Corrupt Transactions - Exploring the Analytical Capacity of Institutional Economics.

Workshop at the University of Göttingen, November 15-16, 2002

Motivation

The New Institutional Economics can be developed further into a tool that helps to understand corrupt deals and network economies. This enables an analysis of the Achilles heel of corrupt deals - suggesting avenues for reform.

The workshop was kindly supported by

and

Organizers

This workshop was organized by three different chairs of the "Georg-August-Universität Göttingen" and the "Gerhard-Mercator-Universität Duisburg", by Prof. Dr. Johann Graf Lambsdorff, Dipl. Ök. Matthias Schramm and Prof. Dr. Markus Taube.

All participants engaged in research with close links to the institutional economics and corruption. Participants were expected to contribute a topical study from their research in the area. Unpublished research and discussion papers were particularly welcome.

See the schedule and the contributions of the participants.

The contributions to the workshop have now been published.

The workshop intended to provide the opporunity for intensive discussion. Therefore the group of participants was small. We asked that all participants to attend the entire workshop. Our idea was to have an exchange of ideas that can help set an agenda for future work.

Participants were expected to distribute their contributions prior to the workshop.

All contributions were presented by the authors at the workshop. Afterwards another participant was given time to serve as a discussant. All participants were expected to serve as discussants for one other paper.

Please click on the pictures of the conference to get a larger view!

Picture © by Michael Wiegmann

The workshop was funded by the German Research Council (DFG) and SAP.

The anti-corruption bureau wants you... ... just a minute, Sir! Hear me fully, Sir.... it wants to invite you to a seminar on corruption! Laxman, Times of India, Sep. 17 2002

Corruption is an illegal exchange between two partners, one side paying a bribe, the other providing a corrupt service. Since an informal contract exists between the partners, the tools developed by Institutional Economics can enrich our understanding of this exchange. Indeed, this approach has obtained increased interest of late, [Husted 1994], [della Porta and Vanucci 1999], [Rose-Ackerman 1999: 91-110] and [Lambsdorff 2002a and 2002b].

The focus of New Institutional Economics is largely on the transaction costs of legal contracts. These are costs that occur as a consequence of exchanging services or goods for a return. They include costs associated with searching for partners, determining contract conditions, and enforcing the agreement. This approach was fruitfully adapted to help also our understanding of illegal and informal contracts. But corrupt transactions differ from legal ones because, first, corruption does not allow for legal recourse, second, corruption must be hidden from the public and, third, because of the ever-present threat of mutual denunciation, partners of a corrupt agreement are "locked-in" to each other even after an exchange has been finalized. As a consequence, there seems to be consensus in the academic literature that opportunism is particularly difficult to avoid in case of corrupt contracts. Transaction costs are higher than in the case of legal contracts. These institutional difficulties motivate partners in a corrupt exchange to explore private solutions to make their agreement self-enforcing. Various forms of institutional solutions come into play.

There exists ongoing research on a multitude of institutions that are used to facilitate corrupt transactions. The use of intermediaries has been subject to study of late, [Bray 1999], [Lambsdorff 2002b]. For example, these can help in identifying corrupt partners, where searching in the open is too risky. They may even provide a legal appearance to a corrupt deal, camouflaging a bribe as a commission. Middlemen can monitor how well public servants stick to their promises, providing reasons for public servants to invest in a reputation as an "honest bribee". While there seems to be a strong argument in favour of the use of intermediaries, whether these are indeed helpful to corrupt parties still requires a sound institutional economic analysis. Also, this analysis would profit further from more detailed case studies, fieldwork and surveys.

Another important question with regard to corrupt transactions is whether these can be linked to legal transactions. The legal relationship can be used to act as a "guarantor". For example, a repeated legal market exchange between business partners can serve as a basis for a corrupt deal, because the thread to end the legal relationship effectively prevents opportunism. Also a hierarchical relationship within a firm may help in arranging a corrupt exchange, because it provides control mechanisms to sanction opportunism and to harass an offender. Also this issue deserves further scrutiny. Finally, network ties can be helpful in facilitating a corrupt transaction. For members of such a social structure, the advantages to be gained from benefiting another member may outweigh the motivation to behave opportunistically or to denounce another member. Such social structures can facilitate the sealing of a corrupt contract, [Rose-Ackerman 1999: 98]. Social structures may also be helpful in spreading information on corrupt opportunities. Group-members can be entrusted with delicate pieces of information that must not spread outside the group. Large varieties of potential social structures come into play, for example kinship [Krug, Hendrischke, 2002] or belonging to the same ethnic or cultural group. Many forms of network ties are already helpful for regular business transactions. They represent a transaction cost reducing approach to enabling economic exchange, see e.g. [Ben-Porath 1980]. However, in doing so, they may also facilitate the sealing of corrupt deals by embedding individuals in trusted social relationships that contain opportunism. This impact may be dampened when networks not only strive for the material benefit of their members but also cultivate some type of fairness towards third parties. But when fairness to third parties is not relevant, kins and network ties may facilitate corrupt deals. For example, the Chinese guanxi networks embed individuals in social structures that provide safeguards against opportunism, but they simultaneously facilitate corrupt transactions, [Schramm and Taube, 2002]. Also the role of secret societies and criminal organizations is important as guarantors of corrupt transactions, [Anderson 1995: 42-7]. Their capability to use violence against people can provide them with a prime position to prevent opportunism and to promote the material benefit of their members. The variety of networks and the mechanisms employed there to facilitate corruption still deserve scrutiny. Focusing on networks can also be helpful in finding out why corruption is so much more prevalent in some countries as compared to others.

Approaching corruption from an institutional economic perspective can enrich our understanding of the causes of corruption and the scope for reform. Instead of focusing on legal institutions and their potential to contain corruption, institutional economics can approach the topic from inside the corrupt relationship. Partners in a corrupt exchange face a challenging task in negotiating the terms of their agreement and in making sure that each side adheres to its promises. At the same time they are constantly tempted to betray each other. This betrayal can be a good thing, because it assures that corruption is a troublesome business and convinces others to refrain from corruption. Based on this approach, methods can be developed for reform. Likewise, disregarding institutional economics can be troublesome. Fjeldstad and Tungodden [2001] argue that the way customs services was downsized in Tanzania was a failure because those officials who were fired at a later stage engaged as middlemen in creating trusted corrupt relationships. After a first crackdown on corruption, the corruption networks were revitalized and strengthened, and corruption returned towards its original level. Apparently, strategies in fighting corruption can fail when they do not adequately take notice of the network ties and the mechanisms that facilitate corruption.

Various reform instruments deserve evaluation from an institutional economic perspective, for example the potential to regulate intermediaries. Equally important is to encourage whistleblowing, [Pope 2000]. Containing corruption has become a primary concern of almost all multinational lenders and development agencies. The workshop thus intends to provide some further analytical support for the current initiatives. But such an approach can easily be helpful also beyond the scope of fighting corruption. Informal network ties such as "hawala" have played a major role in facilitating and obfuscating payments for terrorist purposes. Understanding the functioning of such a conspiratorial networks thus directly feeds into other reform requirements, which are of primary importance nowadays.

References

Anderson, A. (1995), "Organized Crime, Mafia and Governments." The Economics of Organized Crime, ed. by G. Fiorentini and S. Peltzman, (Cambridge: Cambridge University Press), 33-54.

Ben-Porath, Y. (1980), "The F-Connection: Families, Friends, and Firms and the Organization of Exchange. Population and Development Review, VI (1), 1-30.

Bray, J. (1999), "Beyond Compliance: Corruption as a Business Risk". Conference on Fighting Corruption in Developing Countries and Emerging Countries: The Role of the Private Sector, Organisation for Economic Cooperation (OECD) Development Centre, Washington DC, February 1999. (http://www.crg.com/publications/compliance.htm, retrieved December 6, 2001).

della Porta, D. and A. Vanucci (1999), Corrupt Exchanges, Actors, Resources and Mechanisms of Political Corruption, (New York: de Gruyter).

Fjeldstad, O.-H. and B. Tungodden, (2001), "Skatteunndragelse og korrupsjon i Tanzania. En studie av Tanzania Revenue Authority", Den Ny Verden XXXIV (3).

Husted, B.W. (1994), "Honor Among Thieves: A Transaction-Cost Interpretation of Corruption in Third World Countries." Business Ethics Quarterly, IV, 17-27.

Krug, B. and Hendrischke, H. (2002), "The Economics of Nepotism", Corruption: Its Realities in Asia, ed. by J. Kidd (Basingstoke, Hampshire: Palgrave), forthcoming.

Lambsdorff, J. Graf (2002a), "How Confidence Facilitates Illegal Transactions -- An Empirical Approach", American Journal of Economics and Sociology LXI, forthcoming.

Lambsdorff, J. Graf (2002b), "Making Corrupt Deals -- Contracting in the Shadow of the Law", Journal of Economic Behavior and Organization, XLVIII (3), pp. 221-241.

Pope, J. (2000), The Transparency International Source Book 2000 -- Confronting Corruption: The Elements of a National Integrity System. (Berlin: Transparency International). Online version at http://www.transparency.org/sourcebook/.

Rose-Ackerman, S. (1999), Corruption and Government. Causes, Consequences and Reform, (Cambridge: Cambridge University Press).

Schramm, M. and M. Taube (2002), "The Institutional Economics of Legal Institutions, Guanxi, and Corruption in the PR China", Corruption: Its Realities in Asia, ed. by J. Kidd (Basingstoke, Hampshire: Palgrave), forthcoming.