Three essays on political corruption and common agency

(1)

Three essays on political corruption

and common agency

Thèse Octavian Strîmbu Doctorat en Économique Philosophiæ doctor (Ph.D.) Québec, Canada © Octavian Strîmbu, 2013

(2)

(3)

Résumé

Ma thèse se compose de trois articles. Les deux premiers ont pour ambition d’apporter une contribution à la littérature de la microéconomie de la corruption. Le dernier article aborde le problème de la provision de biens publics depuis un angle inédit, qui pose le bien public comme un bien de confiance.

Le premier article de ma thèse s’intitule «La corruption bureaucratique et la corruption politique ne sont pas l’endroit et l’envers d’une même pièce». Il s’agit non seulement d’offrir une revue de littérature à jour sur le thème de la microéconomie de la corruption, mais aussi de rappeler l’urgence d’établir une distinction claire entre les corruptions bureaucratique et politique dans la science économique. La ligne de démarcation entre ces deux phénomènes étant jusqu’à présent restée floue, les avancées réalisées dans la modélisation de la corruption bureaucratique en recourant au modèle principalagent -ont paradoxalement conduit à un vide de la littérature pour ce qui est de la formalisation de la corruption politique.

Néanmoins, deux branches de l’économie politique se concentrent sur les rentes et les transferts monétaires associés à la corruption politique. Je défends l’idée que les rentes proposées dans les modèles d’agence politique s’apparentent davantage à des détourne-ments de fonds publics qu’à de véritables pots de vin politiques. De plus, les transferts monétaires présentés dans la littérature de la représentation d’intérêts (lobbying) ne correspondent pas non plus exactement à la définition du pot de vin, ce qui ne manque pas d’alimenter la confusion entre lobbying et corruption politique.

Dans le second article intitulé «Quand les politiciens prennent des décisions inefficaces. Un modèle d’agence commune appliqué à la corruption politique», je propose un modèle d’agence commune simple, dans lequel deux principaux (groupes d’intérêts) tentent d’influencer la décision d’un agent (politicien). La nouveauté théorique de ce modèle réside dans l’introduction d’un écart d’information entre les principaux: tandis que le premier groupe d’intérêts est toujours en mesure d’observer l’action posée par le

(4)

politicien, le second doit faire confiance à un organe de surveillance imparfait pour faire la lumière sur le choix effectif de ce dernier. Dans ce contexte, le politicien a la possibilité d’opter pour une action inefficace, pour laquelle il accepte des transferts monétaires privés (pots de vin politiques) du groupe d’intérêt disposant de plus d’information. Mon principal résultat est que l’augmentation du degré de transparence (soit la réduction de l’écart d’information entre principaux) aboutit à faire monter les pots de vin attendus. Cela ne signifie pas pour autant qu’une transparence accrue soit une mauvaise politique. En fait, en augmentant la transparence, on améliore le bien-être attendu. L’article propose un second résultat ayant trait à l’inefficacité des salaires fixes des politiciens comme outil de lutte contre la corruption.

«La provision de biens publics de confiance selon l’agence commune», le troisième et dernier article de ma thèse, montre que dans un modèle d’agence commune utilisant des biens publics de confiance, même le moindre degré d’asymétrie d’information est sus-ceptible de conduire à l’inefficacité. Le bien public est une forme de bien de confiance, étant donné que chaque principal observe avec une certaine probabilité (au moins) un de ses attributs. Ainsi, les principaux ne sont pas nécessairement en mesure de distin-guer un projet public d’un autre, et ils n’ont pas d’autre choix que de faire confiance à la parole de l’agent au moment de faire leurs contributions. Au-delà de l’inefficacité résultante, je décris le comportement des principaux vis-à-vis de leurs contributions. Le fait d’avoir accès à davantage d’information (soit le fait de pouvoir distinguer adé-quatement plus souvent les projets publics les uns des autres) peut, au final, amener les principaux à contribuer moins. Enfin, je dérive la probabilité de choisir le projet ineffi-cace. Et comme cette probabilité mesure le bien-être attendu, je conclus sur quelques considérations politiques liées à l’accès des principaux à l’information.

(5)

Abstract

My thesis is composed of three articles. The first two articles aim to bring a contribution to the microeconomics of corruption literature. The last one deals with the problem of public good provision from a new perspective: the public good is also a credence good. The first paper of my thesis is called “Bureaucratic and political corruption, the same side of two different coins”. It is not only an up-to-date review of the microeconomics of corruption literature, but also a caveat that a clear distinction between political and bureaucratic corruption is direly needed in economics. Because the line separating bu-reaucratic and political corruption has been fuzzy, the success in modeling bubu-reaucratic corruption - by employing the principal-agent framework - has paradoxically left a gap in the formalization of political corruption.

Nevertheless, two branches of political economy focus on rents or monetary transfers associated with political corruption. I argue that the rents proposed by the political agency models resemble rather the embezzlement of public funds than actual political bribes. Moreover, the monetary transfers proposed by the lobbying literature don’t fully fit the definition of political bribes, generating confusion between lobbying and political corruption.

In the second paper entitled “When politicians make inefficient decisions. A common agency model of political corruption” I present a simple common agency model in which two principals (interest groups) try to influence the decision of an agent (politician). The theoretical novelty of the model is the presence of an information gap between principals: while one interest group always observes the action implemented by the politician, the other has to rely on an imperfect court to investigate the politician’s actual choice. In this context the politician may choose an inefficient action by ac-cepting private monetary transfers (political bribes) from the better informed interest group. My main result is that an increase in transparency (i.e. the information gap between principals diminishes) will rise the expected bribes. This doesn’t mean that

(6)

increasing transparency is a bad policy. In fact, increasing transparency improves the expected welfare. A second result concerns the ineffectiveness of politicians’ flat salaries in fighting corruption.

“The provision of credence public goods under common agency”, the third paper of my thesis, shows that in a common agency model featuring credence public goods even the smallest degree of information asymmetry may lead to an inefficient outcome. The public good is also a credence good as each principal observes only with some probability (at least) one of its attributes. Therefore, the principals may not distinguish a public project from another and they have to trust the agent’s word when making contributions. Besides this inefficiency result, I characterize the principals’ contributing behavior. Getting access to more information (telling the difference between the public projects more often) may, surprisingly, bring the principals to contribute less. Finally, I derive the probability of choosing the inefficient project. And since it measures the expected welfare, I reach some policy considerations regarding the principals’ access to information.

(7)

Remerciements

to Marion Cassen, mon grand amour;

to my grandmother for always reminding me that simple and outstanding are not contradictory;

to my mother and my sister for teaching me resilience; to Patrick González for trusting my research skills;

to Kevin Moran, probably the nicest macro-economist ever; to all my friends, you have always been my second family; to everyone in the U. L. Economics Department.

(12)

(13)

Avant-propos

Je suis l’auteur unique des trois articles qui composent cette thèse. Une version du deuxième article, réécrite avec Patrick González et intitulée «Est-ce que la transparence réduit la corruption politique ?», sera envoyée sous peu pour publication.

(14)

(15)

Introduction

Corruption involves monetary transfers, embezzlements of funds, rigged contracting, distorted prices and incentives, impacts on welfare and growth, so it is little wonder that microeconomists feel comfortable tackling this phenomenon and that the microe-conomics of corruption has been a very active field for the last decades. But scrutinizing the microeconomic models of corruption will reveal that they mainly deal with the bu-reaucratic - or petty - corruption and that political corruption is somehow overlooked. Starting with this observation, the goal of the first chapter of this thesis is to review the core of the microeconomics of corruption literature and to explain why there has always been a bias against political corruption. To this end, the minimal characteristics of a political corruption setting are set out as follows:

• there must be a strategic interaction between at least two interest groups and a politician;

• there must be a hidden monetary transfer between one interest group and the politician, a transfer that influences some policy; and

• the interaction between the corruptor and the politician must bring about a sig-nificant change in social welfare.

After reviewing the literature, my main remark is that the principal-supervisor-agent models (the bulk of this literature) are far from satisfying these requirement and this is why they should only be considered as bureaucratic corruption models. Furthermore, some political economy models - the political agency and the common agency models applied to lobbying - may come close to a political corruption setting, but I argue that they fail at least one of the above mentioned requirements.

Minding this situation, in the second chapter I propose a common agency model that, I believe, captures an important part of the complex phenomenon of political corruption.

(16)

In my model, two interest groups try to influence a politician. The fact that one interest group is “closer” to the politician is formalized by postulating an information gap between the interest groups. That is, one interest group observes the action taken by the politician only from time to time. In equilibrium, if the information gap is small enough, the politician chooses an efficient action. But if the gap is big enough, the politician may choose an inefficient action and accept hidden monetary transfers from the better informed interest group. I identify this scenario as political corruption. The surprise result is that an increase in transparency (a smaller information gap) will increase the expected political bribery. However, it will also increase the expected welfare. The model can also be used to show that a rise in the politician’s flat salary will increase the occurrence of political corruption.

In the third and final chapter, I employ a common agency with a slightly richer in-formation structure to show how the credence attribute of a public good influences its provision. The information structure of the model is richer in the sense that both principals may fail to observe some attribute(s) of a public good. In other words, the principals may fail to tell the difference between two public projects provided by the agent. The first finding is that this type of information asymmetry brings about inef-ficiency: in equilibrium the provider (agent) chooses the inefficient project with some probability. The principals’ contributing behavior is interesting as well. Even if they are better informed, in equilibrium, the principals are likely to contribute less. Ulti-mately, does the principals’ access to information improve welfare? In general, it does. But if the principal who tries to impose the efficient project is ill-informed, improving the other principal’s access to information proves to be a flawed policy.

(17)

Chapter 1 Bureaucratic and political corruption,

the same side of two different coins. A

critical perspective on the

microeconomics of corruption

literature

(18)

1.1 Introduction

The term “corruption” covers a $100 bribe paid to a customs officer by tourists who want to smuggle a few cigars as well as a $1 million bribe that a foreign trade minister receives for granting a monopoly position over tobacco imports. To draw a line between these sorts of extremes, the media, various institutions and the scientific literature often make a distinction between bureaucratic and political corruption.

The bureaucratic versus political corruption dichotomy is commonly based on the hi-erarchical position of the public servant committing a corrupt act. This is why they are also called “petty” and “grand” corruption: bureaucratic corruption is associated with low-level public servants, while political corruption points out towards high-level government officials.

If we regard corruption from an economic perspective, a corrupt act should be “small” or “big” depending on its impact on social welfare. Since a corrupt deal occurring at a higher level of public administration usually bears a higher impact on the social welfare, the above denominations make economic sense as well.

One goal of this paper is to review some important contributions to the microeconomics of corruption literature.1 _{Its central aim, though, is to show that the formalization of}

bureaucratic and political corruption developed unevenly. While much attention has been given to bureaucratic corruption, the formalization of political corruption lags behind even if its economic implications are arguably deeper. There are three major reasons that explain this state of the microeconomics of corruption literature:

1. the advances in principal-agent (contract) theory privileged the development of models that fit mostly bureaucratic corruption.

2. the political agency models often capture some forms of rent-seeking specific to political life. However, I will show that these rent-seeking activities resemble the embezzlement of public funds rather than actual political corruption.

3. a confusion between lobbying and political corruption persists within the interest group literature. Complete information and adverse selection common agency models have successfully been employed to formalize lobbying. Still, some authors

1_{For further references please see Bardhan (1997), a classic review of literature on the economics} of corruption. For a more recent review of literature on the microeconomics on corruption see Aidt (2003) or Jacquemet (2006). There are also two excellent and recent collections of articles on the economics of corruption: Mishra (2005) and Rose-Ackerman (2006).

(19)

suggest that these models could also apply to political bribery. I will argue that this is not the case and that the common agency models have to be adapted in order to accommodate political corruption.

I will structure this review around the above points. In Section 2 I present two classic articles of the microeconomics of corruption literature: Becker and Stigler (1974) and Shleifer and Vishny (1993). The reader may notice that simple models can bring pow-erful results. On the other hand, the restrictive hypotheses of these classics have left the door opened for asymmetric information models to explain further the corruption phenomenon. In Section 3 I describe the two major types of asymmetric information models usually associated with corruption. In the first type I include all the models which use a principal-supervisor-agent hierarchy and formalize corruption as a collu-sion between the supervisor and the agent. The second type is the political agency model. Section 4 covers the common agency models. In the last part of this section I try to predict where the microeconomics of corruption should head to in order to achieve a better understanding of this phenomenon and its consequences. Section 5 is a conclusion.

The definition of bureaucratic and political corruption

Since the time of the Greek philosophers, to the contemporary international institutions, a lot of scholars and a few sciences have contemplated corruption. Because we are dealing with a complex phenomena and even the meaning of the term “corruption” has changed over time, I begin by clarifying this concept and giving a definition of corruption in general and of political corruption in particular.

Even if the debate for a definition of corruption is still ongoing2_{, somehow the economists}

have reached a partial agreement: corruption is “an abuse of public office for private gain”. I will use this broad definition throughout this paper.

But what is the difference between bureaucratic and political corruption? For Trans-parency International (2004) political corruption is “the abuse of entrusted power by political leaders for private gain”. As I have already mentioned, from this perspective the only difference between bureaucratic and political corruption is that the latter in-volves high-level politicians while the former is perpetrated by low-level public officials.

(20)

To be more precise and, what is essential for this review, to be able to formally dis-tinguish bureaucratic corruption models from political corruption models, I employ a definition of political corruption proposed in Besley (2006). The author defines political corruption as “a situation where a monetary payment - a bribe - is paid to the policy maker to influence the policy outcome”.

In a microeconomics of corruption literature dominated by contract theory, this defi-nition of political corruption is very helpful because it closely relates to the principal-agent model. According to the definition, what should set apart a political corruption model from bureaucratic corruption or simply embezzlement models is the presence of transfers (bribes) from the principal (a special interest, for example) to the agent (a politician). Moreover, these transfers should be contingent on the agent’s choice over a policy. I will use Besley (2006)’s definition of political corruption especially in Section 3.

As helpful as they are, the above definitions leave three aspects of bureaucratic and political corruption aside:

1. concerning the latter definition of political corruption, one may ask who has an interest in the policy outcome? In other words, whose welfare is altered by the policy? Almost any decision of a politician affects the welfare of more than one interest group.3 _{This is why, with the politician acting as agent, a realistic}

political corruption formalization must build on a multiprincipal model.

2. the bureaucratic and political bribes are transfers of a hidden, private nature (contrary to legitimate wages or political contributions, for example). There are two reasons why these transfers are hidden. First, bribes are simply illegal. The second and deeper reason is that when bribes are discovered, certain actions or traits of the corrupt public official are also revealed and he usually prefers to conceal them form the rest of the society. We will see later, for example, that in the case of bureaucratic corruption, a public servant accepts bribes when he chooses not to report an offence (pollution, tax evasion, etc). If the offence is hidden, the bribe must be a hidden, private payment as well.

3. the level of the corrupt public official is not the only difference between bureau-cratic and political corruption. A second important difference is unfortunately

3_{For instance, a selling permit given by a health minister to a drug company will affect the profit} of the seller but also the welfare of the consumer. See the F.D.A.’s generic drug scandal in the United States.

(21)

leveled by the utilization of the term “abuse”. For the economists, an abuse indi-cates a harmful economic effect, so a decrease in social welfare. Nevertheless, it has long been documented that bureaucratic corruption may be efficient.4 _And

even if it brings inefficiency, the economic effect of a single bureaucratic corrupt act should be relatively small.

In contrast, by the nature of his position, a high-level politician makes decisions that have a significant impact on social welfare. Thus, as a subversive mean to influence the politicians’ decisions, the political corruption has to be seen as a major abuse5 and its microeconomic formalization must feature an important

loss of welfare.

With an emphasis on political corruption, I will discuss again this characteristics in Section 4.

1.2 The beginning of the microeconomics of

corruption literature

Becker (1968) and Becker and Stigler (1974) are two path-breaking articles for the economics of crime in general and for the economics of corruption in particular. While in both articles the authors use economic modeling to answer questions concerning the law enforcement, Becker and Stigler (1974) will eventually have the bigger influence on the microeconomics of corruption literature. The first important point of Becker and Stigler (1974) is that choosing to accept bribery over effective law enforcement is not a moral matter but an economic one.

The Becker and Stigler (1974) model is a simple choice under uncertainty model.6

Consider that a public employee that is supposed to enforce a law may choose between accepting a bribe or refusing it. In case he refuses the bribe he gains a wage W . In case he accepts the bribe, let π be the probability he is caught and dismissed. Being dismissed he gains a reservation wage W0. With a probability (1 − π) the public

employee is not caught taking the bribe and gains a bribe b plus his wage W .

4_{On efficient corruption see Aidt (2003), for example.}

5_{See Robin (2010) for example on the rBGH scandal in Canada. Or Blasi, Kroumova, and Kruse} (1997) on the loans-for-shares scheme in Russia.

(22)

In other words our employee has to choose between a certain wage W and a lottery that gives him W0 with a probability π and (b + W ) with a probability (1 − π). Because the

employee is risk neutral, his expected utility of the lottery is π · W0+ (1 − π) · (b + W ).

Hence, one has to pay the employee a wage W ≥ W0+

(1 − π)

π b in order to make him refuse the bribe and avoid corruption. Not surprisingly, the corruption-free wage is increasing in the reservation wage W0 and the bribery b and decreasing in π.

This is the second important point of Becker and Stigler (1974): to keep a public employee honest one has to pay him a wage that is directly proportional to the potential bribes he might accept and to the wage he might get working in another sector. In the same time his wage has to be inversely proportional to the probability of being caught. One hypothesis of the above model is that the probability π and the bribe b are ex-ogenous. As the asymmetric information modeling took over the microeconomics of corruption in the 1990s, this hypothesis has been changed. Still, Becker and Stigler (1974)’s idea of (what later would be called) an efficiency wage that deters corruption had dominated the microeconomics of corruption literature ever since.7

But what is usually missing from the microeconomic analyses of corruption is the reverse side of Becker and Stigler (1974)’s story. There is no secret that wages in the public sector have implicit upper bounds. Given these bounds, if the government and the justice system will not succeed in making the public employees believe that there is a strictly positive and high enough probability of being caught and punished, they will always take a chance and choose bribery. Furthermore, marginally rasing wages in the public sector is likely to yield little or no results in fighting corruption.

A second classic of the microeconomics of corruption literature is Shleifer and Vishny (1993). There is hardly any article in this research field during the last eighteen years that do not cite this paper. There are two reasons for this success.

In the first place, the authors argue that the decentralization of the public administra-tion may bring a rise in bribe level. This statement probably surprised many. In the same time it reflected very well the new realities from the former communist countries, for example.

In the second place, Shleifer and Vishny (1993) has been successful because the models

7_{This idea has not only had theoretical implications. In many countries and for many institutions,} rasing wages in the public sector has been seen for years as the miracle strategy for anti-corruption agendas.

(23)

proposed in the article are simple. Two text-book models are employed to explain the behavior of corrupt public employees: the monopoly and the multiproduct monopoly. Even if one may find these models in any industrial organization text-book, I will briefly show how they are applied to corruption.

Consider that the government is the only provider of a private good (for example passports or permits). A public employee is supposed to sell this good at a fixed price pgov.Because there is no supervision from his superiors, the public employee decides by

himself the market price and how many units are sold. Let p be the market price. There are two cases. If the public employee declares his activity, he will act as a monopoly that has to cover a marginal cost of pgov. He will pay to the public budget

pgov for every unit sold and his bribe per unit is (p−pgov). The authors call it corruption

without theft.

It is easy to see that if the public employee succeed to hide all his activity, his marginal cost is zero, he will pay nothing to the public budget and his bribe per unit is p. This is the corruption with theft.

This straightforward application of the monopoly model already brings an important result: the provision of private goods by a government at fixed prices may be a bad idea. If the public employee actually selling the good is not supervised, he will embezzle the difference between the market price and the fixed price or even the entire market price.

Consider now that the government has the monopoly power over two private goods. These goods are complements. If the public administration is decentralized, the public employees actually selling these goods act separately. Because each of them acts as a separate monopoly and maximizes his individual amount of bribes, they hurt each other. When one sets his price, he does not internalize the effect of his price on the demand of the other good.

In contrast, if the administration is centralized, the employees coordinate. In order to maximize the total amount of bribes they set the prices at a lower level than in the separate monopolies scenario. Hence, the level of bribe per unit is lower and the total amount of bribes higher when the administration is centralized.

This is not a final result, though. In corrupt administrations artificial complementarity may be created. If in the multiproduct monopoly model an additional good that is

(24)

a complement to existing ones is sold by the government, the total amount of bribes increases.

In conclusion, in a decentralized administration that allows entries of new corrupt employees, the bribes per unit and the total amount of bribes may be higher than in a well organized centralized administration.

I argued that the success of Shleifer and Vishny (1993) is partially due to simplicity. Using simple models turned out to be a strength of the analysis, but one hypothesis of the above model is particularly prone to criticism: the government has only one hierarchical level. Our corrupt public employee could be an independent governmental agency or the government itself.

This particular hypothesis left the door open for an asymmetric information approach to the corruption problem. In the next section I will present the asymmetric infor-mation models that have brought an important contribution to the microeconomics of corruption literature.

1.3 Corruption and information asymmetry

The first microeconomic models that addressed corruption and which had an important impact were fairly simple. Two hypotheses of these models were particularly restrictive. When modeling the behavior of corrupt public employees, Becker and Stigler (1974) assumes that the bribes and the probability of being caught are exogenous. Moreover, Shleifer and Vishny (1993) assumes a minimal, one-tier government.

During the 1990s a number of moral hazard and adverse selection models were proposed in order to bring a higher degree of sophistication to the microeconomic research on corruption. These models tried to tackle different aspects of corruption but they all took advantage of the fact that the theoretical base for an asymmetric information approach to corruption had already been set in a remarkable article: Tirole (1986). The novelty of Tirole (1986) is that the author adds a supervisor to the classic principal-agent hierarchy. Hereafter, I will refer to the type of model advocated by Tirole (1986) as the principal-supervisor-agent (P-S-A) model.

In parallel with the development of the P-S-A models, the political economy research has proposed the celebrated political agency model in order to explain the behavior of politicians facing elections. Pioneered by Barro (1973) and Ferejohn (1986), the

(25)

political agency is also a principal-agent model. Its particularity is that the principal’s only possibility to discipline the agent is voting.

1.3.1 The P-S-A models of bureaucratic corruption

In Tirole (1986) a principal has the authority over an organization. His utility function depends on a variable q. The principal delegates the choice of q to the agent. The variable q is observable and verifiable, and may be a production level, for instance. By choosing q the agent maximizes his own utility which depends on a second variable θ. The variable θ is the agent’s type and it may be a marginal cost, for example.

The roles of the principal and of the agent are the same as in a typical adverse selection model.8 _{What changes is the presence of a supervisor that brings a different information}

structure. Let θ ∈ {θ, θ} where 0 < θ < θ and θ is the “bad” type or low productivity type and θ the “good” type or the high productivity type. The agent always observes his type. The supervisor receive a signal s ∈ {θ, φ}. If s = θ the supervisor learns the agent’s type and if s = φ the supervisor observes nothing. Let s = θ with a probability π and s = φ with a probability 1 − π. The probability π is exogenous. The principal is the least informed, he does not observe the state of nature.

I will not detail the contract theory elements of this model but the principal’s problem is to design a payment scheme (contract) that will determine the agent to reveal his type and the supervisor to report his true signal. This problem is not trivial because besides the classic participation and incentive constraints there is another issue. In the state of the nature where θ = θ and s = θ the agent and the supervisor may collude: the agent pretends that he is a type θ and the supervisor reports that he observes θ or nothing. By colluding, the agent uses a part of his information rent to bribe the supervisor, and in consequence the supervisor will lie in his report.

Tirole (1986) puts forward a pure theoretical model. The goal is to design an efficient contract that avoids the collusion between the agent and the supervisor. Hence, there is no bribery going on in equilibrium.

Despite the fact that Tirole (1986) does not focus on corruption, its principal-supervisor-agent hierarchy and the main idea underlying its information structure were inherited by the most important asymmetric information models other than political agency -that try to answer the corruption problem.

8_{In fact Tirole (1986) presents a "false moral hazard" model. Given the goal of this paper, I outline} a simplified version.

(26)

One of the most achieved P-S-A models is Mookherjee and Png (1995). In this article the authors study the “old” law enforcement problem but within an upgraded three-tier hierarchy. Here the principal is the government, the supervisor is an inspector hired by the government and the agent is a factory that pollutes. By law, there is a fine on pollution and the government must enforce the law.

The information structure is slightly different from Tirole (1986). The factory chooses over a quantity of pollution q.9 _{Only the factory knows the level of pollution in all the}

states of the world.

The inspector receives a signal s ∈ {q, φ} about the pollution level. If s = q the inspector observes the factory’s pollution level and if s = φ the inspector observes nothing. Let π be the probability that s = q. The inspector may exert a costly effort in order to increase his chances of learning the level of pollution, so π is endogenous. When the inspector receives s = q, he faces a second choice: to report or not the level of q.

The government has no information on q but he may use an payment scheme (contract) composed of three instruments to influence the factory’s and the inspector’s decisions. The inspector may be rewarded proportionally to his report on q. Also, the government may punish the inspector and the factory if the inspector is caught underreporting and accepting bribes from the factory.

As in Tirole (1986), the corruption in this model is about hiding information. If the government misuses his instruments (for example does not punish enough the supervisor for taking bribes), the inspector and the factory will collude and split the gain from underreporting the level of pollution. In other words, to avoid the fine for polluting, the factory has the interest to hide the true level of pollution; and if the government gives them wrong incentives, the factory will bribe the inspector to keep his information for himself.

One goal of Mookherjee and Png (1995) is to find out how - as long as corruption occurs - a small change in government’s payment scheme will affect the corruption rate, the expected bribe and the level of pollution. For example, a small increase of the penalty on the inspector for accepting bribes will lower the corruption rate, but the effects on the expected bribe and pollution are ambiguous.

A second important result is that for every payment scheme that entails corruption,

(27)

there is another payment scheme that avoids corruption and that improves the social welfare. Thus, for a discrete change in the government’s payment scheme, one recognizes here the "efficiency wage" argument.

Besides the law enforcement, the P-S-A model was employed to answer other long-standing questions related to corruption. For example, Laffont and N’Guessan (1999) attempts to determine the effect of competition on corruption. Besley and McLaren (1993) sets up a model of corrupt tax administration. Acemoglu and Verdier (2000) shows how the government intervention intended to correct market failures may be undermined by corrupt public servants.

Even if the P-S-A model is very popular in the microeconomics of corruption literature, two of its characteristics are frequently overlooked. First of all, if the principal maxi-mizes his utility or some kind of social utility, there is no corruption in equilibrium. The interest of the principal is to “break” the collusion between the agent and the supervisor because it gets him closer to the first-best utility level. Mookherjee and Png (1995) avoids this impasse by assuming that the principal is simply not able to design optimal incentive schemes. Another solution proposed in the literature and employed by Besley and McLaren (1993), Laffont and N’Guessan (1999) and Acemoglu and Verdier (2000) is to assume heterogeneity between supervisors. This type of hypothesis is justified if one tries to formalize a selection process (for example the selection of a group of “honest” tax inspectors); but if one attempts to explain the occurrence of corruption, supposing that some supervisors are “honest” and some are “dishonest”, it’s too simplistic of an approach.

A second issue of the P-S-A model is that it can only apply to bureaucratic corruption. As the reader noticed, this model features a benevolent principal, the policy to be implemented (pollution regulation, taxation, etc.) has already been established, and corruption appears during the implementation phase (when the supervisor colludes with the agent). Because the policy can not be changed and there are no transfers towards the policy-maker, the P-S-A model doesn’t have any chance to fit the realities of political corruption.

Since the P-S-A model suits only bureaucratic corruption, is there a political corruption model? The first alternative that could come to the mind of a political economist is another celebrated asymmetric information model: the political agency. The fact that political agency should be a part of the microeconomics of corruption literature is supported by recent research like Besley and Prat (2006), a paper that combines the

(28)

P-S-A model (media play the supervisor role) with political agency.10 _{In the following}

section I argue, though, that while the political agency captures a form of corruption, i.e. public funds embezzlement by politicians, it’s quite a stretch to consider it a political corruption model.

1.3.2 The political agency models of public funds

embezzlement

I will shortly present here a version of political agency developed in Persson and Tabellini (2000). The citizens (the principal), who get their utility from a public good g and a private good, delegate the choice over g to a politician (the agent). The public good is financed by taxing the citizens’ revenue y at a rate τ. Besides spending on g, the tax may be used by the politician to extract a rent r. Thus, the politician’s budget constraint is: τy = g + r.

Typical of a principal-agent model, there is a conflict between citizens and the politician over the choice of r. The main feature of the political agency is that the citizens may only discipline the politician by voting. There are (at least) two politicians competing for office, and winning the elections brings an exogenous “ego rent” R. Each politician proposes a policy platform (g, r) trying to maximize p, the probability of winning the elections. In the simplest versions of political agency, the politicians have preferences only on the two rents, so there is an unambiguous trade-off between extracting r or getting pR, the expected gain from winning the elections.

In such a simple setup, the electoral competition drives the endogenous rent r to zero. To obtain r > 0 in equilibrium, one may introduce, for example, heterogeneity between politicians (their “technology” for providing the public good may differ) or a more sophisticated voting system. Undoubtedly, the selection problems or the problems generated by voting are of major importance11_{, but the main interest of this review is}

to discuss the nature of the rent r.

If the broad definition of corruption is considered - so if corruption is “an abuse of public office for private gain” - r is definitely a corrupt gain. But is this rent a political bribe? As I argue in the introduction, a political bribe is a transfer from a principal (an interest group, for example) towards the politician and the purpose of such a transfer

10_{To my knowledge, this is the first review that includes the political agency in the microeconomics} of corruption literature.

(29)

must be a change in policy. In the above version of political agency, the rent r is a sum extracted by the politician from the budget of a public project and, evidently, it does not qualify as political bribe. Instead, it should simply be interpreted as embezzlement of public funds. This distinction is important because even in very recent research like Brollo, Nannicini, Perotti, and Tabellini (2010), the presence of this type of rents is, misleadingly in my opinion, referred as political corruption.

In other versions of the political agency model, the endogenous rent r is closer to the definition of political bribe. Besley (2006) formalizes a scenario in which a “dissonant” politician (the agent) gets a rent if he chooses a certain action, which action affects the utility of the voters (the principal). The author suggests that this rent may come from an interest group. Still, the interest group is not explicitly present in the model (one doesn’t know, for example, if and how the politician’s action affects its utility), thus there is no strategic interaction between this alleged interest group and the rest of the players.12

To build a model that better tackles the occurrence of political corruption, the next step should consist in inserting a second principal in the classic principal-agent hierarchy. This brings us into the realm of common agency models. In the following section I show that the common agency models have to be adapted in order to accommodate the presence of political bribes and avoid confusion with lobbying.

1.4 Towards a common agency model of political

corruption?

Given the models described in the previous parts of this paper, one may state that the bureaucratic corruption is well covered by the microeconomics of corruption literature. For example, the P-S-A models closely reflect the corrupt incentives that might be found in the lower levels of the public sector. Instead, the political corruption has only been captured as a side and implicit effect of the political agency setup.

Following the definition and the characteristics mentioned in introduction, a formal-ization of political corruption has to mirror the fact that a number of interest groups (special interests, citizens, etc.) influence the decision of a high-level public official.

12_{This kind of implicit political corruption is also present in earlier research on political agency.} Coate and Morris (1995) supposes that a “bad” politician “cares” about an interest group, but there is no actual bribes that change hands between the two. Again, there is no direct strategic interaction between the politician and the interest group.

(30)

This framework is not new for the microeconomic literature. Bernheim and Whinston (1986) proposes a theoretic model where multiple principals determine the choice of an agent by committing monetary transfers for each action the agent may take. This model is called “common agency” or “menu auction”.

Bernheim and Whinston (1986) is a powerful theoretical model and it has already been employed in political economy. A whole branch of the lobbying literature has been developed as an application of the common agency model. For Grossman and Helpman (1994) or Grossman and Helpman (2001) this model has proved to be very useful for answering questions related to campaign contributions, for example.

As Harstad and Svensson (2011) notices, there is something puzzling about the lobbying and corruption literature, though. Until recently there has been no clear distinction between these two concepts.13 _{For instance, in the lobbying literature the terms “bribe”}

and “political contribution” are substituted frequently. The lobbying literature talks also about corrupt politicians even if lobbying is a legal activity.

One key to this puzzle is to notice that the classic applications of the common agency model to lobbying are complete information games. If in equilibrium the monetary transfers are known by all the players of a political influence game, they should be interpreted as legitimate political contributions. I argued in introduction that bribes are hidden, private payments, thus the complete information common agency games inevitably fall short of reflecting this reality.14

As far as I know, Le Breton and Salanie (2003) and Martimort and Moreira (2010) are the first application of the common agency under asymmetric information to polit-ical influence games. Still, the information structure of the model can’t accommodate political bribes. The agent has private information about his preferences, but since all principals have the same information, the monetary transfers from interest groups towards politicians correspond, once again, exclusively to the legitimate political con-tributions.

Consequently, one challenge for the microeconomics of corruption is to propose a com-mon agency model featuring an information structure that will establish a clear distinc-tion between lobbying and political corrupdistinc-tion. Unlike lobbying and even bureaucratic

13_{Only Svensson (2005) and Harstad and Svensson (2011) begin to distinguish lobbying from} cor-ruption.

14_{In fact, Grossman and Helpman (2001) themselves argue that the transfers of the complete} infor-mation common agency games should be interpreted as political contributions.

(31)

corruption - which may be efficient - political corruption is a major abuse of public office, it has a subversive influence on political decision-making, so hopefully a com-mon agency model with a suitable information structure will uncover the roots of the inefficiencies caused by this phenomenon.

1.5 Conclusion

From a microeconomic point of view, a corrupt political environment is characterized by (i) a number of interest groups concerned with a politician’s decision, (ii) private, hidden transfers (bribes) paid to the politician by (at least) one of the interest groups (iii) the outcome of this type of political influence game should be a socially inefficient policy. Surveying the microeconomic literature on corruption reveals that, surprisingly, there is no model that fully matches these characteristics of political corruption. Featuring just one (benevolent) principal, the P-S-A models cover well, but cover only bureaucratic corruption. Furthermore, the political agency models formalize political rent-seeking, however it is a form of public funds embezzlement rather than political corruption. Finally, due to their information structure, the common agency models of political influence portray lobbying but not political corruption.

(32)

(33)

Bibliography

Acemoglu, D., and T. Verdier (2000): “The Choice between Market Failures and Corruption,” The American Economic Review, 90(1), 194–211.

Aidt, T. S. (2003): “Economic Analysis of Corruption: A Survey,” The Economic Journal, 113(491), F632–F652.

Bardhan, P. (1997): “Corruption and Development: A Review of Issues,” Journal of Economic Literature, 35(3), 1320–1346.

Barro, R. J. (1973): “The Control of Politicians: An Economic Model,” Public Choice, 14, 19–42.

Becker, G. S. (1968): “Crime and Punishment: An Economic Approach,” The Jour-nal of Political Economy, 76(2), 169–217.

Becker, G. S., and G. J. Stigler (1974): “Law Enforcement, Malfeasance, and Compensation of Enforcers,” Journal of Legal Studies, 3(1), 1–18.

Bernheim, B. D., and M. D. Whinston (1986): “Menu Auctions, Resource Alloca-tion, and Economic Influence,” The Quarterly Journal of Economics, 101(1), 1–32. Besley, T. (2004): “Joseph Schumpeter Lecture: Paying Politicians: Theory and

Evidence,” Journal of the European Economic Association, 2(2/3), 193–215. (2006): Principled Agents? Oxford University Press.

Besley, T., and J. McLaren (1993): “Taxes and Bribery: The Role of Wage Incen-tives,” The Economic Journal, 103(416), 119–141.

Besley, T., andA. Prat (2006): “Handcuffs for the Grabbing Hand? Media Capture and Government Accountability,” The American Economic Review, 96(3), 720–736.

(34)

Blasi, J. R., M. Kroumova,andD. Kruse (1997): Kremlin Capitalism: Privatizing the Russian Economy. Cornell University Press.

Brollo, F., T. Nannicini, R. Perotti, and G. Tabellini (2010): “The Political Resource Curse,” NBER Working Paper No. 15705.

Coate, S., and S. Morris (1995): “On the Form of Transfers to Special Interests,” The Journal of Political Economy, 103(6), 1210–1235.

Ferejohn, J. (1986): “Incumbent Performance and Electoral Control,” Public Choice, 50(1/3), 5–25.

Grossman, G. M., and E. Helpman (1994): “Protection for Sale,” The American Economic Review, 84(4), 833–850.

(2001): Special Interest Politics. The MIT Press.

Harstad, B.,andJ. Svensson (2011): “Bribes, Lobbying and Development,” Amer-ican Political Science Review, 105(01), 46–63.

Jacquemet, N. (2006): “Micro-économie de la corruption,” Revue française d’économie, XX(4), 117–159.

Johnston, M. (2001): “The Definition debate: Old Conflicts in New Guises,” in The Political Economy of Corruption, ed. by A. K. Jain, pp. 11–31. Routledge.

Laffont, J.-J., and T. N’Guessan (1999): “Competition and corruption in an agency relationship,” Journal of Development Economics, 60, 271–295.

Le Breton, M., and F. Salanie (2003): “Lobbying under political uncertainty,” Journal of Public Economics, 87, 2589–2610.

Martimort, D.,andA. Semenov (2007): “Political Biases in Lobbying under Asym-metric Information,” Journal of the European Economic Association, 5(2-3), 614–623. Mishra, A. (ed.) (2005): The Economics of Corruption. Oxford University Press. Mookherjee, D.,andI. P. L. Png (1995): “Corruptible Law Enforcers: How Should

They Be Compensated?,” The Economic Journal, 105(428), 145–159.

Persson, T., and G. Tabellini (2000): Political economics: explaining economic policy. Massachusetts Institute of Technology.

(35)

Robin, M.-M. (2010): The World According to Monsanto: Pollution, Corruption, and the Control of the World’s Food Supply. The New Press.

Rose-Ackerman, S. (ed.) (2006): The International Handbook on the Economics of Corruption. Edward Elgar Publishing.

Shleifer, A., and R. W. Vishny (1993): “Corruption,” The Quarterly Journal of Economics, 108(3), 599–617.

Svensson, J. (2005): “Eight Questions about Corruption,” The Journal of Economic Perspectives, 19(3), 19–42.

Tirole, J. (1986): “Hierarchies and Bureaucracies: On the Role of Collusion in Orga-nizations,” Journal of Law, Economics, and Organization, 2(2), 181–214.

Transparency International (ed.) (2004): Global corruption report 2004: special focus: political corruption. Pluto Press.

(36)

(37)

Chapter 2 When politicians make inefficient

decisions. A common agency model of

political corruption

(38)

2.1 Introduction

One trait of democratic political systems is that they offer the citizen rather effec-tive means to observe and influence the politicians’ decisions. Nevertheless, even in well-established democracies assuming the politicians make decisions reflecting citi-zens’ preferences seems sometimes overly optimistic. Every now and then the medias report cases of policies that hardly maximize any kind of social welfare function: public procurements at exorbitant prices, supporting hazardous economic activities in envi-ronmentally protected areas, providing useless public facilities, are just a few examples. The matter is even worse for new democracies and authoritarian regimes. Pretending to act in the public interest, the politicians seem often only interested in increasing their own wealth.

The research in economics and political economy proposes a number of reasons to explain why the government may get caught in inefficient decision-making. In this paper I deal with political corruption as a cause of “government failure”. More precisely I explain how, when having access to information more often than others, certain interest groups may bring the politicians to take socially inefficient actions. In addition, I will answer the following questions:

• does transparency in political decision-making helps deterring corruption? • may the salary of politicians be a useful tool for fighting corruption?

To get to grips with political corruption, I present a common agency model in which two interest groups (the principals) try to influence the decision of a politician (the agent). The novelty of the model is the presence of an information gap between principals: while one interest group always observes the actions implemented by the politician, the other does not directly observe these actions and has to rely on a court to investigate the politician’s choices. When the court does not observe the implemented actions, the less informed interest group has to trust the politician’s word. In this particular moral hazard setting and given that the interest groups have conflicting interests, the celebrated efficiency result of the common agency model holds if the information gap between interest groups is small. But the more interesting scenario unfolds when the information gap between interest groups is big enough: the politician may choose in-efficient actions and accept bribes (private transfers) from the better informed interest group.

(39)

The principal-supervisor-agent (hereafter P-S-A) models have extensively been used in the microeconomics of corruption literature leading to a consensus regarding the role of information and salaries in fighting corruption. In the first place, within the P-S-A models bribes are information rents. Hence, more information for the principal means less rent to be paid by the agent to the corrupt supervisor. Using a common agency model featuring asymmetric information between principals allows me to show that in the specific case of political corruption1 _{information may have quite a different effect.}

In fact, my finding is that marginally decreasing the information gap between interest groups (i.e. slightly increasing transparency) increases the expected bribe. Ultimately, it will take a large, discrete, improvement in the transparency of political decision-making to deter bribing.

Despite this somehow surprising result, my point is not that increasing transparency is a bad policy. I also show that expected welfare actually increases with transparency as the politician is led to take more often efficient actions.

In the second place, in the P-S-A models - typical of incentive theory settings - a raise in the contingent salary (payment for performance) should help to discipline the potentially corrupt public servants.2 But again, in the case of political corruption

this matter should be approached quite differently. Besley (2004) for example argues that due to an incomplete contracting problem, in political life contingent salaries are practically non-existent. The author also notices that the politicians’ flat salaries are relatively low. My finding is that when the information gap between principals is big, raising the politician’s non-contingent salary increases the occurrence of political corruption. This result may explain why the politicians’ observed flat salaries are generally small.

Political corruption: definition and literature

The concept of political corruption has significantly changed over time.3 _Recently

Besley (2006) defined political corruption as: “a situation where a monetary payment - a bribe - is paid to the policy maker to influence the policy outcome”. As helpful as it is, this definition raises further questions. Who has the interest to influence the policy outcome? In other words, whose welfare is altered by the policy? Almost any

1_{I will discuss the difference between political and bureaucratic corruption in the following short} review of literature.

2_{For a review of literature on corruption and efficiency wages see Aidt (2003) or Jacquemet (2006).} 3_{See Heidenheimer and Johnston (2002).}

(40)

decision of a politician affects the welfare of more than one interest group. Awarding a government contract, for example, affects the welfare of the firm executing the contract but also the taxpayer. Hence, besides a politician, there must be at least two interest groups to consider when analyzing political corruption.

Furthermore, are bribes somehow different from other monetary payments received by politicians? Is there a difference for example between bribes and legitimate political contributions? The above definition states that a monetary transfer from an interest group to a politician is a bribe if it is contingent on a politician’s action. This is not the only characteristic of bribes, though. Corruption is famously a secret phenomenon. If a firm pays the politician a bribe in order to get a government contract, they will keep both the deal and the bribe secret. There are two reasons why a politician and an interest group may want the bribe to be a hidden, private payment. First, this contingent payment is generally banned from political life. Second, in the event the bribe is discovered, the politician’s action is also revealed and this may damage his career. Continuing our example, the fact that the politician receives a bribe during a government contracting process may be an indication that he has not chosen the best firm to execute the contract.

Since the development in the mid-80s of the P-S-A model4, the microeconomic

for-malization of corruption has reached undisputed success. Besley and McLaren (1993), Mookherjee and Png (1995) or Acemoglu and Verdier (2000) among others bring useful insights into this phenomenon and at the same time relate to its essential character-istics. Aidt (2003) suggests as well that by setting up an agency framework in which one benevolent principal (the policy-maker) tries to prevent the collusion between a corrupt supervisor (the bureaucrat) and a corrupt agent, the P-S-A model became a powerful tool for analyzing corruption. Unfortunately, though, the P-S-A model applies only to bureaucratic corruption. Probably because in the microeconomics of corrup-tion literature the line between political and bureaucratic corrupcorrup-tion is often fuzzy, this important clarification is overlooked.

I argued earlier that a model of political corruption should feature at least two interest groups and a politician. Since it features only one principal and the role of the policy-maker is basically inverted, the P-S-A model doesn’t have any chance to fit the realities of political corruption.

Paradoxically, the success of the P-S-A model has left a gap in the formalization of

(41)

political corruption. To fill this gap, two models of the political economy research may be considered. They are not models of political corruption per se, but include rents or monetary transfers associated with political corruption.

The first one is the political agency model. Pioneered by Barro (1973) and Ferejohn (1986), presented and developed lately in Persson and Tabellini (2000) and Besley (2006), it explains the behavior of politicians facing elections. In its simplest form the political agency is a principal-agent model: a decision affecting the welfare of the citizen (the principal) is delegated to a politician (the agent). The politician may “shirk” and acquire a rent. The particularity of political agency model is that the citizen’s only possibility to correct the politician’s incentive to shirk is to vote him out of office. Focusing on the electoral process, the political agency model proposes a fairly simple type of rents. By the standards of a broad definition of corruption, these rents might be interpreted as corrupt gains.5 _{However, they do not correspond to the definition of}

political corruption employed in this article because they are not monetary transfers contingent on a politician’s action. More precisely, in the political agency model the potential rents are settled at the beginning of the elections and the politician can decide to get (a part of) them by risking his office. In this respect these rents resemble rather the embezzlement of public funds than actual political bribes.

The more sophisticated versions of the political agency model address this issue by introducing one or more interest groups as a second principal. This extension brings us into the realm of common agency games6, the second type of model adopted by

the political economy research in the attempt to assess potentially corrupt political influences.

The theoretical foundations of the common agency games were set by Bernheim and Whinston (1986) and Bernheim and Whinston (1986a). Including Grossman and Help-man (1994), GrossHelp-man and HelpHelp-man (2001), Le Breton and Salanie (2003) and Marti-mort and Moreira (2010), an entire branch of the lobbying literature has been developed as an application of this model. As Harstad and Svensson (2011) mentions, there is something puzzling about the lobbying literature, though. The monetary transfers from interest groups towards politicians are frequently called bribes creating confusion be-tween lobbying and political corruption. This puzzle is easy to solve if one considers the distinction between bribes and political contributions I made earlier. The lobbying

5_{In a famous definition corruption is “an abuse of public office for private gain”.} 6_{Or “menu auctions”.}

(42)

models built on common agency feature equilibrium transfers that are known by all the players. Therefore, these payments should be interpreted as legitimate political contributions. Bribes are hidden, private payments and the current applications of the common agency to lobbying fall short of reflecting this reality.

The remainder of the paper is organized as follows. In Section 2 I outline the model. I also find the standard complete information equilibrium and the asymmetric informa-tion equilibrium if the informainforma-tion gap is small. Secinforma-tion 3 covers the political corrupinforma-tion scenario. When the information gap is big, I find the mixed strategy equilibrium, calcu-late the probability of political corruption and the effect of a change in the politician’s non-contingent salary on this probability. Section 4 includes a short conclusion.

2.2 The model

Consider a common agency setting with two interest groups (the principals) and a politician (the agent). The game takes place during the politician’s term of office. An interest group may be a group of citizens or a special interest.

The interest groups have preferences over a policy p and some transferable commodity. The policy p is stochastic and may take two values, p ∈ P = {p1_{, p}2_}_{. Besides being}

stochastic, p is observable but not verifiable. The politician can induce p’s distribution by taking an action a ∈ A = {a1_{, a}2_}_{. This influence is specified by two conditional}

distributions which satisfy

Pr(p = p1_{|a = a}1_{) > Pr(p = p}1_{|a = a}2₎_.

The interest groups’ preferences over A are represented by u, a von Neumann-Morgenstern utility function. Let ui(aj) be the interest group i’s utility for action aj, where i, j ∈

{1, 2}are indexes for interest groups and actions, respectively. I assume u1(a1) > u1(a2)

and u2(a1) < u2(a2), so ex ante the first interest group prefers the first action and the

second interest group prefers the second action.7 I normalize u

1(a2) = 0, u2(a1) = 0

(the utility of the less preferred action is zero for both interest groups) and denote u1(a1) = v, u2(a2) = w, where v, w ∈ R++. This simplified notation sets out v and w

as expected marginal utilities.

7_{Obviously, ex post the first interest group strictly prefers the first policy and the second interest} group strictly prefers the second policy.

(43)

I assume v > w and since I also assume that the politician does not have preferences over A, the first action is socially efficient.

To influence the politician’s choice over a, the interest group i offers the politician a contingent transfer ti(a), where ti : A → R+. I will call the couple (t1(a), t2(a))a menu

contract. Denote Ti = {ti(a)|ti(a) ∈ R+}the interest group i’s strategy space.

In this simple model the politician gets his utility only from the interest groups’ trans-fers. Nevertheless, the interpretation of these transfers may be quite rich. For instance, if the first interest group is a large group of citizens and the second one is a numer-ically small special interest, the citizens may vote and keep the politician in office if he chooses the efficient action. Because staying in office brings to politician a certain utility,8 _{the incentives provided by elections are actually similar to those used in our}

model. Another example of an incentive scheme may be a media campaign financed by one interest group, which favours the politician if he chooses a certain action.

Typically for a moral hazard setting, if both interest groups observe a, they prefer to write contracts on the ex ante action a rather than the realization of p.9 _The

assumption that p is not verifiable will become important in the asymmetric information setting where a is not always observable. This particular assumption is common in the incomplete contracts literature and capture the idea that in most cases it would be extremely complicated and costly to write contracts between interest groups and politicians on the outcomes of a certain policy.10 It is natural instead to regard the

duties that come with the office and the political promises as implicit contracts on the ex ante politicians’ actions.11

The symmetric information setting

Assume both interest groups observe a and there is a court which also observes a and enforces the contracts between players. The interest groups simultaneously commit to a menu contract (t1(a), t2(a)), the politician chooses a∗, a policy p is realized and the

interest groups pay the transfers t1(a∗) and t2(a∗).

8_{In the political economy literature this utility is usually called “ego rent”.}

9_{It is not the goal of our paper, but it may be proved that even if principals are risk neutral, they} both strictly prefer to write contracts on a rather than p.

10_{One may think of a contract between citizens and politicians on the outcomes of an agricultural} policy, for example.

11_{An alternative way to view the above model is to reckon that action a is similar to a credence} good.

(44)

The politician chooses a∗ _{= a}1 _if

t1(a1) + t2(a1) ≥ t1(a2) + t2(a2) (2.1)

and chooses a∗ _{= a}2 otherwise.

If a∗ _{= a}1 _{is chosen, the interest groups’ expected payoffs (net of transfers) are v−t} 1(a1)

and −t2(a1), respectively. Likewise, if a∗ = a2 is chosen, the interest groups’ expected

payoffs are −t1(a2) and w − t2(a2).

Definition 1. An action a∗ and a menu contract (t1(a), t2(a)) are an equilibrium of

the symmetric information game if

• given (t1(a), t2(a)), a∗ maximizes the politician’s payoff.

• neither interest group may offer a contingent transfer t0

i(a) 6= ti(a) which, given

t−i(a) and the subsequent choice of the politician, strictly increases i’s expected

payoff.12

This definition looks standard, but one should keep in mind that the interest groups have to anticipate the politician’s choice when they propose the menu contract.

Because the above game has an infinite number of equilibria, I will use a refinement originally proposed by Bernheim and Whinston (1986).13

Definition 2. An equilibrium is called “compensating” if t1(a1) ≤ v and t2(a2) ≤ w.

In words, an equilibrium is called “compensating” if the interest groups can’t commit to transferring for their preferred actions an amount strictly higher than their expected marginal utility.

The first proposition characterizes the unique compensating equilibrium of the sym-metric information game.

Proposition 1 (Bernheim and Whinston (1986)). In the compensating equilibrium the politician chooses the ex ante efficient action a∗ _{= a}1_{. The compensating equilibrium}

transfers are: t1(a1) = w, t1(a2) = 0, t2(a1) = 0, t2(a2) = w.

12_{I use the common game theory notation: when i indexes an interest group, the index −i refers to} the other interest group.

13_{Bernheim and Whinston (1986) call their refinement “truthful”. To avoid confusion, I will use for} this particular refinement a name proposed later by Grossman and Helpman (2001).

(45)

Proof. One only has to apply the first corollary of the second theorem from Bern-heim and Whinston (1986) to the common agency game where the interest groups get u1(a1) = v, u1(a2) = 0 and u2(a1) = 0, u2(a2) = w with certainty.

The efficiency result of the common agency models may be surprising at a first sight. Because the interest groups have conflicting interests on actions, in equilibrium they will never offer a positive transfer for their less preferred actions. And while the second interest group offers his expected marginal utility for his preferred action, the first interest group’s best response is to offer a transfer that will ensure a binding (2.1). Hereafter it will be easy to observe that in equilibrium the interest groups always offer the lower bounds of ti’s codomain as transfers for their less preferred actions. This

is why I let t1(a2) = 0 and t2(a1) = 0 without further proof. The importance of the

transfers t1(a2) and t2(a1) will appear clearly in the next section when I will impose

restrictions on the strategy space Ti.

For political life, the assumption that both interest groups always observe the politi-cian’s action and can perfectly enforce their contracts is unrealistic. More often than not certain interest groups seem to be “closer” to politicians, they know better than others what and how political decisions are made and, finally, arrive to defend better their interests.14

The asymmetric information setting

In this setting I assume that when the politician promises to take an action, the second interest group always observes the action eventually implemented by the politician. The first interest group, however, is only able to observe the implemented action via a court. If asked by the first interest group, an imperfect court of law may conduct an investigation on the actual choice of the politician over a. The court is imperfect in the sense that she can’t always observe the politician’s choice. If the court does not observe the implemented action, the first interest group has to rely on the politician’s initial promise.

The steps of the game are:

14_{One may consider the information gap that usually exists between consumers on one side, and} producers and government on the other side, when establishing an agricultural policy. See Berry (1982).

Three essays on political corruption and common agency