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«Bruno Bosco2 Margherita Savona DEMS DSG University of Milan–Bicocca Piazza Ateneo Nuovo, 1 20127 Milan, Italy Abstract In this paper corruption is ...»

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The social cost of non-compliance and the optimal punishment of corruption. Can

European policy measures be helpful?1

Bruno Bosco2 Margherita Savona

DEMS DSG

University of Milan–Bicocca

Piazza Ateneo Nuovo, 1 20127 Milan, Italy

Abstract

In this paper corruption is analysed in a model in which private compliance costs are

explicitly introduced as well as asymmetry of information between government and private agents in a Principal–Agent model of costly regulation. Conditions leading to efficient anti corruption measures are derived and compared with those obtained by previous literature. An explicit analysis of the efficiency cost of corruption is also presented. European legislation is examined and evaluated according to the model’s results. The potential effects of European norms are discussed in the perspective that corruption is a great obstacle to an efficient management of the public sector that negatively affects the role of institutions in each country.

Keywords: Regulation; Compliance Costs; Corruption; Efficient Penalties; European Anticorruption Measures.

“My remaining two months in office [as Governor of Arkansas] were tough on my staff. They needed to find jobs. The usual route out of politics is through one of the big companies that do a lot of business with state government, but we had angered all of them.” B. Clinton, My life, Vintage Books, N.Y., 2005, Vol.

I, page 373 (emphasis added).

“Bribes are paid for two reasons – to obtain government benefits and to avoid costs”, S. Rose–Ackerman (1996) This paper is part of a research project of the Economics of Institutions that we are developing at the University of Milan–Bicocca. Research funds FAR/2013. We the usual disclaimers we thank M. Monti, A. Santoro and F. Stroffolini for helpful comments.

Corresponding author. E–mail address: bruno.bosco@unimib.it.

1. Introduction In any civil society, economic and social activities should generally conform to some legally determined standards of conduct intended to promote efficiency, safety, order or some other public goals. The legislative sphere (government) sets these standards and, in an idyllic world, private individuals/firms comply with the rules. However, compliance often requires costly and burdensome activities on the part of privates (e.g.

applying for a complicated licence; submitting a detailed environmental-impact study when planning a construction investment; paying high fees for a licence, not to mention taxes). Since some private agents may fall short of ethical civil conscience, complete and spontaneous compliance should not be always assumed. Hence, independent administrative structures (bureaucracy) are in charge of the control and the evaluation of the extent to which private activities conform to prescribed rules. This activity mostly consists in i) the discovery of illegal conducts that undermine the social benefits of regulation and ii) the application of law-determined fines to non-complying subjects.

Yet, since the circumvention of the rules might be vastly beneficial for successful private agents, the potential benefit of avoiding compliance provides incentives for potential corruption activities. Indeed, even bureaucrats may fall short of the abovementioned civil virtues and could accept/solicit bribes for not monitoring/imposing the application of the law up to the full consequences. In turn, this creates the need to adopt anti-corruption measures on the part of governments. So, all over the world, governments, officials and private agents engage in a sort of perverse triangular liaison in which the government sets the rules, privates often try to circumvent them and public officials chase and eventually fine the circumventing privates who, in turn, may resort to bribing to avoid punishment and forced compliance. Corruption is the dark side of the above triangular liaison and generally moves a huge amount of resources whose exact volume is, not surprisingly, virtually unknown because even indirect indicators of corruption could be misleading or ambiguous (a low arrest rate for bribery may signal either low corruption or widespread corruption). Still, the forms, causes and damages of corruption, as well as remedies, are the subject of great discussions and speculation in contemporary societies. Hence, corruption is the source of an increasing concern for national governments and international organizations and generates intense political and academic debates.

At the European level, corruption continues to be a cause of concern, as it is globally3.

Although the nature and extent of corruption vary, it most probably exists in all Member States and causes serious economic, social, and political harm. International instruments and EU anti-corruption legislation are already in place but implementation remains insufficient. The Commission calls on EU Member States to ensure that they fully transpose all relevant legal instruments into their legislation and effectively enforce the anticorruption measures through the detection and prosecution of corruption offences as well as by a systematic record of accomplishment of deterrent penalties and asset recovery. To that end, the Commission has set up the EU Anti-Corruption Report to assess periodically Member States' efforts, starting in 2013. In parallel, the EU The process of enlargement of the EU has been a key vehicle for major anti-corruption reforms in the candidate countries and potential candidates. The 2005 negotiating frameworks for Croatia and Turkey introduced a specific chapter covering a range of rules of law issues, including judicial reform and the fight against corruption. The renewed consensus on enlargement, endorsed on 14 and 15 December 2006, has further strengthened the focus on the rule of law.





participates in the Council of Europe Group of State against Corruption (GRECO). The EU will also continue to address corruption through all relevant EU policies – internal as well as external. The most sensible areas include: i) corruption in the sphere of judicial and police cooperation; ii) modernised EU rules on confiscation of criminal assets; iii) revision of EU public procurement legislation; iv) improvement of EU crime statistics; v) enhancement of an anti-fraud policy to protect EU financial interests; vi) stronger use of conditionality in EU cooperation and development policies. At the same time, private-public dialogue at EU level on how to prevent corruption within the business sector will be further developed with the support of the Commission. It is therefore clear that EU perceives corruption as a great obstacle to an efficient management of the economy – of the public sector in particular – directly affecting the role of institutions in each country as well as the policy instruments to be used for any recovery path towards overall efficiency and more balanced budget policies. Although the total economic costs of corruption in Europe cannot be easily calculated, it is estimated that 120 billion Euros per year, or approximately 1% of the EU GDP, is lost because of corruption4 and that a good 5% of the EU citizens pay a bribe annually.

Outside Europe, corruption might well amount to 5% of GDP at world level and one study suggests that corruption may add as much as 20-25% to the total cost of public procurement contracts5.

Economic theory initially saw corruption as “oil in the wheels” of economic systems and as a form of self-defence of markets against burdensome and noxious public regulation. Then, Myrdal (1968), Rose-Ackerman (1975, 1978) and a subsequent literature showed that corruption is “sand in the wheels” of the economic mechanism and many eempirical works revealed the damages of corruption to GDP, GDP growth, investment and overall public budget policy. Yet, existing economic theory analyses corruption/bribing decisions as a two-party utility maximization choice under uncertainty and generally does not consider the government as an active party. Models generally assume that the pay-off of a corrupted transaction is ex-ante known to equally informed parties who try to reach a Nash equilibriums deal about the extent of corruption and bribing. The properties of these equilibriums are analysed to derive policy indications for measures (concavity of the penalty function, differences in the fines charged to corrupted parties, properties of the wage structure of public officers, etc.) apt to discourage such transactions. Hence, the main concern of the literature seems to regard the equilibrium relationship between briber and bribee given the probabilities of being discovered and the penalties structure. Yet, no general analysis of corruption has been undertaken with the purpose of deriving anti-corruption measures from the maximization of a properly defined social welfare function in which the wellbeing of the main actors (government, officers and privates) are included, compliance decisions are related to government regulation and the existence of asymmetric information on compliance costs between government and agents is properly taken into account. This paper intends to contribute to the current debate by proposing that kind of analysis. We present a simple but general model of optimal regulation activity generating compliance costs to private subjects who, under the hypothesis of The cited figure is based on estimates by specialised institutions and bodies, such as the International Chamber of Commerce, Transparency International, UN Global Compact, World Economic Forum, Clean Business is Good Business.

Data are obtained from www.transparency.org/policy_research/surveys_indices/gcb and www.nispa.org/files/conferences/2008/papers/200804200047500.Medina_exclusion.pdf.

asymmetric information with the government, may resort to bribing public officers in order to reduce the “burden of regulation”. Under reasonable assumptions on compliance costs, we derive i) the conditions for efficient costly regulation; ii) the implications of regulation on compliance and compliance costs and consequently on the privates’ decisions on the extent of their compliance and iii) the properties of the fine structure for corrupted privates and officers consistent with the above optimal conditions. We show that, since regulation may induce private costly compliance as well as social benefits, Governments, in order to induce the most efficient pro compliance behaviour and reduce corruption to a minimum level, should make the efficient fines conditional on the effects of regulation on compliance costs and on privates’ reaction to regulation. The second purpose of the paper is to discuss the main EU policy measures against corruption in the lights of the above results. We try to evaluate the potential effectiveness of these recommended measures as instruments able to curtail corrupted transaction in European economies. The potential effects of European norms are discussed in the perspective that corruption is a great obstacle to an efficient management of the public sector that negatively affects the role of institutions in each country as well as their budget policy.

The paper is organized as follows. Section 2 contains a short review of the economists’ view of corruption and stresses differences in the approaches and in model building as well as in policy indications. In sections headed 3 we present our model of optimal regulation in the presence of compliance costs (observable by the government, section

3.1 and non observable, section 3.2) and the results emerging when the model encompass the idea that bribing generates a specific distorsive cost likewise an indirect tax (section 3.3). In section 3.4 we discuss our results and compare them with those obtained by the previous literature. In sections headed 4, some of the main EU anticorruption policy issues are evaluated in the lights of results obtained mainly in sections

3.2 and 3.3. A brief section 5 concludes.

2. Corruption: definitions, causes and consequences

Economic analysis has investigated corruption at both theoretical and empirical level.



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