Underdevelopment and the Economics of Corruption: a Game

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World Development,Vol. 10, No. 8, pp. 677-687, 1982. 0305-750X/82/080677-1 1$03.00/O Printed in Great Britain. o 1982 Pergamon Press Ltd.

Underdevelopmentand the Economics of Corruption: A Game Theory Approach

JOHN MACRAE”

Summary. - Previous attempts to treat corruption arc surveyed critically. A game theory approach is preferred on the grounds that it can most cffcctivcly explain the basis for decisions of reasonable men to bc corrupt. A simple model is presented showing how bribery might be a dominant strategy. A prisoner’s dilemma type of situation emerges with the added complication that the judge and jailer may be corrupt. Other conclusions arc that one official will not accept bribes from more than one firm. It is impossible to predict which firm will win the contract. No obvious solution emerges and legal remedies are discounted. This paper then reviews the principal gcncral equilibrium effects and concludes that their likely effect on economic dcvclop- ment is negative.

Although, as we shall see, economists and 1. 1NTRODUCTION political scientists are divided over the overall influence of corruption on economic growth or The debate on the topic of corruption and development, political events speak more underdevelopment, in which Myrdal’s (1968, clearly. Corruption has been the principal argu- 1970) classic contributions stood virtually ment used by the leaders of the recent coup unchallenged for a decade, has now shown d’etat in Liberia to justify the overthrow of the signs of being reopened. Recent contributions regime of President Tolbert. In Syria many of include empirical analyses (Sarrassoro, 1980) the top Ministers were recently ousted as part and theoretical discussions based on a utility of an intensive campaign against graft and maximizing under uncertainty methodology corruption. Lack of serious analysis of the (Rose-Ackerman, 1975; Beenstock, 1979). The issues involved and of basic hard facts has also present article attempts to contribute to the led to remedies which, to many, appear worse debate at a methodological level. In particular it than the disease. The main elements of the proposes the thesis that if one is interested in Syrian solution are to raise the salaries of State answering the question, what is the basis for servants and army officers by 50-10070 and to decisions of reasonable men to be corrupt, try to seek out political leaders whose leading then a game theory approach would seem to attribute is that they are sufficiently rich so as provide a useful methodology. We argue that to avoid being tempted by the opportunities to game theory can enable progress to be made turn aside public funds for private purposes where utility maximization falters and that (Le Monde, 16 January 1980). useful conclusions can be derived from a These are only two recent entries in a long minimum of assumptions. list of concrete examples where the topic to That serious discussion of the influence of be discussed reveals itself to be of prime corruption on economic development is long importance for the development prospects of overdue scarcely needs repeating. For develop- much of the Third World today. Given the ing countries, the object of the analysis here, complex and wide-ranging influence of corrup- corruption is of growing rather than declining tion on the allocation of resources, we have importance. Myrdal (1968) makes the point limited the discussion to a number of precise that practically everything that has happened in questions to be treated analytically. In particu- the post-Independence era in South-east Asia lar, we shall be concerned with bribing by has raised the incentive and opportunity for corruption. Recent surveys of selected African countries have confirmed its grip of the public * Independent Development Consultant, Paris. I am sector and noted its increase in importance as grateful to the journal for the valuable comments of the general level of economic development rises the anonymous rcfcrees on an earlier draft of this (Sarrassoro, 19 80). paper. 671 678 WOKLO L)L:VI~l.Ol’hll~N I oligopolistic firms or their agents in the context corruption, it contradicts the views of those of contract tendering. In Section 2, we present who consider it solely as a cost incurred b> our definition and a brief critical survey of pre- capital-rich countries in their lending to capital- vious methodological approaches. This leads us poor ones4 If the arrangement results in firms to prefer a game theory approach which is or nationals of capital-rich countries gaining employed in Section 3 to answer the following projects or positions in capital-poor ones, is it questions. (1) Do all firms, or only some, have not more in the nature of an investment yield- an interest in being corrupt? (2) What role do ing recurring benefits, rather than a cost, that assumptions about rival behaviour play in this the arrangement ought to be considered? decision? (3) Is there any limit on the amount The evident similarity between official of corruption that can exist? Can bribes be market exchange and the ‘shadow’ market for extorted from everyone? What provides such arrangements has been accepted by some limits? (4) What is the likely role of legal sanc- authors of the ‘political science school’ as the tions in discouraging corruption. In Section 4, basis for an argument that such ‘open’ corrup- we bring out some of the important general tion is an optimal means of bypassing burrau- equilibrium effects such as the influence on cratic inertia and is even conducive to economic technology choice, the composition of produc- growth.” There are two critical points which tion and the distribution of income. can he made about this form of analysis, First. it is based on a false analogy. the sinrilarity between the official and unofficial markets is in 2. CORRUPTION: DEFINITION AND fact more apparent than real. Second, the con SURVEY OF METHODOLOGIES elusion suffers from the fallacy of composition. Regarding the first point. there are at least To avoid the moralistic overtones associated three factors which dominate the market for with the term ‘corruption’, we shall use the arrangements but which are absent from a corn- term ‘arrangement’ whenever possible to define petitive official market (we treat imperfect the object of our analysis. An arrangement is a markets later). First, whereas the competitive private exchange between two parties (the market is based on full information to compet- ‘demander’ and the ‘supplier’) which: (1) has an ing parties, the market in arrangements is based influence on the allocation of resources either on secrecy, i.e. the segmentation of information immediately or in the future, and (2) involves amongst different parties. Second, there is the the use or abuse of public or collective responsi- importance of rival behaviour. In the market bility for private ends.’ Whilst conclusion of an for arrangements there will be no ‘bidding’ pro- arrangement implies the expectation of a net cess for if all are bidding then they will cancel gain for both parties, the form of the gain varies each other out (Section 3). Last, there is the considerably as do the circumstances of the heavy element of both risk. for instance of dis- negotiation. If the most common form is prob- covery, and uncertainty as to the final outcome ably monetary as a result of an arrangement associated with an arrangement. In a competitive contracted between private individual and market, e.v post, there is no uncertainty as to public official, the payment for, or counterpart the outcome, hut in the case of arrangements of, the arrangement may be political patronage, this uncertainty will always exist for there is no tutelage or some other type of harter.z guarantee that the arrangement will ‘work’: there are other uncontrolled factors at work. The treatment of risk has been at the centre of (a) Traditional views and false analogies recent economic theories of corruption [see The basic assumption adopted by this Section 2(b)]. definition, and running through the models to It is the need of authority, in its thousand be outlined later, is that corruption is part of a and one forms, to vet or decide over the con- rational calculus and an integral and often ditions under which economic activity can be deeply-rooted method by which reasonable undertaken, that confers on the official what men take decisions in the soft-states of the Beenstock (1979, p. 16) describes as ‘conferred Third World. It thereby opposes the view of monopoly status’. This situation implies an Myrdal who argues that it is in some way analogy with the imperfect market functioning opposed to the operation of the profit-motive, of traditional microeconomics, but this analogy being part of an amalgam of social attitudes is also debatable. Often the analysis is made which impede the introduction of natural that the arrangement price is like a tax which is decision-making along these lines into LDCS.~ passed on to the consumer with all the normal In stressing, also, the exchange nature of consequences such as changes in producers’ and UNDERDEVELOPMENTANDTHEECONOMlCSOI~CORRUPTION 679 consumers’ surpluses.6 But whether the arrangement is concluded ; (2) the degree of risk associ- ment cost will be passed on will depend on, ated with the contracting of the arrangement amongst other things, the assumptions made and the attitude towards risk taking; (3) what about rival behaviour by the party seeking the rivals are prepared to offer for their parts; and arrangement. Arrangements, in the context of (4) official settlement costs, i.e. the level of contract negotiations for important ‘one-off’ fines etc. We shall concentrate first on factor projects in LDCs are more a reflection of the (2). Differential arrangement prices may be presence of intense competition amongst rivals thought to reflect the different degree of riski- rather than the absence of it and the arrange- ness involved in concluding an arrangement, ment cost may well be absorbed as part of a with those higher up in the hierarchy receiving strategy to gain the contract rather than passed greater compensation for they risk more on. The fact still remains that traditional micro- important positions. However, using a utility- economics is fairly unsuited for analysing the maximizing approach, first adopted by Rose- bargaining dynamics of this sort of situation Ackerman (1975), Beenstock ( 1979) shows where rival reactions are important and supply that the relationship between risk and the and demand curves can scarcely be held to arrangement price is not a straightforward one. exist (Shubik, 1970). This is where a game At higher levels the chances of detection are theory approach can score, but first consider plausibly greater. Consequently a contracting the problem noted earlier of the fallacy of party, seeking to maximize his expected utility, composition. may choose a lower than maximum level of Corruption, it is argued, may promote bribe. This seems scarcely a realistic empirical bureaucratic efficiency by quickening the pro- case, however, for the risk of discovery would cess of decision-making and the execution of appear to be in general quite low [Section 2(c)]. these decisions7 but delays are no more the In order to be able to manipulate utility cause of corruption than they are the conse- functions, the actors involved in this model are quence of it. Delays provide an indication of the buying and selling representatives of multi- the ‘shadow price’ of an arrangement. There national companies, and if a ‘corruptibility con- will be delays before the arrangement is negoti- dition’ (Beenstock, 1979, p. 20), which largely ated, but the contracting of the arrangement depends on the degree of their risk aversion, is will presumably bring these delays to an end. satisfied, then an arrangement will be struck. Its Although bribery by one individual or firm may price is determined by the equation of the lead to a more efficient resolution of that indi- marginal utilities of the individual buying and vidual’s or firm’s problem, this cannot be so for selling representatives with their respective everyone. If everyone resorts to bribery, no one expected gains at the margin. However, if the will gain much, yet the underlying problems arrangement demander (the selling represent- motivating the bribing - queues, greed for ative) explicitly incorporates a consideration of monopoly profits, impatience in front of struc- his company’s profitability into his decision, tural inefficiencies - all remain.8 More import- this is not the case for the arrangement supplier antly, who ultimately pays for the cost of the who bases his decision entirely on a personal arrangement? Only a full-scale general equilib- financial reward. The corrupt buyer in this case rium analysis can answer this question and it must be acting clandestinely with respect to his seems unlikely that even then any clear answer employer. But is the seller as well acting inde- will emerge, so complex are the various factors pendently? This is not clear. Is it realistic in at work. We shall try to point out the most effect to analyse the behaviour of company important of these general effects on the overall representatives independently of their employ- pattern of development in Section 4. ing institutions? Will not the attitudes of these institutions influence the degree of risk aversion of their agents and hence the likelihood of (b) Expected utility maximization and entering an arrangement in the first place? And differential arrangement prices what, therefore, determines the likely attitude of these institutions? It is here that the The question of what determines the level of importance of assumptions regarding rival the arrangement price is naturally one that con- behaviour enter in. cerns economists and is at the centre of recent The utility-maximizing approach would economic analysis of corruption. It is possible appear more suited to answering the question to distinguish, a priori, four sets of factors ‘what level of unit arrangement price is likely which lead to different arrangement prices: (1) to be offered?’ rather than ‘why does a decision the level of the hierarchy at which the arrange- to be corrupt occur in the first place?‘, As we 680 WOKLI) I)l:Vl LOl’hll N I

noted earlier, it attempts to answer this latter the irnportLmce ot the special chara~trristl~~\ question by postulating a corruptibility con- cancel each other out at this stage. dition which must be satisfied if a corrupt The role of the corruptible official is to decision is to be possible. However, the specifi- enhance the probability 11 of firm A getting the cation of such a condition is incomplete, It contract. We shall assume that his capacity to does not incorporate the likely gains under do this is reflrcted by the value of the parsmete the alternative assumptions - corrupt or not ‘u’. In terms of absolute values, 0 most commonly exposed in the contemporary under ~‘i’ti’rj.T parihus assumptions regarding media, of an overseas corporation considering rival hehaviour. If others are offering bribes, the rationale for bribing a local official as part then this will alter the chance of A getting the of an attempt to gain a contract. Whereas project, even if he is bribing. Furthermore, all Beenstock (1979) uses the mean-variance model competitors cannot, if corrupt, expect to get 11’ to explore the relationship between a single for then the sum of these 11’values may exceed seller and buyer, in the approach which follows unity, which is clearly impossible. We assutnc, we assume a situation with several possible therefore, that ‘a’ is the maximzlnz premium that sellers or arrangement demanders, confronting the official can offer and if there is more than a single buyer. We use this approach to answer one demander this premium has to be shared the following three questions. (1) Do all rival out between them. The official has every firms or only the most ambitious have an interest to offer the maximum premium. but interest in seeking arrangements? (2) Are there the existence of arrangement-seeking rivals will any limits to the amount per firm and the mean that ‘a’ will not reflect the real shadow aggregate income per contract sought that will price of the arrangement to the individual firm. be paid to the official or is his likely rernuner- except in a special case where he is the only ation from this source in effect unbounded? (3) demander. Exactly what chance each will have What is the role of legal sanctions in influencing of others are corrupt too, is determined by the the decision to adopt a corrupt strategy? Qucs- further requirement that the probability of get- tion (1) approaches the problem from the ting the project for a firm that is not in the perspective of the arrangement demander, market for arrangements, but that everyone elsr assuming the determinants of the supplier’s is, must bc greater than zero. If it is zero, then behaviour as given. Answering questions (2) no-one will be intcrcsted in being not corrupt, and (3) however involves taking jointly into and hence all will cancel themselves out in their account the perspectives of both demander and attempts to get the contract. This probability supplier. will also exceed zero on account of the slightly I:irm A is one of a number of rival firms (/I: heterogeneous nature of the product offered. in total) tendering for a project worth P units in The innocent rival’s bid has therefore ;I chance value. Each firm offers a slightly different pro- of being acceptc‘ti for this reason. duct but this is not essential to the analysis We call this probability, i.e. that ot an since disguising of the kickhack could still innocent rival getting the contract with all occur even if the product offered was horno- others corrupt, I?“. For the (I\’ - 1) rivals. we gencous. It is certainly a more realistic assump- define /I; as the probability of A getting the tion and makes a corrupt outcome more likely contract if all (A’- 2) others are corrupt, and A since the extra payment involved can far more follows a corrupt strategy too. Therefore. 11” easily he concealed. In the analysis that tallows. atid 1); are rclatetl as follows: the chance of A getting thr contract in a corruption-free environment will, however. bc approximated by l//V or I?, i.e. we assume that UNDERDEVELOPMENT AND THE ECONOMICS 01: CORRUPTION 681

a(N- 1) and p2F is the conditional probability given P” zz 1 -(N-l)(&) = i-7. innocent rivals. Setting fiiF = (UpiF) and Yi = EYi + C, i= 1, (3) 2 we write equations (4) and (5) as: From equation (3), the upper limit to ‘a’ is t = AA, (8) given by l/(N- l), i.e. a < l/(N- 1). If there where? = [Y;, Y;],g = [(x),(1 -x)],and are four bidders, the official cannot offer any one corrupt rival a premium in excess of j. Since firms are going to pay in proportion to A = (P-filF)P P”p the premium offered this is the first evidence (P’ - fi2F)P Pp we meet of a limit to the aggregate amount of i 1. arrangement income. We shall soon see that it is Clearly, unless the values of fiiF are quite high, a very significant one. then the corrupt strategy will always dominate However, the real source of uncertainty for A because p > p” and p’ > p. Furthermore, if filF is that he does not know whether his rivals are is not greatly different from $2~ then the scene corrupt or not. He has to undertake his calcu- is set for co-operative strategies.” To demon- lations under the alternative assumptions that strate this, consider the following example. they may or they may not be. We define the proportion of rivals who are corrupt asx. Firm A’s problem is to compare the expected income (a) An arithmetic example (EY) from the project under both assumptions or strategies, namely that he accepts to be We assume the following values for the corrupt (EYr) and that he is non-corrupt (EY,). model’s variables and parameters. N = 6, P = To complete our model, we assume that, in 10, a = _i?, filF= &, j&F = A. Hence in this the light of what we saw in Section 2, a firm case: which has decided to follow a non-corrupt strategy will have its life made harder b; the A= frustrated official. These costs, in the form of delays and difficulties of formalities, are represented by the variable ‘d’, and must be To analyse the strategies, let us assume also that deducted from the expected net gain under a of firm A’s rivals two have decided not to be non-corrupt strategy. The arrangement price is corrupt - they may be ultra-conservative or ‘c’, so if payment is according to opportunity ‘irrational’ in Myrdal’s sense, but this is not cost d = c, but as we have suggested earlier, ‘c’ important for the analysis since the conclusions is also likely to be related to the arrangement hold irrespective of the value of x chosen. Two premium ‘a’.” We assume that legal sanctions others have decided to be corrupt. So the game on the demander exist and that the probability played between A and B, the only undecided of their being actually imposed [we take the rival, yields the following pay-offs. By substi- sanction here to be expressed in monetary tuting first x = 3, then x = $, into equation terms, i.e. a fine (F)] is pF. The two basic (8) and calculating q we get the following pay- equations expressing the expected net incomes offs, and the pay-off matrix as follows: from a successful bid for the project (P) are as x= $,9 = (13, If); follows: x = 5, * = (13, 1%). EYr = p(x)P+p’(l -x)P--pFF-c,(4) If c = d, then ? also represents the relative pay- EY, = p”(x)P+p(l -x)P--. (5) offs net of these costs: The first entry is A’s pay-off, the second B’s, To simplify the arithmetic, we put c = d and set F in relation to [by a proportionality factor ___-B’s strotegles (v)] the aggregate project benefits:

F = VP. (6) _! ,I EIRkZ :;:,:I:Or.U,, So we may write pF F as:

PFF = PIF(X)V~+ PzF(~ --X)np, (7) where plF is the probability of being fined Clearly the C strategy is dominant. Whatever given that all rivals are also involved in bribing, B does, A is best to be corrupt. Even the most 682 WORLD I)I:V~.LOl’hll~.N’I honourable of competitors will be led, if they successful co-operative agreement with one of follow the track of rational self-interest, to be his rivals (_Y= f. 1;’ = 14; /:‘Ya = 1 ). Thr dishonest. This is another example of the classic official’s security level here is zero (So),‘* ‘prisoner’s dilemma’. The response to a situation Is H the only feasible solution? What if the of this kind emerging has generally been to official is greedy and bargains with .4 for Y suggest regulation by outside authority of firm higher (c > f) price? Ought the firm to con- or individual behaviour in an effort to ensure cede? The answer is ‘no’. For as soon as A that private and public interests are brought begins to trade some of its net expected gain into line. But this solution is of doubtful applic- (up to a maximum of 4 for S, = 1) along Hf;. ability in this case for it is the very behaviour of the final outcome is not Pareto optimal. We are these authorities that has been made an integral thus forced to the conclusion that the aggregate part of the game. The shock that the formu- arrangement price does have an upper limit. lation of the problem in the above way provides provided by the initial value of ‘c’ which we is that there may be no effective ‘independent’ expect to be directly related to ‘a’. l+tering agent to implement public fines or other sanc- into a co-operative agreement, although in the tions for these agents are already engaged in official’s interest, will not have any influence taking bribes themselves. on his aggregate income from a particular arrangement.13 The burden of adjustment falls on the official who cannot expect more than (b) The case for co-operation his initial asking price.r4 Let us summarize the conclusions that we If we analyse the nature of the solution have reached so far, (1) If the circumstances more carefully, various questions are posed. exist for corrupt strategies to dominate, firms First, apart from ‘irrational’ motives mentioned and officials will seek to co-operate. (2) We will earlier, why would any firm be interested in not in general observe multiple bribing. (3) being honest? Will the official be able, then, to Unless we assume differential willingness to pick up his arrangement from all of them, and will this be a stable long-run situation? In the earlier example, both the maximum 2 l/z and the minimum gain fall for A as x rises from s 0 to 1. Would it not be reasonable to suggest the interest of A in excluding B, C. D etc. from being corrupt - i.e. to collaborate with the official who, as part of the deal, would refuse arrangements from A’s rivals? Would the official be interested in such co-operation? Following Von Neumann and Morgenstern (1944), there are two conditions which must hold if a co-operative solution is to be found, namely: (1) that the negotiated solution must be Pareto optimal, and (2) that the co-operative strategies must yield pay-offs at least as great as could be had by both parties without co- operation. To establish whether a negotiation set exists, we display graphically the ‘convex hull’ of the mixed (C/NC) strategies (Figure 1) UO (with (Bacharach, 1976). We assume c = d = :, and BC AD LfO sanctions) plot the relevant pay-offs to A (CIA) and the total arrangement price to the official or his pay-off (U,) as follows. Only points along BC are Pareto optimal, and of these, point B is a solution, given c = 4, i.e. the arrangement price is kept at its initial level, for otherwise r/, would exceed 1. The security level condition is also satisfied. Here A’s security level (S,) is 1 because this is his minimum alternative gain, given by the net expected income of a non- corrupt strategy with the official concluding a UNDERDEVELOPMENTANDTHFECONOMICSOI:CORRUPTlON 683 pay, then economic considerations will not his gross arrangement income minus the help us to determine which of the rivals the expected value of the monetary sanction which official will choose to collaborate with. This he would have to pay if discovered, i.e.: will have to be determined on grounds of UO = Rc-pPOFFO (9) ethnicity, nepotism, social contact or some other ‘parochial’ consideration. (4) The burden where R is the number of corrupt rivals paying of adjustment falls on the official rather than ‘c’, POF is the probability of the official being the firm which stands to gain relatively more fined and FO the amount of the fine. Both pOF from co-operation. The upper limit to the and Fo have, up till now, been taken as zero. latter’s arrangement price is determined by his The effect of this type of sanction may be influence parameter (a); and since co-operation illustrated by referring again to Figure 1. occurs, this also provides the upper limit to the Positive values for POF and Fo will reduce the official’s arrangement income from a given official’s expected pay-off for each value of R, deal. Empirical evidence points to (2) being but, unlike sanctions on the agreement verified. There are well-known examples (Scott, demander, their introduction affects the 1972, Chaps. 4 and 5) of firms bribing officials expected income gains under both the corrupt separately for a given service, but we have not and non-corrupt strategy. Point A remains fixed come across, in our research so far, any case of but other co-ordinates along both BC and AD multiple bribing as understood here. will be shifted to the left by the amount of the To what extent are these conclusions depen- expected value of the fine. The pay-off set can dent on the particular assumptions we have therefore be displaced into negative UO pay-off made? We have already touched on the import- space, if this expected value is high enough. ance of the legal sanctions parameters (pIF, Figure 2 shows the influence of the intro- pzF, v. F;). Let us consider these in more detail. duction of legal sanctions. AEFGH represents the adjusted convex hull of Figure 1 after sanctions with expected value = 4 have been intro- (c) The role of legal sanctions duced. The pay-off set has been reduced but a co-operative game solution with a corrupt It has been assumed that legal sanctions may strategy dominating is still likely. To change be represented by a monetary value, F, or may this result appears to depend on introducing be given a monetary equivalent form. In some high absolute values of POF and fi.O. It is cases this may not be very reasonable. In a possible to point out here that the value of recent case of bribery in Iraq the death sentence POF probably rises with R, the number of rivals was imposed on the official and Life imprison- with whom the official deals, because the risk ment on the business representative. We have of detection rises. Combining high values of not taken into account, in the earlier analysis, PoF (rising also with R), and FO would give the the risk of sanctions on the official, which as extreme case illustrated in Figure 3. Here the earlier example shows, do exist and are PUFF, is high enough to yield [by equation sometimes effectively implemented, even in the (9)] negative values of UO for low values of R. context of ‘soft-states’. Effective legal sanctions at this level of In terms of the model, effective sanctions of severity do now change the likely outcome of a monetary nature, whether imposed on supplier the game profoundly. For instance co-operation or demander or both, operate in general to shrink with any one rival at a given level of ‘c’, the the convex hull, and to reduce the likelihood unit arrangement price, is now no longer feasible, that a corrupt solution will dominate. Their role is crucial in determining whether there is a game to be played, and what the likely outcome will be. Taking first sanctions on the arrangement demander, raising PF or F or both, will, in the example given earlier, serve to lower the vector BC in Figure 1 (EYr). When it coincides with AD, then at this value of sanctions there is a ‘crossover point’ such that, with higher sanctions or more effective implementation of these G D non-corrupt strategies will become dominant. I I I The effect of introducing sanctions on the arrangement supplier is more complex. The official’s expected pay-off (UO) will now equal Figure 2.The effect of IeRa sanctions. 684 WORLD I~l~VI~.LOI’MI Nl

3. (;FNER,iL EQCIILIBKICJM FI:I’l:(‘I’S

If we accept as a general definition of a d~s- tortion, any factor, whether policy imposed C)I not, incompatible with the operation of the economy at a Pareto optimal equilibrium, then corruption bely;gs within this definition (Corden. 1974). If only normal profits w-erz to be gained from a project, no one wo~ht he willing to offer an arrangement price which would result in a lower rate of profit. Although for the official’s security level (1/o = 0) is not the general theory of distortions is now a core satisfied. The official may seek to co-operate element of modern development theory, one with a subset of firms so as to raise his mini- can read through the key contributions on the mum likely pay-off above his security level, but subject without encountering one substantial such a strategy has its own risks and only discussion of the role of corruption in influenc- further empirical research will show whether it ing the patterns of resource allocation and use is a realistic possibility. in LDCs (Little c’t al., 1970; Healey, 1972: One important question that is raised in this Magee, 1973). (‘orruption is analogous to an context is how, in the presence of corrupt overvalued exchange rate or a bordrr tax on officials and multinational corporations whose commodities in the sense that it affects the activities are not subject to any clearly defined entry cost into a given market. But since it does national juridicial authority, such legal sanctions not necessarily fall only on foreign suppliers. can be established and, in practice, implemented. hut is in principle payable by domestic pro- In the models outlined earlier the sanction is ducers as well, then it does not have thr same assumed to be a monetary amount known in effect on the cornpositron of production as ;I advance, e.g. a traffic fine. What is not known is border tax which will discriminate in tavour ol how well it will be implemented. But in practice locally produced substitutes. there are many factors (including corruption It is generally argued that distortions have itself) which will determine the nature and operated to lower the relative price of capital in amount of a fine that a guilty party may be LDCs thus serving to encourage the LISA 01 required to pay. It will rarely be the case that capital-intensive technology. Corruption on the the ‘official settlement cost’ will be known in other hand tends to raise the relative cost of advance. Specialist studies have shown that in capital. If nominal interest rates are low. effec- most LDCs no special apparatus exists for the tive interest rates in Lrn have to include the treatment of corruption. Recourse is occasion- arrangement price payable to the relevant bank ally taken to mass media campaigns in an effort manager in order to be able to get loans or to mobilize public opinion. One jurist who has credits.‘” It is the arrangement-in~lusivc price studied the problem intensively in the Central which is in effect the means by which scarce African context is deeply pessimistic about the capital is rationed out. If arrangement charges value of legal sanctions, at the national level, to art’ taken into account, will the so-called gap Cope with the phenomenon of corruption between ‘organized’ and ‘unorganized’ sector (Sarrassoro, 1980). interest rates still bc found to exist in fact, Moreover, nation-states jealously guard the as the thesis continues to exist in the text- right to adjudicate all cases of penal law books? (Yotopoulos and Nugent, 1976; (ihatak, infringement committed on their territory, so 1978). little in the nature of an ‘international’ solution Corrupt practices also affect the validity ot may be expected. It is significant that the lnter- arguments based on the hypothesis of OVCT- national Court of Justice has not yet treated a valued exchange rates as a factor determining single case of corruption as defined here. In unsuccessful development performance (Power sum, therefore, no clear limits to the level of and Sicat, 1971 :Klock, 1972). Corrupt practices the arrangement price is likely to be provided in the allocation of scarce foreign exchange. e.g. from a legal standpoint. Whilst the potential role through the private distribution of import- of sanctions is very great, for various reasons licences at a given arrangement price, will work their actual role is ineffective in discouraging in the direction of raising the domestic price ot the widespread espousal of corrupt strategies. foreign exchange and may cancel out the initial UNDI~RDEVELOPMENTANDTHIS ECONOMiCSOFCORRUPTlON 685 impact of the overvalued exchange rate on the the case of jobs being allocated according to level of domestic prices of importables.‘7 In political or parochial considerations. In these cases such as these, the arrangement charge circumstances, where there is a dominance of operates to correct distortions at the level of ‘institutional’ methods in determining the allo- production or consumption decisions, certainly cation of jobs, the negative effects of corruption at the expense of distributional equity (see are likely to be the greatest. later). Despite its impact on the cost of capital raised locally, corruption may distort the choice of (b) Distributional effects investment project in favour of capital as opposed to labour intensive projects. This has From our analysis in Section 3 we have seen been confirmed, for example, in a recent survey that the payment of the arrangement represents of managerial practices regarding technology a reduction in the net rate of profit earned by choice in Nigeria (Winston, 1979). Winston’s the successful rival, and a transfer from the rival (1979) survey showed that the risks of a particu- to the official. In the case of an unsuccessful lar arrangement for the purchasing manager corrupt rival a transfer also occurs to the official. (‘the supplier’ of the arrangement) rose with the In so far as this transfer represents a shift in the number of transactions, the number of people distribution of income from reinvestible profits involved and the complexity of the material pur- to consumption by the official, overall growth chased. ‘These biases in cost per dollar of the rates will suffer. However, we have also seen kickback create incentives for the opportunistic that corruption biases the choice of techniques manager to choose capital-intensive, technically in favour of capital. Factor income distribution sophisticated, imported equipment when strictly will therefore shift in favour of capital (generally above-board calculations of strictly above-board overseas capital) by a greater amount than the costs would recommend less capital, less sophis- arrangement will transfer income in favour of tication, less foreign exchange and more small local LDC officials. Moreover, there is the fact units from domestic suppliers’ (Winston, 1979, that the arrangement revenues will generally be p. S41). spent on high import content luxury goods, or But bribes received by officials often exceed, deposited in a foreign bank account, so having in absolute terms, the entire annual turnover of virtually no multiplier effects within the LDC, indigenous smaller-scale enterprises. Overseas probably negative balance-of-payments effects, firms can raise finance overseas on non-corrupt and a loss of tax revenues to the LDC govern- terms, but local firms have to go through the ment on account of the unofficial nature of the local banking system and the costs which that transactions involved. implies. Large capital-intensive firms, using Since the supply price of the arrangement methods that give rise to lumps of fixed capital rises with the level of the hierarchy, so that being advanced at particular stages of the pro- larger amounts are shared amongst smaller num- ject’s completion have a greater chance of being bers of individuals, the distributional conse- able to conceal the arrangement price than does quences at the level of the distribution of a labour-intensive contractor. The labour- personal incomes are disequalizing. Both the intensive contractor with a heavy demand for gap between rich and poor and the inequality circulating or working capital may have diffi- of the post-tax distribution of incomes will culty in finding a sufficient amount of reserves increase, the latter arising from the untaxable at any one time to meet the arrangement price nature of the gains from corruption and the fact which is usually payable in advance. therefore that the rich will gain both absolutely Another serious influence which needs to be and relatively more. One way around the diffi- more deeply researched, is the effect of corrup- culty of actually measuring the extent of this tion on the allocation of labour, especially influence on the real distribution of personal skilled labour, in the LDC. The spreading of incomes, since the gains will never be recorded corruption into the universities and other insti- in the official statistics, would be through sur- tutions of higher education in the Third World veys of consumption levels or holdings of real (Myrdal, 1970, p. 231) and the consequential wealth, i.e. after the arrangement price has been awarding of formal educational qualifications transferred into the form of some fixed asset where these have not been properly earned, (villa, car etc.), in which form it is often pro- results in the placement of graduates in jobs vided in the first case. A properly administered which are beyond their actual competence and wealth tax combined with an expenditure tax inefficiency is the inevitable result. This mis- would be preferable on equity grounds to the allocation of resources is even more evident in income tax or general sales tax as a means of 686 WORLD DI:Vt:LOPhll~Nl correcting the inequalities arising from this sumption, factor prices, the distribution of real source of private gain in LDCs. income, balance of payments, the price level etc. There is lastly the real-income effect to con- in an LDC today. Our approach in this article sider, arising from the need to pay arrangement- has concentrated on explaining the omni- inclusive prices for all goods, services, primary presence of corruption by illustrating a logical inputs etc. subjected to corrupt practices regard- basis on which decisions to be corrupt may be ing their allocation. The poor will be subjected taken. From this, we deduced certain conse- to this effect in the same way as the rich. The quences for the pattern of economic dcvclop- poor urban dweller will have to pay the arrangement. It appeared that the balance of these ment price to have a plot of land individualized effects, especially at the level of distribution. in his name as part of a process which will also was strongly negative. tax the richer man. Indeed the rich may have to We have argued that legal solutions are pay more as a result of corruption than the unlikely to be effective in solving a problem poor, for example on account of their patterns which has its roots in the day-to-day operation of expenditure, so that it isobviously impossible of society from the lowest to highest levels of to say a priori what the overall effect on the dis- decision-making. What limits, then, do exist? tribution of real income will be. It is simply not The only ones to emerge from our analysis are true to say, however, that the gains from corrup- provided by the ‘hidden hand’ of calculated tion are concentrated solely within ‘the tiny new self-interest, e.g. in limiting the value of ‘c’ and upper-class’.18 The reality is more complex and the number of firms actually paying ‘c’. What it is the net gains that have to be analysed. then of the role of well-selected economic policies? Certainly some measures aimed at the reinforcement of market constraints may assist 5. CONCLUSIONS in limiting corruption and distributing gains more evenly. Increasing ,Y, the number of rivals All economic undergraduates today know tendering,, will as we have seen reduce the pre- about the Scitovsky criterion that for any mium (p -p) that a corrupt official can pro- change to increase welfare the losers must not vide to any one arrangement seeker. Open be able to bribe the gainers to oppose the auctioning of licences would also help, hut vzry change; but who knows about the economics of soon limits to the effective implementation of’ bribery in the real world today’? In this world it such policies will be met. No solution to the is not the losers who aim to do the bribing in problem is anywhere in sight and it remains as most cases, but those who are going to gain, and true today as it was 14 years ago that in most the importance of bribery is not limited to the LDCs ‘before the power structure has been redistribution of a given amount of gain between changed by evolution or revolution. it will be consumers. It has complex and wide-ranging difficult to decrease corruption or even to effects on the composition of production, con- hinder its continual increase’.”

N0TT.S

1. 1Vhat represents ‘use’, what ‘abuse”! Only the (votes vs dollars). The distinction bctwccn e.\tortion social mdres of the particular context being discussed and subversion is, xcording to Hccnstock (1979). that can determine this. In many LDCs corruption is mdre for the fornicr the af~plicat~t is, ex arzfe, not intent on t11c aKepted ‘tise’ of power, a sort ot‘ reward for nndcrtakinp ;L corrupt deal but in the cxx of subversion sncwss. To the outside (DC) observer. the silmc he is. bnt, ex posr. both arc cngagcd in ;i presumably actions appear ‘abusive’ since he views them from 21 illegal act :md the significance ot‘ the distinction is not different moralistic perspective. lor LI relevant dis- clear. lor cxnnple. Btxnstock (1979, pp, 22-23) cussion uf the pre-Kcvolutionary Chincsc cast, set srgnes that c\turtiun is likely to bc mnre hnrtfnl to Needham. (1974, ,‘f’. 2433245). allocative et‘t’icicncy than subverston. but m tact this wnclusion dcpcnds on what additional assumptions 2. bccnstuck (1979) adopts a fio.~~n~~nic al~~rwh nrc made about initial conditions. Set Section 4(a). to distinguish between five dit‘tcrcnt ‘casts’ 01‘ corruption: extortion. subversion. political and judicial 3. Lfyrdnl. (1970, 1’. 230). corruption, gratnitics and benign corruption. fldwevcr. in most countries, only the first three casts arc corrupt 3. Yotoponlos 2nd Nqxnt (1976, p. 8). sccording to his dct’inition which strews illegality or secrecy. In all thcae three L‘UCS, an c\change olcmcnt 5. SW in particular Scott (1972. p 70). ,\lorgan exists. The distinction between case 3 and casts 1 and (1975, 11. 370) and Myrdal (1970, 17. 238) provide 2 is largely a matter

6. Beenstock (1979, p. 16); Winston (1979). sanctions on the arrangement supplier. See Section 3(c). 7. See Myrdal (1969, p. 950) for references. 13. It may be shown that in the alternative case where 8. One might argue that the queues will move more (P --P,=) > (P’ _b2F)’ the conditions for co- rapidly due to the better paid and now motivated operation do not exist. See Note 11. This result is not official. This remains uncertain. pursued here.

9. Beenstock (1979, p. 21) notes the riced for this 14. This conclusion provides one answer to the qucs- approach to answer questions of ‘bargaining dynamics’ tion raised by Beenstock (1979, p. 21) regarding the which his expected utility-maximizing approach is possible process of adjustment that will be followed unable to deal with. when buyer and seller have different ‘ideal bribes’.

10. We have noted earlier that ‘a’ lies in the interval 15. It is therefore not very helpful to compare cor- 0 jlF. But if at the price of f210,OOO sterling per liccnce. See .i)>~ is too high then it will outweigh the differential &main 1 ‘Afrique (1980). gain from bribing (p’ > p), 18. Myrdal (1970, p. 239).

12. WC are at this stage ignoring the existence of legal 19. Myrdal (1970, p. 248).

REFERENCES

Bacharach, M., Economics and the Theory of Games Myrdal, C., Asian Drama (London: Allen Lane, 1968). (London: Macmillan, 1976). Myrdal, G., The Challenge of World Poverty (London: Becnstock, M., ‘Corruption and devclopmcnt’. World Allen Lane, 1970). Development, Vol. 7, No. 1 (January, 1979), pp. Needham, J ,, La Tradition Scientifique Chinoise 15-24. (Paris: Collection Savoir, tIermann, 1974). Corden, W. M., Trade Policy and Economic Welfare Power, J. H and G. P. Sicat, Industrialisution and (London: Oxford University Press, 1974). Trade Policies, the Philinuines and Taiunn Demain I’Afrique, ‘La fonction publique malade de la (London: Oxford University Less, 1971). corruption?‘, No. 44 (January 1980). Rose-Ackerman, S., ‘The Economics of corruption’, Chatak, S., Development Economics (London: Long- Journal of Public Economics, Vol. 4 (1975), pp. mans, 1978). 187-203. tlealey, D. T., ‘Development policy: new thinking Sarrassoro. II., La Corruption des Fonctionnaires en about an interpretation’, Journal of Economic A.frique (Paris: Editions Economica, 1980). Literature, Vol. 10 (September 1972), pp. 757- Scott, .I: C., Comparative Political Corruption (Engle- 797. wood Cliffs, New Jersey: Prentice-tlall, 1972). Klock, D. J., ‘The impact of direct trade controls and Shubik, M., ‘A curmud~con’s guide to microccon- an overvalued exchange rate on factor proportions omits’, Journal of Economic Literature. Vol. 8 in manufacturing’, Journal of Development (1970). Studies, Vol. 8 (July 1972). Von Neumann, J. and 0. Morgcnstern, The Theory of Little. 1.. T. Scitovsky and M. Scott. Industr_y and Games and Economic Behaviour (Princeton, New 7Yade in Some Developing Countries (London: Jersey: Princeton University Press. 1944). Oxford University Press, 1970). Winston, G. C., ‘The appeal of inappropriate tcch- Magee, S., ‘t:actor market distortions, production and nologies: self-inflicted wages, ethnic pride and trade’, Oxford Economic Papers, Vol. 25 (March corruption’, World Development. Vol. 7, No. 1973), pp.-l-43. S/9 (August-September 1979), pp. 835-845. Morgan, T., Economic Development, Concept and Yotopoulos, P. A. and J. B. Nugcnt. Economics of Strategy (New York: Harper & Row. 1975). Development (New York: Harper & Row, 1976).