CHAPTER 5
5.1 INTRODUCTION
In the previous chapter we discussed various methods the government can use to distribute resources. The welfare costs of the different methods were investigated and it was found that a number of these methods are inefficient. There seems to be a strong case for using the market as a distribution mechanism. In this chapter we wish to investigate how our conclusions would be modified if account is taken of so-called "rent-seeking" activities. Rent seeking is defined by Buchanan as follows:
The term rent seeking is designed to describe behavior in institutional settings where individual efforts to maximize value generate social waste rather than social surplus (1980, page 4).
This stands in contrast to profit seeking defined as occurring when entrepreneurs' efforts to increase their wealth yield benefits to the collectivity as well. As we pointed out in Chapter 2, the entrepreneurs' efforts to maximise profits can result in the efficient allocation of resources. In simple terms, rent-seeking activities are observationally equivalent to profit-seeking activities, except for the fact that the costs imposed on the collectivity outweigh any benefits.
The rent-seeking phenomenon captures critically important aspects of the inescapable fact that there is no such thing as a free lunch; resources are used up in the process of creating and fashioning change. Even in the case of the market, resources will be used up in the to-and-fro of competition. Once this point is accepted, it is not at all obvious that the market towers above all other forms of distribution. Since all forms of distribution will use up resources, the question becomes which sorts of institutions minimise the costs of rent seeking?
5.2 RENT SEEKING AND THE ASSIGNMENT OF PROPERTY RIGHTS
Perhaps the easiest way of unfolding the concept of rent seeking is to reconsider the example of the grazier and the farmer. Consider Figure 5.1 which is based on the farmer/grazier example discussed in Chapter 3. Recall that the farmer's crops were being damaged by straying cattle belonging to the grazier and that there exist potential gains from trade. Suppose that the initial point before negotiations have taken place is at point A.
From the discussion in Chapter 3, we know that this point is inefficient and that points along the line segment BC are both efficient and feasible if the government acts costlessly. In order for the move towards BC to take place by means of negotiation between the farmer and the grazier, the government must assign initial entitlements. Suppose that the government has failed to do this and that the farmer wishes to convince the government to rule in his favour. In order to do this, the farmer takes time off work and forgoes income as a result. The grazier notices this and he also approaches the government in order to defend his claims.
The immediate effect of the lobbying efforts by the farmer and the grazier is to reduce both their incomes. They now find themselves at point D. Another result of the lobbying is to shift the income possibility curve inward. This occurs because both individuals are spending time in lobbying rather than in their usual profession; they cannot generate as much income as they did. The cattle have not been dipped as well as they should have been and the farmer has not had time to spray his crop. So even when the government makes a decision, the income available to them jointly will be lower. Suppose this is reflected by a shift of the income possibility curve to EF. Once the government has decided on whose rights should prevail, the farmer and the grazier can negotiate again. Trade would be expected to occur somewhere on the line between points G and H.
In comparing the outcome after bargaining to the point they were located at initially (point A), a number of possibilities arise. If the outcome is somewhere on GI, then the farmer will have gained at the expense of the grazier. (26) Similarly, if the outcome is on JH, then it is the grazier who gains at the expense of the farmer. The intermediate case occurs when bargaining results in some point on IJ. In that case, both the farmer and the grazier have gained despite lobbying. Notice that in all these cases the collectivity is better off in income terms despite the fact that lobbying occurred. This is all in comparison to the original income position at A and given that the government was not acting on its own initiative. Of course, the distribution may be such as to leave the farmer or the grazier worse off, but taken jointly they are better off. In terms of our definition above, the lobbying has yielded a social surplus and hence does not constitute rent seeking.
Matters are much worse if the forgone output as a result of lobbying is such as to shift the income possibility curve to KL. In this case, the initial distribution of income at point A is no longer attainable even after negotiation has been successfully completed. The segment of mutual gain for the farmer and the grazier once a property assignment has been made is now MN. Irrespective of where the individuals bargain to on MN, the result of their opportunistic lobbying of the government has been to leave the collectivity poorer. In this case, lobbying constitutes rent seeking. (27) Both agents perceived that they could gain by lobbying the government and indeed, one of them may have gained. The point is, however, that collectively they are worse off because the other has lost by more than the successful individual gains.
The phenomenon of rent seeking occurs also in dynamic settings. Consider once again the example from Chapter 3 involving farmers contemplating settling a farm in the West. We had found that the social optimum could be achieved if the land was sold to the highest bidder in an open auction. If the government chooses to assign entitlements on the basis of first-come-first-served then, as we showed in Section 3.2, settlement will take place too early from the societal perspective, thereby dissipating the potential rent from the farm in the West. The behaviour leading to this welfare loss falls under the general rubric of rent seeking; the rent dissipation did not result in social surplus but rather led to a collective loss. The loss identified in Section 3.2 may in fact be an understatement of the actual loss for reasons identified by Dennen (1977). When, in the Nineteenth Century, the U.S. Federal government released land to be settled under the Homestead Act of 1862, a land rush developed. This Act allowed any person to take up 160 acres of land free of charge provided he resided on the land and cultivated it for at least 5 years, after which ownership resulted. In order to claim rights over the best land, individuals expended resources in order to arrive sooner than their competitors. Dennen gives some interesting details about this:
For example, considerable time was spent simply waiting, or jockeying for an advantageous position at the starting line. On occasion special vehicles were constructed which would presumably speed more quickly over the land to claim the site (1977, page 730).
The waiting at the starting line represents a waste of resources over and above that identified from premature settlement for precisely the same reasons that were put forward in Section 4.6. The time spent waiting represents the use of resources that is not captured by any other agent anywhere else in the economy. The waiting therefore represents a loss of wealth to the economy.
The rent-seeking problem captures the fact that resources can be wasted in the distributional struggle. The rent-seeking hand, unlike the invisible hand, contorts and threatens to choke off the wealth of the nation.
5.3 RENT SEEKING AND METHODS OF DISTRIBUTION
The phenomenon of rent seeking has far-reaching implications for all of the conclusions reached in Chapter 4. In turns out that in all forms of distribution, rent seeking may emerge and therefore affect the size of the burden on the economy. In this section, the implications of aspects of rent seeking for the methods of distribution are briefly explored.
5.3.1 Auctions
From a reading of Chapter 4, it is easy to gain the impression that the auction method stands head and shoulders above the other methods of distribution. It is the method that maximises total benefits to the collectivity. This conclusion does not follow automatically in a rent-seeking environment. Individuals will devote resources in order to capture the revenue of the auction. For example, they may lobby the government into spending the revenue in a manner beneficial to their special interests. The time engaged in lobbying can represent a waste from a societal point of view. Instead of devoting time to the production of goods and services, the special interest groups use their time in order to effect a transfer. To the extent that the lobbying does not yield socially valuable by-products such as information to imperfectly-informed politicians, it must be deemed to be socially wasteful. The lobbying has created nothing of value but has cost something in the form of forgone output.
The welfare analysis of auctions under rent seeking can be easily illustrated with the aid of Figure 4.2. As we saw in Section 4.3, the revenue from the auction is equal to ACP1O and it was counted as a benefit to the government and therefore society as a whole. Now suppose that the loss of output due to the rent-seeking struggle over how the revenue will be spent is exactly equal to the revenue. (28) In order to gain some appreciation of what is going on, imagine five special interest groups that each devote time in order to gain the revenue of the auction. Suppose the revenue is $100. Under certain conditions each will spend up to one-fifth of the revenue on this lobbying, that is, each group spends $20 worth of resources on lobbying. The successful group will gain $100 at a cost of $20, clearing $80. This is not a benefit to society, however, since the lobbying by the four unsuccessful groups has resulted in $80 of forgone output. When the lobbying expenses are taken into account, it is clear that the revenue from the auction has been squandered in the distributional struggle.
If the entire revenue is dissipated through rent seeking, then the total benefit to the collectivity from the resource is only ECP1. As a result of the rent seeking, the total benefit is only equal to the consumer surplus. In Section 4.6, a similar result occurred under queuing. This is not surprising; both methods result in the dissipation of some portion of the rents from the resource because the time spent in lobbying or standing in the queue yields no tangible benefit. If rent seeking is rampant, then the auction method loses its glitter.
5.3.2 Distribution by characteristic
In Section 4.5, it was argued that the government could achieve an efficient allocation of resources if it chose to distribute entitlements on the basis of characteristics. This would arise in two settings. First, when the characteristic was perfectly correlated with the individuals' willingness to pay. Second, when the government allowed individuals to exchange their entitlements through a market. The two scenarios could, however, result in two fundamentally different distributions of income. Rent seeking will take place if individuals devote resources to influence a governmental agency to use a specific characteristic as the test of whether they receive the resource or not.
For example, in the case of the issue of land development versus aboriginal sacred sites discussed in Section 4.5, aborigines and other interested groups could lobby the government to use first inhabitancy as the relevant characteristic. Land developers, on the other hand, would probably lobby the government to adopt economic growth contribution as the relevant characteristic. Each party in the dispute will devote resources to the lobbying efforts and waste will occur if the amount spent in total exceeds the rent available from the land. For example, in terms of Figure 4.4, if the total sum spent on lobbying exceeds GFBC, then the excess represents wasted resources. Implicit in this result are the assumptions that the lobbying itself creates no rents to any agent and that there are no externalities associated with giving the land to one group rather than to another.
In some but not all cases, once the characteristic has been adopted there will be a further round of rent seeking aimed at changing the individual's eligibility. Of course, in the case of the Norfolk Islanders, it is simply impossible to acquire the required characteristic if one does not already possess it; one either is or is not a descendant of a mutineer from HMS Bounty. In the case of old age pensions made on the basis of marital status, on the other hand, it is very easy to obtain the necessary characteristic. For example, a few years ago in Australia some pensioner couples were getting divorced in order to get higher benefits individually. In order to make their "divorce" credible to the authorities, they had to undertake costly activities such as different postal addresses, separate bedrooms, etc., that were of no benefit to either themselves or anybody else. Their extra payments were dissipated to a certain extent by these rent-seeking activities.
5.3.3 Exactions
In Section 4.7 above, we saw that exactions, taking the form of payments in kind to the community, normally have significant welfare costs associated with them. This is because in general terms $100 in cash is worth more than $100 in kind. Despite these welfare costs, governments do on occasion accept payments in kind. One explanation of why they do is that payments in kind are more acceptable to the public at large than are straightforward cash payments. But these forms of payment can be of benefit to the politician too. The politician who gets a large company to build a swimming pool in his electorate on the eve of an election under the rubric of an exaction has his chances of re-election bolstered as a result. Hence, the gift in kind is equivalent to a boost in his (expected) income. Furthermore, there is nothing illegal about this implicit income transfer either.
5.3.4 Resource rent tax
In Section 4.8, it was shown that the appropriately structured resource rent tax (RRT) can be a means by which the government can extract the full amount of rent from a resource. It would seem, therefore, that the RRT is not marred by significant welfare costs, at least if uncertainty is not a problem.
Unfortunately, matters are not this simple in the rent-seeking society. Reconsider the case of complete certainty and full loss offset reported in Table 4.1. It was shown that the total amount of the rent is captured by the government in the form of auction receipts ($4.03) and tax payments ($2.69). In Section 5.3.1 we have already shown that rent seeking can occur over the auction receipts with possible rent dissipation as an unfortunate outcome. The same holds for the tax receipts as well. It may very well be the case that special interest groups in society observing the revenue raised from the RRT will attempt to lobby the government in order for it to spend the tax revenues in some preferred manner. In their attempts to influence the manner in which the tax revenue is spent, they may well waste resources, thereby dissipating yet another portion of the rent from the resource. (29)
5.4 CORRUPTION
Up to this point we have been considering the various ways in which resources can be distributed legally in an economy. A moment's reflection upon past and current events in Australia indicates that entitlements are sometimes secured by illegal means. Indeed, one of the tasks of the Fitzgerald Commission has been to examine the extent of corruption in Queensland; that is, to explore to what extent entitlements have been unlawfully distributed in Queensland. Something similar can be said regarding the inquiry into WA Inc. in Western Australia.
In the preceding discussion the focus has been on two ways of exchanging property rights. One is through the use of the market, and the other is via lobbying of the political sector. Both methods involve the legal transfer or reassignment of entitlements. A third method that may be used is that involving corruption. Although there are various shades of meaning to the concept, Revel defines corruption in the following way: (30)
being "corrupt" means somehow misapplying political or administrative power, whether directly or indirectly, outside its proper sphere, for one's own financial or material advantage or in order to distribute the gains among one's friends, colleagues, relations, or supporters. ... (1987, page 36).
Corruption occurs, for example, when a government official reassigns a property right in a manner deemed to be illegal by the judiciary. As such, it is a specific form of rent-seeking behaviour. The difference between lobbying and corrupting a government minister is subtle but clear. If the minister decides a certain course of action should be taken on the strength of arguments put forward and the decision is made according to the procedures of government, then lobbying is said to have occurred. If, on the other hand, the decision is made after free lunches are consumed or bags of money have been delivered to the minister's door steps -- where the appropriate procedures have been sidestepped -- then corruption has occurred. The crucial difference is that one method of persuasion is legal and the other is not. One is within the rules while the other is outside the rules of the game. In the case of corruption, the rules of the game as laid down in the constitution and codified in the legal system, have been violated.
5.4.1 Why is corruption bad?
It is not always obvious from the discussion in the economics literature why corrupt activities should be proscribed in the first place. The exchange between the politician and the individual seeking the favour seems to be little more than trade, albeit in the political sector. Indeed economists normally talk of the payment between the farmer and the grazier discussed in Chapter 3 as representing a bribe. Here, bribery merely represents an act of compensation in a trade between two agents. One might argue that the conclusion that bribery can yield desirable end-results is deficient. The payment between the farmer and the grazier represents but an isolated case, even in the literature in economics. The presumption would seem to be that there are few activities where bribery will lead to an improvement in resource allocation.
But there are a whole range of examples, at least in the literature of economics, that are presented to illustrate the point that bribery can lead to a more efficient allocation of resources. Take the case of a highly paid business person who has just arrived in town and wants to eat at a particularly popular restaurant. Suppose that bookings to the restaurant have been fully made on a first-come-first-served basis and that there is no charge for making a booking. Let us assume the individual bribes the maître d'hotel in order to be given a table. The maître d' is in a position to bypass the conventional administrative or booking process to his and the businessman's advantage, which is, of course, to the detriment of the person who now finds that his booking is slighted. But this misappropriation of his power means, according to the definition given above, that the maître d' and the businessman have engaged in a corrupt activity. Economists, however, normally laud the process as a means of overcoming a potential inefficiency. The conventional argument goes something along the following lines. Since the business person has a high cost of time he is willing to pay a good deal for a table at this well known night spot. Here, bribery can and will result in a better allocation of resources, if the payment to the maître d' results in the table being reallocated from an individual who is not willing to pay as much for this table. (31)
Alternatively, consider an individual who bribes a telecommunications official to place his request for a telephone line ahead of that of other individuals in a queue. (32) The point raised about the beneficial effects of greasing the maître d's hand is a general one. It applies equally here. If the bribe to the telecommunications official results in the line being reallocated from someone who was prepared to pay less than this amount to have the service first, then there will be an improvement in resource allocation. The general point to be drawn from all this is that corruption is not normally considered, at least from the viewpoint of conventional economics, to be a socially wasteful activity. It is useful in overcoming the inefficiencies brought about when a property right is not allocated by the market or when there is a failure of the market.
Now all of this stands in stark contrast to the everyday understanding of the word "corrupt" which immediately conjures up negative connotations. To say that someone is corrupt is to draw a pejorative assessment of that person's actions. One need not look too far for examples of bribery that are regarded as undesirable and unacceptable to the system as a whole. Attempting to bribe a police officer or an official of the court is almost universally accepted as wrong. Is economics so out of step with the average man on the street and the findings of the Royal Commissions which reach us each day in the newspapers or on the television? One is immediately forced to ask, what is the difference between these two activities. Why is it that compensation (bribery) in one circumstance is viewed as something entirely inappropriate and yet in other contexts is lauded for its role in resource allocation? As we shall see there are several reasons in economics for viewing corruption negatively.
5.4.2 Corruption and external costs
The first reason for viewing corruption in a negative light lies with the now familiar issue of externalities. In the case of the bribery of state officials, individuals suffer external costs that are only different in kind from the external costs borne by the farmer resulting from the grazier's lack of control over his stock. Individuals suffer when they learn, for example, that public officials are exploiting their position of power to their own personal advantage. (33) On the other hand, members of the community apparently bear no moral cost when the farmer bribes the grazier to change his actions. Their actions appear to be perfectly acceptable for they are regarded as part and parcel of the market process. In addition, the trade takes place only between the affected parties and therefore agreement is a sign that there have been gains from the reorganisation of assets. The trade between the entrepreneur and the public official differs in that other agents who are not party to this trade are adversely effected.
It will be worthwhile to analyse some of the aspects of this point with the aid of a diagram. In Figure 5.2 the demand curve (D) reflects the willingness to pay for corrupt activities. The supply curve (S) represents the compensation that bureaucrats require in order to engage in corruption. (34) Under competition, the equilibrium level of corruption would be OA and the price of the bribe would be OJ. It is worth pointing out that the bribe need not take the form of a monetary exchange. The corrupt official may receive his compensation in kind, for example, free lunches, stock market tips, favourable coverage in the press, etc.
The competitive result is not necessarily an efficient one for the collectivity. Corruption will impose considerable costs on other agents. They include negative externalities in the form of psychic costs -- you might, for example, be infuriated if you find out that the person you voted for is exploiting his position for personal gain.
Assume that the cost of corruption imposed on society (often called external cost) per unit of the corrupt activity is constant and equal to OB in Figure 5.2. The curve labelled EC denotes these constant per unit external costs due to corruption. As the level of corruption in society increases, the total damages caused by it increase as well. At the corruption level OA, these damages are represented by the area OACB. The direct cost of "producing" the level of corruption OA is given by the area OAEJ. The social cost of the corruption level is given by the direct cost plus the external cost, in other words, the sum of areas OACB and OAEJ. By adding the supply curve (S) and the external cost curve (EC) vertically, we obtain the curve representing the social cost of corruption, labelled SC. For the corruption level OA, the social costs are equal to OAFG. The total benefit of that corruption level is OAEH. The social surplus is represented by the area HIG minus FEI.
If the suppliers of corruption had incorporated the social costs of corruption into their supply calculations, then SC would be the supply curve of corruption and the equilibrium would be at I. The price of corruption would be OG and only OK units of corruption would be produced. It is easy to show that the equilibrium at I would be better for the collectivity than that at E, in the sense that the social surplus is larger at I than at E. The net improvement is equal to area FEI in Figure 5.2. (35) By not taking into the account the social damages of corruption, the suppliers of corruption have produced too much of it and in the process, they impose waste on the collectivity equal to FEI.
In this case discussed here, the socially optimal level of corruption is OK units; it is not necessary, or even desirable, to stamp out corruption altogether. This conclusion holds because the external costs and the benefits of corruption were relatively low compared to the direct costs of the suppliers of corruption. Suppose, for example, that the external costs are larger, say OL per unit of corruption. In this scenario, the competitive outcome would still be OA, but the social optimum would now occur at a zero corruption level. The benefit from even the first unit of corruption (OH) is not sufficient to compensate for the social cost imposed on the collectivity (OL plus OJ).
This conclusion does not take into account the costs associated with attaining the social optimum of no corruption. Royal Commissions come with a high price tag and if these costs are taken into account, stamping out corruption altogether may no longer be the social optimum. Indeed, it is quite conceivable that these policing costs may become prohibitive as the level of corruption is reduced to very low levels. As a result, it is likely that the optimal choice to society is to tolerate a certain amount of corrupt activities.
An interesting paradox emerges if the political climate is such as to make one party virtually sure of a mandate regardless of its performance. This may be due to extreme gerrymandering, a divided opposition or a particularly charismatic leader. In such a case, the market for corruption is not competitive, but monopolistic. The officials of the party in charge are able to increase the rents they receive from corruption by restricting supply. The argument under pure monopoly in the market for corrupt activities can again be illustrated with the aid of Figure 5.2. The marginal revenue curve (MR) reflects the increase in total revenue from corruption as more units of corruption are sold. It is downward sloping because in order for the monopolistic supplier of corruption to be able to sell more corruption, he has to lower its price. If all units are sold at the same price, this price reduction holds for all the units of corruption, not just the extra units. (36)
The profit maximising choice for the monopolist occurs where the revenue from the sale of one extra unit is exactly equal to the additional direct cost incurred in producing that unit, that is, at the intersection of MR and S at point M. The level of corruption is ON which is less than in the competitive case discussed above (OA). On first glance, the reduction in the level of corruption would seem to be a good thing. The intuition behind this is that corruption is bad. A monopolist constrains output, thereby reducing corruption. Thus, we draw the paradoxical conclusion that if corruption is inevitable, part and parcel of political life, then it is better to have it supplied by a single entity. (37) The welfare analysis confirms this conclusion; the net improvement to society is represented in Figure 5.2 by area FEI minus area PIQ. (38)
Up to this point the discussion has centred on the psychic costs imposed on the community when they learn of the illegitimate transactions. The impression may have been created that if the collectivity is unlikely to learn of the graft, then there is no case to be made here against corruption. If, say, a speeding motorist bribes a police officer, in order to avoid a sanction that will be recorded by the authorities, then the collectivity will be none the wiser and would not seem to bear any external costs. This argument is, of course, a variant of the adage that what you don't know about won't hurt you. The argument is incomplete. In order to see this point, assume that the expected penalty imposed on individuals driving at excessive speeds is equal to the expected real costs of accidents caused by speeding motorists. In this setting, the fine encourages motorists to reduce their speed to the socially appropriate level. The penalty acts like any other price and rations their use of the public road system. The bribe between the speeding motorist and the police officer may, however, break this nexus. This is true when the bribe paid to the officer is less than the fine he would have paid at the court. For while a potential speedster will reduce his speed in order to reduce the likelihood of having to pay a bribe to an officer, the expected fine will still be too low, his speed will therefore be excessive and there will be too many accidents.
5.4.3 Corruption and rent seeking
The second and perhaps primary reason why bribery can represent a waste of resources is that it is merely another instance of rent seeking. If individuals have devoted resources to effecting a transfer, say, to get a government bureaucrat to waive a regulation to their advantage, then the transaction costs of the deal represent a waste of resources. Resources are dissipated when a businessman haggles and connives over the promise to build a swimming pool in the Minister's electorate. The resources put into setting up and disguising the act of bribery represent waste. They can be so great that nothing of value has been created in the process. In addition, officials may go out of their way to create situations in an attempt to increase the number or amount of bribes. In the beginning, the greasing of the maître d's palm may have occurred without design and corrected the inefficiencies created by the booking system. In the end the maître d' will be deliberately over-booking the restaurant, creating long queues in an attempt to regularly supplement his income. In the process of attempting to extract rents from potential customers, the potential efficiency gains from reallocation will be dissipated in the form of longer queues and poorer service from the maître d'.
The rent-seeking phenomenon is similar in many respects to the phenomenon of theft. Just as special interest groups compete for possession of rights "held" by politicians, so do thieves compete for the possession of objects owned by the victims. Since theft is an example of the waste of rent seeking, it is useful to examine the relatively well-developed literature on the economics of theft in the private sector. Once the basic economics of theft is set out, attention can be turned to the more controversial issue of theft in the political sphere. The advantage of this approach is that the issue is not clouded at the outset with emotive issues.
The economics of theft is a relatively recent addition to the economics armoury. Authors such as Becker (1968) and Tullock (1967) were the main pioneers in the area. The central message of this literature is that criminal behaviour can be explained in terms of benefits and costs just like any other entrepreneurial activity. The difference between theft and other entrepreneurial activities is that the former is against the law and the latter are not. The illegality of theft affects the size of the benefits and costs associated with it. For example, $100 (after tax) earned in a legal manner by working as a clerk in a bank is not the same as $100 earned in a hold-up of a bank. The second prospect is by necessity much more risky; one may get caught, injured, tried and placed in jail for several years. This adds a cost in the form of forgone earnings. The individual weighing up which activity to pursue will compare expected income streams with an adjustment for risk associated with a criminal career taken into account; if the reward from crime exceeds that of an honest life then the rational individual will choose the former.
It must not be concluded from this that there is a potential criminal in every one of us, waiting for the appropriate pecuniary incentives. Part of the cost of being a criminal includes the psychic cost associated with breaking one's own moral code of conduct. For some individuals this cost is not very high, but for other persons it is prohibitive. As we saw in Chapter 2 in the taxi ride example, the moral code has a distinct role to play in the smooth functioning of the economic system; most of us pay for our taxi ride despite the low risk of apprehension. The economics of crime has most relevance for those individuals who feel less inhibited by moral codes and as such, incur lower costs by breaking them. Institutions are put in place so as to raise the costs of crime to them through different channels, thereby providing an incentive to move into legal forms of entrepreneurship. For example, if police enforcement is undertaken to a greater extent, then the probability of getting caught is higher, which in turn increases expected costs and reduces the expected net return. One need only muse on the effect of random breath testing of drivers to see this mechanism at work.
The relationship between the probability of crime detection and policing activities is by no means simple and direct. In many cases, the transaction by its very nature is difficult to detect. For example, in the case of illegal drugs, it is often difficult to catch Mr Big as the industry operates through many links in the chain of distribution. (39) Another example is that of prostitution. There, the crime is of such a transitory nature as to make detection very difficult; the agreement to trade sex for money, which constitutes the crucial element of proof, can take place in a matter of seconds.
The analysis of corruption is no different from theft in the private sector. Politicians and public bureaucrats will weigh the net returns of corrupt and honest behaviour against each other. As in the private setting, many politicians will have moral codes making them, in practical terms, incorruptible. Other persons may not have very strong ethical codes and may therefore be more easily corrupted.
One important point that needs to be made at the outset involves the relationship between the scope for bribery and the market process. If the market process is expanded, then the possibility for bribery generally decreases. In order to see this reconsider the example of the distribution of bookings at the restaurant. In the previous chapter it was argued that under a system of first-come-first-served the possibility arises that bribery may lead to a better allocation of resources. There is little or no possibility for bribery to emerge if property rights are well-defined. Suppose bookings are allocated on the basis of a market process. The idea is not altogether fanciful. Individuals in the tourist market often reserve their place by making a down-payment and individuals who wish to see a particular performance of a movie or stage play often buy a ticket in advance. A competitive market for bookings at the restaurant would have the characteristic that all these individuals who value the resource less than the competitive price would not be allocated any units of the resource. Suppose for example, the going market price for a booking at the restaurant is $35. Then individuals who do not value a seat at the restaurant as worth this amount will not be allocated a table. In this case, there would be little point for any of these individuals to bribe any current holder of a booking. As they would not be prepared to pay the going market price, any bribe they would offer would be rejected out of hand as being too small. In addition, notice that the power of the maître d' has been severely curtailed. It is the holders of the reservations and not the maître d', who determine whether their entitlement will be reassigned. The scope for rent seeking by the maître d' would be reduced.
The result that bribery is minimised under a competitive market process holds, however, only if the existing holders of the reservations have well-defined property rights. In order to see why this is the case, reconsider our example. Suppose a particular couple arrives on time to take up their reservation which merely specifies that under normal circumstances a table will be kept for them upon their arrival at an appointed time. Ten minutes before they had arrived the maître d' had, however, redistributed their booking to the business person in return for a bribe of $30. The maître d' is suitably apologetic to the couple and explains that he is unable at present to honour the reservation. He proceeds to extricate himself from this predicament by explaining that customers are taking somewhat longer to eat their meals tonight -- the situation is not normal -- and that if they would like to wait at the bar he will see what can be done about their position. The maître d' scurries off into the distance pretending that he has been called elsewhere leaving the couple to while the time away at the bar. The maître d' can only treat the couple in this high-handed fashion because the property rights are not well-defined. If, for example, their booking had guaranteed them both a table at a particular time and full compensation in the event of any delay, then there would be little scope for the maître d' to engage in bribery.
The rent seeking issue has implications for the conclusions made in the previous section on the appropriate level of corruption. Agents will expend time and effort to obtain the potential profits from supplying the services required by the somewhat unscrupulous demanders. As Figure 5.2 illustrates, the monopolist earns a profit equal to JMQR. In the competitive case, all corrupt officials just cover costs and make only a normal return on their time and effort. There is consequently a clear incentive for agents to attempt to become the monopolist in the market for corrupt activities. Under competitive rent seeking, up to JMQR will be dissipated on activities yielding no social benefits at all. This wasteful rent seeking changes our earlier conclusion about the desirability of monopolising the corruption market. Since JMQR is wasted, the social benefit of monopolisation is now represented by FEI minus PIQ minus JMQR. In the case illustrated here, this is clearly negative. It can be preferable, therefore, to have the competitive case which involves a greater degree of corruption.
The policy choice seems clear. It is desirable to have some competition between corrupt agents in order to reduce the waste associated with rent seeking. But unfettered competition is not appropriate as this results in too much corruption from a social point of view. In order to reduce the costs of corruption, what is required is an incentive structure which induces self-interested agents to change their actions in such a way that the level of corruption is reduced without wasteful rent seeking. In Chapter 6 below, we indicate how this may be achieved in practice.
5.4.4 Corruption and democracy
Up to this point, the discussion has centred on why corruption may be considered a socially wasteful activity. There is a third reason why market-like forces are regarded as inappropriate in the political setting. For the purpose of developing the issue, consider the following example. Suppose a government calls an election but fails to secure a majority of the seats in the lower house. In fact, none of the political parties have secured enough votes to rule in their own right. Imagine that after the election three of the opposition parties form an accord that will leave them with a one-seat majority over the government. The parties to the accord threaten to pass a no-confidence motion in the government upon the resumption of parliament. Suppose a businessman attempts to bribe one of the members of the accord to cross the floor when the no-confidence motion is to be voted on. The politician, however, reports the incident to the police, who later charge the businessman with bribery.
When confronted with this example, some people see nothing wrong with the businessman's behaviour. For the individual is merely attempting to "buy" the politician's vote in order to pursue his own self-interest, an act no different in kind from Chico's when he purchased an egg. And just as the egg was efficiently allocated to the individual who is willing to pay the most, the politician's vote will be similarly efficiently allocated. The analogy here, between the expression of self-interest in a market and a political setting is, however, unsound.
One might be inclined to call the whole incident into question because the politician was asked to sell a property right he did not own; the attempt stepped outside the rules of the game. The electorate expects a politician to represent their interests rather than his own narrow interests. There are some difficulties with this argument as it stands. A politician could claim that he was supporting the opposition since it was his belief that this was consistent with his reading of his electorate. He could go on to claim that the money he received was simply part of his campaign contributions. We suspect that most individuals would feel uncomfortable with the politician's justification -- that is, that there is something wrong about a politician accepting any amount of money to change his position on various policy issues, even if the money is transferred to the political party's campaign funds.
The argument against such influences rests on the fact that the political process must operate along fundamentally different lines to that of other institutions. One of the major strengths of the democratic process is the transient nature of the majority. On some issues individuals will find themselves holding the minority viewpoint and subject to the decisions made by the majority. While the individuals may be depressed and even angry with the majority decision on this issue, they find the process of majority rule to be acceptable since they know that on other issues their position will come to the fore. Moreover, they perceive that the decisions made by the government of the day can be overturned by new and transitory majorities of the future. Buchanan (1954) stresses that majority rule "... serves to ensure that competing alternatives may be experimentally and provisionally adopted, tested and replaced by new compromise alternatives approved by a majority group of ever changing composition". Majority rule therefore holds out the possibility of compromise, and through time, the peaceful development of a consensus. In this way, the persistent tyranny of a specific minority may be avoided.
The tyranny of a specific minority is significantly advanced, however, if politicians can be bribed. If bribery were to become common-place, then majority rule would no longer exist as a process that allows social experimentation of a range of issues. The danger exists that individuals with greater wealth can purchase the power of politicians and thereby exert inordinate control over the political agenda and power over the outcomes of the political process. In such circumstances, it would not be surprising for the less wealthy minority to reject majority rule. Interpreted in this light, the recent allegations of political bribery in Tasmania can be seen as threatening the acceptance of majority rule decisions. Laws against the buying and selling of votes can be seen as an attempt to preserve a system of majority rule in which the minority are not persistently subject to the tyranny of the wealthy. (40)
Another cost of widespread corruption which diminishes the social capital of our democratic system is related to the breakdown of norms and moral codes of conduct. For example, most people file a tax return not as a result of a threat of the law but because they feel it is the correct thing to do. If they believe that politicians are reaping illegal untaxed gains through bribery, then they may feel less inclined to be so honest in the revelation of their earnings. Widespread tax evasion leads to significant welfare effects. The point is more general than simply tax evasion, however. If the corruption is rampant among our public officials, then it may very well be the case that the moral base underlying market exchange collapses and we return to the Hobbesian world where life is "nasty, brutish, and short".
Perhaps the easiest way of seeing this point is through the case of the Prisoners' Dilemma, a game attributed to the American mathematician A. Tucker. (41) Two criminals have been caught by the police for a relatively minor offence. The evidence of this crime is irrefutable and each is bound to spend a brief period in jail upon conviction. The payoffs in terms of well-being for the two individuals are represented in the different cells of Table 5.1.
The police, however, suspect the two criminals of a far more serious crime but have insufficient evidence to go ahead with any charges. Note that the two criminals are held in separate jail cells and are kept isolated from each other for the entire time they are questioned in the city watchhouse. The police officer attempting to get a confession presents each criminal with the following alternatives. If you confess and your partner does not confess, then we will drop all charges against you. This is your reward for turning Queen's evidence against your companion in crime, who can expect a very long unpaid vacation at the government's expense. Such a case is represented in cell III where individual A who assists the Crown derives a payoff of 4 and person B who is ultimately convicted obtains a payoff of 1. Since each criminal is presented with the same set of alternatives, person B would derive a payoff of 4 from turning Queen's evidence and it would be A who spends the best years of his life behind bars. The payoffs are represented in cell II. If both confess to the crime, the police officer indicates that he will make a plea for leniency at the court proceedings. Each can expect an intermediate sentence -- one somewhere between the brief stay and the long years of incarceration. The payoffs arising from this scenario are represented in cell IV. In this particular game the so-called dominant pure strategy for each criminal is to confess. If the prisoner confesses, then he will gain a payoff of 4 rather than 3 when his partner does not confess and a payoff of 2 rather than 1 if his partner does confess. Since both criminals face the same set of alternatives, both will confess resulting in prison terms of the intermediate length which leads to a level of well-being for each criminal of 2. Here, the pursuit by each individual of his own self-interest results in an inferior outcome for both individuals. This outcome in cell IV is clearly inferior for both of the criminals. If each had remained silent of their deeds in the more serious crime, then each would have been a free man only after a relatively short period in jail and each would have received a payoff of 3 as opposed to 2. The Prisoner's dilemma is useful in reminding us that the invisible hand of self-interest played within the confines of some institutional settings can generate outcomes which are inferior for both players.
With a small amendment to Table 5.1 and a small amendment to the discussion, it is possible to cast some light on the point made on the intersection between corruption and morals. Suppose the choice 'do not confess' is replaced with 'obey the law', and 'confess' is replaced with 'evade the contract', and the two criminals are replaced with two citizens. The payoffs remain the same as in the case of the two criminals. The individual stands to gain an increased payoff when he evades the law and the other obeys the law since he can exploit the situation to his own advantage. When both individuals disobey the law, each receives a payoff of 2 units. The low payoff reflects the fact that individuals dissipate resources in protecting and seeking rents from other individuals when they step outside the implicit social contract. The dominant strategy of each individual as in the case of the two criminals is to evade the contract, that is to evade the law to his own advantage. The world here will ultimately be a 'nasty, short and brutish' one. The social consequence of the pursuit of individual self-interest here, is that each individual ends up in the inferior outcome.
It is important to bear in mind that corruption need not be the inevitable outcome of the prisoner's dilemma. Individuals may suffer psychic costs of breaking the norms of the society. An individual may bear a cost of 2 units as a result of violating his own moral code. The self-imposed penalty will reduce the payoff from non-cooperative behaviour to such an extent that each person's dominant strategy is now to obey the moral law, as Table 5.2 illustrates.
Moral codes are likely to be important in mitigating the effects of the prisoner's dilemma in small communities. Since they are constantly dealing with each other, the individuals can reap the gains from reciprocal behaviour. One good turn is noticed and deserves another is, perhaps, one way of capturing the idea of cooperative behaviour in the small community. The small number of individuals enhances also the building of shared interests and shared values. The social capital of norms can only be threatened by the nightly parade of public officials who have shown by their actions that they hold the community in disrespect, for soon the moral person will argue that if all of them are cheating, then I might just as well abandon the high ground and join the club. Now none of this is meant to deny the fact that legal rules of the game can be used to harness individual self interest for the good of all. Each person can recognise that if laws are obeyed in general, then each will secure a higher payoff. Fewer resources will be wasted in unproductive attempts aimed at personal gain. Each individual, even when unmoved by moral arguments, may be willing to accept a system of fines, of say 2 units, in order to escape the non-cooperative end. We nevertheless ignore the erosion of our social capital of norms at our peril: The law may not be enough to escape the prisoner's dilemma.
ENDNOTES
26. It may strike readers as odd that an individual would devote resources to lobbying the government and end up worse off as a result. Just as individuals spend money on court cases they lose, this is caused by the fact that in all cases considered here, the individual had some possibility of ending up in a better state.
27. See Brooks and Heijdra (1988, 1989) for a discussion of some of the issues regarding rent seeking.
28. This assumption has been used throughout the rent-seeking literature but is by no means uncontroversial. For some discussion on this issue see Tollison (1987) and Brooks and Heijdra (1989).
29. See Brooks and Heijdra (1989) for a discussion of these so-called "revenue-seeking" activities.
30. See Nurick (1989) where this definition is quoted and briefly discussed.
31. It is never made clear in the standard account how the maître d' solves the general information problem discussed in Chapter 2. Unlike the competitive market, there is no guarantee that the seats will be reallocated from those willing to pay little to those individuals willing to pay much more.
32. See Salim (1981) for an interesting account of how telecommunication facilities are distributed by means of bribery in India.
33. It ought to be made clear at this point that some care ought to be exercised in drawing on externalities as providing the rationale why bribery is intolerable in a modern economy. And there is some danger of rationalising all government action as the response to some external cost; that the mere whiff of an externality provides a case for government action. The case will not, however, bear scrutiny. Suppose you suffer some psychic cost as a result of your neighbour's decision to paint the eaves of his house some shade of pink. Or you grieve at the sight of males wearing earrings or having shoulder-length hair tied up in pony-tails. Should we prohibit these activities too? The answer is that it all depends. The cost you bear from living next door to that budding Jackson Pollock might be outweighed by the benefit he derives from his suburban work-of-art. In such a case, a government decree on what colours individuals may use to paint their house would not represent an improvement in resource allocation. Equally clearly, the youth's benefit from wearing ear-rings or having a pony-tail might outweigh the cost you suffer. These examples serve to illustrate the general and fundamental point that whether the phenomenon of external cost provides a case for prohibition depends on a comparison of the benefits and the costs case by case. The blanket case against corruption cannot be built on the notion of externalities.
34. It might be more reasonable to assume increasing costs in the production of corruption and consequently, an upward sloping supply curve. In view of the discussion in Chapter 2, this would give rise to quasi-rents in the market for corruption. In order to simplify the discussion, we assume constant costs so that there are no quasi-rents.
35. At point E total benefits are HEAO, social costs are OAFG leaving a surplus of HIG minus FEI. At point I total benefits are HIKO, social costs are GIKO, leaving a social surplus of HIG. Hence, the social surplus at I is larger than that at E by the area FEI.
36. This means that there is no price discrimination. Given the nature of the service, first-degree price discrimination may be more reasonable to assume since information about who is purchasing corruption will not in general be freely available, nor will units be resold. In this case, all the consumer surplus is transferred to the producer. The case discussed in the text differs only in terms of distributional considerations. The passible size of the loss due to rent seeking will be larger under first-degree price discrimination since the profits are larger. Of course, this is true as long as agents are not engaged in activities designed to protect their rents; so-called rent-avoidance activities. See Brooks and Heijdra (1989) for a further discussion.
37. Buchanan (1973) reached the same conclusion in the context of organised crime, a private market activity.
38. The reduction in external cost is represented by area NACT ( = PFEM). The welfare loss due to the restriction in output is QME. Taking into account the common area PIEM, the welfare gain is FEI minus PIQ.
39. Michaels (1987) explains the manner in which the illicit drug industry is organised so as to reduce the probability of detection.
40. See Buchanan (1954) for a discussion of the desirability of inconsistent social choice in a democracy.
41. See Axelrod (1984) for a fascinating discussion of the Prisoners' Dilemma game and the emergence of cooperation in repeated PD games. Theoretical results are provided by Kreps et al. (1982).
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