Anticorruption and the Design of Institutions 2012/13
Lecture 7
The Kleptocrat
Prof. Dr. Johann Graf Lambsdorff
Literature
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 Lambsdorff, J. Graf (2007), The New Institutional Economics of
Corruption and Reform: Theory, Evidence and Policy. Cambridge
University Press: 81-108.
 Myerson, R. (2008), “Perspective on Mechanism Design in Economic
Theory”, American Economic Review Vol. 98 (3): 600-602.
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 How should we define corruption when the government (the principal) is
maximizing only his own interests and disregards public interests?
 The term corruption is misplaced when applied merely to a disobedient
agent. Instead, the principal’s own self-seeking behavior may be termed
corrupt.
 ”misuse” is not clearly related to the trespassing of rules, because rules
are themselves the result of self-seeking:
– Markets are distorted where this profits the principal.
– Public resources are allocated to further the principal’s economic
interests.
– The principal is above any rules and immune to any accusations.
 ”misuse” must be related to public interest (at the cost of offering a less
concise definition).
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 Harden [1993: 186-7 and 208-13] reports about the devastating
environmental effects of the Turkwel Gorge Dam in Kenya and how it was
motivated by overpricing and kickbacks. But feasibility studies did not have
to be falsified, they were just forbidden to be carried out in the first place.
When the Financial Times published information from a whistleblower,
copies of the newspaper were seized at Nairobi Airport.
 Inefficiencies that can be detected are there by design.
 In contrast to a single agent, the principal (government) can follow its
corrupt goals in a much more systematic way.
 The principal does not have to circumvent laws and regulations but can
design them to serve his own interests.
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 The principal (government) thus takes advantage of his monopoly position.
 A common conclusion is that prices are likely to increase. Market
restrictions and price increases already occur with corrupt agents. But
principals can impose such restrictions in a much more forceful way by
making them part of law.
 While we may feel desperate about such a ruler, welfare losses are difficult
to prove. Imagine a “perfect” kleptocrat, a totalitarian ruler who seeks to
maximize this wealth .
 Welfare losses reduce the kleptocrat’s potential to take away income from
the citizenry; a kleptocrat therefore dislikes welfare losses.
 A kleptocrat attempts to organize a corrupt system to operate like a tax.
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 He contains low-level corruption among the bureaucracy.
 He prevents individuals from ”overgrazing” the market.
 He dislikes low quality in public procurement.
 He dislikes white-elephant projects.
 He attempts to take more from those who can give more.
 It is argued that the “stationary bandit” exercises power consistent with the
interests of society, (Olson 1993). A ruler has an ”encompassing interest”
(unlike the predator).
 Murphy, Shleifer and Vishny [1993: 413] argue that the problems with
corruption are mitigated when corrupt rulers can collect bribes efficiently.
 So, why worry about this type of corruption?
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Welfare losses due to monopoly price setting
Return from
investment
Consumer surplus
with maximum price
Supply
Dead Weight Loss
Producer surplus
with maximum price
Demand
0
sectors
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The kleptocrat can levy the burden equally by price discrimination
Return from
investment
Kleptocrats surplus
Supply
Demand
0
sectors
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Wizard of ID,
Parker and Hart,
September 17, 2000
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 Example: One of the grandchildren of President Suharto in Indonesia
attempted to make a cut from taxes on beer which was collected by his
private company. But as a result tourism in Bali was suffering from a
shortage of beer and inflated prices, forcing President Suharto to withdraw
the tax.
 Counterexample: One illustration of a strong and corrupt government is
that of Mobutu in Zaire, an uncontested kleptocrat for decades. But his
regime crippled the economy and established a strong example that public
welfare bitterly suffers from such regimes.
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 In reality various problems exist for kleptocrats.
 They assign property rights to comrades and contestants (rather than to
those making best use of resources) in exchange for loyalty.
 A flourishing economy may threaten their power.
 A short time horizon motivates them to “run with the loot while they can”.
Wizard of ID, Parker and Hart, May 11, 2000
 But, is an eternal dynasty of uncontested rulers the solution?
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 Investments require the committing of resources, hoping that their initial
investment will be honored.
 Their resources are sunk and cannot easily be transferred or assigned to
different tasks. Railroads cannot be removed, power plants cannot be
relocated to different countries. Investors fear for the expropriation of their
future revenues. They carry out investments if political promises to honor
their revenues are credible.
 Kleptocrats can impose an excessive tax burden on investors; they can
apply the law arbitrarily and even draft laws that set investors at a
disadvantage.
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 In a survey of business people in Karnataka, India, it was found that the
software industry was less affected by the high level of corruption among
the local administration. Compared to the construction and manufacturing
industries these units could easily shift assets outside the state because
this industry depends less on immovable assets. This lower dependency
seems to have reduced extortionate demands for bribes among public
officials. For other sectors credibility is essential because investments
cannot be redeployed.
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 Investors want to rely on binding laws, but corruption motivates rulers to
arbitrarily change the law and expropriate resources.
 Strong corrupt rulers are motivated only by self-enrichment and face no
restrictions.
 They cannot credibly commit to effective policies.
 Due to kleptocrats' failure to make binding commitments, they are not
trustworthy to investors.
 Investments will be stopped unless the ruler is effectively limited.
 This implies that kleptocratic rulers may have an (apparently very limited)
interest to engage in anti-corruption. This is somewhat comparable to
Mafia bosses who attempt to legalize their business in a strategy to avoid
the hazards for their offspring. Kleptocrats must seek ways to commit
themselves to their announced policies, which opens the door to reform.
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The Problem of the Kleptocrat

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Myerson (2008) provides a good model for the credibility problem faced by
autocrats.
 Assume production, Y, in a country to be determined by capital, K, and raw
materials, n, according to Y=(K+n)0.5.
 An autocrat may honor the investments and allow a return of rK. The variable
r is the country’s discount rate, which would just suffice to keep capital in the
country. The autocrat would thus tax (or take as bribes) only the difference,
which is (K+n)0.5-rK. The current value of his income would be ((K+n)0.5rK)/(r+b). The variable b is an additional discount rate due to the autocrat’s
exogenous risk of losing power.
 An autocrat may also expropriate the capital, which suggests that in future
periods capital is no longer provided by international investors (K=0). The
current value of his income would then be K+n0.5/(r+b).
 The autocrat’s moral hazard constraint is thus
((K+n)0.5-rK)/(r+b) ≥ K+n0.5/(r+b)
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 The ideal capital stock that maximizes ((K+n)0.5-rK)/(r+b) is obtained by the
first derivative, (0.5(K+n)-0.5-r)/(r+b) =0  (K+n)-0.5=2r. With r=0.05 we
obtain K=100-n. Let, for example, n=12 and we see that the moral hazard
constraint is violated. For any K>0 this results, suggesting that only K=0
(n=100) is feasible.
 The autocrat may now liberalize his regime, for example by designing
constitutional constraints or countervailing powers that limit his capacity to
expropriate. The extent of liberalism l, 0 ≤ l ≤1, reduces his income from
expropriation according to (1-l)[K+n0.5/(r+b)].
 There is also a random risk for an honest autocrat to be overthrown, which
is 0.05.l. His income from honesty thus reduces to
((K+n)0.5-rK)/(r+b+0.05l),
which he seeks to maximize by setting l subject to his moral hazard
constraint,
((K+n)0.5-rK)/(r+b+0.05l)≥(1-l)[K+n0.5/(r+b)]
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 This moral hazard constraint is depicted in the figure below, alongside with
the isopayoff-curve.
Liberalization and Capital with n=12
IsopayoffCurve
100
Capital K
80
Moral
Hazard
Constraint
60
40
20
0
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
Liberalization l
 Optimal liberalization is achieved with l=0.504, inviting for capital
investments K=52.4
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 In case of n=0 the autocrat’s optimal regime would have l=0 and K=44.2.
Liberalization and Capital with n=0
100
IsopayoffCurve
Capital K
80
Moral
Hazard
Constraint
60
40
20
0
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
Liberalization l
 Intuitively, a lack of natural resources makes it more costly for the ruler to
lose his reputation for protecting capital, and so he can credibly encourage
substantial investments even without liberalizing. Examples of such
countries may be Singapore, Monaco or Liechtenstein.
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 In case of n=25 the autocrat’s optimal regime would have l=0 and K=0.
Liberalization and Capital with n=25
100
IsopayoffCurve
Capital K
80
Moral
Hazard
Constraint
60
40
20
0
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
Liberalization l
 Intuitively, a great wealth of natural resources makes the ruler unwilling to
accept the additional political risk from liberalization, even though it means
that nobody will invest in the nation without liberalization. Examples may
be Saudi Arabia and Venezuela.
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 The dilemma faced by a kleptocrat arises with a similar logic for the
bureaucrat who acts as an agent for a principal.
 Imagine a principal in charge of delegating a task to the agent. Both would
profit if the task is carried out as agreed.
 But if the agent takes bribes he his disloyal and produces a loss to the
principal. Anticipating this, the principal would prefer to cancel the project.
 Bribery implies that potentially beneficial contracts are no longer tenable.
 Those contracts that require honesty and the absence of corruption will not
be sealed when the principal faces an agent who will take advantage of the
arising opportunities.
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 The agent will suffer from his own corrupt intention. The agent fails to
maximize by being unlimited in his capacity to maximize.
 When agents cannot credibly promise to reject side-payments from
clients, they are not trustworthy when writing contracts that require the
absence of such payments. Principals will be reluctant to offer such
contracts in the first place.
 An illustrative example on this is provided by Bates [1981]. He argues
that in Sub-Saharan Africa peasant farmers avoided corruption by taking
refuge in subsistence production. They simply avoided exchange with
those who might extort them. The welfare enhancing profits from a
division of labor could not be achieved because farmers had no
guarantee that they would not be cheated.
 It may be worthwhile to construct good-quality roads. But principals may
choose to cancel the project if bad quality is expected to result from
unavoidable collusive behavior.
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 A fair and efficient tax system is desirable. If tax collectors cannot be kept
from taking bribes such a system may fall into disfavor and be terminated
by the principal.
 The citizenry prefers to vote against tax increases for otherwise useful
purposes because administration and politics cannot be kept from
embezzling the funds.
 Supervisors may be unable to guarantee honest reports that are not
influenced by bribes. Their contribution loses value for the principal and
they may not be hired in the first place.
 Ultimately, those agents who are willing to take bribes must bear the
burden of the drop in welfare – they are jobless.
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 In this perspective, a bureaucrat who tries to maximize with a willingness
to take bribes fails to maximize.
 His actions can be anticipated; his superior (the principal) has no reason
to trust in his loyalty.
 The agent will not be hired in the first place.
 Any new agent must resist the temptation provided by their discretionary
power.
 If an agent can commit to honesty, he will be preferred and given the job.
 Commitment to such a mechanism provides agents with a competitive
advantage.
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 Bureaucrats thus often have an intrinsic motivation to resist temptation.
They need help in this desire, just as anonymous alcoholics need their
peer group to support their integrity. Reform may find support among the
bureaucracy, even if it cuts down on the capacity to take bribes.
 We have allies everywhere in the fight against corruption. There is
honest willingness to contain corruption.
 Some economist’s have suggested that corruption is just as natural as
self-seeking. I suggest the opposite: the quest for integrity is part of
human nature.
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Appendix
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Discussions
1) Describe the type of corruption that emerges when self-seeking is the actual
object of government!
2) How may in this case allocation be distorted?
3) Show that in a static model a “perfect kleptocrat” avoids welfare losses!
4) Why is such a static analysis misleading?
5) What may motivate autocrats to abstain from taking bribes?
6) In how far is abundance of raw materials important for an antocrat’s
decision to restrict his actions by liberalizing?
7) Why may maximizing bureaucrat face problems similar to that of the
kleptocrat? Explain by use of a principal-agent approach!
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