L3. Competition and Lobbying

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Anticorruption and the Design of Institutions
2008/09

Lecture 5 Competition and Lobbying
Prof. Dr. Johann Graf Lambsdorff
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Literature

• Lambsdorff, J. Graf (2007), The New
  Institutional Economics of Corruption and Reform
  Theory, Evidence and Policy. Cambridge University
  Press 109-135.
• Rose-Ackerman, S. (1999), Corruption and
  Government. Causes, Consequences and Reform,
  (Cambridge Cambridge University Press) 9-26.
• Shleifer, A. and R.W. Vishny (1993),
  Corruption. Quarterly Journal of Economics,
  Vol. 108 599617.

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Bureaucratic Competition

• One of the inspiring economic principles is that
  of competition.
• Competition is assumed to act like an invisible
  hand, allowing for public welfare to prosper in
  the absence of individuals social mindedness.
• Can competition also help fighting corruption
  and limiting the resulting welfare losses?
• Unfortunately, the answer is less
  straightforward.
• We will consecutively investigate competition
  among bureaucrats, politicians and private firms.

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Bureaucratic Competition

• Misusing ones office as a maximizing unit is
  particularly troublesome when bureaucrats are in
  a monopoly position.
• Competition between bureaucrats might drive down
  bribes and bring the outcome closer to the
  initial equilibrium.
• Departments could be given the right to issue
  licenses and permits also in areas that belong
  (geographically or functionally) to other
  departments. Their jurisdiction would overlap.
  This suggestion has thus been labeled
  overlapping jurisdiction.
• This solution appears attractive when
  bureaucrats extort payments in exchange for
  licenses and permits. Payments for extortion
  would be reduced to zero.

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Bureaucratic Competition

• But it fails in many other areas of the public
  sector
• In public procurement contracts can be awarded
  only once. There is a natural monopoly in the
  awarding of a contract and the principle is of no
  use.
• Whenever corruption involves also the defrauding
  of the state (e.g. tax collectors underreporting
  due taxes in exchange for a bribe), competition
  would ensure that the most fraudulent bureaucrats
  are preferred by customers.
• Whenever truthful inspection of application
  requirements is needed, competition would no
  longer ensure that the best qualified bureaucrats
  are selected by clients.
• Similar problems are observed with regulators
  and inspectors a race towards the lowest
  standards may arise.

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Bureaucratic Competition

• An approach of overlapping jurisdictions would
  effectively decrease bribes in areas where
  bureaucrats formerly extorted businesspeople.
• But the concept runs counter to other legitimate
  tasks of the bureaucracy such as tax collection,
  inspection and regulation.

Hints for Reform
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Political Competition

• Some economic models assume benevolence among
  policymakers. This assumption is sometimes
  overemphasized.
• Politicians may not be primarily motivated by
  productive efficiency or the public interest.
• How does competition affect the goals pursued by
  politicians?
• Competition for votes is commonly seen to reduce
  corruption.
• This effect is parallel to that of the invisible
  hand in private markets even self-seeking
  politicians must convince voters by effectively
  containing corruption among bureaucrats and among
  their own ranks.

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Political Competition

• Competition among politicians thus enables
  society to get rid of those performing poorly.
• Competition disciplines politicians fear for
  their office when losing votes.
• This effect becomes stronger if votes are
  pivotal for staying in office.
• A political leader who loses or wins anyways
  is little disciplined by elections.

vote
A politicians indifference curve
50
income
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Political Competition

• However, this effect can be undermined by
  various forces
• Promises to reduce corruption may not be
  credible.
• Crucial for sound competition is not the amount
  of political parties, because these might be
  founded ad hoc and may be unable to make credible
  commitments.
• Crucial is also whether political parties have a
  long-standing tradition that keeps them from
  disappointing their voters.
• The proceeds from corruption can be shared in
  exchange for political support. Honest
  politicians have fewer such resources at their
  disposal and fail to obtain support from
  influential actors.
• This represents another type of political
  corruption, not aimed at generating income for
  politicians but subverting the electoral process.

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Political Competition

• Another downside effect of competition relates to
  the subordinates (agents) of politicians (the
  principal).
• Agents may obtain bargaining power when they can
  choose between supporting different principals.
• Thus, competition may weaken politicians control
  over agents (e.g. departments, regulation
  authorities).
• In return for political support politicians may
  turn a blind eye to bribe-taking among lower
  levels in the public service.

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Political Competition
Parker and Hart,December 8, 2001
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Political Competition

• Empirical results from a cross-section of
  countries reveal that democracy and levels of
  corruption do not correlate well, once
  regressions are controlled for income.
• Only those democracies that are in place for
  decades exhibit systematically lower levels of
  corruption.
• Investigating non-linear influences is revealing.
  An ambiguous impact is obtained for countries
  scoring between 7 and 2 in the Freedom House
  index. Only the good score of 1 brings about
  decreased corruption.
• Higher participation in general election is
  important for containing corruption.
• Fighting corruption by introducing political
  freedom is possible, but it is a thorny road
  where in transition corruption may even increase.

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Political Competition

• Political competition can in the long run lower
  levels of corruption.
• Political parties and candidates must establish
  long-term oriented programs that can be
  identified by voters and must seek ways to commit
  to their announcements.
• Clear rules on party and election finance appear
  indispensable for democratic systems to reduce
  political corruption.

Hints for Reform
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Competitive Lobbying

• Public servants have ample opportunities to sell
  preferential treatment to private parties. They
  can protect firms by hindering competition
  impose import quotas or tariffs grant tax
  privileges give subsidies award profitable
  contracts privatize industries.
• These activities are valuable to private parties.
  We call the associated value rent a surplus
  the accrues to a firm beyond what the firm would
  obtain otherwise.
• Once rents are created private firms attempt to
  get hold of this favor. They compete with the
  help of lobbying and corruption.
• This type of rent-seeking differs from (normal
  microeconomic) profit-seeking where investments
  into production bring about profit only if
  someone else is better off buying a superior
  product.

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Competitive Lobbying

• Wizard of ID, Parker and Hart, March 9, 2000

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Competitive Lobbying
Supply Marginal Costs
Rent
Marginal Revenue
Demand
0
Quantity
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Competitive Lobbying
Only one out of n firms can win the competition
for a monopolistic position created by the state,
worth an exogenously given value R. The
probability for winning the competition (pi) is
proportional to a firm's investments into
rent-seeking (xi). A single firms' probability
decreases with the investments undertaken by its
competitors (xj). Expenses for rent-seeking have
no value to any of the firms or the state.
, i, j 1, ..., n Firms are
risk-neutral, face identical (profit and
probability) functions and are unable to
influence their competitors' level of
rent-seeking xj. They maximize the expected
profit, E(piR-xi).
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Competitive Lobbying
The first order condition is
Introducing symmetry, xixjx. This brings about
the Cournot-Nash-equilibrium
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Competitive Lobbying
In the case of two players, the first order
condition simplifies and the following reaction
function is obtained
Symmetry (xixjx) brings about
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Competitive Lobbying
Figure 1 Rent-seeking with two players
xj
xixi(xj)
R/4
xjxj(xi)
xi
0
R/4
R
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Competitive Lobbying
x
R/4
Total expenses (S) for rent-seeking then sum up
to
S
R
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Competitive Lobbying

• What are the consequences for welfare?
• The creation of rents not only distorts private
  markets, leading to inefficient outcomes (for
  example due to monopolistic dominance).
• There are additional costs because firms pay for
  bribes and lobbying. They devote resources
  without creating a social surplus.
• Waste only arises in case of competition.
• Waste increases with the number of competitors.
• In case of lacking competition the monopolist can
  be sure to obtain the rent and will not expend
  resources for lobbying.

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Competitive Lobbying

• If you two behave like this while sharing every
  item, I'm going to unilaterally decide which
  state should have what!
• Laxman,
• Times of India,
• December 7, 2000

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Competitive Lobbying

• Corruption versus lobbying what is the
  difference?
• Public decisions are for sale in both cases, but
• As opposed to lobbying, corruption is
  intransparent and entails little competition.
• Politicians profit from corrupt payments (bribes)
  but not from lobbying, which may entail
  harassment instead.
• Lobbyists represent broader interests while
  corruptors represent only their own interest.
• The conclusion by rent-seeking theory is most
  unusual Corruption is better than lobbying
  because it entails little competition and
  resources are not wasted but merely transferred
  to politicians.

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Competitive Lobbying

• One key shortcoming of the model Rent-seeking
  theory provides no adequate description for the
  causes of policy distortions and the creation of
  rents.
• Rent-seeking theory fails to observe that
  corruption can cause the creation of rents.
• Politicians will weight the welfare losses of the
  rent R against political benefits from imposing
  the relevant market restrictions.
• Thus, is competition really bad?
• Not necessarily when the size of rents is itself
  a function of rent-seeking expenses.
• Public servants will create rents (R) when they
  are induced to do so primarily by bribes.

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Competitive Lobbying

• The positive impact of rent-seeking expenses (S)
  on the rent (R) will be felt more when few
  competitors exist. For competing firms the
  overall size of the rent is a public good which
  they will hardly lobby for.
• For a monopolist the total rent is not a public
  good but his own private good. A monopolist may
  thus be willing to devote resources to
  rent-seeking activities.
• As opposed to lobbying, corruption is more
  forceful in motivating distorting rents.
• Lobbying is more transparent and includes broader
  segments of society. It can represent a form of
  participation where not narrow defined interests
  are exchanged but responsibility for broader
  interests emerges.
• Lobbying should be preferred.

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Competitive Lobbying

• Lobbyists can be turned into partners in the
  fight against corruption.
• Once transparent rules and codes of conduct for
  lobbyists are passed, these may be helpful in
  disciplining their members.
• They can help in ordering communication between
  business and politics.
• Hindering lobbyism may backfire.

Hints for Reform
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Competitive Lobbying

• Lobbies face organizational difficulties they
  strive to obtain a rent for a whole sector, even
  if the individual firms do not contribute to the
  functioning of the lobby.
• Members face a prisoners dilemma, which may
  hinder the foundation and functioning of a lobby.
  
• Is this good or bad?
• Some researchers argue that this is good, because
  lobbies intervene in otherwise undistorted
  decisions.
• I would argue that it is bad, because lobbies
  balance the various interests of their members to
  form broader interest that are pursued
  transparently only those striving for narrow
  interests will survive if lobbies are hindered.

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Competitive Lobbying

• Independent courts and Presidents with veto power
  restrict the parliaments capacity to sell
  laws.
• Courts have discretionary power in interpreting
  law courts check the consistency of laws against
  older legislation and the constitution, setting
  preferences in case of conflict courts have the
  power to reject the enforcement of new laws.
• In case of a veto power, two parties must be paid
  for passing favorable laws.
• Both institutions introduce continuity in the
  otherwise unbound and potentially arbitrary laws
  enacted by parliament.
• Are veto powers helpful in containing corruption?

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Competitive Lobbying

• Some would argue that this is bad, because the
  value of rents increases. Laws, once passed,
  assign long-term income streams to those who were
  able to influence legislation in their favor. The
  judiciary helps to enforce the 'deals' made by
  effective interest groups with earlier
  legislatures.
• I would argue, instead, that this is good. Laws
  that are valid over a longer period will be
  fought for by larger lobbies which promote
  broader interests. Quickly changing laws and ad
  hoc decisions are lobbied for by those striving
  for narrow interests.
• Still, the overall judgment on the usefulness of
  veto powers is more complex, in particular,
  because there might be intransparent collusion
  among veto powers.

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Appendix
Discussions1) What is the concept of
overlapping jurisdictions? Where may it help in
reducing corruption, where not? 2) Does
competition for political positions increase or
decrease corruption? Explain the diverging
positions!3) What is rent-seeking as opposed to
profit-seeking?4) What determines the extent of
waste?5) Why is competition regarded to be
harmful by rent-seeking theory?6) Why is
competition for rents not as bad as suggested by
rent-seeking theory?7) What are the pros and
cons of independent courts and political veto
powers?
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Appendix
Exercise Three firms compete for a monopoly
license for gambling. The total rent is US 180
Mio. a) One firm assumes that its competitors
will spend US 10 Mio. for bribes and lobbying
each. Determine its optimum probability to win
the contest, assuming that its probability to win
the contest is proportional its own rent-seeking
expenses, divided by all firms expenses!b) If
all firms expect their competitors to optimize
their rent-seeking expenses (Cournot-Nash
solution), how much will each spend for this
purpose? c) Rent-Seeking theory concludes total
rent-seeking expenses increase with the number of
firms. What is the economic reason for this
conclusion? d) Why may this relationship not
arise in reality?