Bargaining for Bribes: The Role of Institutions

We develop a bargaining model of corruption where firms pay bribes to avoid regulation. Consistent with this setup, we find that time spent bargaining with bureaucrats and amount of bribe payments are positively correlated, but that this association is weaker (and, thus, corruption more “efficient”) in more rule-based environments, where the terms of illegal transactions are more transparent. Much time and effort has been devoted to assessing the extent of bribery across firms, industries, and countries, and the effects that bribery, or corruption, has on various social and economic outcomes. The correlation between the level corruption and growth has been firmly established at the cross-country, as well as at the firm level and the literature indicates that a high level of corruption has a negative impact on economic development. For example, early work from Mauro (1995) shows that corruption is strongly associated with lower growth at the country level, while more recent work by Svensson (2003) studies similar issues using data from firms in Uganda. However, among the set of countries where corruption is perceived to be rampant, there exists tremendous heterogeneity in the level of economic performance over the past several decades. For example, parts of Southeast Asia have thrived, while sub-Saharan Africa has stagnated. Many nations in both regions are perceived to be very corrupt. This evidence leads to the question − largely unexamined in the economics literature thus far − of whether there exist institutional and social factors that mitigate the growth-retarding effects of corrupt government. In this paper, we examine the role of institutional characteristics such as the amount of regulatory burden or the extent of discretionality in bureaucracies in determining the efficiency with which corrupt transactions between entrepreneurs and public officials take place (and hence, ultimately, society’s overall level of productivity). The relatively sparse existing work in this area has focused on the role of corruption as efficient grease of the bureaucratic system. For example Liu (1985) 1 Corrupt practices differ widely across countries. It has been noted, for example, that corruption tends to be more centralized in East Asia, while it is more uncoordinated in Africa and South Asia. Many factors can account for these differences, including the level of ethnic fractionalization (see amongst others Olson, 1992 and Shleifer and Vishny, 1993). However, an in depth discussion of these aspects of corruption is beyond the scope of this work. presents a queuing model where bribes reflect the opportunity cost of time. Huntington (1968) characterizes bribes as a form of personalized de-regulation. Conversely, Kaufman and Wei (1999) develop a model where nominal harassment is endogenous and as a result, bribe-payers are forced to cope with greater harassment. Neither of these approaches, however, identifies the institutional setups in which corruption is more or less efficient, and, as such, the literature provides limited guidance to economists or policymakers on the institutional features that are effective in reducing the distortionary costs associated with corruption. This paper develops a simple framework for thinking about the characteristics that are associated with high social costs of corruption – in the deadweight loss sense – rather than simple transfers of wealth from firms to bureaucrats. Our contribution to the existing literature is twofold. First, we lay out a simple model to describe the nature of negotiations between a corrupt bureaucrat and a bribepaying firm, and consider how these negotiations will be affected by a bargaining friction parameter. Thus, we provide a link between the literatures on the nature of corruption and the quality of institutions, an area of research that has flourished in recent years. At the core of our investigation is the question of whether there are institutional arrangements that minimize the deadweight loss from bribery; that is, the extent to which corruption is more or less “efficient” in different environments. More importantly, we will examine the prediction of the model using data from a number of recently collected datasets. These include several firm-level data sets that provide information on firms’ relations with government agents, as well as country-level data on the nature of institutions across countries. In particular, we report results that suggest that bargaining frictions are lower in rule-based governmental systems, which we propose may be the result of the greater clarity in the bribe bargaining process afforded by rule-based systems. The rest of this paper proceeds as follows: In Section 1, we develop a simple illustrative bargaining model of bribery; Section 2 describes the data utilized in this paper; Section 3 presents are empirical results, and Section 4 concludes and discusses issues for future research. 2 See, for example, Acemoglu et al. (2002) for a recent take on the institutionalist perspective 1. Theoretical framework In this section we develop a simple descriptive bargaining model of bribery. We consider, as an illustrative example, a bargaining situation where firms must deal with a number of bureaucratic regulations at a cost of r per regulation. Obvious examples include compliance with labor safety standards and environmental impact regulations. Firms differ in the number of regulations, nf, they must comply with, based on individual circumstances. To further simplify, we consider a decentralized model, where the firm is engaged in a series of bilateral negotiations with government officials, each of whom may force the firm to comply with the regulatory requirements, or pay a bribe to circumvent these requirements. In each bilateral negotiation, we assume that the regulation may be costlessly circumvented by the bureaucrat, so that a surplus of r is created by joint agreement to avoid the regulation. The standard Stackelberg bargaining solution has the two parties splitting this benefit, so that the bribe will be r/2. However, in order to reach this agreement, a nontrivial amount of time may be spent negotiating this payment. We further assert that some bureaucratic systems will have an easier time in pricing these payments, and hence the time cost will be lower. Finally, we allow for the intuition that firms paying numerous bribes will have economies of scale so that we describe total bribes paid as αg(nf) where α is a parameter that reflects frictions in the bargaining process and g () captures economies of scale in bargaining and is such that g’>0,g’’<0. In this highly stylized model, it is immediate that the time firms spend with bureaucratic hassle is an increasing function of the level of bribes paid, B, since each is a positive function of the number of regulations that the firm wishes to circumvent: