The Persistence of Corruption: A Labor Market Approach Bonnie J. Palifka Presented at the 150-mile conference Edinburg, Texas April 22, 2006

Outline Introduction The Model Labor Market Implications Conclusions and Extensions

Introduction: Corruption and Growth Bribes are expensive. Corruption may introduce uncertainty. Both of these factors reduce investment, especially FDI. Many governments are now trying to combat corruption.

The Study of Corruption 1990s resurgence of institutional economics economies in transition development of corruption indices (Transparency International). Research: –Corruption and growth (Mauro, 1995) –Determinants of Corruption (Schleifer and Vishny, 1993; Bac, 1996)

The Persistence of Corruption Corruption is hard to combat: it persists. Approaches to the Persistence of Corruption: inherited reputation (Tirole, 1996) collusion between workers and supervisors (Bac, 1996) externalities (Andvig and Moene, 1990) Each of these models examines the decision to accept or reject a bribe once in a position to do so.

The Persistence of Corruption My model is one of labor supply: the choice between a position with the opportunity to receive bribes, and one without such “perqs”. separating equilibrium four progressively complex models self-sorting based on propensity to corruption –"honest" workers take the job without bribery opportunities –"corrupt" workers sort themselves into the "corrupt" job.

The Model The Agents Honest = H Corrupt = C The agents are identical in all other respects. The risk aversion or corruptibility of each is privately known but unobservable.

The Model Risk Aversion (proxy for propensity to corruption) To capture the disparity in risk aversion, I use the constant relative risk aversion (CRRA) utility function: if   0,   1 if  = 1 where v is the value of employment in a given position and  is a measure of aversion to risk.

The Model Risk Aversion For simplicity, I assume  H = 1  C = 0 (C is risk-neutral.) This can be generalized to a continuum of risk aversion.

The Model Employment options private sector job = J P government job = J G Wages are w P and w G, respectively. J G has monopoly control over the provision of a license, permit, or other government service.

The Model Case 1: the simplest case. Each period any worker in J G is offered and must accept a bribe of fixed amount b. If detected, the worker is fined X. The supervisor detects, charges, and fines one worker each period, so the probability of detection is q = 1/N.

The Model Case 1: the simplest case. a separating equilibrium exists if In other words, C chooses J G (and H does not) when the difference between the expected bribe and the expected punishment is larger than the wage gap (but not too much larger). High b Low q (high N) Low X

The Model Case 2: Bribe Offered with Fixed Probability Gives the same result, with the bribe subject to a probabilistic factor. The “acceptable” wage gap is lower than in Case 1. Case 3: Bribe Drawn from a Distribution Gives the same basic result, with uncertainty

The Model Case 4: Career Choice in the Face of Risk and Uncertainty basic lifecycle utility model with uncertainty concerning future wages and bribes

The Model Case 4: Career Choice in the Face of Risk and Uncertainty—Results 1.H prefers J P as w P -w G and b decrease and as the variances of w G and b increase. Therefore, if either the government wages or possible bribes become more uncertain, the honest agent will be less likely to want the government job. 2.C responds only to changes in the means of (expected) future wages and bribes.

The Model Case 4: Career Choice in the Face of Risk and Uncertainty—Results 3.in a multi-agent continuum of risk aversion, higher variances in government wages or bribes accruing to government positions will result in a higher proportion of such employees being "corrupt". Variances in wages might arise from perennial budget problems or change-of-regime phenomena, while variance in bribes could be caused by changing regulatory environments.

Labor Market Implications Equilibrium bribe and wages b (distribution) is determined in the market for "bent rules". (Palifka, 1997) If b , then a larger proportion of agents prefer J G and the supply of labor in the government sector increases, while that of the private sector decreases. w G  w P  (w P - w G )  but then fewer risk-averse workers will change sectors, ameliorating the wage-gap effect.

Regulations  Bribe Corruption  wG wG may Persistence of Corruption

Conclusions and Extensions Conclusions This paper presents an alternative explanation for the persistence of corruption in certain occupations: when a separating equilibrium exists, the opportunity for bribery attracts a disproportionate number of "corrupt" workers to “government” jobs, while "honest" workers avoid such jobs.

Conclusions and Extensions Conclusions When the corrupt job is in the government sector, regulations may raise the equilibrium bribe, attracting more risk-averse workers to that sector, depressing government wages and raising private sector wages, with the net effect of increasing the public-private wage gap that is often blamed for government officials turning to bribery in the first place.

Conclusions and Extensions Minor Extensions Detection distribution (Beenstock, 1979) Finite (known) length of employment Exogenous probability of termination (e.g., Carrillo, 1996) Corrupt hiring official Corrupt supervisor

Conclusions and Extensions Major Extensions General equilibrium, including demand for labor and the market for “bent rules”. Endogenous government regulations Endogenous anti-corruption enforcement (Dabla, 1997) Empirical testing with data

Thank you! Your comments are appreciated.