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A dynamic model of corruption deterrence
Journal
of Public
Economics
A DYNAMIC
31 (1986) 215-236.
MODEL
OF Francis
North-Holland
CORRUPTION
DETERRENCE
T. LUI*
Department of Economics, State University of New York at Buffalo, Buffalo, NY 14260, USA Received
September
1985, revised version
received July 1986
This paper presents a model of corruption deterrence with a simple overlapping-generations structure built into it. A crucial assumption is that when corruption becomes more prevalent in the economy it is harder to audit a corrupt official eNectively. It is shown that this assumption may give rise to several stationary equilibrium levels of corruption. This possibility has been exploited to explain why sometimes a government may temporarily resort to an extremely severe deterrence policy and why the same deterrence scheme may imply quite different levels of corruption. A case study is provided to give empirical support to the model.
1. Introduction Corruption has from time to time attracted research interest from a wide range of disciplines in the social sciences.’ Pertinent to this subject, there are two issues that seem to deserve greater attention. The first is whether corruption is beneficial to the economy, and the second concerns the consequences of various corruption deterrence schemes. Recent work has shown that it is possible for corruption to improve social efficiency in the sense that bureaucrats may try to speed up the administrative process so as to obtain more bribes [Lui (1985b)]. If we strictly follow the modern economic approach to the study of crime and punishment, which uses the maximization of social income as the criterion for optimal enforcement of laws [e.g. Ehrlich (1982)], under some circumstances there seems to be no need to prohibit corruption. Nevertheless, corruption deterrence schemes are still deemed necessary on several grounds. For instance, corruption may give rise to distributional consequences which are usually socially undesirable. Moreover, the efficiency result mentioned above is conditional upon the use of a particular rule of resource allocation. If it is possible to replace it by another allocative mechanism, then efficiency may improve even in the absence of corruption. Corrupt officials with vested interests in protecting *I have benefited from discussions with John Chipman, Isaac Ehrlich and Edward Prescott. Thanks are also due to two anonymous referees who provided very useful suggestions. Any remaining errors are my own. ‘For a fairly complete bibliography of the subject, see Montias and Rose-Ackerman (1981). 0047-2727/86/$3.50
0
1986, Elsevier Science Publishers
B.V. (North-Holland)
216
F.7: Lui, Corruption deterrence
their benefits generally have the tendency to spend real resources to oppose this kind of institutional change.2 Corruption deterrence schemes are therefore often important in societies interested in social reforms. In the literature there exist many models of crime and punishment in general, and corruption in particular.3 By and large, most of them are formulated within a static framework. However, in the real world a corrupt official upon being discovered will find himself not only punishable by law, but also by the loss of his reputation. The latter in turn affects his future income. It therefore seems important that the decision to be corrupted depends also on some expectations about the future. Moreover, just as in recent equilibrium business cycle theories where agents’ decisions on supplying labor are assumed to depend on the relative wage rates across different periods [e.g. Kydland and Prescott (1980)], it is natural to think that the decisions on when to accept bribes are affected by the intertemporal differences in the expected penalties. It appears that a dynamic model is more appropriate for helping us to understand the implications of a corruption deterrence scheme. A dynamic model cannot be taken as superior to a static one unless it can yield richer results than the latter. In the simple overlapping-generations model that will be formulated in this paper, an explicit dynamic structure is incorporated. Beside being able to yield results consistent with conventional analysis, the model also provides explanations for some phenomena that are less readily accountable by static models. For example, the level of corruption in a country may be much higher than before, but at the same time the parameters of the punishment scheme are not much different. It is sometimes observed that a government, especially one that belongs to a developing country, may temporarily resort to an extremely harsh deterrent policy that seems suboptimal according to standard analysis4 From the point of view of dynamic optimization, is there any justification for this practice? Externality plays a crucial role in the model of this paper. A fundamental observation on corruption is that it becomes very costly to audit an official effectively if many other officials are also corrupt. The reason for this will be discussed in section 2. The incorporation of this assumption into the model makes it possible for the economy to exhibit several corruption equilibria. This result will be exploited to explain the phenomena outlined above. ‘This is in the spirit of Krueger’s (1974) analysis of the rent-seeking society. Note that reformers can also bribe corrupt officials to accept the reforms. In this way, corrupt oficials no longer have to spend the real resources. A recent example in disguise is the current economic reform in China, where some old conservative officials are promised great retirement benefits if they agree to leave their posts. 3For example, see Becker and Landes (1974) and Rose-Ackerman (1978). 4From the point of view of maximization of social income, punishments that are ‘too severe’ are not optimal [Becker (1968)]. Also, too high a penalty for a minor offence may result in an increase in a more serious one [Stigler (1970)].
F.7: Lui, Corruption deterrence
217
In the next section I shall outline the physical set-up of the model and determine the level of corruption in the economy. In section 3, the stationary equilibrium levels of corruption in the economy are derived and different paths of convergence to the equilibria are examined. Section 4 discusses the effects of changes in the parameters and provides interpretations of the phenomena outlined above. In section 5 I present a case study of the history of corruption and its deterrence in contemporary China. The study provides evidence for the basic assumption in this paper. In addition, it shows that the implications of the model are empirically important, at least in China. Section 6 is a summary of results.
2. The economy In this section the physical environment of the model economy will be described. I shall then determine the proportion of corrupt officials in the economy. If the proportion is high, then the economy is regarded as more corrupt, and vice versa. An overlapping-generations abstraction will be used because it provides a simple way to incorporate a dynamic structure. The behavior of people in one generation is not independent of that in others because of the particular rule of auditing probability that will be specified later in this section. 2.1. The physical environment and the proportion of corrupt officials In the economy, in every period, there are two overlapping generations of officials, the young and the old. The numbers of officials in the two generations are always equal. In each period every official is offered one unit of bribe revenue, which he can decide to accept or not. If a young official accepts it, and is audited subsequently, then with probability one he will be required to pay a fine of C units of revenue. He can continue to keep the job in the next period. However, if he again accepts the bribe and is audited, then the new fine will be C’ units. I assume that C’ is so high that an official who is punished while young will never accept another bribe so long as the probability of being audited is positive. The precise parametric restriction on c’ that guarantees this will be developed later. Also, the probability of auditing the officials at time t is the same for everyone. This is denoted by p(t). Officials in a generation are assumed to be heterogeneous only with respect to their degrees of honesty h. If an official with h accepts the bribe, then he only values it at 1 -h unit. The higher h is, the more honest is the official. I choose to incorporate honesty into the model because people do seem to be different in their willingness to accept bribes. It is assumed that h is a random variable with a uniform probability distribution function F(h). The lowest value for h is zero, while the largest value is l/f: Thus, the
F.7: Lui, Corruption deterrence
218
proportion of officials having h lower than a value h* is fh*, provided that h* 5 l/j The distribution function F(h) is the same for every generation. It is also assumed that all officials are risk neutral. At time t, an old official who has not been punished before will accept the bribe if and only if his expected payoff is 1 -h-p(t)CZO.
(1)
Define We(t)= 1 -p(t)C. An official with h belonging
At time old at time t be p”(t + opportunity will accept
to this group will be corrupted
if and only if
t a young official has to consider his expected payoff when he is t + 1. Let the probability of auditing at time t + 1 expected at time 1). Then, since a punished young official in effect will lose the to accept a bribe in the future, a young official with h at time t the bribe if and only if
l-h-p(t)[C+max[l-h-p”(t+l)C,0]]20.
(3)
Since max [ 1 -h -p’(t + l)C, 0) 20, the opportunity cost of a young official to accept a bribe is at least as big as that of an old official. This implies that the latter is more susceptible to corruption than the young, provided that the old official has not been punished before. This result is also consistent with Rose-Ackerman (1978) who argues that ‘lame duck’ politicians may be especially susceptible to bribes. Define Wo(t + 1) = 1 -p’(t + l)C. Similar to the argument above, a young official with h at t expects that he will accept the bribe at t+ 1 if and only if Wo(t+ l)>,h. Suppose
I
(4)
(4) is satisfied. Then (3) is equivalent P(WC1 -p'(t+ l-p(t)
_
111 =. >h
(5)
Define m
@)=
Y
1
_
P(WC1 -P'(t+ l-P(t)
to
1)l .
219
F.7: Lui, Corruption deterrence
Then the young
official with h will accept the bribe if and only if
l&(t) 2 h.
(6)
Suppose (4) is not satisfied, that is, the young accept the bribe at t + 1. Then (3) becomes
at t does
not
expect
to
1 -hLp(t)C20. Define WY(t) = 1 - p(t)C. The young official with h will then accept the bribe if and only if W,(t) 2 h.
(7)
Since there are two to decide whether to which one is chosen. WY(t), and W,(t). It is %(r+
l)-
possible cutoff points, WY(t) and WY(t), for the young accept the bribe or not, it is necessary to determine To do this I shall first find the ordering of Wo(t+ l), easy to show the following:
W(r)=
ivy(t) - WY(C) =
Q(t)-p’(t+
l)),
P(WCP(Q -P”(L+ 111 1-P(t)
(8)
(9)
Hence, l&(t) < P&(t) < Wo(t + 1) if and only if p(t) > p”(t + 1). Suppose ~(t)>p”(t+ 1). Consider an h smaller than l&(t). The person then accepts the bribe at time t even when the expected payoff of accepting a bribe at t + 1 is positive, that is, (4) is fulfilled. However, since WY(t) < Wo(t+ l), h is also smaller than Wo(t+ 1). Hence, the young official will accept the bribe at t. Now, consider an h between WY(t) and Wo(t+ 1). Again, (4) is fulfilled. Because of (6) he will not accept the bribe. For h > Wo(t+ l), it is also larger than WY(t) and l&(t). His bribe revenue at t must be zero. It follows that as long as ~(t)>p’(r+ l), the young officials will use WY(t) as the cutoff point. In other words, the proportion of young corrupt officials at t is given by F(l&(t)). Now assume p(t)spe(t+ 1). By following similar arguments to the above, it is easy to show that the cutoff point this time is WY(t), In other words, the proportion of young corrupt officials at t is given by F(W,(t)). These results are directly applicable to the decision problems of young officials at time t - 1 also. Let the probability of auditing at time t expected at time t- 1 be p’(t). Also define Wy(t-
I)= 1 -p(t-
1)C
220
F.7: Lui, Corruption
deterrence
and m
(t_
Y
I)=
1
_
P(t- lM1 1 -p(t-
-P'(O)
1)
If p(t - 1) >p’(t), the proportion of young corrupt officials at t - 1 is F(my(t - 1)). On the other hand, if p(t - 1) 5 p’(t), then this proportion is F( Wy(t - 1)). As can be seen from above, the relative values of p’(t) and p”(t + 1) play an important role in the model. I impose the assumption that for all t, p”(t)2 p(t1) if and only if p(t)zp(t - 1). In other words, the sign of the change in p(t) is always anticipated correctly. The main task of this section is to determine the proportion of corrupt officials in the economy under different conditions. We have already obtained the expressions for the young at t. It remains to determine the proportion for the old at t. By following similar arguments to the above and making use of the assumption in the last paragraph, these results can be proved: (i) If p’(t) 2 p( t - l), then the proportion of corrupt old officials at t is (1 -p(t - l))F( H&(t)). (ii) If p’(t)
punished official will not accept any new bribe again. Let B(t) be the proportion of corrupt offkials within the entire population of offkials at time t. B(t) is in fact the average of the proportions of young and old offkials who accept bribes at t. This is used as a measure of the level of corruption in the economy at time t. The preceding results can be summarized by the following four cases. Case 1: Suppose p(t-l)Spe(t)
and
p(t)Sp’(t+l).
(10)
Case 2: Suppose
p( t -
1) >
p”(t)
and
p(t) > p”( t +
1).
(11) Case 3: Suppose
p( t -
1) >
p”(t)
and
p(t) 5 p”( t +
1).
B(t)=(1/2)CF(W,(t))+F(W,(t))-p(t-l)F(@‘d- 1Nl. Case 4: Suppose
p(t -
(12)
1) <=p’(t) and p(t) > p’(t + 1).
(13)
F.7: Lui, Corruption
deterrence
221
If all the proportions F( .) are less than one, then we can also substitute the appropriate values of the w’s into the above expressions to obtain:
B(t)=W)CG-P(t-
+Jzl
1))(1-P(W-Jl
(14)
where
J,=
P(WCP(t)-P’(t+111 if 1-p(t) ’ 0,
MJ,=
l))‘CCl-P7Ql 1 -p(t-
1)
p(t)>pe(t+
1) 3
if
p(t)sp”(t+
-p(r-
l)p(t)C,
l),
if
p(t-
l)>p’(t),
if
p(t-
l)sp’(t).
From eq. (14) it is clear that B(t) depends on the probabilities of auditing. To complete the model, it is necessary to specify how the probabilities are determined. 2.2. The probability
of auditing and the level of corruption
As remarked in section 1, it is more costly to audit an official effectively if there are more corrupt officials in the economy. We can explain this observation by abstracting the investigative process as follows. At a given level of corruption, B(t), to find out whether an official is corrupted the government has to collect evidence from some of his colleagues, say j of them. It is assumed that the corrupt activities of an official are often related to those of others. If some of these j colleagues are themselves corrupt, they will be less likely to supply accurate information to the government because successful uncovering of the case may lead to further investigations of themselves. Suppose now that the level of corruption in the economy increases. Then it is more likely that some of the j colleagues are corrupt. To make sure that an investigation is still effective, the government then has to collect information from more people. In other words, when B(t) is higher, the cost of an effective audit is also higher. To capture this feature into the model, I make the following assumptions. Each period, the government spends R units of resource for auditing. The resource necessary for one completely effective auditing at time t is r(t). It is assumed that r(t) = l/(m - nB( t)),
F.7: Lui, Corruption deterrence
222
where m and n are positive parameters, and m > n. Note that r(t) is positively related to B(t). Moreover, the second derivative of r(t) with respect to B(t) is positive. Let there be N people in the bureaucracy. Then, R/r(t)
p(t) =T=
Rm - RnB(t) N
Define A= Rm/N and k = Rn/N. Then, p(t) =
A - kB( t).
(15)
Eq. (15) can be substituted into (14) and we can obtain the law of motion of B(t). This will be done in section 3. The assumptions just made are useful for showing that a given parametric value of R may give rise to several stable equilibrium levels of corruption. One simple possibility is as follows. Suppose that the initial level of corruption in the economy is low. Because of the cheaper cost for each effective audit, the available resource can be used to investigate more people. Hence, fewer people will choose to be corrupted and the level of corruption will remain low. The same logic applies to the opposite case. If the initial level of corruption is high, then it will remain high because the probability of being audited is low.” 2.3. Parametric
restrictions
It is useful to specify some restrictions on the parameters of this model. First, since m> n>O, we must have A> k >O. Otherwise, a negative probability could occur. Second, the largest p(t) occurs when B(t) =O. In this case, p(t) = A. Hence, A < 1. Third, we require that 1 -p(t)C>O. If this is not fulfilled, no (risk-neutral) sufficient condition for (16) to be true is
(16)
officials
will accept
any
bribes.
A
l-AC>O. ‘Generally speaking, if a variable depends on itself or on its past values, it may be possible to obtain several stationary equilibria. An example is the residential segregation model of Schelling (1972). In this model, the future black-white percentage of population in a neighborhood depends on its current value. If the current percentage of white is small enough, then some whites will begin to leave the neighborhood and this causes more whites to leave. Hence, if the percentage of white is small, it will remain small. A similar logic applies to the opposite case. Thus, it is possible that there are several stationary equilibria.
223
F. 7: Lui, Corruption deterrence
Fourth, I want to investigate the possibility that all members of a generation decide to accept the bribes. This requires F(1 -p(t)C)= 1 for some p(t). It means that f(l -p(t)C)z 1 for some p(t). Since 1 -p(t)C< 1, it must be true that f> 1. Lastly, if an old official who had been punished before accepts the bribe again, his penalty if audited is C’. To ensure that he will not accept the bribe at t, 1 need l-p(t)C’O, which is the same as C’> l/(A-k). To summarize, the parametric restrictions
are:
l>A>k>O,
(17)
C>l>AC,
(18)
f>l
(19)
3. Stationary equilibrium levels of corruption In this section I determine the stationary equilibrium levels of corruption and examine the time paths of B(t). To do this, I must obtain the law of motion of B(t). At a stationary equilibrium level B *, B(t) = B* for all t. Because of (15) p(t)=p* for all t, where p* is the auditing probability corresponding to B*. Since the auditing probabilities and also their expected values are all equal, the terms J, and J, in eq. (14) will both drop out. This of course is a special situation of case 1 where p(t) sp’(t + 1) and p(t- 1) ~Zp’(t). Eqs. (10) and (15) are therefore suflicient for determining the stationary equilibrium level of B(t). In fact, if we are interested only in the determination of B*, we do not even have to pay attention to cases 2 to 4 in section 2. The consideration of these is useful only when we also want to examine the time paths of B(t), which can provide us with additional insights into the understanding of corruption. Assume p(t- l)Sp’(t) and p(t)Sp’(t+ 1). Note that F(W,(t)) =F(Wo(t))= f(l-p(t)C) if f(l-p(t)C)sl, and F(W,(t))=F(W,(t))=l if f(l-p(t)C)>l. From eq. (lo), we have
B(t) =
(f/W-p(t1 -(V)p(t-
I))(1 -p(t)C), I),
if f(l -p(t)C)S if f(1 -p(t)C)>
1, 1.
(20) (21)
F.7: Lui, Corruption
224
I first consider the situation whenf(1 (20), the following can be obtained:
deterrence
-p(t)C)
5 1. By substituting
(15) into
B(t)=(f/2)(2-A+kB(t-l))(l-AC+kCB(t)).
(22)
This difference equation describes the law of motion of B(t) under assumptions of case 1. From (22), at a stationary equilibrium B*, following is true: B*=(f’/2)(1-AC+kCB*)(2_A+kB*).
the the
(23)
Since this is a quadratic equation, we may or may not have real roots for B*. I next consider the situation whenf(1 -p(t)C) > 1. From (15) and (21), B(t)= 1 -(.4/2)+(k/2)B(tThe corresponding
stationary
B*=(2-,4)/(2-k).
(24)
1). equilibrium
level of corruption
is (25)
The above results can be illustrated by a numerical example. Let f = 1.25, C = 1.25, k = 0.6 and A = 0.71. It is readily verifiable that f( 1 -p(t)C) > 1 if B(t)>0.9167. Hence, for B(t)s0.9167, we use eq. (20) and otherwise use (21). The roots of B* from eq. (23) are 0.3604 and 0.8951, respectively. The solution of B* in eq. (25) is 0.9214. The same ideas can be illustrated by a phase diagram. In fig. 1 I plot B(t) against B(t - 1). The curve ABCD corresponds to eq. (20). It crosses the 45” line OM at two points, namely B and C. This means that B* has real solutions.‘j The straight line DF which represents eq. (21) cuts the 45” line at E. In the numerical example, E occurs at B(t)=0.9214. Thus, there are three stationary equilibrium points, but it can easily be seen that only B and E are stable. Nore that for B(r- 1) falling between B, and B,, or between B, and one in the diagram, B(t) 5 B(t - 1) for all t. It follows that p(t) >,p(t - 1) and consequently p’(t)zp(t - 1) for all t. These are precisely the conditions necessary for eqs. (20) and (21) to be applicable. It is therefore legitimate to use the curves BC and EF to guide us in seeing how B(t) converges to B, ‘Given the parametric restriction I -AC 20, B(t) is always strictly positive. This is why the lowest value of B(t) occurs at point A in Iig. 1, where B(t) is strictly positive. In the numerical example, it is 0.2294. However, the initial value B(t- 1) can be of any value between zero and one. In fact, in the model, B(t - 1) affects B(t) only because B(t) depends on p(t - 1). The meaning of B(t - 1) =0 should be interpreted rather as p(t - 1) = A. Suppose, initially, that the economy is at a certain point B’(t - 1). Corresponding to this, there is a probability p’(t - 1). If there is a parametric change in A or k, we have to use the p’(t- 1) and the new values of A and k to determine the new initial value of B(t- 1).
F.T. Lui, Corruption deterrence
B(t)
A
0 B(t-1) Fig.
and and (20) (20) B(t).
1
B,. However, for B(t-- 1) falling between zero B,, B(t) > B(t - 1) and hence p’(t)
and B,, or between B2 all t. The conditions for which correspond to eqs. tracing the time path of
To illustrate the different types of time paths of B(t), I shall use the possibilities that can be generated by case 2 as examples. Now assume p’(t + 1)
if
p(t-l)>=p*,
(26)
(l+u)p(t-1)--p*,
if
p(t-l)
(27)
226
F.71 Lui, Corruption
deterrence
p’(t+ 1)=Pwu/P* -P(t)\ if p(O2p*. (1 +u)p(t)--up*,
if
p(t)
(28) (29)
The parameter u is less than one and greater than zero. This expectation formation rule guarantees that p’(t)=0.8951, the corresponding p* is 0.1729. The computed values of B(t) can be plotted against B(t- 1) in a phase diagram. At B(t - 1) =O, B(t) =0.9648. For B(r - 1) sO.3604, the curve is negatively sloping, with kinks occurring at B(t - 1) = 0.1345 and B(t - 1) =0.1447. For B(t- 1)20.8951, the curve is positively sloping with kinks occurring at B(t- 1) equal to 0.9016, 0.9019 and 0.9168, respectively. The kinks occur because eq. (11) involves the distribution functions F(Wo(t)), F(@$(t)) and F( @$(t - 1)). As B(t) gets larger these distributions become exactly equal to one, but not larger, consecutively. The qualitative features of this simulation are represented in fig. 2. Here I replace the curves AB and CDE in fig. 1 by GB and CHE, respectively, while retaining the same portion BC. GB and CHE are obtained from simulations under the assumptions that p’(t) > p(t - 1) and p’(t + 1) > p(t). BC is from the simulation when p”(t) 2 p(t - 1) and p’(t + 1) $p(t). From the figure, it can be seen that if the initial value of B(t- 1) is larger than B,, or if B(t- 1) is so small that B(t) is higher than point C, then B(t) will converge to point E. Otherwise, it will converge to point B.7 Thus, the simple model is capable of generating several stationary equilibria, a feature which seems important in the understanding of corruption.
4. Changes in corruption equilibria In this section I examine how the equilibrium levels of corruption respond to changes in the parameters. It is useful to distinguish between small and ‘Strictly speaking, the portion of the GB curve which is close to point B is not applicable to the situtation where p’(t) B(t + 1). This is not a continual increase in B(t). The appropriate conditions should be the case when p’(t) cp(t - 1) and p’(t + 1) > p(t). We can of course carry out the simulation for this situation. A similar negatively sloping curve can be obtained, and the qualitative results in the next section still remain valid. Since this problem is only peripheral to the model, I ignore it.
F.T Lui, Corruption deterrence
B(t)
B2
B1
B3
B(t-l) Fig. 2
large changes in the parameters because their effects are quite different. I shall discuss small changes first. Algebraically it is more convenient to deal with the stationary equilibrium auditing probability p* rather than B*. Because of (15), p* is related to the stationary equilibrium corruption level B* by the following equation: p*=A-kB*.
(30)
From fig. 2 there are three possible equilibria for B(t). They are B, C and E. By virtue of (20) and (30), the first two are determined by the equation Cfkp*2-[fk(2C+
l)-2]p*+2(fk-
A)=O.
(31)
Since this is a quadratic equation there are two solutions for p*, which may or may not be real. Consider the situation when the solutions are real, that is, the curve in fig. 2 crosses the 45” line. It is sufficient to consider the larger root of p* only, since this corresponds to the equilibrium B* which is stable (point B in fig. 2). By working on the implicit function defined by eq. (31) we can tell what will happen to p* when there are parametric changes. It is possible to show the following: dp*ldC>O; dp*ldfcO; and dp*ldR >O. It
J.P.E.
-D
F.7: Lui, Corruption deterrence
228
should be noted that these results are true only for the larger root of p*. Also recall that R is the resource used for auditing. From section 2 we know that R affects both A and k, which are parameters appearing in eq. (31). From (30) B* is negatively related to p *. Hence, the above results should be interpreted as follows. If the penalty C or the auditing resource R increases, then B* goes down. On the other hand, if the average degree of honesty h in the economy declines, then f and B* go up. These are standard results one should expect from a model of corruption deterrence. Since beside point B, E is also a stable stationary equilibrium solution, we should also examine how it responds to changes in parameters. From (21), the equilibrium point at E can easily be shown to be B*=(2-A)/(2-k).
(32)
This B* does not depend on the penalty C. However, when the resource R is increased, both A and k will go up the same proportion. Consequently B* will decline. Hence, if the economy is at a high level corruption equilibrium, changes in R can reduce corruption, but small changes in C cannot. In this model, since there can be two stable equilibria, it is of interest to see how B(t) can move from one to the other. Suppose the economy is at a low level corruption
equilibrium,
that is, point
B in fig. 2. The position
of the
curve GBCHEF of fig. 2 depends on the parametric values. If there are sufficiently large changes in the parameters, it is possible that this curve does not pass through the 45” line. In other words, B* as given by (23) does not have real roots. B(t) will then converge towards the higher level equilibrium point E. This can be illustrated by the numerical simulation that we have used before. Suppose we retain all the parametric values, with the exception that C = 1. This will shift the GBCHEF curve upwards far enough to miss the 45“ line completely. This is illustrated in fig. 3. The equilibrium point must move from B to E. This simple example gives an important insight into the understanding of corruption. It says that if society becomes more lenient towards corrupt officials, it is sometimes possible to have a sudden large increase in the level of corruption. Moreover, once the high level of equilibrium is attained it will stay there, even if the parameters come back to their previous values. This explains a problem posed in the beginning of this paper, namely two otherwise identical economies may have very diffeent levels of corruption even though the parameters of their deterrence schemes are roughly the same. The intuitive explanation for this phenomenon is that once corruption is common, the cost for each auditing becomes higher. The deterrence effort of the government will be less effective. The analysis can be carried another step further in the reverse direction. Suppose now the economy is at a high level of corruption equilibrium. How
F.7: Lui, Corruption deterrence
229
B(t-1) Fig. 3
can the government move it to the lower level? This can be done by shifting the curve of the phase diagram downwards. For example, one could change the value of C to 1.4 while retaining all the other parametric values. This will be sufficient to create a situation such as that depicted in fig. 4. B(t) will then converge to point B. The change in C need not be permanent. Indeed, once B(t) is close enough to point B, the government may find it unnecessary to maintain the severe penalty. Even when C is changed back to a more normal level, say the original value of 1.25, the economy will still stay at the low level equilibrium.* Because of the possibility of moving from one equilibrium to another, sometimes a harsh deterrence scheme which seems suboptimal in the short run may in fact be optimal from a long-term perspective.’ Lastly, sometimes a temporarily harsh deterrence scheme can also produce just the opposite effect if the economy is already at the low level equilibrium. Referring to fig. 2 again, suppose the economy is initially at point B. Then assume the government increases C (or R) significantly at time t- 1. This will *This example shows that even if the parameters of the deterrence scheme become variables which respond to changes in the corruption level, it is still possible for the model economy to exhibit several stable equilibria. ‘This analysis is similar to the so-called ‘big-push’ theory in economic development [Nelson (1956)]. If the corruption in the economy is initially at a ‘high level equilibrium trap’, then it is necessary to make a ‘big push’ in order to restore it to the low level equilibrium.
F.7: Lui, Corruption
230
deterrence
B(t)
B( t-l)
Fig. 4
move point B to the left. If the policy is only temporary, then at time t, point B will come back to the original position. However, B(t- 1) has a small value, and if it is close enough to zero, B(t) can become very high. If it is higher than point C, it will converge to the high level equilibrium point E. The result occurs mainly because of the intertemporal substitution decision problem solved by the officials. At very low B(t - l), or equivalently very high p(t - l), they may perceive that the probability will be lower in the future. Therefore, it pays for them to refrain from accepting the bribes now and wait until next period. Moreover, since not many people are corrupt at t - 1, very few of them are punished. This means that more old officials at t are liable to become corrupt. 5. The history of corruption in a developing country In this section I present a case study of the history of corruption in China from the early 1950s to the mid-1980s. The choice of China is particularly appropriate for empirically illustrating the relationship between corruption and its deterrence. As argued in Lui (1985a, ch. l), corruption occurs more easily if there are lots of market distortions. The Chinese economy is far from being perfectly competitive, and corruption is likely to be widespread if there
F.T. Lui, Corruption deterrence
231
are no deterrence schemes. Another nice feature about the Chinese experience is that both the level of corruption and the severity of the deterrence schemes underwent large changes during the period. This permits us to learn more about the underlying relationship between the two. More specifically, I shall show three things. First, the Chinese government often resorted temporarily to severe crackdown policies. Second, the level of corruption in the economy could increase even when the government invested more resources in deterrence and penalties became more severe. Third, the basic assumption in this paper has strong empirical support. In other words, there is evidence that coalition formations among corrupt officials made it very difficult to audit them. During the revolutionary period before 1949, corruption, though not completely absent [Mao (1967)], was seldom associated with the Chinese Communist Party. However, after coming into power in 1949, the communist government was soon alarmed by a series of serious corruption incidents in the bureaucracy. An anti-corruption campaign was then called for by a highranking official in Northeast China in August 1951 [Jen-min Jib-pm (23 1951, this had already developed into a November, 1951)]. lo By December major national campaign called the sanfulz (three anti: anti-corruption, waste and bureaucratism), which was soon reinforced by a second campaign, the wufan (live anti: anti-bribery, tax evasion, stealing state property, cheating in workmanship and materials, stealing state economic intelligence). The campaigns were widely publicized and forcefully organized. In the heyday in early 1952, it was difficult to find an issue of the party organ, Jen-min Jihpao, not flooded with reports and documents on corruption. In city after city, mass rallies consisting of thousands of people were held for the public trials of corrupt officials, many of whom were sentenced to death [e.g. JMJP (2 February, 1952)]. Special people’s courts to deal with corruption were established [JMJP (25 March, 1952)]. Corruption acts were promulgated to serve as guidelines in deciding the penalties. People were mobilized to report corruption cases to the government [JMJP (5 January, 1952)]. The campaigns were officially ended in June 1952. To assess the effectiveness of the campaigns, we have to compare the pervasiveness of corruption before and after the campaigns. During the sun fun and wu fun, the Chinese government often stressed that the situation was serious [e.g. Hsin-ha Yueh-puo (January 1952, p. 15)].’ 1 The chief official of the campaigns estimated the total bribes accepted by officials in the central government (during the first two years of the regime) were sufficient to buy enough grain to feed 280,000 people for a year, and the total for the whole country could feed several million people [JMJP (2 February, 1952)]. ‘“Jen-min Jib-pm, or People’s Daily, will be abbreviated as JMJP. “Hsin-hua Yieh-pao, or New China Monthly, will be abbreviated as HHYP.
232
F.7: Lui, Corruption
deterrence
Although moderate by contemporary Chinese standards. these were large figures in the 1950s. However, after the campaigns, the corruption level went down significantly. Even the rate of crime, which included corruption, fell from 500,000 cases in 1950 to an average of 290,000 in the period from 1950 to 1965 [Washington Post (30 August, 1980, p. A24)]. During this time, corruption was so low that it was seldom mentioned again in the Chinese press. In fact, even nowadays the general attitude of the government towards the period from the early 1950s to the mid-1960s is that is was a golden age of honesty [e.g. JMJP (3 September, 1983)]. Thus, China at that time could impress a noted Western scholar and many South Asian intellectuals as ‘a strong disciplined state, one that is scrupulously honest by South Asian standards’ [Myrdal (1968, p. 938)]. In terms of reducing corruption, the campaigns were therefore a success. The above experience shows that heavy penalties,12 together with massive efforts in auditing, could effectively bring down the corruption level. Even more remarkably, the Chinese government did not spend any significant amount of resources for auditing within the next 30 years, but corruption remained low until the mid-1960s. Thus, a temporary crackdown policy apparently could have a long-lasting effect. This result is of course consistent with the multiple equilibria theory proposed earlier in this paper. While a harsh crackdown may bring corruption down to a low-level equilibrium, a sufficiently large relaxation in the deterrence scheme may also restore it back to a high-level equilibrium. Beginning in 1966, the Cultural Revolution broke out in China. An important design of the Revolution was to destroy the existing government machinery so that a new one could be created. Law and order were supposed to be detrimental to this end [e.g. JMJP (31 January, 1967)]. ‘Thoroughly smash the public security, procuracy and courts’ was a famous slogan of the time. In 1975, when the Cultural Revolution was near its end, the new constitution formally abolished the procuratorial organs and placed people’s courts under the control of the administrative organs at the same level [Chiu (1982)]. Evidently, this practice effectively reduced the probability of punishing a corrupt official who might himself be the decision-maker in the court. By the end of the 197Os, corruption again attracted nationwide attention. In 1979, the reporter Liu Bin-yan published a brilliant case study which showed in detail how the Party secretary of a local coal company, through various corrupt activities, was able to obtain for herself more than half a million yuan, a sum enough to pay the salary of a worker for 1,000 years [Liu (1979)]. A striking feature of the case was that the corrupt official was ‘*Penalties for corrupt A criminal who accepted gold, could be sentenced the yuan used in the early
criminals during sari Jan and wu Jan were severe by Western standards. 100 million yuan, which at that time could buy about 110 ounces of to death. See JMJP (2 February, 1952). Because of a currency reform, 1950s was not comparable in value to the yuan used today.
F.T. Lui, Corruption deterrence
233
well protected by other officials which made the investigation process extremely diflicult. Liu’s article received immediate concern from all over the country. In his words, this was because the details described in his article were pervasive and commonly known to people [Liu (1980)]. The seriousness of corruption soon led the State Council of the government to conclude that the problem had become much worse than that during the sun fun period [HHYP (April 1982, p. 27)]. In 1982, 164,ooO cases related to economic crimes, most of which were corruption, were registered, and about 30,000 people were convicted [HHYP (February 1983, p. 32)]. In value terms, the State Council reported that in the two years before the end of 1985 the amount related to economic crimes which had been discovered was 8.9 billion yuan (2.9 billion dollars) [Chung Pao (19 December, 1985)]. Although these figures indicate a situation unprecedented in contemporary Chinese history, they represent only the small officially investigated fraction of corruption cases. The large number of reports on the subject show that corruption has permeated into the everyday lives of people. For example, because of the low-rent policy, housing is in acute shortage in the cities. As a result, a main source of dissatisfaction towards the bureaucracy is that many officials have used their power to allocate houses for their own uses [HHYP (August 1982, p. 93)]. In international trade, it is well known among businessmen in Hong Kong that they often cannot get contracts signed unless bribes have been paid [Qishi Niundui (April 1982, pp. 15-19)]. Other examples of corruption include custom officials confiscating smuggled materials for themselves, exaggeration of budgets for engineering projects [Qishi Niundui (April 1982, pp. 13-15)], officials in grain stations stealing grain, and postal workers selling postal bags for personal profits [HHYP (July 1983, p. 42)]. In short, if an official has decision power in the allocation of a commodity, it is not surprising to find him making use of that power for his own benefit. The Chinese Communist Party long realized that corruption was detrimental to its image. After an important meeting of its Central Committee in 1978, the Party began to rebuild its disciplinary organs aimed at auditing and punishing its corrupt members [HHYP (February 1983, p. 24)]. Starting from February 1982, a major anti-corruption campaign was launched. Once again, as in the sun fun and wu fun, the news media were filled with publicity on the campaign. The Central Committee also announced that it would pay as much attention to the campaign as to the economic reform taking place at the same time [HHYP (April 1982, p. 26)]. However, there were two differences between this new campaign and the sun fan and wu fun. First, the 1982 campaign lasted for a much longer time. In 1983 it was integrated with a massive anti-crime campaign beginning at that year. In 1984 and 1985, the campaign had slowed down but not completely stopped. Then, in January 1986, 8,000 high-ranking officials were asked to attend a meeting aimed at
234
F.7: Lui, Corruption deterrence
putting greater efforts into the anti-corruption campaign [Jiushi Niundai (February 1986, pp. 39-42)]. Second, in the new campaign, formal laws played a more important role. China’s first Criminal and Criminal Procedure Codes were promulgated in 1979 and became effective in 1980. The penalty structure in the Criminal Code had been deliberately made very flexible so that two persons committing the same crime could be punished quite differently. An official justification for this was that the severity of the punishment should depend on the political situation of the time [JMJP (14 September, 1981)]. During the campaign, the general attitude was that criminals had to be punished to the limit of the severity described by the law. In addition, several laws were amended in August 1983 to make the penalties related to corruption more severe [JMJP (3 September, 1983)]. The ancient saying, ‘Heavy penalties have to be used in chaotic times’, was often quoted to rationalize this change. Some observations should be made here. The efforts put into the investigations of corrupt officials during the 1980s were definitely higher than those between 1952 and 1965, and penalties were at least as severe. However, corruption in the 1980s was much more serious than before. This fact is again consistent with the multiple equilibria result in this paper. Second, the corruption deterrence campaign beginning from 1982 was much less successful than the sun fan and wu fan, since even now there is no evidence for any significant reduction in corruption. A possible explanation lies in the difference in coalition formations among the corrupt oflicials in the two periods. As early as the sun fan and wufan there were reports that corrupt officials formed the so-called ‘offensive and defensive alliances’ when they faced the danger of being audited [e.g. JMJP (2 February, 1952)]. However, since the bureaucracy was relatively new at that time, it was unlikely that the coalition networks were very well organized. Three decades later, this situation had changed. In Liu’s (1979) report, he described how the investigation process had been made difficult because a team of officials were trying to help the audited corrupt official. In 1983, after encountering much difficulty in auditing corrupt officials, the Central Disciplinary Committee stated that many cases could not be pursued because they involved other higher ranking officials [JMJP (15 September, 1983)]. According to another report, in most cases officials in the leadership were involved. They generally provided protection for the lower ranking ones. If a leading official was audited, it was common for his corrupt subordinates to misguide the investigators, or sometimes, a minor official might even end up bearing all the responsibility [HHYP (February 1982, p. 39)]. In many instances, people who sent out confidential reports to uncover corruption cases could be revenged, because the report might be handed to the corrupt otfcial by other officials in coalition with him [HHYP (June 1982, p. 31)]. In short, coalitions among
F.7: Lui, Corruption deterrence
235
the corrupt officials had formed an effective barrier against auditing. Although the resources spent on auditing were large, the actual probability of success was low. Moreover, after the much longer time of learning how to organize the coalitions, the network seemed to be much more extensive and effective than before. A deterrence scheme that was successful in the past was not sufficient for the 1980s. One way to interpret this result is to assume that the parameters A and k defined in section 2 decrease, causing the curves in figs. 14 to shift upwards. Hence, the same deterrence scheme cannot bring corruption from a high to low equilibrium.
6. Concluding remarks I have developed an overlapping-generations model capable of explaining In addition to generating some standard various aspects of corruption. results on corruption, the model also provides simple dynamic interpretations of several phenomena that cannot readily be handled by static marginal analysis. A crucial assumption of the model is that it is more costly to audit officials when a greater proportion of them become corrupt. When corruption is prevalent, the deterrence scheme will be less effective, and hence the economy will remain highly corrupt. The reverse argument is also true. If most officials do not accept bribes, it will be easier to discover those who do. The corruption equilibrium will be lower. The possibility of having several equilibria has been exploited to explain large changes in the level of corruption. In particular, this explains why the same deterrence scheme can give rise to several levels of corruption with large differences. It also tells us why sometimes a government may temporarily adopt harsh policies so as to shift a high level equilibrium level to a lower one. The model suggests that an excessively lenient policy or temporary neglect of the problem of corruption by the government may have undesirable consequences. Once a high level equilibrium is attained, it is costly to bring it down. This paper contains not only a theoretical model of corruption deterrence, but also a case study to show that the model has empirical content. I have chosen contemporary China for the case study. This choice is appropriate for illustrating the relationship between &he level of corruption and its deterrence schemes because both have undergone several important changes in China. The experience there shows that there is evidence to support the basic assumption in this paper. The results of the model are also useful for interpreting the history of corruption in China. The model need not be confined to the study of corruption. With appropriate modifications, it is applicable to a wide range of criminal activities, as, for example, tax evasion. As long as the probability of being
236
F.7: Lui, Corruption deterrence
punished decreases because of greater prevalence of the activity, similar results may emerge. This condition seems likely to be satisfied since society only has limited resources for deterrence schemes. References Becker, Gary S., 1968, Crime and punishment: An economic approach, Journal of Political Economy, March-April. Becker, Gary S. and William M. Landes, 1974, Essays in the economics of crime and punishment (Columbia University Press, New York). Chiu, Hungdah, 1982, Chinese law and justice: Trends over three decades, Occasional papers/ reprints series in contemporary Asian studies, School of Law, Univeristy of Maryland. Chung Pao (Centre Daily News), December 19, 1985. Ehrlich, Isaac, 1982, The optimum enforcement of laws and the concept of justice: A positive analysis, International Review of Law and Economics 2, 3-27. Hsin-hua Yueh-pao (New China Monthly), various issues. Jen-min Jih-pao’(People’s Daily), various issues. Jiushi Niandai (The Nineties). Februarv 1986 issue Krueger, Anne; 1974, The political economy of the rent-seeking society, American Economic Review, June. Kydland, Finn and Edward Prescott, 1980, A competitive theory of fluctuations and the feasibility and desirability of stabilization policy, in: Stanley Fischer, ed., Rational expectations and economic policy (University of Chicago Press, Chicago). Liu, Bin-yan, 1979, Between man and demon, Jen-min Wen-hsueh (People’s Literature), September. Liu, Bin-yan, 1980, Replies to readers concerning ‘Between man and demon’, Jen-min Wen-hsueh (People’s Literature), January. Lui, Francis T., 1985a, Essays in the economics of corruption, Ph.D. dissertation, University of Minnesota. Lui, Francis T., 1985b, An equilibrium queumg model of bribery, Journal of Political Economy, August, 7&78 1. Mao, Tse-tung, 1967, Our economic policy, in: Selected works of Mao Tse-tung, vol. 1 (Foreign Languages Press, Peking). Montias, J.M. and Susan Rose-Ackerman, 1981, Corruption in a Soviet-type economy: Theoretical considerations, in: Steven Rosetielde, ed., Economic welfare and the economics of Soviet socialism (New York). Myrdal, Gunnar, 1968, Asian drama (Pantheon, New York). Nelson, Richard R., 1956, A theory of the low level equilibrium trap in underdeveloped economies, American Economic Review, December. Qishi Niandai (The Seventies), April 1982 issue. Rose-Ackerman, Susan, 1978, Corruption, a study in political economy (Academic Press, New York). Schelling, Thomas C., 1972, A process of residential segregation: Neighborhood tipping, in: Anthony H. Pascal, ed., Racial discrimination in economic life (Lexington Books, Lexington, Massachusetts). Stigler, George, 1970, The optimum enforcement of laws, Journal of Political Economy, March, April. Washington Post, August 30, 19801
of Public
Economics
A DYNAMIC
31 (1986) 215-236.
MODEL
OF Francis
North-Holland
CORRUPTION
DETERRENCE
T. LUI*
Department of Economics, State University of New York at Buffalo, Buffalo, NY 14260, USA Received
September
1985, revised version
received July 1986
This paper presents a model of corruption deterrence with a simple overlapping-generations structure built into it. A crucial assumption is that when corruption becomes more prevalent in the economy it is harder to audit a corrupt official eNectively. It is shown that this assumption may give rise to several stationary equilibrium levels of corruption. This possibility has been exploited to explain why sometimes a government may temporarily resort to an extremely severe deterrence policy and why the same deterrence scheme may imply quite different levels of corruption. A case study is provided to give empirical support to the model.
1. Introduction Corruption has from time to time attracted research interest from a wide range of disciplines in the social sciences.’ Pertinent to this subject, there are two issues that seem to deserve greater attention. The first is whether corruption is beneficial to the economy, and the second concerns the consequences of various corruption deterrence schemes. Recent work has shown that it is possible for corruption to improve social efficiency in the sense that bureaucrats may try to speed up the administrative process so as to obtain more bribes [Lui (1985b)]. If we strictly follow the modern economic approach to the study of crime and punishment, which uses the maximization of social income as the criterion for optimal enforcement of laws [e.g. Ehrlich (1982)], under some circumstances there seems to be no need to prohibit corruption. Nevertheless, corruption deterrence schemes are still deemed necessary on several grounds. For instance, corruption may give rise to distributional consequences which are usually socially undesirable. Moreover, the efficiency result mentioned above is conditional upon the use of a particular rule of resource allocation. If it is possible to replace it by another allocative mechanism, then efficiency may improve even in the absence of corruption. Corrupt officials with vested interests in protecting *I have benefited from discussions with John Chipman, Isaac Ehrlich and Edward Prescott. Thanks are also due to two anonymous referees who provided very useful suggestions. Any remaining errors are my own. ‘For a fairly complete bibliography of the subject, see Montias and Rose-Ackerman (1981). 0047-2727/86/$3.50
0
1986, Elsevier Science Publishers
B.V. (North-Holland)
216
F.7: Lui, Corruption deterrence
their benefits generally have the tendency to spend real resources to oppose this kind of institutional change.2 Corruption deterrence schemes are therefore often important in societies interested in social reforms. In the literature there exist many models of crime and punishment in general, and corruption in particular.3 By and large, most of them are formulated within a static framework. However, in the real world a corrupt official upon being discovered will find himself not only punishable by law, but also by the loss of his reputation. The latter in turn affects his future income. It therefore seems important that the decision to be corrupted depends also on some expectations about the future. Moreover, just as in recent equilibrium business cycle theories where agents’ decisions on supplying labor are assumed to depend on the relative wage rates across different periods [e.g. Kydland and Prescott (1980)], it is natural to think that the decisions on when to accept bribes are affected by the intertemporal differences in the expected penalties. It appears that a dynamic model is more appropriate for helping us to understand the implications of a corruption deterrence scheme. A dynamic model cannot be taken as superior to a static one unless it can yield richer results than the latter. In the simple overlapping-generations model that will be formulated in this paper, an explicit dynamic structure is incorporated. Beside being able to yield results consistent with conventional analysis, the model also provides explanations for some phenomena that are less readily accountable by static models. For example, the level of corruption in a country may be much higher than before, but at the same time the parameters of the punishment scheme are not much different. It is sometimes observed that a government, especially one that belongs to a developing country, may temporarily resort to an extremely harsh deterrent policy that seems suboptimal according to standard analysis4 From the point of view of dynamic optimization, is there any justification for this practice? Externality plays a crucial role in the model of this paper. A fundamental observation on corruption is that it becomes very costly to audit an official effectively if many other officials are also corrupt. The reason for this will be discussed in section 2. The incorporation of this assumption into the model makes it possible for the economy to exhibit several corruption equilibria. This result will be exploited to explain the phenomena outlined above. ‘This is in the spirit of Krueger’s (1974) analysis of the rent-seeking society. Note that reformers can also bribe corrupt officials to accept the reforms. In this way, corrupt oficials no longer have to spend the real resources. A recent example in disguise is the current economic reform in China, where some old conservative officials are promised great retirement benefits if they agree to leave their posts. 3For example, see Becker and Landes (1974) and Rose-Ackerman (1978). 4From the point of view of maximization of social income, punishments that are ‘too severe’ are not optimal [Becker (1968)]. Also, too high a penalty for a minor offence may result in an increase in a more serious one [Stigler (1970)].
F.7: Lui, Corruption deterrence
217
In the next section I shall outline the physical set-up of the model and determine the level of corruption in the economy. In section 3, the stationary equilibrium levels of corruption in the economy are derived and different paths of convergence to the equilibria are examined. Section 4 discusses the effects of changes in the parameters and provides interpretations of the phenomena outlined above. In section 5 I present a case study of the history of corruption and its deterrence in contemporary China. The study provides evidence for the basic assumption in this paper. In addition, it shows that the implications of the model are empirically important, at least in China. Section 6 is a summary of results.
2. The economy In this section the physical environment of the model economy will be described. I shall then determine the proportion of corrupt officials in the economy. If the proportion is high, then the economy is regarded as more corrupt, and vice versa. An overlapping-generations abstraction will be used because it provides a simple way to incorporate a dynamic structure. The behavior of people in one generation is not independent of that in others because of the particular rule of auditing probability that will be specified later in this section. 2.1. The physical environment and the proportion of corrupt officials In the economy, in every period, there are two overlapping generations of officials, the young and the old. The numbers of officials in the two generations are always equal. In each period every official is offered one unit of bribe revenue, which he can decide to accept or not. If a young official accepts it, and is audited subsequently, then with probability one he will be required to pay a fine of C units of revenue. He can continue to keep the job in the next period. However, if he again accepts the bribe and is audited, then the new fine will be C’ units. I assume that C’ is so high that an official who is punished while young will never accept another bribe so long as the probability of being audited is positive. The precise parametric restriction on c’ that guarantees this will be developed later. Also, the probability of auditing the officials at time t is the same for everyone. This is denoted by p(t). Officials in a generation are assumed to be heterogeneous only with respect to their degrees of honesty h. If an official with h accepts the bribe, then he only values it at 1 -h unit. The higher h is, the more honest is the official. I choose to incorporate honesty into the model because people do seem to be different in their willingness to accept bribes. It is assumed that h is a random variable with a uniform probability distribution function F(h). The lowest value for h is zero, while the largest value is l/f: Thus, the
F.7: Lui, Corruption deterrence
218
proportion of officials having h lower than a value h* is fh*, provided that h* 5 l/j The distribution function F(h) is the same for every generation. It is also assumed that all officials are risk neutral. At time t, an old official who has not been punished before will accept the bribe if and only if his expected payoff is 1 -h-p(t)CZO.
(1)
Define We(t)= 1 -p(t)C. An official with h belonging
At time old at time t be p”(t + opportunity will accept
to this group will be corrupted
if and only if
t a young official has to consider his expected payoff when he is t + 1. Let the probability of auditing at time t + 1 expected at time 1). Then, since a punished young official in effect will lose the to accept a bribe in the future, a young official with h at time t the bribe if and only if
l-h-p(t)[C+max[l-h-p”(t+l)C,0]]20.
(3)
Since max [ 1 -h -p’(t + l)C, 0) 20, the opportunity cost of a young official to accept a bribe is at least as big as that of an old official. This implies that the latter is more susceptible to corruption than the young, provided that the old official has not been punished before. This result is also consistent with Rose-Ackerman (1978) who argues that ‘lame duck’ politicians may be especially susceptible to bribes. Define Wo(t + 1) = 1 -p’(t + l)C. Similar to the argument above, a young official with h at t expects that he will accept the bribe at t+ 1 if and only if Wo(t+ l)>,h. Suppose
I
(4)
(4) is satisfied. Then (3) is equivalent P(WC1 -p'(t+ l-p(t)
_
111 =. >h
(5)
Define m
@)=
Y
1
_
P(WC1 -P'(t+ l-P(t)
to
1)l .
219
F.7: Lui, Corruption deterrence
Then the young
official with h will accept the bribe if and only if
l&(t) 2 h.
(6)
Suppose (4) is not satisfied, that is, the young accept the bribe at t + 1. Then (3) becomes
at t does
not
expect
to
1 -hLp(t)C20. Define WY(t) = 1 - p(t)C. The young official with h will then accept the bribe if and only if W,(t) 2 h.
(7)
Since there are two to decide whether to which one is chosen. WY(t), and W,(t). It is %(r+
l)-
possible cutoff points, WY(t) and WY(t), for the young accept the bribe or not, it is necessary to determine To do this I shall first find the ordering of Wo(t+ l), easy to show the following:
W(r)=
ivy(t) - WY(C) =
Q(t)-p’(t+
l)),
P(WCP(Q -P”(L+ 111 1-P(t)
(8)
(9)
Hence, l&(t) < P&(t) < Wo(t + 1) if and only if p(t) > p”(t + 1). Suppose ~(t)>p”(t+ 1). Consider an h smaller than l&(t). The person then accepts the bribe at time t even when the expected payoff of accepting a bribe at t + 1 is positive, that is, (4) is fulfilled. However, since WY(t) < Wo(t+ l), h is also smaller than Wo(t+ 1). Hence, the young official will accept the bribe at t. Now, consider an h between WY(t) and Wo(t+ 1). Again, (4) is fulfilled. Because of (6) he will not accept the bribe. For h > Wo(t+ l), it is also larger than WY(t) and l&(t). His bribe revenue at t must be zero. It follows that as long as ~(t)>p’(r+ l), the young officials will use WY(t) as the cutoff point. In other words, the proportion of young corrupt officials at t is given by F(l&(t)). Now assume p(t)spe(t+ 1). By following similar arguments to the above, it is easy to show that the cutoff point this time is WY(t), In other words, the proportion of young corrupt officials at t is given by F(W,(t)). These results are directly applicable to the decision problems of young officials at time t - 1 also. Let the probability of auditing at time t expected at time t- 1 be p’(t). Also define Wy(t-
I)= 1 -p(t-
1)C
220
F.7: Lui, Corruption
deterrence
and m
(t_
Y
I)=
1
_
P(t- lM1 1 -p(t-
-P'(O)
1)
If p(t - 1) >p’(t), the proportion of young corrupt officials at t - 1 is F(my(t - 1)). On the other hand, if p(t - 1) 5 p’(t), then this proportion is F( Wy(t - 1)). As can be seen from above, the relative values of p’(t) and p”(t + 1) play an important role in the model. I impose the assumption that for all t, p”(t)2 p(t1) if and only if p(t)zp(t - 1). In other words, the sign of the change in p(t) is always anticipated correctly. The main task of this section is to determine the proportion of corrupt officials in the economy under different conditions. We have already obtained the expressions for the young at t. It remains to determine the proportion for the old at t. By following similar arguments to the above and making use of the assumption in the last paragraph, these results can be proved: (i) If p’(t) 2 p( t - l), then the proportion of corrupt old officials at t is (1 -p(t - l))F( H&(t)). (ii) If p’(t)
punished official will not accept any new bribe again. Let B(t) be the proportion of corrupt offkials within the entire population of offkials at time t. B(t) is in fact the average of the proportions of young and old offkials who accept bribes at t. This is used as a measure of the level of corruption in the economy at time t. The preceding results can be summarized by the following four cases. Case 1: Suppose p(t-l)Spe(t)
and
p(t)Sp’(t+l).
(10)
Case 2: Suppose
p( t -
1) >
p”(t)
and
p(t) > p”( t +
1).
(11) Case 3: Suppose
p( t -
1) >
p”(t)
and
p(t) 5 p”( t +
1).
B(t)=(1/2)CF(W,(t))+F(W,(t))-p(t-l)F(@‘d- 1Nl. Case 4: Suppose
p(t -
(12)
1) <=p’(t) and p(t) > p’(t + 1).
(13)
F.7: Lui, Corruption
deterrence
221
If all the proportions F( .) are less than one, then we can also substitute the appropriate values of the w’s into the above expressions to obtain:
B(t)=W)CG-P(t-
+Jzl
1))(1-P(W-Jl
(14)
where
J,=
P(WCP(t)-P’(t+111 if 1-p(t) ’ 0,
MJ,=
l))‘CCl-P7Ql 1 -p(t-
1)
p(t)>pe(t+
1) 3
if
p(t)sp”(t+
-p(r-
l)p(t)C,
l),
if
p(t-
l)>p’(t),
if
p(t-
l)sp’(t).
From eq. (14) it is clear that B(t) depends on the probabilities of auditing. To complete the model, it is necessary to specify how the probabilities are determined. 2.2. The probability
of auditing and the level of corruption
As remarked in section 1, it is more costly to audit an official effectively if there are more corrupt officials in the economy. We can explain this observation by abstracting the investigative process as follows. At a given level of corruption, B(t), to find out whether an official is corrupted the government has to collect evidence from some of his colleagues, say j of them. It is assumed that the corrupt activities of an official are often related to those of others. If some of these j colleagues are themselves corrupt, they will be less likely to supply accurate information to the government because successful uncovering of the case may lead to further investigations of themselves. Suppose now that the level of corruption in the economy increases. Then it is more likely that some of the j colleagues are corrupt. To make sure that an investigation is still effective, the government then has to collect information from more people. In other words, when B(t) is higher, the cost of an effective audit is also higher. To capture this feature into the model, I make the following assumptions. Each period, the government spends R units of resource for auditing. The resource necessary for one completely effective auditing at time t is r(t). It is assumed that r(t) = l/(m - nB( t)),
F.7: Lui, Corruption deterrence
222
where m and n are positive parameters, and m > n. Note that r(t) is positively related to B(t). Moreover, the second derivative of r(t) with respect to B(t) is positive. Let there be N people in the bureaucracy. Then, R/r(t)
p(t) =T=
Rm - RnB(t) N
Define A= Rm/N and k = Rn/N. Then, p(t) =
A - kB( t).
(15)
Eq. (15) can be substituted into (14) and we can obtain the law of motion of B(t). This will be done in section 3. The assumptions just made are useful for showing that a given parametric value of R may give rise to several stable equilibrium levels of corruption. One simple possibility is as follows. Suppose that the initial level of corruption in the economy is low. Because of the cheaper cost for each effective audit, the available resource can be used to investigate more people. Hence, fewer people will choose to be corrupted and the level of corruption will remain low. The same logic applies to the opposite case. If the initial level of corruption is high, then it will remain high because the probability of being audited is low.” 2.3. Parametric
restrictions
It is useful to specify some restrictions on the parameters of this model. First, since m> n>O, we must have A> k >O. Otherwise, a negative probability could occur. Second, the largest p(t) occurs when B(t) =O. In this case, p(t) = A. Hence, A < 1. Third, we require that 1 -p(t)C>O. If this is not fulfilled, no (risk-neutral) sufficient condition for (16) to be true is
(16)
officials
will accept
any
bribes.
A
l-AC>O. ‘Generally speaking, if a variable depends on itself or on its past values, it may be possible to obtain several stationary equilibria. An example is the residential segregation model of Schelling (1972). In this model, the future black-white percentage of population in a neighborhood depends on its current value. If the current percentage of white is small enough, then some whites will begin to leave the neighborhood and this causes more whites to leave. Hence, if the percentage of white is small, it will remain small. A similar logic applies to the opposite case. Thus, it is possible that there are several stationary equilibria.
223
F. 7: Lui, Corruption deterrence
Fourth, I want to investigate the possibility that all members of a generation decide to accept the bribes. This requires F(1 -p(t)C)= 1 for some p(t). It means that f(l -p(t)C)z 1 for some p(t). Since 1 -p(t)C< 1, it must be true that f> 1. Lastly, if an old official who had been punished before accepts the bribe again, his penalty if audited is C’. To ensure that he will not accept the bribe at t, 1 need l-p(t)C’
are:
l>A>k>O,
(17)
C>l>AC,
(18)
f>l
(19)
3. Stationary equilibrium levels of corruption In this section I determine the stationary equilibrium levels of corruption and examine the time paths of B(t). To do this, I must obtain the law of motion of B(t). At a stationary equilibrium level B *, B(t) = B* for all t. Because of (15) p(t)=p* for all t, where p* is the auditing probability corresponding to B*. Since the auditing probabilities and also their expected values are all equal, the terms J, and J, in eq. (14) will both drop out. This of course is a special situation of case 1 where p(t) sp’(t + 1) and p(t- 1) ~Zp’(t). Eqs. (10) and (15) are therefore suflicient for determining the stationary equilibrium level of B(t). In fact, if we are interested only in the determination of B*, we do not even have to pay attention to cases 2 to 4 in section 2. The consideration of these is useful only when we also want to examine the time paths of B(t), which can provide us with additional insights into the understanding of corruption. Assume p(t- l)Sp’(t) and p(t)Sp’(t+ 1). Note that F(W,(t)) =F(Wo(t))= f(l-p(t)C) if f(l-p(t)C)sl, and F(W,(t))=F(W,(t))=l if f(l-p(t)C)>l. From eq. (lo), we have
B(t) =
(f/W-p(t1 -(V)p(t-
I))(1 -p(t)C), I),
if f(l -p(t)C)S if f(1 -p(t)C)>
1, 1.
(20) (21)
F.7: Lui, Corruption
224
I first consider the situation whenf(1 (20), the following can be obtained:
deterrence
-p(t)C)
5 1. By substituting
(15) into
B(t)=(f/2)(2-A+kB(t-l))(l-AC+kCB(t)).
(22)
This difference equation describes the law of motion of B(t) under assumptions of case 1. From (22), at a stationary equilibrium B*, following is true: B*=(f’/2)(1-AC+kCB*)(2_A+kB*).
the the
(23)
Since this is a quadratic equation, we may or may not have real roots for B*. I next consider the situation whenf(1 -p(t)C) > 1. From (15) and (21), B(t)= 1 -(.4/2)+(k/2)B(tThe corresponding
stationary
B*=(2-,4)/(2-k).
(24)
1). equilibrium
level of corruption
is (25)
The above results can be illustrated by a numerical example. Let f = 1.25, C = 1.25, k = 0.6 and A = 0.71. It is readily verifiable that f( 1 -p(t)C) > 1 if B(t)>0.9167. Hence, for B(t)s0.9167, we use eq. (20) and otherwise use (21). The roots of B* from eq. (23) are 0.3604 and 0.8951, respectively. The solution of B* in eq. (25) is 0.9214. The same ideas can be illustrated by a phase diagram. In fig. 1 I plot B(t) against B(t - 1). The curve ABCD corresponds to eq. (20). It crosses the 45” line OM at two points, namely B and C. This means that B* has real solutions.‘j The straight line DF which represents eq. (21) cuts the 45” line at E. In the numerical example, E occurs at B(t)=0.9214. Thus, there are three stationary equilibrium points, but it can easily be seen that only B and E are stable. Nore that for B(r- 1) falling between B, and B,, or between B, and one in the diagram, B(t) 5 B(t - 1) for all t. It follows that p(t) >,p(t - 1) and consequently p’(t)zp(t - 1) for all t. These are precisely the conditions necessary for eqs. (20) and (21) to be applicable. It is therefore legitimate to use the curves BC and EF to guide us in seeing how B(t) converges to B, ‘Given the parametric restriction I -AC 20, B(t) is always strictly positive. This is why the lowest value of B(t) occurs at point A in Iig. 1, where B(t) is strictly positive. In the numerical example, it is 0.2294. However, the initial value B(t- 1) can be of any value between zero and one. In fact, in the model, B(t - 1) affects B(t) only because B(t) depends on p(t - 1). The meaning of B(t - 1) =0 should be interpreted rather as p(t - 1) = A. Suppose, initially, that the economy is at a certain point B’(t - 1). Corresponding to this, there is a probability p’(t - 1). If there is a parametric change in A or k, we have to use the p’(t- 1) and the new values of A and k to determine the new initial value of B(t- 1).
F.T. Lui, Corruption deterrence
B(t)
A
0 B(t-1) Fig.
and and (20) (20) B(t).
1
B,. However, for B(t-- 1) falling between zero B,, B(t) > B(t - 1) and hence p’(t)
and B,, or between B2 all t. The conditions for which correspond to eqs. tracing the time path of
To illustrate the different types of time paths of B(t), I shall use the possibilities that can be generated by case 2 as examples. Now assume p’(t + 1)
if
p(t-l)>=p*,
(26)
(l+u)p(t-1)--p*,
if
p(t-l)
(27)
226
F.71 Lui, Corruption
deterrence
p’(t+ 1)=Pwu/P* -P(t)\ if p(O2p*. (1 +u)p(t)--up*,
if
p(t)
(28) (29)
The parameter u is less than one and greater than zero. This expectation formation rule guarantees that p’(t)
4. Changes in corruption equilibria In this section I examine how the equilibrium levels of corruption respond to changes in the parameters. It is useful to distinguish between small and ‘Strictly speaking, the portion of the GB curve which is close to point B is not applicable to the situtation where p’(t)
F.T Lui, Corruption deterrence
B(t)
B2
B1
B3
B(t-l) Fig. 2
large changes in the parameters because their effects are quite different. I shall discuss small changes first. Algebraically it is more convenient to deal with the stationary equilibrium auditing probability p* rather than B*. Because of (15), p* is related to the stationary equilibrium corruption level B* by the following equation: p*=A-kB*.
(30)
From fig. 2 there are three possible equilibria for B(t). They are B, C and E. By virtue of (20) and (30), the first two are determined by the equation Cfkp*2-[fk(2C+
l)-2]p*+2(fk-
A)=O.
(31)
Since this is a quadratic equation there are two solutions for p*, which may or may not be real. Consider the situation when the solutions are real, that is, the curve in fig. 2 crosses the 45” line. It is sufficient to consider the larger root of p* only, since this corresponds to the equilibrium B* which is stable (point B in fig. 2). By working on the implicit function defined by eq. (31) we can tell what will happen to p* when there are parametric changes. It is possible to show the following: dp*ldC>O; dp*ldfcO; and dp*ldR >O. It
J.P.E.
-D
F.7: Lui, Corruption deterrence
228
should be noted that these results are true only for the larger root of p*. Also recall that R is the resource used for auditing. From section 2 we know that R affects both A and k, which are parameters appearing in eq. (31). From (30) B* is negatively related to p *. Hence, the above results should be interpreted as follows. If the penalty C or the auditing resource R increases, then B* goes down. On the other hand, if the average degree of honesty h in the economy declines, then f and B* go up. These are standard results one should expect from a model of corruption deterrence. Since beside point B, E is also a stable stationary equilibrium solution, we should also examine how it responds to changes in parameters. From (21), the equilibrium point at E can easily be shown to be B*=(2-A)/(2-k).
(32)
This B* does not depend on the penalty C. However, when the resource R is increased, both A and k will go up the same proportion. Consequently B* will decline. Hence, if the economy is at a high level corruption equilibrium, changes in R can reduce corruption, but small changes in C cannot. In this model, since there can be two stable equilibria, it is of interest to see how B(t) can move from one to the other. Suppose the economy is at a low level corruption
equilibrium,
that is, point
B in fig. 2. The position
of the
curve GBCHEF of fig. 2 depends on the parametric values. If there are sufficiently large changes in the parameters, it is possible that this curve does not pass through the 45” line. In other words, B* as given by (23) does not have real roots. B(t) will then converge towards the higher level equilibrium point E. This can be illustrated by the numerical simulation that we have used before. Suppose we retain all the parametric values, with the exception that C = 1. This will shift the GBCHEF curve upwards far enough to miss the 45“ line completely. This is illustrated in fig. 3. The equilibrium point must move from B to E. This simple example gives an important insight into the understanding of corruption. It says that if society becomes more lenient towards corrupt officials, it is sometimes possible to have a sudden large increase in the level of corruption. Moreover, once the high level of equilibrium is attained it will stay there, even if the parameters come back to their previous values. This explains a problem posed in the beginning of this paper, namely two otherwise identical economies may have very diffeent levels of corruption even though the parameters of their deterrence schemes are roughly the same. The intuitive explanation for this phenomenon is that once corruption is common, the cost for each auditing becomes higher. The deterrence effort of the government will be less effective. The analysis can be carried another step further in the reverse direction. Suppose now the economy is at a high level of corruption equilibrium. How
F.7: Lui, Corruption deterrence
229
B(t-1) Fig. 3
can the government move it to the lower level? This can be done by shifting the curve of the phase diagram downwards. For example, one could change the value of C to 1.4 while retaining all the other parametric values. This will be sufficient to create a situation such as that depicted in fig. 4. B(t) will then converge to point B. The change in C need not be permanent. Indeed, once B(t) is close enough to point B, the government may find it unnecessary to maintain the severe penalty. Even when C is changed back to a more normal level, say the original value of 1.25, the economy will still stay at the low level equilibrium.* Because of the possibility of moving from one equilibrium to another, sometimes a harsh deterrence scheme which seems suboptimal in the short run may in fact be optimal from a long-term perspective.’ Lastly, sometimes a temporarily harsh deterrence scheme can also produce just the opposite effect if the economy is already at the low level equilibrium. Referring to fig. 2 again, suppose the economy is initially at point B. Then assume the government increases C (or R) significantly at time t- 1. This will *This example shows that even if the parameters of the deterrence scheme become variables which respond to changes in the corruption level, it is still possible for the model economy to exhibit several stable equilibria. ‘This analysis is similar to the so-called ‘big-push’ theory in economic development [Nelson (1956)]. If the corruption in the economy is initially at a ‘high level equilibrium trap’, then it is necessary to make a ‘big push’ in order to restore it to the low level equilibrium.
F.7: Lui, Corruption
230
deterrence
B(t)
B( t-l)
Fig. 4
move point B to the left. If the policy is only temporary, then at time t, point B will come back to the original position. However, B(t- 1) has a small value, and if it is close enough to zero, B(t) can become very high. If it is higher than point C, it will converge to the high level equilibrium point E. The result occurs mainly because of the intertemporal substitution decision problem solved by the officials. At very low B(t - l), or equivalently very high p(t - l), they may perceive that the probability will be lower in the future. Therefore, it pays for them to refrain from accepting the bribes now and wait until next period. Moreover, since not many people are corrupt at t - 1, very few of them are punished. This means that more old officials at t are liable to become corrupt. 5. The history of corruption in a developing country In this section I present a case study of the history of corruption in China from the early 1950s to the mid-1980s. The choice of China is particularly appropriate for empirically illustrating the relationship between corruption and its deterrence. As argued in Lui (1985a, ch. l), corruption occurs more easily if there are lots of market distortions. The Chinese economy is far from being perfectly competitive, and corruption is likely to be widespread if there
F.T. Lui, Corruption deterrence
231
are no deterrence schemes. Another nice feature about the Chinese experience is that both the level of corruption and the severity of the deterrence schemes underwent large changes during the period. This permits us to learn more about the underlying relationship between the two. More specifically, I shall show three things. First, the Chinese government often resorted temporarily to severe crackdown policies. Second, the level of corruption in the economy could increase even when the government invested more resources in deterrence and penalties became more severe. Third, the basic assumption in this paper has strong empirical support. In other words, there is evidence that coalition formations among corrupt officials made it very difficult to audit them. During the revolutionary period before 1949, corruption, though not completely absent [Mao (1967)], was seldom associated with the Chinese Communist Party. However, after coming into power in 1949, the communist government was soon alarmed by a series of serious corruption incidents in the bureaucracy. An anti-corruption campaign was then called for by a highranking official in Northeast China in August 1951 [Jen-min Jib-pm (23 1951, this had already developed into a November, 1951)]. lo By December major national campaign called the sanfulz (three anti: anti-corruption, waste and bureaucratism), which was soon reinforced by a second campaign, the wufan (live anti: anti-bribery, tax evasion, stealing state property, cheating in workmanship and materials, stealing state economic intelligence). The campaigns were widely publicized and forcefully organized. In the heyday in early 1952, it was difficult to find an issue of the party organ, Jen-min Jihpao, not flooded with reports and documents on corruption. In city after city, mass rallies consisting of thousands of people were held for the public trials of corrupt officials, many of whom were sentenced to death [e.g. JMJP (2 February, 1952)]. Special people’s courts to deal with corruption were established [JMJP (25 March, 1952)]. Corruption acts were promulgated to serve as guidelines in deciding the penalties. People were mobilized to report corruption cases to the government [JMJP (5 January, 1952)]. The campaigns were officially ended in June 1952. To assess the effectiveness of the campaigns, we have to compare the pervasiveness of corruption before and after the campaigns. During the sun fun and wu fun, the Chinese government often stressed that the situation was serious [e.g. Hsin-ha Yueh-puo (January 1952, p. 15)].’ 1 The chief official of the campaigns estimated the total bribes accepted by officials in the central government (during the first two years of the regime) were sufficient to buy enough grain to feed 280,000 people for a year, and the total for the whole country could feed several million people [JMJP (2 February, 1952)]. ‘“Jen-min Jib-pm, or People’s Daily, will be abbreviated as JMJP. “Hsin-hua Yieh-pao, or New China Monthly, will be abbreviated as HHYP.
232
F.7: Lui, Corruption
deterrence
Although moderate by contemporary Chinese standards. these were large figures in the 1950s. However, after the campaigns, the corruption level went down significantly. Even the rate of crime, which included corruption, fell from 500,000 cases in 1950 to an average of 290,000 in the period from 1950 to 1965 [Washington Post (30 August, 1980, p. A24)]. During this time, corruption was so low that it was seldom mentioned again in the Chinese press. In fact, even nowadays the general attitude of the government towards the period from the early 1950s to the mid-1960s is that is was a golden age of honesty [e.g. JMJP (3 September, 1983)]. Thus, China at that time could impress a noted Western scholar and many South Asian intellectuals as ‘a strong disciplined state, one that is scrupulously honest by South Asian standards’ [Myrdal (1968, p. 938)]. In terms of reducing corruption, the campaigns were therefore a success. The above experience shows that heavy penalties,12 together with massive efforts in auditing, could effectively bring down the corruption level. Even more remarkably, the Chinese government did not spend any significant amount of resources for auditing within the next 30 years, but corruption remained low until the mid-1960s. Thus, a temporary crackdown policy apparently could have a long-lasting effect. This result is of course consistent with the multiple equilibria theory proposed earlier in this paper. While a harsh crackdown may bring corruption down to a low-level equilibrium, a sufficiently large relaxation in the deterrence scheme may also restore it back to a high-level equilibrium. Beginning in 1966, the Cultural Revolution broke out in China. An important design of the Revolution was to destroy the existing government machinery so that a new one could be created. Law and order were supposed to be detrimental to this end [e.g. JMJP (31 January, 1967)]. ‘Thoroughly smash the public security, procuracy and courts’ was a famous slogan of the time. In 1975, when the Cultural Revolution was near its end, the new constitution formally abolished the procuratorial organs and placed people’s courts under the control of the administrative organs at the same level [Chiu (1982)]. Evidently, this practice effectively reduced the probability of punishing a corrupt official who might himself be the decision-maker in the court. By the end of the 197Os, corruption again attracted nationwide attention. In 1979, the reporter Liu Bin-yan published a brilliant case study which showed in detail how the Party secretary of a local coal company, through various corrupt activities, was able to obtain for herself more than half a million yuan, a sum enough to pay the salary of a worker for 1,000 years [Liu (1979)]. A striking feature of the case was that the corrupt official was ‘*Penalties for corrupt A criminal who accepted gold, could be sentenced the yuan used in the early
criminals during sari Jan and wu Jan were severe by Western standards. 100 million yuan, which at that time could buy about 110 ounces of to death. See JMJP (2 February, 1952). Because of a currency reform, 1950s was not comparable in value to the yuan used today.
F.T. Lui, Corruption deterrence
233
well protected by other officials which made the investigation process extremely diflicult. Liu’s article received immediate concern from all over the country. In his words, this was because the details described in his article were pervasive and commonly known to people [Liu (1980)]. The seriousness of corruption soon led the State Council of the government to conclude that the problem had become much worse than that during the sun fun period [HHYP (April 1982, p. 27)]. In 1982, 164,ooO cases related to economic crimes, most of which were corruption, were registered, and about 30,000 people were convicted [HHYP (February 1983, p. 32)]. In value terms, the State Council reported that in the two years before the end of 1985 the amount related to economic crimes which had been discovered was 8.9 billion yuan (2.9 billion dollars) [Chung Pao (19 December, 1985)]. Although these figures indicate a situation unprecedented in contemporary Chinese history, they represent only the small officially investigated fraction of corruption cases. The large number of reports on the subject show that corruption has permeated into the everyday lives of people. For example, because of the low-rent policy, housing is in acute shortage in the cities. As a result, a main source of dissatisfaction towards the bureaucracy is that many officials have used their power to allocate houses for their own uses [HHYP (August 1982, p. 93)]. In international trade, it is well known among businessmen in Hong Kong that they often cannot get contracts signed unless bribes have been paid [Qishi Niundui (April 1982, pp. 15-19)]. Other examples of corruption include custom officials confiscating smuggled materials for themselves, exaggeration of budgets for engineering projects [Qishi Niundui (April 1982, pp. 13-15)], officials in grain stations stealing grain, and postal workers selling postal bags for personal profits [HHYP (July 1983, p. 42)]. In short, if an official has decision power in the allocation of a commodity, it is not surprising to find him making use of that power for his own benefit. The Chinese Communist Party long realized that corruption was detrimental to its image. After an important meeting of its Central Committee in 1978, the Party began to rebuild its disciplinary organs aimed at auditing and punishing its corrupt members [HHYP (February 1983, p. 24)]. Starting from February 1982, a major anti-corruption campaign was launched. Once again, as in the sun fun and wu fun, the news media were filled with publicity on the campaign. The Central Committee also announced that it would pay as much attention to the campaign as to the economic reform taking place at the same time [HHYP (April 1982, p. 26)]. However, there were two differences between this new campaign and the sun fan and wu fun. First, the 1982 campaign lasted for a much longer time. In 1983 it was integrated with a massive anti-crime campaign beginning at that year. In 1984 and 1985, the campaign had slowed down but not completely stopped. Then, in January 1986, 8,000 high-ranking officials were asked to attend a meeting aimed at
234
F.7: Lui, Corruption deterrence
putting greater efforts into the anti-corruption campaign [Jiushi Niundai (February 1986, pp. 39-42)]. Second, in the new campaign, formal laws played a more important role. China’s first Criminal and Criminal Procedure Codes were promulgated in 1979 and became effective in 1980. The penalty structure in the Criminal Code had been deliberately made very flexible so that two persons committing the same crime could be punished quite differently. An official justification for this was that the severity of the punishment should depend on the political situation of the time [JMJP (14 September, 1981)]. During the campaign, the general attitude was that criminals had to be punished to the limit of the severity described by the law. In addition, several laws were amended in August 1983 to make the penalties related to corruption more severe [JMJP (3 September, 1983)]. The ancient saying, ‘Heavy penalties have to be used in chaotic times’, was often quoted to rationalize this change. Some observations should be made here. The efforts put into the investigations of corrupt officials during the 1980s were definitely higher than those between 1952 and 1965, and penalties were at least as severe. However, corruption in the 1980s was much more serious than before. This fact is again consistent with the multiple equilibria result in this paper. Second, the corruption deterrence campaign beginning from 1982 was much less successful than the sun fan and wu fan, since even now there is no evidence for any significant reduction in corruption. A possible explanation lies in the difference in coalition formations among the corrupt oflicials in the two periods. As early as the sun fan and wufan there were reports that corrupt officials formed the so-called ‘offensive and defensive alliances’ when they faced the danger of being audited [e.g. JMJP (2 February, 1952)]. However, since the bureaucracy was relatively new at that time, it was unlikely that the coalition networks were very well organized. Three decades later, this situation had changed. In Liu’s (1979) report, he described how the investigation process had been made difficult because a team of officials were trying to help the audited corrupt official. In 1983, after encountering much difficulty in auditing corrupt officials, the Central Disciplinary Committee stated that many cases could not be pursued because they involved other higher ranking officials [JMJP (15 September, 1983)]. According to another report, in most cases officials in the leadership were involved. They generally provided protection for the lower ranking ones. If a leading official was audited, it was common for his corrupt subordinates to misguide the investigators, or sometimes, a minor official might even end up bearing all the responsibility [HHYP (February 1982, p. 39)]. In many instances, people who sent out confidential reports to uncover corruption cases could be revenged, because the report might be handed to the corrupt otfcial by other officials in coalition with him [HHYP (June 1982, p. 31)]. In short, coalitions among
F.7: Lui, Corruption deterrence
235
the corrupt officials had formed an effective barrier against auditing. Although the resources spent on auditing were large, the actual probability of success was low. Moreover, after the much longer time of learning how to organize the coalitions, the network seemed to be much more extensive and effective than before. A deterrence scheme that was successful in the past was not sufficient for the 1980s. One way to interpret this result is to assume that the parameters A and k defined in section 2 decrease, causing the curves in figs. 14 to shift upwards. Hence, the same deterrence scheme cannot bring corruption from a high to low equilibrium.
6. Concluding remarks I have developed an overlapping-generations model capable of explaining In addition to generating some standard various aspects of corruption. results on corruption, the model also provides simple dynamic interpretations of several phenomena that cannot readily be handled by static marginal analysis. A crucial assumption of the model is that it is more costly to audit officials when a greater proportion of them become corrupt. When corruption is prevalent, the deterrence scheme will be less effective, and hence the economy will remain highly corrupt. The reverse argument is also true. If most officials do not accept bribes, it will be easier to discover those who do. The corruption equilibrium will be lower. The possibility of having several equilibria has been exploited to explain large changes in the level of corruption. In particular, this explains why the same deterrence scheme can give rise to several levels of corruption with large differences. It also tells us why sometimes a government may temporarily adopt harsh policies so as to shift a high level equilibrium level to a lower one. The model suggests that an excessively lenient policy or temporary neglect of the problem of corruption by the government may have undesirable consequences. Once a high level equilibrium is attained, it is costly to bring it down. This paper contains not only a theoretical model of corruption deterrence, but also a case study to show that the model has empirical content. I have chosen contemporary China for the case study. This choice is appropriate for illustrating the relationship between &he level of corruption and its deterrence schemes because both have undergone several important changes in China. The experience there shows that there is evidence to support the basic assumption in this paper. The results of the model are also useful for interpreting the history of corruption in China. The model need not be confined to the study of corruption. With appropriate modifications, it is applicable to a wide range of criminal activities, as, for example, tax evasion. As long as the probability of being
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