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«Why firms pay occasional bribes: the connection economy Ariane Lambert-Mogiliansky ´ ` CERAS, Ecole Nationale des Ponts et Chaussees, 28 rue des ...»

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European Journal of Political Economy

Vol. 18 (2002) 47 – 60

www.elsevier.com/locate/econbase

Why firms pay occasional bribes:

the connection economy

Ariane Lambert-Mogiliansky

´ `

CERAS, Ecole Nationale des Ponts et Chaussees, 28 rue des Saints-Peres, 75 343 Paris, France

Received 1 November 2000; received in revised form 1 March 2001; accepted 1 May 2001

Abstract

This paper suggests that legal business networks facilitate corruption. When the prospects of future deals fail to provide incentives to comply, bribes can be enforced relying on punishments in the network through exclusion. Network members administer the punishments because of the fear that the bureaucrat will retaliate against all network members. The bureaucrat may, for instance, stop revealing his private information to the network. The analysis predicts that the extent of occasional corruption can be larger when the legal and administrative rules are complex and unstable, and if the market is poorly developed. The paper discusses policy measures to reduce corruption. D 2002 Elsevier Science B.V. All rights reserved.

JEL classification: L14; L2; K42 Keywords: Corruption; Network; Enforceability

1. Introduction Some illegal transactions are occasional by nature. An example of this is when a hotel manager ‘‘buys’’ a building permit in violation of environmental laws.1 In other cases, a corrupt transaction may be the first step in a long-running illegal relationship. The deal can, however, be perceived as occasional when the prospects of future cooperation are uncertain because, for example, the parties do not know each other.2 Occasional corruption is then a E-mail address: ariane.lambert@mail.enpc.fr (A. Lambert-Mogiliansky).

When the hotel is built, the owner of the hotel has no need for other illegal favors (in particular from the construction permit bureau). He simply runs his business.

The firm may not know how long the civil servant will remain in office.

0176-2680/02/$ - see front matter D 2002 Elsevier Science B.V. All rights reserved.

PII: S 0 1 7 6 - 2 6 8 0 ( 0 1 ) 0 0 0 6 8 - 4 48 A. Lambert-Mogiliansky / European Journal of Political Economy 18 (2002) 47–60 port of entry into repeated illegal cooperation. The fact that the transaction is occasional exacerbates the parties’ incentives to cheat each other: Why do firms pay bribes in such situations?

This paper suggests that business networks can provide an answer to this question. Firms generally belong to a business network because it is profitable to do so (in particular, they gain access to the insiders’ information). A bureaucrat will be able to exploit this fact if the non-payment of the bribe triggers exclusion. Cheating then becomes very costly. I show that, in a network, firms can be induced to discipline each other with respect to bribe payment for fear of collective punishment. To obtain an intuition for this result consider the following situation. We have a bureaucrat who can seldom offer illegal favors to any particular firm. The threat of terminating the relationship is therefore not sufficient to secure the payment of bribes. We now assume that the bureaucrat has also private information that is of (little) value to firms (for example, he is aware of procurement projects before this information is released to the public). In a situation where the firms discount the future, this feature may only have a limited impact on incentives to pay the bribes. In the presence of a business network, however, the effect can be quite dramatic: large bribes become enforceable. The reason is that the bureaucrat can threaten not to reveal his information to the network unless the firm that failed to honor the illegal contract, i.e. refused to pay the bribe, gets excluded. The firms may then prefer to exclude from the network cheating members. As a result firms also prefer to pay their bribes rather than to lose access to the resources available in the network.

A contribution of the approach taken in this paper is to highlight links between the extent of corruption and aspects of the legal economy. In particular, I unveil the significance of asymmetric information between the firms and the bureaucrat.3 The bureaucrat is able to profit from illegal collusion because the firms value his (or her) private information on legal matters. The more unstable and complex the legal administrative framework, the more valuable the bureaucrat’s insider information. This favors the (strategic) complementarity between corruption and network interaction.

A second aspect of transparency in the legal economy relates to inter-firms relationships.

The better developed the market, the lower the value of the firms’ private information to others (because prices convey most of the business-relevant information). This can make it more difficult to sustain occasional corruption. In contrast, in an economy where firms are highly dependent on ‘‘good connections’’ to do business, corruption is expected to be more widespread.

The results suggest that a government that wishes to reduce corruption should settle for simple and stable legal and administrative rules and improve on the information provided to the private sector. The government should also promote development from a personalized ‘‘connection economy’’ into an anonymous market economy, for example, by promoting the development of efficient arbitrage courts.4 This is distinguished from asymmetric information between the ‘‘principal’’ (the government) and the bureaucrat as in most agency models of corruption (collusion). See for instance Laffont and Tirole (1993).





The idea is that in the absence of well-functioning arbitrage, business partners do in effect bear the whole risk for defection from the other parts. Therefore, they would need a lot of information to evaluate those risks. A business network may be the best place to obtain this kind of information.

A. Lambert-Mogiliansky / European Journal of Political Economy 18 (2002) 47–60 49 There exists a widespread consensus among empirical and theoretical sociologists (see for instance Kadushin, 1995; Skworetz and Willer, 1993; Useem, 1982) that networks play an important role in business. In particular, privileged access to information is regarded as a main resource of a business network. The connections between occasional corruption and business networks have been emphasized by the French sociologists Meny (1992) and Cartier Bresson (1997).5 In the 1990s, corruption affairs in France also revealed a close connection between powerful networks and corruption.6 My aim in this paper is to formally investigate a mechanism that connects corruption to business networks. The argument I develop is by no means exhaustive. There exist other mechanisms with a potential to enforce occasional bribes. Organized crime is one of these. Another mechanism is when the bureaucrat retaliates by refusing to provide legal services.7 The economic literature concerned with collusion and corruption usually assumes that side contracts are enforceable.8 I shall relax this assumption. Instead, I propose a solution using the theory of community enforcement.9 Fascinating applications that have shed light on economic historical puzzles have been developed by Milgrom et al. (1990), Greif (1989) and Greif et al. (1994). Grief et al. provide an explanation as to why, in the Middle Ages, rulers in trade centers promoted merchant guilds. They argue that the guilds provided the rulers with an instrument to commit to the safety of alien merchants. Safety was necessary for the expansion of trade. As in the case of occasional corruption, bilateral reputation (between the ruler and alien merchants) was not sufficient. Merchant guilds allowed for a multilateral reputation mechanism to develop. As a result, fair and safe trade could be secured. In a similar way, I argue here that a business network provides a multilateral reputation mechanism that is able to surmount the enforcement problem in occasional corruption.

The results in the paper are also consistent with findings in development economics. In particular, Barnerjee and Newman (1998) investigate the links between the ‘‘connection economy’’ in traditional sectors and under-development. They show how the informational advantage of the traditional inefficient sector may result in the economy becoming stuck in a poverty trap.10 Cartier Bresson (1997, p. 80) writes: ‘‘In the second case (when corruption is occasional), it is most often organized by social networks.’’ Central participants implied in the corruption scandals in the management of social housing (HLM) in les Hauts-de-Seine and Nimes were free masons (Vogelweith and Vaudano, 1995 pp. 128 – 129). L’Usine Nouvelle (1996) provides an exhaustive description of the French regional business networks and their connections with prominent people involved in corruption scandals.

This argument, however, raises the issue of why the bureaucrat would bother with illegal favors when he can extract rents by simply threatening not to do his job. My view is that extortion is a topic of its own that deserves more research.

See for instance Laffont and Tirole (1993), Kofman and Lawarree (1993), Lambert-Mogiliansky (1998). An exception is in Tirole (1992) who briefly develops a reputation argument.

The theory of community enforcement has been developed by Cremer (1986) and Kandori (1992).

Corruption is now widely recognized as a main obstacle to development in LDCs and Transition economies. See for instance, Hellman et al. (2000).

50 A. Lambert-Mogiliansky / European Journal of Political Economy 18 (2002) 47–60 In Section 2, I present the setting. The network interaction and the corruption game are described. In Section 3, I analyze an equilibrium where the bureaucrat can exploit the network to enforce the payment of bribes. In Section 4, I derive comparative static results and discuss implications for anti-corruption policy. Section 5 sets out conclusions.

2. The setting One bureaucrat and n firms interact in two fields.11 To simplify the presentation, we start by describing the network game. We then introduce the corruption game. The two games are brought together in the next section.

2.1. Network interaction Network interaction is modelled as a game where players exchange information. The actions within the network are observable by all network members.12 In each period, the firms simultaneously engage in nÀ1 bilateral interactions. In its interaction with firm j, firm i faces the following choice. It may either cooperate with j or boycott j. When i cooperates with j two things happen: (i) i’s private information goes into a common pool that is, it becomes public within the network, (ii) firm j gains access to the pool. When i boycotts j, (i) no provision to the common pool is made, (ii) j is not given access to the pool (through i). The pool approach is a simple device to capture the following two basic features: (i) a firm i has access to network information if and only if at least one network firm j agrees to cooperate with i, (ii) information is public within the network.

We assume that there is no cost to boycotting a firm. There is, however, a positive per period fixed cost g of cooperating. This cost does not depend on the number of bilateral interactions. It may capture the effort of processing one’s private information so that it can be used by others. When a firm does not contribute (so it saves g) while still interacting with firms (so it has access to the pool), we say that the firm free-rides. The value of the n ˆ firms’ collective contributions is Sn pi ; pi a½; pŠ.13 We define ju Sn pi À p as the i¼1 i¼1 value of the pool for the most contributive firm, i.e. the value of the pool net of that firm’s own contribution.

The bureaucrat chooses between either contributing to the pool, which costs nothing, or not, i.e. exiting, which is irreversible. In each period, the value of the bureaucrat’s contribution to the firms is denoted pk, pk . There is no strict benefit for the bureaucrat from being in the network.14 We assume that when he is indifferent between belonging to the network or not, he chooses to belong.

The reasoning extends to the case with more than one bureaucrat.

Outsiders only observe collective boycotts, i.e. exclusion (see below).

Kadushin (1995, pp. 204 – 205) names four main outcomes from interaction in a network of the French financial elite: better information, increased opportunity for compromises, promotion of the network’s interest in politics, promotion of trust.



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