Lecture 1 Definitions and Opportunities

Anticorruption and the Design of Institutions 2009/10 Lecture 1 Definitions and Opportunities Prof. Dr. Johann Graf Lambsdorff

Literature • Lambsdorff, J. Graf (2007), The Institutional Economics of Corruption and Reform: 1-26. • Andvig, J.C. and O.-H. Fjeldstadt (2000), ”Research on Corruption. A Policy Oriented Survey“, Chr. Michelsen Institute and Norwegian Institute for International Affairs. 5-20, 66-73 www.ICGG.org/downloads/contribution07_andvig.pdf • Shleifer, A. and R.W. Vishny (1993), ”Corruption.” Quarterly Journal of Economics, CVIII, 599–617. • Gupta, A. (1995), “Blurred boundaries: the discourse of corruption, the culture of politics, and the imagined state”, American Ethnologist, Vol. 22 (2), 375-402. • Heidenheimer, A., M. Johnston and V. LeVine (1989), Political Corruption - A Handbook, (New Brunswick: Transaction Publishers). 3-14. • Tanzi, V. (1995), ”Corruption: Arm's-length Relationships and Markets.” The Economics of Organized Crime, ed. by G. Fiorentini and S. Peltzman, (Cambridge: Cambridge University Press), 161-80.

Forms of Corruption • We define corruption as the misuse of public power for private benefit. • “misuse” describes • behavior that deviates from the formal duties of a public role, • behavior that deviates from informal rules (public expectations, codes of conduct, conflicts of interest) • behavior that harms public interest.

Forms of Corruption expectations concerning public duties formal obligations Public interest Definition of Corruption • Formal obligations normally derive via public expectations, which in turn are determined by public interest. • If this process is impeded, definitions of corruption have to refer to the prior category

Forms of Corruption Bribery • Obtaining of money or favors by public decision makers (politicians or bureaucrats) in return for preferential treatment or government services. • Bribery is an exchange of favors between a briber and a bribee. • It involves two individuals, commonly a state agent and a civilian, where the state agent misuses his or her power. • In addition, it requires a third party that is harmed. • Bribery is commonly described in the form of a principal-agent-client relationship; the public interest is embodied by the principal.

Forms of Corruption Pays a bribe /defects

Forms of Corruption Embezzlement • Theft of resources; disloyal employees steal from their employers. • Embezzlement differs from bribery because there is no client involved. • Embezzlement is commonly included in a broader definition of corruption. • There exists an overlap with bribery: Public servants cannot directly and without reason transfer funds to their personal account. Sometimes, they obfuscate embezzlement by requesting fake receipts from inexistent private firms or from own firms whose ownership is not disclosed. This introduces a (fake) client to the transaction and blurs the difference between bribery and embezzlement.

Forms of Corruption • In criminal investigations bribery and embezzlement might be difficult to distinguish. • For example, French firm Elf Aquitaine is alleged to having paid bribes to the Christian Democratic Party in Germany in exchange for being preferred in the privatization of the Leuna refinery and the Minol petrol stations. • But embezzlement within the firm has been suspected as an alternative explanation for the missing funds. • Dieter Holzer acted as an intermediary, receiving a “commission” of 45 million German Marks for only ten weeks of Lobbying. Depending on who finally received the money, either bribery or embezzlement took place.

Forms of Corruption

Forms of Corruption Fraud • Economic crime that involves some kind of trickery, swindle, deceit, manipulation or distortion of information, facts and expertise. • Bribery often involves fraud. • Bribery without fraud: If public servants take speed money but do not obfuscate their malpractice and do not otherwise act against the rules. • Fraud without bribery: Fraud also takes place when state officials engage in organized crime, such as smuggling, counterfeit or when contracts are given to firms where public servants have a stake.

Forms of Corruption • Fraud is typically monitored by internal and external auditing. • This suggests another link between bribery and fraud: supervisors/auditors take bribes in exchange for turning a blind eye to malpractice. • Such behavior suggests another player in a principal-agent model: the supervisor.

Forms of Corruption Extortion • Resources extracted by the use of coercion, violence or the threats to use force. • Extortion may be organized by criminal organizations. This may involve “protection- or security-money”. • Public servants and politicians can extort favors by harassment and threats to disfavor private actors (clients). • The crucial difference to bribery is that no benefit is given to the client. • The extortionist only promises exemption from further harassment. • In court, extortion and bribery might be difficult to distinguish. Bribers may declare having been extorted.

Forms of Corruption • Shleifer and Vishny (1993) establish the difference between “corruption with theft” and “corruption without theft”. • An example relates to customs officials requesting payments from those who seek to clear their goods • In the former case no official tariffs are paid in exchange for a bribe. The officials take bribes and defraud the government. • In the latter case in addition to the official tariffs further payments are requested by threat of harassment (delaying the clearing of goods). There is no apparent case of fraud involved. We label this extortion.

Forms of Corruption • Advocates of free markets tend to be particularly concerned about extortion. • They suggest that reform should focus on strengthening private actors. • For example, in order to avoid harassment by customs officials one may suggest that failure to process goods within 3 days leads to punishment of customs officials (and an eased burden on private actors). • The problem is that while extortion is contained, bribery and fraud (that is, insufficient payment of official duties) may increase. • Customs officials may exchange one source of income by another.

Forms of Corruption • Anti-corruption must embrace all forms of corruption. • Corruption cannot commonly be fought by strengthening one side in a principal-agent-client relationship as opposed to another. Hints for Reform

Forms of Corruption Petty versus grand Street level experience of frequent routine payments for small favors by low placed public servants, like in hospital, schools, local licensing authorities, police, customs and tax authorities. High placed individuals exploit their position to extract large bribes, design contract scams or embezzle large sums of money from the public treasury into private (often overseas) bank accounts.

Forms of Corruption Political versus administrative/bureaucratic • Who was bribed? An (elected) politician or an (appointed) administrator? • Separation between politics and administration is often incomplete, particularly in poor countries. The distinction between these two types of corruption can become difficult. • Cooperation between politicians (who provide connections) and administrators (who provide technical expertise) can further blur this distinction.

Absence of Corruption • While we may agree on a definition of corruption, how would you describe a world that is free of corruption? • Answers seem to depend on what particular model of “good governance” one adheres to. • One suggestion is the arms-length principle: ”personal or other relationships should play no role in economic decisions that involve more than one party. Equality of treatment for all economic agents is essential ...”, [Tanzi 1995: 161]. • Absence of arms-length principle: Pertinent factors in public decision making are overshadowed by personal relationships.

Absence of Corruption • “Sharmaji was a patwari, an official who keeps the land record of approximately five to six villages […]. Sharmaji lived in a small, inconspicuous house deep in the old part of town […]. The lower part of the house consisted of two rooms and a small enclosed courtyard. One of those rooms had a large door that opened onto the street. This room functioned as Sharmaji’s ‘office’. That is where he was usually to be found, surrounded by clients, sycophants, and colleagues […]. Two of the sidewalls of the office were lined with benches; facing the entrance toward the inner part of the room was a raised platform, barely big enough for three people. It was here that Sharmaji sat and held court, and it was here that he kept the land registers for the villages that he administered. All those who had business to conduct came to his ‘office’. At any given time there were usually two or three different groups, interested in different transactions, assembled in the tiny room. Sharmaji conversed with all of them at the same time, often switching from one addressee to another in the middle of a single sentence. Everyone present joined in the discussion of matters pertaining to others. Sharmaji often punctuated his statements by turning to the others and rhetorically asking, “Have I said anything wrong?” or, “Is what I said true or not?” Most of the transactions conducted in this ‘office’ were relatively straightforward […] [but] these things ‘cost money’” (Gupta 1995:379).

Absence of Corruption • The arms-length principle would require a clear separation of public and private. • But as the preceding case from India illustrates, this distinction may be severely violated without suggesting the persistence of corruption. • The idea of the arms-length principle may not obtain global support. It disregards aspects of local participation, accountability and transparency. These are aspects that deserve equal recognition.

Absence of Corruption • Application: Does decentralization lower corruption? • The answer depends particularly ones model of good governance. • Yes: It involves locals in public decision-making, increases participation, subjects public officials to scrutiny of their immediate environment. • No: It violates the arms-length principle. Rational decision-making is impeded by personalism which is stronger at the local level.

Absence of Corruption Application: Does “modernization” lower corruption? • Corruption sometimes arises when traditional societies attempt a transformation into modern nation states, due to the arising conflicts between two existing systems. • Yes: The building of modern nation states frees individuals (and officials) from their traditional ties which otherwise overshadow pertinent arguments in public decision-making. • No: Traditional ties also provide avenues for participation and mechanisms to monitor officials. These mechanisms safeguard against self-enrichment by a ruling class.

Absence of Corruption • Decentralization and modernization are too crude to be guiding concepts for reform. • Increased decentralization might be helpful in some instances but damaging in others. Hints for Reform

Absence of Corruption The World Bank’s Country Policy and Institutional Assessment (CPIA):

Appendix Discussions1) What are the various approaches to define the term “misuse” in a definition of corruption?2) Use a Principal-Agent model to describe the actors that are involved in a corrupt transaction!3) Why may courts fail to distinguish between bribery and embezzlement?4) In how far may bribery go along with fraud or extortion. Define these terms prior to giving an answer!5) What is “corruption with theft”?6) What is the arms-length principle? Is it exhausting for defining corruption?

Lecture 1 Definitions and Opportunities