Those at the top organize the entire hierarchy as abribe-sharing machine and may pressure those farther down the chain both to become part ofthe corrupt system and, once recruited, to pass on a share of their take up the hierarchy. Low-level officials, who may be difficult to monitor in their day-to-day activities, may be given briberyquotas that must be paid to superiors as a condition of maintaining employment or in return for


13/38

good working conditions. Superiors can subvert standard anticorruption proposals to their owninterests. For example, the civil service might have a policy of rotating officials to differentlocations throughout their careers as an anticorruption strategy that prevents them fromestablishing close local ties. In a corrupt hierarchy, in contrast, higher-ups can use thispersonnel policy to punish those who do not join the corrupt system by sending them to poverty-stricken and remote locations.15

In such a system, a reforming chief executive might remove and punish the official at the top ofthe corrupt hierarchy and install an honest agency head. For example, a newly elected mayormight remove a corrupt police chief and install a person of known integrity. Will such an actionlimit corruption or will it simply decentralize bribery and make it less visible? The answerdepends on the nature of low-level corruption and on the role of those higher up the hierarchy. Acorrupt police chief may have more power to extract rents and better information about theirlevel than any other individual official. In that case centralization will be especially harmful(Rose-Ackerman 1978). Such a top official may be able to increase overall payoffs by, forexample, giving low-level officials petty monopoly power, increasing the level of red tape or thediscretion of officials, issuing threats to potential bribers that enhance the extortionary power ofunderlings. Then, removing a corrupt head ought to limit the level of corruption and the harmthat it causes. A new, honest agency head can spearhead reforms to limit corrupt opportunities.

In contrast, if the corrupt top official simply presides over a bribe extraction machine, thenreplacing him will not change the underlying structural features that produce corrupt incentives.However, the policy could still have a positive effect if an honest chief can instill norms ofhonesty in subordinates and improve monitoring and oversight. In the worst case, suggested byOlson (1993), Shleifer & Vishny (1993), Choi & Thum (2004), andOlken & Barron (2009),deterring corruption at the top might increase it at the bottom as officials compete and overfishthe pool of rents, leading to greater social harms. Centralized corruption produces an inefficientand perhaps unfair system as the bribery monopolist maximizes rents, but it avoids the risk ofcomplete breakdown. Under a decentralized system, where officials do not have to share theirgains with superiors, more street-level officials might become corrupt. This assumes, of course,that corrupt superiors were simply rent extractors who provided few benefits to inferiors andmerely threatened and intimidated them.

Multiple Corruption PointsBut pyramids are not the only organizational form relevant to the control of corruption. A secondpossibility is an activity that requires the potential briber to interact with different public officials.These may be in a fixed order, as when a trucker faces multiple checkpoints on a highway, orthey may not have a fixed order, as when a business needs multiple permits to operate. Callthese sequential and fragmented systems, respectively (Rose-Ackerman 1978, pp. 16773).The operation of a sequential corrupt system where applicants must approach officials in a fixedorder depends on the precise model specification. Thus, one model assumes that applicantsNash bargain with officials and share the surplus in a manner determined by their exogenouslydetermined bargaining power that assures them a share xof the total. In that model, if allofficials have the same bargaining power, the last official can extract the highest bribe becausethat is where the surplus is highest.Olken & Barron (2009)illustrate the basic intuition with a

simple example using their empirical study of truckers in Indonesia. Suppose that there are twocheckpoints and that the value of a successful delivery is V. At any checkpoint, the official canconfiscate the shipment at zero benefit to both. At the last checkpoint, all past bribes are sunkcosts, and the choice is between paying a bribe ofxVor getting zero. Moving back one step, thefirst official can only extract a bribe ofx(1 x)V. In other words, the trucker and the first official,looking ahead to future checkpoints, anticipate the second official's bribe demands. Theirempirical work confirmed this prediction for one of the trucking routes in their study (Olken &Barron 2009).


14/38

Lambert-Mogiliansky et al. (LMR) (2007, 2008), using a Nash equilibrium model of sequentialbribe demands, show that, under some conditions, no applicant even starts the processbecause all believe that they will lose money (see alsoYoo 2008). Olken & Barron only studythe behavior of truckers already on the road. They do not try to determine if the volume oftrucking has been affected. Sunk cost, however, plays the same role in both models; at eachstage in the sequence, the applicant/trucker looks ahead to future checkpoints to determine the

level of rents at any checkpoint. However, in the LMR model officials are more powerful but lessknowledgeable. They do not know the value the applicant places on bureaucratic approval, butthey will try to extract the entire surplus in expected value terms, and this produces cases wherethe bribe demand exceeds the surplus. There are no honest bureaucrats in the LMR models, sothe applicant cannot gamble on the chance of confronting officials who do not demand bribes.Hence, in the one-shot case no project is ever approved, and all applicants, anticipating what isto come, simply stay home. From the point of view of conformity with the law, this can bebeneficial if applicants are not legally qualified to obtain the benefit, but it is harmful in case theyare qualified. Olken & Barron's truckers are, in contrast, all qualified to use the roads, althoughmost trucks can be legally fined for being overweight, a factor that influences the size of theirbribe payments. If the process is repeated, however, players remember their own actions andthose they dealt with, and they learn what other actors have done. Here, there can be

equilibrium paths of normal bribes where any defection would cause the whole corrupt systemto unravel (LMR 2007, Yoo 2008). These equilibria impose different degrees of social harmdepending on the pattern of bribes.In contrast, under other model specifications, the first official might have the most bargainingpower and extract most of the rents. That result could occur if the bargaining power ofsubsequent officials is itself a function of the remaining level of positive profits. Officials andapplicants suffer from the sunk cost fallacy in the sense that once the first official has takenmost of the surplus, subsequent officials accept the argument that the applicant has no moreprofits to share. This argument might work especially well if the applicants are repeat playerswho can credibly threaten not to return to the corrupt system if charged too much.In the fragmented case in which the order is not fixed in advance and applicants can keep theorder secret, this will reduce the take of officials. In the Olken & Barron model, no official would

know that he is all that stands between the applicant and final approval, and hence he cannotextract the last checkpoint rent. Similarly, in the second, sunk cost fallacy case, if the order isnot predetermined, no official will know that he is the first in line. The result could be a completebreakdown in the system as officials compete for bribes and discourage applicants.This theoretical and empirical research sheds some light on two contrasting policy proposals.The first advocates a one-stop-shop for the registration of businesses or other bureaucraticapproval processes. This is equivalent to the centralized solution in a hierarchical system. Inboth cases, as discussed above, a single official replaces a multiplicity of potentially corruptindividuals, and the key question is whether overfishing occurs in a decentralized system. If so,a centralized system, even if corrupt, will be less harmful. Alternatively, if centralization goesalong with greater power over applicants for legal services, the one-stop-shop may simplypermit greater rent extraction in a way that distorts the allocation of resources and the fairness

and legitimacy of public programs. In the intermediate case analyzed byLMR (2007), a one-stop-shop may permit officials to consolidate their extortionary power. Thus, a one-stop-shopmay either decrease or increase bribe payments depending upon the equilibrium situation thatprevails in the absence of that reform. Recall, however, that in their model, officials are corruptand face no risk of punishment for their actions. They extend their analysis to the closely relatedcase where the applicant hires an intermediary to obtain the needed permits(LMR 2009).The second proposal goes in the other direction and advocates the appointment of multipleofficials only some of whom must be approached. This structure contrasts with models such asthose developed byLMR (2007, 2008)andOlken & Barron (2009)where the applicant-trucker


15/38

must satisfy a fixed sequence of officials. In the competitive model, officials compete for a shareof the bribes, and this behavior may constrain the overall level of payoffs. Even in that case, ofcourse, the anticorruption benefits of competition among officials depend on the nature of thepublic benefits (Rose-Ackerman 1978, pp. 13766). Overlapping jurisdictions can limit the levelof bribes paid to get legal benefits and hence discourage officials from asking for handouts.Similarly, if bribes are paid to avoid arrest for engaging in illegal activity, overlapping

jurisdictions both lower the bribes that any official can demand and increase the chance thatlawbreakers will be caught. Rather than needing a series of officials to approve before anactivity can go forward, any one of several officials can stop an illegal activity. For example,police may have overlapping beats. Then no one police patrol can obtain a high bribe from anillegal gambling operation because another patrol may come along later and either demand asecond bribe or arrest the operators. However, in that case the police themselves have anincentive to collude to extort payoffs from gambling establishments.Agents and Middlemen

A familiar feature of many corrupt systems is the private middleman with connections whopromises to smooth one's route through the bureaucracy for a price. The payments are usedboth to bribe public officials and to compensate the agent. Many countries' bribery statutescriminalize payments to such agents as well as the acceptance of payments by agents.

However, there is considerable cross-country variation.16Why are such agents so common even when everyone recognizes that they are paying bribes?Why not eliminate the middleman and pay the official directly? The key point is that middlemenare repeat players compared to most of those seeking the benefit. They function in systems inwhich applicants either have little or no recourse to honest complaint mechanisms or areseeking something valuable to which they are not entitled. The middleman is often either aformer official or a current one on an off day. He or she knows the going rate for the service, cansave the applicant time by eliminating a wait in line and/or the need for bothersome extra visitsto government offices. Especially in fragmented systems, they can cut through complex officialprocedures. They seem to be performing a useful service by speeding up bureaucraticprocessing and reducing the time and hassle for citizens. Notice, however, that the better thiscorrupt system works, the greater the incentive of the officials and the middlemen to work

together to increase the time and trouble imposed on honest citizens as an inducement tocorruption. They also have an incentive to refuse service to the honest but qualified applicantsor even to invent offenses.

A recent paper byHasker & Okten (2008)draws on earlier efforts byBayar (2005), GrafLambsdorff (2002), andOldenburg (1987). In their model, intermediaries undermine suchstandard enforcement techniques as increased monitoring or higher penalties. Rotatingbureaucrats through different offices, far from limiting corruption, can increase the impact ofintermediaries, resulting in increased corruption (Hasker & Okten 2008). Because they are notcivil servants, they may be especially hard to control. A policy of firing corrupt officials maybackfire. For example, as described inFjeldstad (2003, p. 172), the Tanzanian governmentlaunched an anticorruption campaign by firing one-third of the bureaucrats in the taxadministration. Private businesses hired these former bureaucrats because of their knowledge

and insider contacts. New corrupt networks soon emerged. What seemed like a simple solutionincreased the problem because the government ignored the market for intermediaries (Hasker& Okten 2008, p. 114).Two experimental studies in India illustrate how such systems can work. One studied theissuance of drivers' licenses, often to people unable to drive, and the other the issuance ofration cards for subsidized food (Bertrand et al. 2006, Peisakhin & Pinto 2010). Both showedhow the use of middlemen speeded up processing, but the ration card experiment had anadditional twist. Applicants who filed a Freedom of Information Act request concerning theirapplication under a new Indian law received relatively speedy service and did not need to pay a


16/38

middleman. This result, if it can be reproduced in other contexts, suggests a promising avenuefor reform.Business FirmsNow consider the other side of the corrupt transaction in which employees of business firms paybribes to public officials for benefits such as contracts, lower tax bills, or exemptions from healthand safety regulations. These transactions all benefit the firm by increasing its profits and may

be worthwhile even if detected as long as expected penalties are sufficiently low. Thus, onecannot rely on the firm's owners and top managers to control this type of bribery. They mayexpress strong ethical principles, but they only have a strong incentive to control commercialbribery that damages the firm's bottom line, such as payments to their own employees fromsales agents. If payoffs help a firm obtain business, managers and owners may hope tofacilitate their subordinates' bribery while remaining ignorant of the details (Rose-Ackerman1978, pp. 189209). If corporations are held criminally liable for the corrupt acts of theiremployees and agents, top management may not support an effective monitoring system.However, if firms escape criminal liability, it may be difficult for the criminal law to imposecredible punishments.17

Arlen (1994, Arlen & Kraakman 1997) analyzes this problem for the general case of corporatecrimes and concludes that various alternative rules are superior to present U.S. law that

imposes pure strict liability on firms. One possibility is a negligence rule under which firms areonly liable if they have neglected their internal enforcement responsibilities. For such a rule tobe workable, however, courts must be able to evaluate internal firm behavior, a difficult task.One solution may be quite precise directives stating what type of internal monitoring is requiredwith checks to be sure it is carried out in good faith.The UK will face exactly this challenge under the new 2010 Bribery Act that permits commercialorganizations to defend against allegations of bribery by showing that they have adequate[preventive] procedures in place [United Kingdom Bribery Act 2010, chapter 23, 7(2)].Similarly, the U.S. FCPA supplements its prohibitions against paying bribes to obtain businessabroad with accounting provisions that apply to firms within the jurisdiction of the Securities andExchange Commission. These firms must establish accounting systems that accurately reflecttransactions involving the firm's assets, and they must have an effective system of internal

accounting controls. Firms and their managers can be subject to both civil and criminal penaltiesfor violating these accounting provisions [FCPA, 15 U.S.C. 78m(b) (1988 & Supp. IV 1992),sect. 102;Jadwin & Shilling 1994, pp. 67980;Nobles & Maistrellis 1995, pp. 9, 19;Pickholz1997, p. 237]. Unlike the new UK statute, the FCPA has no formal due diligence defense. But inpractice, firms that establish and enforce effective internal control systems appear to experiencemore lenient treatment. The Federal Sentencing Guidelines also reward internal firm efforts todetect and punish violations of the law (Nobles & Maistrellis 1995). Thus, both the American andthe UK laws attempt to counter management's incentives to insulate itself from the profit-maximizing malfeasance of employees and agents.

CONCLUSIONTop of pageINTRODUCTION

THE SOCIAL COSTS OF BRIBERY: THEORY AND EVIDENCEDETERRING BRIBERY THROUGH THE CRIMINAL LAWCORRUPTION AND ORGANIZATIONAL STRUCTURECONCLUSIONdisclosure statementacknowledgmentsLaw and economic analysis can help set priorities for anticorruption campaigns, suggestreforms in programs riddled with corruption, recommend law enforcement priorities, and help to


17/38

design workable law enforcement strategies. Economic analysis counsels reformers toconcentrate on the underlying conditions that produce rents. Criminal law should not be the firstor the only line of attack. Rather, programs should be redesigned or eliminated, and governmentshould operate in an accountable and transparent manner. That said, it remains true that lawenforcement against bribery and extortion has a backup role to play. Economic analysis canhelp with the design of law enforcement strategies.

Looking at a range of cases, it appears that the laws on the books are often quite far from therecommendations of law and economics. Penalties seem poorly tied to the marginal benefits ofbribery both to those who pay and to those who receive bribes. Small bribes seem to be moreeffectively deterred than larger ones, unless prosecutorial discretion makes up for the legallanguage. The penalties levied on bribers are not well tied to their gains. The tension betweenobtaining evidence to bring a case and deterrence ex ante has seldom been recognized andhas been imperfectly resolved. We do not know if giving corrupt individuals leniency in return fortheir evidence and testimony limits corruption or encourages people to participate ex ante. Therole of organizational structure, including the status of middlemen and agents, has not been wellincorporated into enforcement programs, and many countries have difficulty deterringorganizations as opposed to individuals, in part because the criminal law only applies toindividuals. Although the fundamental tasks for reformers are the redesign of public programs,

improvements in the motivations and incentives facing public officials, and greater governmenttransparency and accountability, reform of the law of bribery and extortion remains a necessary,if not sufficient, area of reform where economic analysis can help guide the debate.

1.

Ades A, Di Tella R. 1997. National champions and corruption: some unpleasant interventionist

arithmetic. Econ. J. 107:102342 [CrossRef] [Web of Science ]

...Corruption reduces the effectiveness of industrial policies and encourages business to operate in the

unofficial sector in violation of tax and regulatory laws (Ades & Di Tella 1997, Kaufmann 1997)....

2.

Alam MS. 1995. A theory of limits on corruption and some applications. Kyklos 48:41935 [CrossRef]

[Web of Science ]

...disappointed bidders for public contracts can facilitate efforts to limit corruption (Alam 1995)....

3.

Anderson CJ, Tverdova YV. 2003. Corruption, political allegiances and attitudes toward government in

contemporary democracies. Am. J. Polit. Sci. 47:91109 [CrossRef] [Web of Science ]

...corruption reduces the perceived legitimacy of democratic governments (Anderson & Tverdova 2003,

Seligson 2006)....

4.


18/38

Andrianova S, Melissas N. 2009. Corruption, extortion, and boundaries of the law. J. Law Econ. Organ.

25:44271 [CrossRef] [Web of Science ]

...or prostitution, is criminalized, this creates corrupt incentives (Andrianova & Melissas 2009).......a

branch of the literature that grew out ofwork on hierarchical organizations uses the word agent to

refer to the one who pays bribes to a monitor who reports to a principal (see, e.g., Andrianova &Melissas 2009, Mishra 2002).......4Much of the work on the economics of crime counts the benefits and

costs to the criminals as part of the overall social calculus (see, for example, Andrianova & Melissas

2009, Bowles & Garoupa 1997)....

5.

Andvig JC, Moene KO. 1990. How corruption may corrupt. J. Econ. Behav. Organ. 13:6376 [CrossRef]

[Web of Science ]

...it can be maintained with reduced enforcement resources as long as the honest are willing to report

corrupt offers and law enforcement officials follow up on reports of malfeasance they do find (Andvig &Moene 1990...

6.

Arlen J. 1994. The potentially perverse effects of corporate criminal liability. J. Legal Stud. 23:83367

[CrossRef] [Web of Science ]

...Arlen (1994, Arlen & Kraakman 1997) analyzes this problem for the general case of corporate crimes

and concludes that various alternative rules are superior to present U.S. law that imposes pure strict

liability on firms....

7.

Arlen J, Kraakman R. 1997. Controlling corporate misconduct: an analysis of corporate liability regimes.

N. Y. Univ. Law Rev. 72:687779 [Web of Science ]

...Arlen (1994, Arlen & Kraakman 1997) analyzes this problem for the general case of corporate crimes

and concludes that various alternative rules are superior to present U.S. law that imposes pure strict

liability on firms....

8.

Ayres I. 1997. Judicial corruption: extortion and bribery. Denver Univ. Law Rev. 74:123153 [Web of

Science ]

...or someone who must pay to be treated fairly, on the other (Ayres 1997)....

9.


19/38

Bardhan P. 1997. Corruption and development: a review of issues. J. Econ. Lit. 35:132046 [Web of

Science ]

...encourages officials to create even more red tape and delay to increase incentives for payoffs, and

undermines state legitimacy (Bardhan 1997......Other work discusses the range of policy options besides

law enforcement in some detail (Bardhan 1997......it can be maintained with reduced enforcementresources as long as the honest are willing to report corrupt offers and law enforcement officials follow

up on reports of malfeasance they do find (Andvig & Moene 1990; Bardhan 1997, ...

Other reviews that cite this reference:

The Rule of Law and Economic DevelopmentStephan Haggard, Andrew MacIntyre, Lydia TiedeAnnual

Review of Political Science Vol. 11: 205 - 234...and property rights are less secure as a result. Bardhan

(1997, ... What Have We Learned About the Causes of Corruption from Ten Years of Cross-National

Empirical Research?Daniel TreismanAnnual Review of Political Science Vol. 10: 211 - 244...Corruption is

usually understood to mean the misuse of public office for private gain, where the private gain may

accrue either to the individual official or to groups or parties to which he belongs (e.g., Bardhan 1997)....

10.

Bayar G. 2005. The role of intermediaries in corruption. Public Choice 122:27798 [CrossRef] [Web of

Science ]

...A recent paper by Hasker & Okten (2008) draws on earlier efforts by Bayar (2005), Graf Lambsdorff

(2002), ...

11.

Becker GS. 1968. Crime and punishment: an economic approach. J. Polit. Econ. 76:169217 [CrossRef]

[Web of Science ]

...The deterrence of criminal behavior depends on the probability of detection and punishment and on

the penalties imposedboth those imposed by the legal system and more subtle costs such as loss of

reputation or shame (Becker 1968).......The maximal fine is the largest fine that an individual can pay

given his wealth constraint (Becker 1968, Becker & Stigler 1974)....


Behavioral Economics and Psychology of IncentivesEmir KamenicaAnnual Review of Economics Vol. 4:427 - 452...An alternative way to deal with the accident risk would be to increase the fine for causing an

accident (Becker 1968).... Elaborating the Individual Difference Component in Deterrence TheoryAlex R.

Piquero, Raymond Paternoster, Greg Pogarsky, Thomas LoughranAnnual Review of Law and Social

Science Vol. 7: 335 - 360...The essence of the deterrence model laid out by Beccaria and followed by

Bentham remained largely intact in criminology until Becker (1968)... ...According to Becker's (1968)

model of rational choice, there are three logical ways an individual can be deterred: increase the costs


20/38

to committing crimes; decrease the benefits to committing crimes; or increase the probability of

detection, ... Resistance to LegalityRichard A. BrisbinAnnual Review of Law and Social Science Vol. 6: 25 -

44...unemotional decisions that avoid the imposition of sanctions on their resistance actions (Becker

1968, Rodgers & Bullock 1976, Scholz 1997).... The Political Economy of ProsecutionSanford C. Gordon,

Gregory A. HuberAnnual Review of Law and Social Science Vol. 5: 135 - 156...Becker 1968) suggest that

the optimal (cost-adjusted) degree of deterrence could be achieved by heavily punishing some random

subset of all guilty persons.... Economic Contributions to the Understanding of CrimeSteven D. Levitt,

Thomas J. MilesAnnual Review of Law and Social Science Vol. 2: 147 - 164...a plausible generalization

about human behavior is that most individuals do the best they can with what they have. Becker (1968)

presented the first modern economic model of criminal behavior.... NEW ECONOMICS OF

SOCIOLOGICAL CRIMINOLOGYBill McCarthyAnnual Review of Sociology Vol. 28: 417 - 442...Gary Becker

(1968) introduced sociologists to a neoclassical economic approach to crime.... ...Becker (1968, p. 176)

likely alienated many sociologists in his championing of the neoclassical approach at the expense of

sociological explanations: I cannot pause to discuss the many general implications of this approach, ...

...Becker (1968, 1996) and others have extended the study of preferences to include a vast array of

outcomes.... ...Becker 1968) and defines rational behavior as actions that reflect individuals'

consideration of costs and benefits that accrue directly to themselves.... ...The rational choice approach

to crime assumes that crime can be understood as if people choose to offend by using the same

principles of cost-benefit analysis they use when selecting legal behaviors (Becker 1968, Ehrlich 1974,

Eide 1994, Schmidt & Witte 1984).... ...Becker (1968) argues that the frequency of crime is determined

by three factors: (a) the costs associated with arrest, ... ...As noted earlier, Becker (1968) and other

economists (Schmidt & Witte 1984)...

12.

Becker GS, Stigler GJ. 1974. Law enforcement, malfeasance, and the compensation of enforcers. J. LegalStud. 3:118 [CrossRef] [Web of Science ]

...where marginal benefits equal the marginal costs (Becker & Stigler 1974......it will encourage criminal

behavior (Becker & Stigler 1974, Bowles & Garoupa 1997, Polinsky & Shavell 2001).......They follow work

on the law and economics of crime that recommends the use of maximal fines up to the criminal's

wealth constraint (Becker & Stigler 1974).......For example, Becker & Stigler (1974) and Polinsky &

Shavell (2001) suggest the potential of bounties paid to enforcers for successful law enforcement

activity.......The maximal fine is the largest fine that an individual can pay given his wealth constraint

(Becker 1968, Becker & Stigler 1974)....


Corruption in Developing CountriesBenjamin A. Olken, Rohini PandeAnnual Review of Economics Vol. 4:

479 - 509...we provide a simple framework that models the perspective of an individual bureaucrat,

following the ideas of Becker & Stigler (1974)....

13.


21/38

Bertrand M, Djankov S, Hanna R, Mullainathan S. 2006. Obtaining a driving license in India: an

experimental approach to studying corruption. Q. J. Econ. 122:163976 [CrossRef] [Web of Science ]

...and the other the issuance of ration cards for subsidized food (Bertrand et al. 2006, Peisakhin & Pinto

2010)....


Corruption in Developing CountriesBenjamin A. Olken, Rohini PandeAnnual Review of Economics Vol. 4:

479 - 509...Bertrand et al. (2007) examine a similar question in the context of driver licenses in India....

...Bertrand et al.'s (2007) and Olken & Barron's (2009) studies have similar findings: In both cases, ...

Rent Seeking and Corruption in Financial MarketsAsim Ijaz Khwaja, Atif MianAnnual Review of

Economics Vol. 3: 579 - 600...and there is empirical work on bureaucrats as bribe takers in other markets

[e.g., in public service licensing and provision (Bertrand et al. 2007, ... ...they have been effectively

utilized in the related contexts of corruption in public service delivery (Bertrand et al. 2007, ... ...Such

randomized audit-based studies in fact are applied in social services (Bertrand et al. 2007).... The

Experimental Approach to Development EconomicsAbhijit V. Banerjee, Esther DufloAnnual Review of

Economics Vol. 1: 151 - 178

14.

Bowles R, Garoupa N. 1997. Casual police corruption and the economics of crime. Int. Rev. Law Econ.

17:7587 [CrossRef] [Web of Science ]

...it will encourage criminal behavior (Becker & Stigler 1974, Bowles & Garoupa 1997, Polinsky & Shavell

2001).......The optimal deterrence strategy should take into account and seek to deter the corruption of

enforcers, such as the police (Bowles & Garoupa 1997).......4Much of the work on the economics of

crime counts the benefits and costs to the criminals as part of the overall social calculus (see, for

example, Andrianova & Melissas 2009, Bowles & Garoupa 1997)....

15.

Brophy S. 2008. Mexico: cartels, corruption and cocaine: a profile of the Gulf cartel. Global Crime 9:248

61 [CrossRef]

...undermining respect for law enforcement authorities generally and differentially attracting the

potentially corrupt into a career in law enforcement (on the case of Mexico see, for example, Brophy

2008)....

16.

Chin K-L. 1996. Chinatown Gangs: Extortion, Enterprise, and Ethnicity. New York: Oxford Univ. Press

...See, for example, Chin (1996) on the operation of gangs in New York City's Chinatowns and Varese

(2005)...


22/38

17.

Cadot O. 1987. Corruption as a gamble. J. Public Econ. 33:22344 [CrossRef] [Web of Science ]

...it can be maintained with reduced enforcement resources as long as the honest are willing to report

corrupt offers and law enforcement officials follow up on reports of malfeasance they do find (Andvig &

Moene 1990; Bardhan 1997, pp. 133034; Cadot 1987...

18.

Campos JE, Pradhan S, eds. 2007. The Many Faces of Corruption. Washington DC: World Bank [CrossRef]

...Other work discusses the range of policy options besides law enforcement in some detail (Bardhan

1997; Campos & Pradhan 2007...

19.

Choi JP, Thum M. 2003. The dynamics of corruption with the ratchet effect. J. Public Econ. 87:42743[CrossRef] [Web of Science ]

...For an analysis of two closely related cases, see Choi & Thum (2003, 2004)....

20.

Choi JP, Thum M. 2004. The economics of repeated extortion. RAND J. Econ. 35:20323 [CrossRef] [Web

of Science ]

...firms that face extortionary demands may adjust their investment choices away from highly capital-

intensive techniques that will leave them subject to future bribe demands (Rose-Ackerman 1999, pp.

2738; Choi & Thum 2004).......suggested by Olson (1993), Shleifer & Vishny (1993), Choi & Thum (2004),

......For an analysis of two closely related cases, see Choi & Thum (2003, 2004)....

21.

Council of Europe. 1999. Criminal Law Convention on Corruption. Strasbourg: COE

...Legal language frequently distinguishes between active and passive bribery where the former refers to

the briber and the latter to the bribee (see, for example, Council of Europe 1999, ......10See Council of

Europe (1999), articles 7 and 8, and the exception to these articles taken by, ......16See, for example,

Council of Europe (1999), article 12, Trading in Influence, ...

22.

Di Tella R, Schargrodsky E. 2003. The role of wages and auditing during a crackdown on corruption in the

city of Buenos Aires. J. Law Econ. 46:26992 [CrossRef] [Web of Science ]


23/38

...A study of hospital purchasing in Argentina showed how information on the dispersion of prices across

institutions helped rein in corrupt purchasing (these situations are studied in Reinikka & Svensson 2004

and Di Tella & Schargrodsky 2003...


What Have We Learned About the Causes of Corruption from Ten Years of Cross-National Empirical

Research?Daniel TreismanAnnual Review of Political Science Vol. 10: 211 - 244...Some have used

inventive proxies to measure corruption in particular contexts. Di Tella & Schargrodsky (2003) found

that the prices paid by hospitals in Buenos Aires for homogeneous inputs such as hydrogen peroxide

dropped by about 15% during an anticorruption campaign, ...

23.

Echazu L, Garoupa N. 2010. Corruption and the distortion of law enforcement effort. Am. Law Econ. Rev.

12:16280 [CrossRef]

...it neglects the possibility that the

Corruption and Ethics (2)

Documents

Transcript of Corruption and Ethics (2)