Optimal antibribery policy when bribery type is endogenous

• Author: Zhendong Yin,Fuhai Hong
• Published date: 01 December 2019
• DOI: http://doi.org/10.1111/jpet.12399
• Date: 01 December 2019

J Public Econ Theory. 2019;21:1074–1106.wileyonlinelibrary.com/journal/jpet1074

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© 2019 Wiley Periodicals, Inc.

Received: 23 August 2018

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Accepted: 21 July 2019

DOI: 10.1111/jpet.12399

ORIGINAL ARTICLE

Optimal antibribery policy when bribery type

is endogenous

Fuhai Hong

1

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Zhendong Yin

2

1

Department of Economics, Lingnan

University, Hong Kong

2

School of Economics, Central University

of Finance and Economics, China

Correspondence

Fuhai Hong, Department of Economics,

Lingnan University, Hong Kong.

Email: fuhaihong@ln.edu.hk

Abstract

This paper analyzes the optimal allocation of antibribery

resources when bribery type is endogenously determined

by corrupt bureaucrats. A firm is supposed to investto get

licenses for production from bureaucrats. The bureaucrat

commits to a bribes schedule that specifies bribes

demanded from compliant firms (therefore, engaging in

extortion) and noncompliant firms (engaging in collu-

sion) as a precondition of granting the license. The

allocation of antibribery resources determines the prob-

ability that each type of bribery is detected and

prosecuted and thus affects the bureaucrat’s choice of

bribes scheduleand the equilibrium bribery type.We find

that the government should prioritize combating collu-

sion when the resources are sufficiently scarce, should

abstain from combating extortion after it wipes out

collusion when the resources are less scarce, and should

eradicate both types of bribery when the resources are

sufficiently abundant. When there are multiple invest-

ment dimensions, however, there exists a special case

where the government targets both types of bribery when

the resources are at some intermediate level.

1

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INTRODUCTION

Corruption is a major concern in many countries, especially in the developing world. It has

multiple types. Consider a firm that is supposed to invest, according to the law, to get a

production licence from a bureaucrat, a law enforcer. Without the investment, the firm’s

production will be socially undesirable, because the negative externality from production

outweighs its social benefits. However, the bureaucrat may collude with the firm so that the

firm gets the licence by paying a bribe instead of investing. The bureaucrat may also extort

money from a firm that has invested, who still needs to pay a bribe to get the licence. Both

collusion and extortion are socially undesirable because they distort the firm’s incentives of

making the socially beneficial investment.

National governments set corruption‐control policies to curb the spread of corruption.

Because corrupt behavior is typically hidden, it costs the government a large amount of

resources, including manpower, time, and money, to detect and prosecute corrupt behavior. In

many cases, however, the government has scarce resources in combating corruption. With

limited resources, it is sometimes not possible for the government to eradicate all types of

corruption. In this paper, we investigate the question of how the government should allocate

limited resources in combating corruption. Specifically, how should the government allocate

resources between detecting and prosecuting collusion and detecting and prosecuting extortion?

Which type of corruption should the government prioritize to combat?

We study this research question for the case when the bribery type is endogenous in the

sense that the bureaucrat can decide on the bribery type. Most existing studies on corruption‐

control policies (to be reviewed below) assume that the bureaucrat and the firm engage in Nash

bargaining in determining the bribe. Under this assumption, while the bureaucrat still colludes

with the firm without investment and extorts money from the firm that has invested, the

bureaucrat’s role is passive: He cannot choose the type of the firm with which he will interact

and thus cannot choose whether he will engage in collusion or extortion. However, the

bureaucrat may have an incentive to influence the bribery type as the surpluses he can extract

from the two types of bribery could be different: Interacting with a compliant firm may bring a

smaller surplus as the firm bears the investment cost as well. One exception in the literature

that studies endogenous bribery type is Oak (2015).

1

In Oak (2015), the bureaucrat commits to a

bribes schedule as a precondition for giving licenses to compliant and noncompliant firms. The

bribes schedule, which maximizes the bureaucrat’s expected pay‐off taking into account the

firm’s responses, determines the type of bribery in equilibrium. We follow this approach when

investigating the government’s optimal resource allocation in combating corruption.

2

In the

absence of punishment on bribery, the surplus from collusion is higher than that from extortion

as investment is not made under collusion, and therefore the bureaucrat will set a bribes

schedule to ensure that collusion occurs in equilibrium (by demanding prohibitive bribes for

extortion). However, in the presence of punishment on bribery, the resource allocation between

detecting and prosecuting collusion and detecting and prosecuting extortion affects the optimal

bribery type for the bureaucrat, and thus affects the bureaucrat’s strategy in setting the bribes

schedule and eventually the equilibrium bribery type. It is thus nontrivial for the government to

optimally allocate the scarce antibribery resources between the two types of bribery to

maximize social welfare.

In reality, it is common that the firm needs to make investment in multiple dimensions to

comply with the law. For instance, the firm should invest in production safety; it should also

invest in abatement technology to clean up pollutants from its production. Investment cost may

1

Another exception is Hong and Yin (2018), who study the optimal organizational structure when bribery type is endogenous.

2

When committing to a bribes schedule, the bureaucrat maintains a reputation and the bribes schedule is well known. This implies that corruption is

widespread. It is worth noting that by adopting this commitment assumption, our analysis is mainly applicable to the early stage of anticorruption policymaking

when corruption is widespread. We thank an anonymous referee for pointing this out.

HONG AND YIN

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vary across different dimensions. For each dimension, the firm has to obtain approval from a

bureaucrat. In our model, we consider the cases when the firm is supposed to invest in one

single dimension and deal with one bureaucrat and when the firm is supposed to invest in

multiple (two) dimensions and deal with multiple (two) bureaucrats. The existence of multiple

investment dimensions leads to strategic interactions between bureaucrats, on top of the

interaction between the firm and the bureaucrat, which generates qualitatively different

implications for antibribery policies.

There are two interesting features on the optimal antibribery policy. First, the government

should target collusion first when its resources are scarce. Other things equal, the resources

needed to deter extortion are lower than those needed to deter collusion, because the surplus

from extortion is smaller than from collusion. However, if the government prioritizes

combating extortion, deterring extortion simply leads to the collusion equilibrium, which is

even worse from the social viewpoint, because undesirable production without appropriate

investment generates larger social damage than the loss from the unrealized desirable

production caused by extortion. Second, when the resources are too scarce to eradicate any type

of bribery, combating collusion is socially beneficial but imposing some punishment on

extortion is not in general (with an exception discussed below). Combating collusion reduces

the surplus of bribery between the noncompliant firm and the bureaucrat, thus stopping some

socially undesirable production from being implemented. On the other hand, however,

imposing certain punishment on extortion reduces the surplus of bribery between the

compliant firm and the bureaucrat, thus even further discouraging socially desirable production

from being realized, if extortion is not completely eliminated.

Given these two features, our main results with a single investment dimension are the following.

When the government’s antibribery resources are scarce, the government should spend all the

resources combating collusion but not target extortion at all. In this case, allocating some resources to

combat extortion will backfire as this only makes collusion relatively more attractive. When the

government’s resources are at some intermediate level, the government should spend sufficient

resources to eradicate collusion, while it should not combatextortionevenifitstillhassomeresources

available after having eliminated collusion, given the two features discussed above. Finally, when the

resources are sufficiently abundant, then the government should spend enough resources combating

both collusion and extortion to eradicate both types of bribery.

When there are two investment dimensions, there exists a qualitatively different result, if it is

relatively more costly to detect and prosecute collusion than extortion. Suppose the

government’s resources are at a certain intermediate level such that it is possible to eliminate

collusion in the investment dimension with lower cost but not in the other dimension. Having

the firm invest in the dimension with lower cost is still better than having the firm invest in

neither dimension. Under this semi‐investment scenario where the firm invests only in the

dimension with lower cost, extortion occurs in this dimension and collusion in the other. The

surplus from bribery is thus decreasing in the resources combating extortion as well as those

combating collusion. While it is cheaper to combat extortion, the government should still

maintain enough resources to combat collusion to ensure that the firm is willing to invest at

least in the dimension with lower cost. Consequently, the optimal resource allocation will entail

sufficient resources being spent on combating collusion such that the firm is indifferent (and

thus willing) to invest in the dimension with lower cost, and the rest of the resources being

spent on combating extortion. This is the unique case where the government combats collusion

and extortion simultaneously when its resources are not enough to eliminate both types of

corruption.

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