Politicians and Firms
By: Andrei Shleifer and Robert Vishny
Presented by: Barber IV, Bei, Chen & Tkachenko
Introduction:
The business of politics is business. Likewise, business relies upon government to enforce
property rights in order to operate and thrive. Economists from Smith to Marx to Hayek to Keynes
have all written about the symbiotic nature of business and politics. This paper by Schleifer &
Vishny continues the study of private and public sectors by asking: what problems occur when
politics is too closely associated with business?
This paper addresses the issues of corruption, inefficiency, politicians controlling business, and
the effect of privatizing the economy. The paper posits some interesting findings. First the paper
argues that privatization is not a uniform process. The authors delineate between two types of
privatization: control over hiring/firing practices and ownership of profits. The paper finds that
under certain conditions, privatizing and corporatizing business can increase corruption. The
authors argue that limiting corruption and subsidies are best achieved through a strong Treasury
and/or electorate. By placing restrictions on the political feasibleness of subsidies, the electorate
can remove a powerful tool for self-interested politicians to exploit for political gain. By restricting
their ability to provide subsidies, the electorate decreases the incentives for politicians to obtain
economically inefficient labor for political purposes.
This paper relies on very few assumptions. The first being that there are two items that
managers and politicians bargain over: excess labor and subsidies. Excess labor is defined as
workers that contribute nothing and yet extract a positive wage, thus they are a burden upon the
firm. Politicians want excess labor in order to secure political support, and suffer a cost for giving
managers subsidies. Managers want subsidies but do not want excess labor. Second, politicians
always control subsidies through the Treasury, but the control of labor can vary between
politicians and managers. To start the paper, the authors assume that a third party (the Treasury)
controls the amount of subsidies given to firms, but that these two actors are identical. This
assumption is later relaxed in section five.
Third, when politicians do control labor, they are constrained by employing only the number of
workers available until the firm’s profits reach zero. Therefore, they are unwilling to employ labor
at the detriment of the firm. Fourth, the amount of cash flow owned by the manager can vary. In
some circumstances all of the firm’s profit goes to the government, and in others all of the profits
go to the manager. Lastly, when bribes are available to be exchanged, both parties can bribe
the other in order to increase their utility.
From the second and fourth assumption, the paper defines four different types of firms: Public,
Regulated, Corporatized, and Truly Private. Public firms have politicians’ controlling the labor
hired at the firm, and where the government receives most of the cash flow from the firm’s profits.
Regulated firms still have politicians hiring workers, however the managers receive a substantial
amount of the profits from the firm. Corporatized firms have managers’ control the amount of
labor hired in their business; however, the government still owns the lion’s share of the profits.
Lastly the true private firm is the common conceptualization of the firm, where the manager both
hires at her leisure and receives all the profits from the firm. These distinctions are vital in
understanding the implications of this model.
Section II: The Model
Three players: the Treasury, the politician, the manager of the firm
Variables:
L : The unneeded employment of the firm.
w : The wage of each of these employees
B ( L) : Political benefits from excess employment L , a dollar value
π : Firm’s profit before it hires any extra employees
α : Fraction of the firm’s cash flow owned by the manager and outside shareholders
• Publicly owned firm, α à 0
• Private firm, α à1
(1 − α ) : Fraction of the firm’s cash flow owned by the Treasury
t : Transfer from the Treasury to the firm as subsidy
T = t − (1 − α )(t − wL) = α t + (1 − α ) wL : Net transfer amount for the Treasury
• Purely public firm: α = 0,T = wL
• Purely private firm: α = 1,T = t
⑴
C (T ) : The political cost to the politician of making the net transfer T
b : The bribe from the manager to the politician (can be positive or negative)
Assumptions:
• The Treasury is passive, and the politician and the manager bargain over the decisions of
the firm. That is, the politician and the manager bargain over L and T .
• The manager serves the interests of shareholders of the firm.
• The extra employees produce nothing, and their wage w exceeds the market wage thus
is valuable to the worker and hence to the politician.
• The politician benefits from excess employment (and higher wage if make wage
endogenous), and bear a cost for subsidize company such that
•
•
•
•
C (T ) < T .
α is a continuous variable, rather than distinguish sharply between private and public
firms.
Politician controls T , but L can be controlled by either the politician or the manager.
Cash flow and control rights can be allocated separately.
The public is not organized and will not get together to convince or bribe the politicians
and managers to be efficient.
Description of the game:
In the game between the politician and the manager, the politician generally wants the firm to
employ some extra people L , since he derives political benefits B ( L ) from excess employment.
To persuade the manager to do that, the politician can subsidize the firm by making a transfer t
from the Treasury to the firm and bear a cost C (T ) . In general, we allow the manager to bribe
the politician and vice versa (both with and without corruption is considered in this paper), and
bribes are paid out of their own pocket.
Utility function of the politician:
U p = B ( L) − C (T ) + b
Utility function of the manager:
U m = α (π + t − wL) − b = απ + T − wL − b
⑵
⑶
We examine a Nash bargaining game between the politician and the manager with these utility
functions.
The 4 types of company – allocation of rights:
Type 1: Public firm. In a conventional state firm, the politician controls
mostly owned by the Treasury. α is low (can be considered as à0)
L , and the cash flow is
Type 2: Regulated firm. In a regulated firm, the politician still controls
private shareholders have cash flow rights, α à1.
L , but the manager and
Type 3: Corporatized firm. In a “corporatized” or “commercialized” firm, the control rights over L
are turned over from the politician to the manager, yet the Treasury retains ownership of the cash
flows, α à0.
Type 4: Private firm. In a truly private firm, the manager both controls
α à1.
L and owns the cash flow,
Private does not mean L = 0 , and public does not mean politician try to make it as inefficient as
possible. Politicians in this model try to influence all firms through subsidies and bribes, and firms
try to influence politicians through bribes. Thus the question we are interested in is how do
reallocations of cash flow and control rights change outcomes.
Social efficiency:
Political benefits to politicians represent effective transfers from their political competitors, which
are not social benefits. If one politician gets to hire his political supporters, social welfare does not
rise, but rather the politician gets the votes that another politician would have gotten instead.
Similarly, the political cost to the politician of a subsidy from Treasure have some positive net
social cost, since the resources must be raised through distortionary taxes.
Social welfare function: − µ L − σ T
µ : Social opportunity cost of labor.
σ : Social cost of the transfer T
.
With the social welfare function, first-best efficiency dictates L = T = 0 . But because the public
would not convince or bribe politicians and managers to get social efficient, politicians and
managers can use public money to arrive at an outcome that is efficient between them, which is
not the first best.
Section III: Analysis
Before-bribes allocations:
Determine the threat points for manager and politician from which they can bargain to a different
allocation either with or without using bribes.
L and T , they will choose L and T to maximize:
B( L) − C (T ) ⑷
When the politician has control rights over both
subject to
F.O.C
απ + T − wL ≥ 0
T = wL − απ
B '( L) = wC '(T )
⑸
⑹
⑺
Because the politician has control rights, he will choose απ + T − wL = 0 and keeps the firm
down to zero net profits, and uses the firm’s cash flow to hire extra labor until the marginal
political benefit of doing so exactly offsets the marginal political cost of getting extra transfers
from the Treasury to pay for it.
When the manager has control rights over L , the threat point is determined by the Nash
Equilibrium in which the manager and the politician noncooperatively choose L and T ,
respectively. The Nash equilibrium is L = T = 0 .
Politicians
No-subsidy
Subsidize
Hire
α (π + t − wL) , B( L) − C (T )
α (π − wL) , B ( L)
Manager
No hire
α (π + t ) ,
−C (T )
α (π ) ,
0
Compute the “jointly efficient” outcome from the viewpoint of the manager and the politician with
fully transferable utility. Maximizing the combined utility of the manager and the politician:
B( L) − C (T ) + απ + T − wL
F.O.C
B '( L) = w
C '( L) = 1
⑻
⑼
⑽
At the jointly efficient point, the excess employment and transfer decisions are completely
separable. First, the manager and the politician together raise the extra employment to the point
where the marginal political benefit of an extra person is exactly equal to the marginal cost, which
is his wage. They then suck the cash out of the Treasury until the marginal cost of getting an
extra dollar is exactly equal to a dollar.
At this efficient solution, the marginal political benefit of an extra employee is exactly offset by the
marginal political cost of getting subsidies to pay his wage.
Using this basic model, we next ask what happens when bargaining is allowed.
Equilibrium with Bribes:
The Nash Bargaining Equilibrium
A bargaining solution should satisfy a list of reasonable axioms: Pareto Efficiency, Symmetry,
Invariance to Equivalent Payoff Representations, and Independence of Irrelevant Alternatives.
A pair of payoffs
( v1* , v2* ) is a Nash bargaining solution if it solves the following optimization
problem:
max(v1 − d1 )(v2 − d 2 )
v1 ,v2
( v1 , v2 ) ∈ U
Subject to
Where
( v1 , v2 ) ≥ ( d1 , d 2 )
(d1 , d 2 ) denotes the two people’s utility without bargaining, and ( v1 , v2 ) denotes the two
people’s utility after bargaining and reach the equilibrium.
With politician control:
The threat point is given by equations (6) and (7). Denote the labor and transfer at the
disagreement point by Ld and Td .
The politician’s incremental utility from bargaining is given by:
B( L) − C (T ) + b − [ B( Ld ) − C (Td )]
⑾
The manager’s incremental utility from bargaining is given by
!" + T ! wL ! b
⑿
The Nash bargaining solution is:
M = {B( L) − C (T ) + b − [ B( Ld ) − C (Td )]}(απ + T − wL − b) over L, T and b . And
because this will be the efficient outcome, the solution is given by B '( L) = w and C '( L) = 1 .
Maximize
F.O.C:
∂M
= B '( L)(απ + T − wL − b) − w{B( L) − C (T ) + b − [ B( Ld ) − C (Td )]} = 0
∂L
(απ + T − wL − b) − {B( L) − C (T ) + b − [ B( Ld ) − C (Td )]} = 0
Rearrange to get:
b = 0.5{(απ + T − wL) − [ B( L) − C (T ) − B( Ld ) + C (Td )]}
⒀
With manager control:
The threat point utility of the manager is απ , whereas the threat point utility of the politician is
zero. The politician’s incremental utility from bargaining is given by:
B( L) − C (T ) + b
The manager’s incremental utility from bargaining is given by
T − wL − b
The Nash bargaining solution is to maximize:
M = [ B( L) − C (T ) + b][T − wL − b]
Similarly, we can get:
b = 0.5{(T − wL) − [ B( L) − C (T )]}
⒁
From the above analysis, they have two propositions:
Proposition 1: With bribes, the allocation of resources is independent of either the allocation of
cash flow rights α or the allocation of control rights over L .
As stated before, the bargaining will result in the politician and the manager choosing the efficient
point. Having allocated resources efficiently, they use bribes to divide the surplus.
Coase theorem: Economic efficiency is achieved best by full allocation of and completely free
trade in property rights.
This model shows a variant of the Coase theorem. Regardless of who has control and cash flow
rights over L , the politician and the manager internalize the full costs of making inefficient
decisions, and hence act as full owners. Since the public does not participate in the bargaining,
the first-best outcome with L = T = 0 does not obtain. The allocation of control rights and cash
flows can influence bribes, but not the allocation of resources.
It says that, with full corruption, neither privatization nor commercialization matters. In later part of
the paper, we are going to explore the question: how do privatization and corporatization affect
the allocation of resources?
Proposition 2: Under politician control, the equilibrium bribe is increasing in α ; under manager
control, the equilibrium bribe is independent of α . (derived directly from (13) and (14))
Intuitively, with politician control, a higher α rises the value of profits that the politician can extract
from the manager, therefore raises the politician’s utility at the disagreement point. Since the final
allocation is unchanged, the politician benefits from his higher disagreement utility through higher
bribes. However, under manager control, the manager gets απ regardless of whether he agrees
with the politician, and hence the bribe is independent of α .
Propositions 3 to 6 are covered in the following two sections.
Equilibrium with no Bribes: Politician Control
In the case of politician control of both L and T, the manager and the politician cannot bargain to
an allocation that is better for both of them without bribes. Hence the politician's threat point
remains the no-bribes allocation even when bargaining is allowed.
The first question to ask is whether this threat point has a higher L and a lower T than the jointly
efficient point?
Case 1. When politician controls L but cannot take bribes, he inefficiently extracts surplus by
forcing too much excess employment on the firm and giving it too few transfers even when he
does not value the employment too much. At this equilibrium, C'(T) < 1, and B'(L) < w. When
bribes are allowed, the politician extracts surplus more efficiently through bribes rather than
through excess employment. As a result, L is lower and T is higher with bribes. To get this lower
L and higher T, the manager bribes the politician, in the equilibrium with corruption.
Case 2. Jointly efficient point has a higher L and a lower T than the no-bribes politician control
equilibrium. This happens if the politician cares a lot about L, but the cost of transfers is also very
high. To satisfy the manager's individual rationality constraint, the politician keeps both T and L
low when bribes are forbidden. At this equilibrium, B'(L) > w, and C'(T) > 1: the politician is
buying the L that he wants with very expensive T. Once bribes are allowed, the politician can use
the cheaper bribes rather than the more expensive transfers to buy L. As a result, in the
equilibrium with bribes, the politician bribes the manager to have a higher L and a lower T than in
the no-bribes equilibrium, even though the politician has control rights over L. This result obtains
when it is cheaper for the politician to pay for L with cash than with increased subsidies.
The second question we ask is what happens to the politician control no-bribes equilibrium when
cash flows are transferred from the Treasury to the manager. The answer is that with politician
control, an increase in ! leads to an increase in L and a cut in T.
From Figure I, since an increase in ! represents a downward shift of the manager's individual
rationality constraint, and hence a rise in L and a reduction in T at the politician's threat point.
Intuitively, an increase in ! enables the politician to extract more from the manager, since at his
threat point the politician can extract απ .
Implication. In this model, a regulated private firm might have higher excess employment than a
public firm. While in a public firm the politician needs to pay for excess employment through
politically costly subsidies, in a regulated firm he can force the private sector to pay for the
inefficiency. This result suggests that, without bribes, regulation might be an even greater
problem than public ownership.
Equilibrium with no Bribes: Manager Control
Since now the manager controls L and the politician controls T, they can bargain to a superior
allocation by raising L and T simultaneously. Since the manager's disagreement utility is απ, his
incremental utility from bargaining is given by (T - wL). Since the politician's disagreement utility is
zero, his incremental utility from bargaining is given by B(L) - C(T). The no-bribes Nash
bargaining solution maximizes the product of incremental utilities of the manager and the
politician over L and T. FOCs w.r.t. T and L accordingly are as follows:
C'(T) = [B(L) - C(T)]/[T - wL],
B'(L) = w*[B(L) - C(T)]/[T - wL].
Note that at this solution, we again have B'(L) = wC'(T). Without bribes, the manager and the
politician can agree to raise both L and T to make each of them better off.
We ask the same two questions here as we did for the case of politician control. First, where does
the no-bribes manager control equilibrium lie relative to the jointly efficient point?
Case 1. L is lower and T is higher in the no-bribes equilibrium than they are with bribes. When the
manager cannot get bribes from the politician, he earns a return from his control of L through too
little excess employment and too many transfers. At this equilibrium, B'(L) > w, and C'(T) > 1. If
the manager could collect bribes, he and the politician would bargain to a higher L and a lower T,
and the politician would bribe the manager to get to this point.
Case 2. L is higher and T is lower at the no bribes equilibrium than at the jointly efficient point.
This would happen when B(L) and C(T) are both relatively low. The manager wants transfers T.
When bribes are not allowed, he "buys" these transfers through a channel that is expensive to
him and not that highly valued by the politician, i.e., excess employment. As a result, at the nobribes equilibrium, C'(T) < 1, and B'(L) < w. With bribes, the manager can buy transfers more
efficiently, and so can get more T with a lower L. In this equilibrium with bribes, the manager is
bribing the politician to get the T that the politician controls, even though the manager controls L.
The second question is what happens to the manager control no-bribes equilibrium when cash
flows are transferred from the Treasury to the manager.
With manager control, the allocation in the no- bribes equilibrium is independent of management
ownership ! . Intuitively, the reason for this result is that the manager gets απ regardless of
whether he agrees with the politician, and hence the bargaining solution is independent of ! .
Without bribes, once control rights are turned over to the manager, giving him additional cash
flow rights does not influence the allocation. Privatizing cash flows afterwards has no incremental
effect!
Comparative Statics
Propositions 7 & 8 are covered in the following section.
Result 1 Effects of corporatization. Holding ! constant, with no bribes, L is lower, and T is higher
under management control of L than under politician control of L.
At both allocations, we have B'(L) = wC'(T). The manager's indifference curves in Figure I are
straight lines with the slope of w.
Under politician control, the manager's utility is zero (hence the equilibrium lies on his individual
rationality constraint, which has the intercept of - απ ). Under manager control, the manager's
utility is at least απ , and hence the equilibrium lies on an indifference curve above that with the
intercept of zero. That is, under manager control, we must have a lower L and a higher T than
under politician control.
Thus, when managers get control (without bribes), they partially restructure. At the same time, the
budget constraint softens endogenously. When managers get control over L, they can extract
higher transfers from the Treasury. Interestingly, this result may capture the experience of
Russia, where the spontaneous turnover of control to enterprise managers during the late 1980s
has led to an increase in subsidies. Of course, the assumption of no bribes is questionable for
Russia.
Result 2. Effects of corruption
Bribes from politicians to managers raise L and reduce T. Bribes from managers to politicians
raise T and reduce L. The common language meaning of corruption is private parties bribing
government officials. The effect of corruption in this model is to reduce L and raise T.
Corruption promotes restructuring. Thus, conditional on the government control, corruption
reduces costs in Russia. Cash bribes from politicians to managers are less common. There are
a couple of reasons for this:
1. Politicians always have some control rights over firms, such as the power to offer them
government contracts and other favors, and hence always has some ability to make
transfers to the firm and get kickbacks.
2. Politicians and political parties might be cash constrained and hence unable to afford
bribes.
3. Getting political benefits from public enterprises that politicians control might be much
cheaper than getting them from privately controlled enterprises.
C'(T) = [B(L) - C(T)]/[T - wL]
B'(L) = w*[B(L) - C(T)]/[T - wL]
Proposition 9: With bribes, an increase in B(L) raises L and keeps T constant. Without bribes, an
increase in B(L) raises both L and T regardless of who has control rights.
Policy Implication: Proposition 9 says that increased political competition in this model strictly
reduces efficiency since it raises demand for politically motivated resource allocation, with and
without bribes. This should not be interpreted as that political competition is bad for efficiency, as
politicians can also compete with each other in other ways, such as promising a small
government or lower taxes.
Proposition 10: With bribes, when C(T) rises, subsidies and bribes fall while L stays constant.
Without bribes, as C(T) rises, L and T fall regardless of who has control rights.
Policy Implications: With bribes at equilibrium, since L is decided by B(L), L stays constant.
Without bribes, a rise in C(T) means credit policy becomes tighter, in equilibrium both T and L fall.
That is, a harder monetary stance now both reduces subsidies and increases efficiency.
Section IV: Model with Restricted Subsidies
The assumption of unrestricted transfers does not seem plausible for profitable firms, where
subsidies would enrich already wealthy shareholders. This may be viewed as a politically
unacceptable scandal as voters see politicians enriching their friends.
Restricted Subsidy: Politicians can only openly subsidize firms that earn a non-positive profit.
To incorporate restricted subsidy into the model, Schleifer&Vishny introduce the “Decency
Constraint (DC)”:
t > 0 if and only if απ + T - wL < K for some constant K
K is a benchmark above which the politician cannot openly subsidize the firm.
Imagine a firm with a profit απ > K. Suppose L is the amount of excessive employment
!"!!
demanded by the politician. Define!∗ =
. !∗ denotes the maximum amount of excessive
!!
employment the politician can extract by eating up the firm’s extra profit above K.
(i)
If ! < !∗ , the marginal cost to the politician of hiring an additional excessive labor is
1 − ! ∗ !. In other words, the politician can only pay for the excess employment
through the reduction of profits accruing to the Treasury.
(ii)
If ! > !∗ , the marginal price of an excessive labor is w, which means the politician
can openly subsidize the firm, but he/she has to pay the full price (w).
Note that as α converges to 0, the decency constraint converges to the manager's indifference
curve through L = T = 0, whereas as α converges to 1, the first segment of the decency constraint
converges to the L-axis.
Equilibrium
Condition
Right of control
Politician
Bribe
No
Decency Constraint
Irrelevant
Equilibrium
Politician
Politician
Yes
Yes
Binding
Not Binding
Manager
Manager
No
Yes
Irrelevant
Binding
The intersection of the B’(L)=wC’(T) curve with the
manager’s individual rationality condition.
the joint efficient point
The manager and the politician bargain to the
intersection of the B’(L)=wC’(T) curve and the DC (point
X in the graph)
Manager’s threat point, (0, 0)
For απ high enough, or α close to 1, or both, the
manager chooses a lower L than he does with α = 0,
and the firm collects no subsidies.
Proposition 11: With manager control, the decency constraint, απ > K, and no bribes, the
manager chooses zero excess employment.
This is a restatement of row 4 in the table.
Proposition 12: Suppose that bribes are allowed, the manager controls L, and the decency
constraint with a particular K applies. Then for απ sufficiently high, the manager chooses a lower
L than he does with a = 0, and the firm collects no subsidies.
This is a restatement of row 5 in the table.
Policy Implication: Propositions 11 and 12 show the importance of significant outsider ownership
for privatization to lead to restructuring even if firms are profitable. With trivial ownership the
decency constraint is just too weak, making it possible for politicians to use subsidies to convince
managers to stay inefficient. Propositions 11 and 12 thus deliver the result that high management
ownership stimulates restructuring, even when managers are already in control.
Section V: Privatization and Nationalization
Section five discusses the ramifications of privatization and nationalization, and later relaxes the
assumption that the Treasury and the politician act as one. Breaking this assumption
Proposition 13: Politicians always prefer controlling labor compared to managers controlling
labor.
This proposition is perhaps the most obvious of the paper, since when politicians have control of
excess labor they are always in the strongest bargaining position. With control over hiring,
politicians can set the initial level of excess labor to the maximum amount. Then if managers
value labor more than the politicians, politicians can accept bribes from the managers to
decrease the amount of excess labor.
While the politician’s preference over labor control is an unambiguous prediction, the question of
whether they want cash flows to belong to the Treasury or managers depends on who controls
labor.
Proposition 14: Under the decency constraint, politicians prefer managers who control labor (L)
to also have a low ownership stake in the company.
When manager’s control labor, and there is a decency constraint on providing firms with
subsidies, politicians prefer managers to have a low control over the cash flow of the firm. This
result is derived from figure II. The lower stake managers have within a firm, the less private
bribes are required by the politician in order to secure excess labor. However, when managers
have a high stake in the firm, politicians will need to provide large amounts of private bribes
before exchanging subsidies for excess labor. The authors argue that since private, and
substantial, bribes from politicians to managers are rare, that this is a worse case scenario for
politicians.
However, when politicians control labor, the result is the reverse:
Proposition 15: With or without bribes, politicians who have control of firms prefer higher private
and lower Treasury ownership.
When politicians control labor, they wish for politicians to have a full stake in the firm. Manager’s
receiving most of the profits incentivize managers to bribe the politician if they are burdened with
excess labor. In this scenario, managers will increase corruption payments in order to have a
more efficient firm, benefiting the politician with extra bribes.
It is important to note here that when politicians control labor, the effect of privatizing firms
(allowing managers to internalize profits) is to increase corruption. However, this corruption isn’t
necessarily “bad” from a social prospective. Remember that the social efficiency is determined
by the level of subsidies and amount of excess labor within the economy. Here privatization
increases corruption, but also increases social efficiency. While it is not beneficial for managers
to pay bribes to the politician, this action actually makes the country better off. Furthermore,
when there is no decency constraint, public firms can suffer a lower amount of corruption and
enjoy a higher social efficiency. This result makes sense when thinking about the politician as a
manager as well. The politician wants excess labor but not at the expense of completely ruining
the firm. Therefore, politicians internalize the process of excess labor in order to run the firm
properly.
It is also important to note the effect of the decency constraint in this model. When there is no
decency constraint, managers are willing to bargain their excess labor in exchange for subsidies
from the government. This creates both corruption and social inefficiency. However, when the
decency constraint is implemented, managers seek to restructure their firm and get rid of excess
labor. Therefore, the decency constraint is pulling a lot of the theoretical weight in reforming
corruption and inefficiency.
Conclusion:
This paper has shown that under certain situations privatization can lead to increased corruption
and social inefficiency. When bribes from manager to politician are standard practice, and the
political cost of providing subsidies are low, this paper argues that both privatization (allowing
managers to internalize profits) and corporatizing (allowing managers to control hiring) will
increase the amount of corruption and excess labor. This stems from the managers desire to
increase personal gains and politicians desire for excess labor.
It is only through decency constraints, or high costs to providing subsidies in general, that curtail
corruption and social inefficiency. However, when there are high costs to providing subsidies,
both privatization and corporatization can lead to a decrease in excess labor, and thus a lower
level of social inefficiency. In fact this high cost of providing subsidies is one of the only factors
given to explain the decrease in the level of social inefficiency. This might explain why countries
with highly exploitable resources also suffer from anemic economic growth in other sectors of the
economy. When governments have an easily exploitable resource for governmental revenue,
such as oil, politicians are more likely to provide subsidies in exchange for political support.
While this increases the employment levels, this also decreases the incentive for firms to innovate
and grow.
With the authors placing so much weight on the political cost of providing subsidies, it is no
wonder why they argue that true reform can only come from social forces that are concerned with
business. This is, however, in direct contradiction with much of the literature on how political
institutions are formed. Authors such as Acemoglu, Robinson, & Johnson and Boix all argue that
it is only through the rise of the poor class that political institutions reform from government
controlled economy to one that allows for a freer market. These authors argue that through
pressures of revolt and rebellion, political elites provide institutional changes to placate the
masses. All of these authors suggest that it is the people, and not conservative business owners,
that are behind political reformation. However, both of these parties argue that it is larger social
forces that need to push politicians away from their normal, rational, self-maximizing behavior.
While this paper is insightful, it’s tough to assess its impact with such a generic treatment of
politics. This paper assumes one political actor, which we know is not the case in most countries
around the world. Due to this, politicians are responsive to a variety of different constituents in
different countries, which makes direct support of any given businesses a difficult calculus.
Furthermore, while economics is a non-zero sum game, politics rarely is. On the economics side,
the authors implicitly assume that the social inefficiency caused is higher than that of providing
subsidies. This is a curious assumption, especially to a Keynesian, since these additional
employees could at least be able to stimulate the economy rather than being unemployed. If this
is not true, and excess labor can be positive for the economy, than corruption is bad. Not
because it creates inefficiencies, but because it allows managers to take away a socially optimal
level of employment.