“Corruption” by Andrei
Schleifer and Robert
Vishny
Modeling corruption under different
assumptions in order to determine the
consequences of corruption and the
best theoretical parameters for
encouraging growth
The Structure of the Models
• Most models of corruption assume that corrupt
officials are agents with poor incentives acting
on the nominal behalf of a recognized public
principal, the government or state; this is the
principal-agent model of corruption
• In cases where the elite echelons of
government share directly in revenues from
corruption or even direct and control corruption
as a mafia, corruption becomes analogous to
taxation
Principal-Agent Model of
Corruption
• Schleifer and Vishny assume the principalagent model of corruption applies and then
analyze the impact of the structure of the
corruption network on the consequences of
corruption
• Their model’s key assumption is that they are
discussing bribes for homogeneous services
to which payers are theoretically entitled-passports, building permits, licenses--and not
unique or special favors of an extraordinary
sort
Corrupt Official as
Monopolist
• The simplest situation to model is one in
which a single individual (or single office
acting in coordination) has effective property
rights over provision of a government service;
no other office has power in this area, so
“customers” only need to bribe here
• If the corrupt official is free to set the bribe
level and/or the quantity of goods (licenses,
permits, etc.) provided, he is an effective
monopolist, free to set the price as he sees fit
in order to maximize bribe revenue
Monopolist “without theft”
• If the government official is refusing to
provide services without a bribe but is
forwarding the official government price of the
service to the public treasury, he is said to be
engaging in corruption “without theft” from the
treasury.
• In this case, the corrupt monopolist will set his
bribe level such that his marginal revenue
equals the official price of the service
Monopolist Without Theft
• The total cost
with a bribe
here always
exceeds the
official price;
in this way
corruption
without theft
tends to raise
costs
Monopolist with theft
• If a corrupt official is collecting a bribe and not
forwarding the official price of a service to the
public treasury, he is said to be engaging in
corruption “with theft”
• Since the official has no marginal cost, he will
likely sell the service until the marginal
revenue equals zero; so the service will be
provided more cheaply than the official
government price
Monopolist with theft
• Because the
price is lower
with theft,
businesses
prefer it; but
this reduces
government
revenues
Without theft vs. with
• The general consequences of corruption with
theft differ from those of corruption without theft.
Corruption with theft, if an official discriminates
between “customers,” has the potential to render
all companies not bribing an official
uncompetitive
• Example: When border guards takes small bribes
to let importers avoid duties, they reduce a major
expense for importers. Only importers paying the
bribe last; others are outcompeted
Without theft vs. with
• Competition for access to corrupt officials
thus ensures the spread of corruption with
theft.
• Since their bribe is cheaper than the official
price, citizens have little personal incentive to
expose corruption
• Corruption without theft increases the cost of
government services, so citizens try to avoid
and/or expose excessively corrupt officials
Govt. Revenue
• In both cases, government revenues are
reduced for the service
• In corruption with theft, the government gets
nothing (or a small token amount)
• In corruption without theft, the higher effective
price of the service will reduce the quantity
demanded and the government will only get
the official price for each sale of the service
• The principal in the model, therefore, suffers
from corrupt agents in either case
Govt. Solutions that Create
Bad Incentives
• Some governments accept the inevitability of
corruption and try to sell government positions in
order to raise revenues to compensate for the effects
of corruption
• However, this increases the costs of the corrupt
official, resulting in much higher bribe demands from
them, the assumption that they will never be
prosecuted for corruption (assumption of immunity),
and the institution of universal corruption
• When mid-level government jobs are purchased,
non-corrupt officials cannot afford to hold office, as
the cost of office will rise with corruption levels
Intuitions for Govts
• Corruption with theft aligns the interests of corrupt
officials and “customers” of corruption, and so is more
persistent since no one turns in officials
• Corruption with theft also reduces government
revenues more than corruption without theft, and forces
governments to increase taxes, which hurts growth
• Therefore, reducing obvious theft is a good way to
reduce corruption; accounting systems that record all
permits, licenses etc. let governments measure what
revenue should have been and punish corruption with
theft accordingly; this can force a switch to corruption
without theft, which increases govt. revenues and also
gives citizens an incentive to turn in corrupt officials
Intuitions for Govts (cont’d)
• Accounting mechanisms are more likely to reduce corruption in
systems where there is significant accountability and/or rule of
law--the switch from corruption with theft to corruption without theft
will only decrease overall corruption if citizens feel there will be a
response to consistent complaints. In systems with no
responsiveness to citizen pressure and no reliable law
enforcement, corruption without theft isn’t necessarily an
improvement
• These government intuitions only apply in cases where the corrupt
official in a monopolist providing a homogeneous good that
customers are confident will provide them with the full rights they
need. The situation gets more complicated if other officials can
potentially demand bribes for the same good, or new
complementary permits or licenses, or perhaps a promise not to
create arbitrary red tape/bureaucratic obstructions
Industrial Org of Corruption
• When officials are not monopolists in the provision of a
good/service or when they do not have full control of
their regulatory purview--i.e. other officials or offices
can “enter the market” or produce complementary
goods by threatening to derail or interfere with
business activities approved by the officials in the first
office--the model of behavior changes significantly.
• If several offices can provide the same basic service,
the monopoly model fails and competition must be
accounted for
• If citizens need several complementary goods, like
multiple permits and licenses, the model also changes
Complementary Corruption
• When multiple offices intrude on one another’s regulatory
purviews, by, for instance, requiring a permit from each
office for a building project, the situation can be modeled
as independent and rivalrous monopolists selling perfect
complements- the permit from one agency is basically
worthless without a permit from the other agency
• Independent agencies selling complementary goods won’t
take into account the effect of raising their bribe on the
quantity demanded of the complementary good, and so
both agencies set higher bribes than they would if a joint
monopolist sold both complementary goods. This reduces
total bribes collected and, more importantly for growth,
the number of permits issued
Complementary Corruption
• Complementary corruption becomes exceptionally dangerous
in countries that have poorly designed bureaucratic and
regulatory structures such that there is essentially free entry
into the provision of new, mandatory complementary goods
and services like permits.
• In many African countries, the purviews of dozens of agencies
and offices at multiple levels of government overlap such that
bribes can be demanded by dozens of different officials, so for
a private business or person the total bribes can rise to infinity.
• In such a case, questions over how many complementary
bribes are required mean that bribes no longer secure effective
property rights over a permit or license. As a result, the list of
complementary inputs is not fixed, so investment declines
Complementary Corruption
• The well-known analysis of extralegal business activity by
Hernando de Soto explains this phenomenon quite well,
though it is not explained by Schleifer and Vishny.
• Hernando de Soto and Schleifer & Vishny conclude that
insecure property rights induce a lack of formal investment,
which limits economic growth; de Soto explains how this
results in low-efficiency extralegal economies (Schleifer &
Vishny focus on insecure license and permitting rights rather
than physical property, but the same intuition applies)
• The ruinous nature of complementary corruption when there
is free entry into the market occurs because of the insecurity
felt by customers--in cases where there is coordination or
cartel-like behavior that restricts entry into the market,
complementary goods can make corruption more expensive
for businesses but aren’t necessarily ruinous
Real Life Consequences of Free Entry
into Complementary Corruption
• In modern rural India, individual towns set “tolls,” which in
practice are intended to be to little more than bribes to the
official collecting the bribe (corruption with theft, but with
knowledge form superiors); because there are so many
towns and almost all of them set bribes to get by on the
road, it is very expensive to move goods inland.
• Zaire has an even worse problem: bribes required to move
goods make it cheaper to ship goods across the ocean
than a hundred miles inland
• Such trade corruption problems pop up wherever there are
many officials managing the flow of goods and corruption is
endemic: frequent demands for bribes prevent trade form
enriching inland areas of many poor countries, explaining
why landlocked, corrupt countries are almost always poor
Competitive Corruption
• If different government official, offices, or agencies can all provide a
particular good, then the monopoly model fails
• Schleifer and Vishny assume that Bertrand competition will force
bribes down to zero in cases of corruption without theft and down to
near zero in cases of corruption with theft
• Schleifer and Vishny go so far as to suggest that the American
federal system with many offices and officials within each agency
each capable of issuing documents conferring legal rights and
protections explains the low level of corruption experienced by
ordinary citizens
• If one passport official demands a bribe to issue a passport in a
corruption without theft model, the customer will just go to another
office to avoid the bribe; hence Bertrand competition
• Accounting mechanisms make it difficult for most US officials to
engage in corruption with theft
Competitive, Complementary
Corruption
• If there is competition or even the risk of free entry into the
provision of every one of the required goods in a
complementary goods model of corruption, Schleifer and
Vishny predict results identical to that of the competitive
single good scenario
• In a larger sense, the goods cease to be perfect
complements with free entry provided that the papers
provided by the official charging the lowest bribe obviate
the need for papers from the officials charging higher bribes
• Competition in the provision of each license, permit, etc. is
thus a major recommendation of Schleifer and Vishny
provided that there are accounting measures in place to
ensure all corruption is “without theft”
Corruption Preferences
• In countries where weak rule of law and responsiveness to
citizen complaints guarantees the presence of a culture of
corruption, the question arise, what is most efficient
assuming agencies have overlapping purviews?
• Under the Schleifer and Vishny model, competitive
complementary corruption is the most efficient--with simple
accounting mechanisms, officials are forced into corruption
“without theft,” meaning competition should drive the price
down to roughly the official price
• Joint monopoly is second best, as the coordinated
corruption will result in the issuance of many permits
• Independent monopolies are the worst--bribes will be set
too high, and few permits will be issued, hurting growth
Corrupt Joint Profit Maximizing
• Directly akin to enforcing collusion in an oligopoly setting
• Joint bribe maximizing occurs by preventing any individual
agent from charging bribes above the agreed-upon level
• Enforced collusion only occurs when there is strong central
control of the bureaucracy by figures involved in the
corruption with ample ability to mete out punishments to
officials at any level; prisoner’s dilemma otherwise
• Centralized police states like the Soviet Union, or allpowerful political mafias like the Chicago Democratic Party
Machine, or small elites like Marcos’ Philippines are able to
enforce collusion; however, regimes with information
asymmetries, costly information gathering, or weak central
control over low-level bureaucrats cannot
Cartel Profit Maximizing
• Joint bribe maximization can only occur when there is an
effective cartel in charge
• This cartel must be able to fire bureaucrats and officials or
reassign them to roles where they cannot collect bribes (or
otherwise control membership in the cartel) in order to
enforce set bribe levels
• It is observed that joint monopolies/cartels managing bribes
are far preferable to independent monopolists providing
complementary goods (and infinitely preferable to free entry
into the creation of new complementary goods)
• Russia under the USSR, Marcos’ Philippines, and Chicago
all had solid growth and established corruption cartels;
Sub-Saharan Africa, Bolivia, and Russia 1991-2000 had
independent monopolist officials and stagnation
State Strength & Cartels
• Strongly centralized, authoritarian states often find
enforcing cartels easier than decentralized and/or partially
democratized and reformed states, according to Schliefer &
Vishny
• They cite the example of Russia in 1991 as the epitome of
a emergent free entry into complementary government
goods: almost overnight, Russia’s centralized cartel
collapsed and bureaucrats became independent
monopolists with overlapping purviews; the breakdown of a
strong nomenklatura oligarchy due to the rise of (weak)
democracy destroyed centralized, absolute control over the
bureaucrats which destroyed the cartel
• This discouraged growth through free entry into
complementary goods creation, according to S&V
Schliefer & Vishny’s Advice, #1
• S&V argue that competition in the provision of
each government good will minimize corruption
by driving bribes toward 0 so long as accounting
mechanisms ensure corruption is without theft;
this is a controversial point
• They admit that in cases where accounting
mechanisms allow corruption with theft,
competition in the provision of each government
good (price falls) will increase total theft from the
government—but will increase provision of each
service, which may be a net positive
Corruption and Secrecy
• Schliefer and Vishny also add secrecy to their model
• They hypothesized that secrecy is what distinguishes
bribery from taxation and makes it far more distortionary
• Taxation is generally publicized and well-known, whereas
corruption must be kept secret; even in countries with
endemic corruption, publicizing corruption will usually result
in embarrassment, demotion, dismissal, prosecution, etc.
• This secrecy shifts incentives for public officials
dramatically; officials have incentives to create regulatory
roadblocks to discourage activities that are hard to profit
from illicitly
• At its most extreme, this may result in bans on goods,
services, or activities that reduce bribes for officials
Secrecy Changes Policy
• Schliefer and Vishny use real-life examples to argue that
the need to keep corruption secret encourages highly
wasteful policies and expenditures by government officials
• It’s hard to skim significant sums off of, say, purchasing
medicines or books for which there are wide substitutes
available and hide it in an invoice (how does an official
explain a $10,000 textbook available for $70 on Amazon?)
• This may explain large infrastructure and defense
expenditures in corrupt developing countries that underinvest in human capital (education) and health care
• In a memorable example from Mozambique, officials
ordered a needlessly expensive, unique machine so there
was no comparison good; this allowed invoice skimming
Mozambique Secrecy
• In Mozambique, a state factory requested foreign aid to
purchase a modern piece of manufacturing equipment
• There were many machines available at $10,000 that would
meet all of the factory’s needs, but the manager and several
officials insisted that they needed a unique machine costing
nearly $100,000
• The unique machine probably would have offered limited
additional value—S&V use $20,000 as an estimation—but
because investigators had no easy comparison product, the
manager and ministers were likely able to over-invoice and
steal
• Social losses of nearly $80,000 then occur, as $100,000
earmarked for aid was wasted on a unique machine just so
officials could steal a couple thousand dollars
Broader Consequences
• The need for secrecy similarly provides an incentive for
procurement officials to prefer spending on defense, where
comparison goods are less common, rather than on basic
medicines and school supplies, where comparison goods are
easily available
• Since primary education and basic health care have very high
returns while defense spending provides very low returns for
most countries, the social costs of the need for secrecy are likely
enormous
• Infrastructure projects are also bastions of graft, since kickbacks
from contractors are common. Here, there is usually at least
some social return from investment, but societies gain little from
repaving the same road every single year, which officials might
well do if they get a good kickback from the relevant contractor
Advice #2 : Change Incentives
• The principal-agent problem is one of bad incentives: the officials
have every incentive to engage in graft and demand bribes if there is
not an accounting/accountability system (to deter theft), a reporting
system (to catch corruption without theft), & multiple possible
sources for each good (competition to drive bribe prices down)
• In the absence of anti-corruption measures, a bribe-maximizing
cartel run by rational technocrats can at least limit the damage from
corruption by reducing excess bribe demands; without the cartel,
officials have every incentive to act as independent monopolists
• Due to secrecy and the “other people’s money” problem, officials are
encouraged to procure goods to maximize graft rather than results
and to ban substitute goods that limit corruption; this leads to lowreturn government investments
• Requiring all purchases to have comparison goods can reduce such
graft; combined with aggressive invoice accounting and independent
internal affairs investigations, corrupt practices should be minimized
Broad Implications of Corruption
• The final consequence of corruption is that, in order to keep
knowledge about the degree of corruption to a minimum and
maximize revenues from corruption, corrupt officials have
every reason to favor socially suboptimal monopolies or
oligopolies (easier to collect bribes from a small number of
large firms), to limit foreign entry to the domestic market, and
to protect reliable partners in corruption against efficient
companies that may be reluctant to spend money on
corruption when they feel they can report it
• These moves toward more closed economies with fewer firms
and barriers to entry for new firms and thus new ideas can
prevent economic development
• Foreign investors get deterred and domestic innovators get
destroyed by red tape
Conclusions
• Schliefer and Vishny conclude that governments should:
• Maintain basic accounting and accountability procedures
• Ensure that there is a response system in place to deal with
reports of corrupt officials simply stealing from the treasury
to eliminate corruption with theft
• Make government agencies compete to provide the same
services
• Create a competitive political climate in which
responsiveness to citizen complaints is emphasized
• Use political openness to force freedom of information-style
openness on bureaucratic actions to prevent opacity
Discussion:
• Models only deal with day-to-day corruption
– Paper does not discuss special deals like sales of government property
• S&V have no real advice for how to make government
auctions more fair
• What about customs officials, border guards, building
inspectors, and environmental inspectors?
Discussion:
• They assume that all government documents have value
– in a country where the police can be bribed cheaply, it is unlikely
anyone would bother bribing clerks for documents when they
can just pay not to be arrested
• They may overemphasize the importance of secrecy in
countries with endemic corruption
Discussion:
• Their models are very useful for corruption involving
homogeneous government goods
• Their solutions are broadly applicable within the
parameters of their model
• The principal-agent model of corruption is instinctively
reasonable and relies only on rational responses to
incentives by agents
• Their conclusions about democracy and openness need
more evidence
– Example: Russia in 1989 vs. 1994
Discussion:
• They assert competition will result in Bertrand
competition
– Competition is almost never going to match the perfect competition model
– Government offices tend to be far apart
– Will people really walk five miles to avoid a bribe when they
might just be charged a bribe at the other government office?
• This explains why even in the US, we see some
corruption-if the bribe is very low, it’s easier to just pay
and avoid a hassle