The New Institutional Economics of Corruption

Johann Graf Lambsdorff, Markus Taube, Matthias Schramm

• Publisher: Taylor & Francis
• Year: 2004
• eBook ISBN: 9781134316717
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This book constitutes a thorough analysis of the phenomenon of corruption, as seen from the perspective of New Institutional Economics - one of the most influential new schools of thought in the social sciences of the past decade.

1 Corrupt contracting

Exploring the analytical capacity of New Institutional Economics and New Economic Sociology

Johann Graf Lambsdorff, Markus Taube and Matthias Schramm

Introduction

Corruption has emerged high on the agenda of multinational development agencies, private firms and policy-makers. This increased interest in the phenomenon of corruption has produced a multitude of policy prescriptions, reform initiatives and conferences. The world is not short of ideas on how to tackle corruption. While good intentions abound we currently know little about their likely success. Being short of empirical evidence and profound experience, there is not even a theory available that allows us to put the various approaches into comparative perspective. How should bureaucrats be punished? How should administrative procedures be reformed? How far should parliamentarians be accountable to the public? What piece of information should be made publicly available? Is transparency always helpful? Is it possible to reward honesty? Can corruption be effectively fought by focusing on technical and organizational issues? What should be the role assigned to civil society? How far can we expect bureaucrats to follow their narrow self-interest as opposed to ethical considerations? How many resources should we spend for improving the judiciary? How should we deal with whistleblowers?

While there are numerous questions that are crucial to anti-corruption, mostly a holistic approach is suggested. This is due to the fact that corruption in one sector breeds malfeasance in another. Anti-corruption therefore is similar to destroying the Gordian knot; piecemeal approaches appear futile. However convincing such a holistic approach may appear, it does not clearly provide direction to reform. It alerts the public that much has to be done, without suggesting preferences. We need more theoretical inspiration that is able to better direct our energies in the fight against corruption. A consistent economic theory may provide valuable insights, but the task is too complex to rely on a single theoretical tradition. If we want to generate sound policy advice, only an interdisciplinary approach is likely to be successful. This is what this book is about.

We must understand the link between norms, trusts and the precise mechanisms by which corrupt relationships are established. A theoretical approach that links the corrupt exchange of goods and services with the underlying social patterns, moral sentiments and the necessity to find trusted partners is provided by New Institutional Economics (NIE) and its closely linked sociological correlate, the New Economic Sociology (NES). This volume is interdisciplinary by embracing contributions from political scientists, sociologists and economists. But the methodological approaches are not as diverse as one would expect. All contributions meet in a working environment that is concerned with institutions, both formal and informal ones. We intend to identify those institutions that are employed or especially evolve in order to meet the coordination needs of corrupt exchange. This is a task where economics and sociology meet and their joint approaches may greatly enrich our understanding of the phenomenon of corruption.

Therefore, this volume embraces the puzzle of corrupt transactions from two directions. A sociologist’s viewpoint investigates the role of norms, trust and social embeddedness in corrupt transactions. Adhering to a more sociologist tradition, individuals tend to regard these institutions as a given. They optimize their behaviour given these exogenous normative and moral constraints. A more economic line of thought is to regard institutions as being themselves the result of individual optimization. They are deliberately chosen due to their capacity in organizing everyday life – and they are equally chosen when they prove superior in organizing corrupt exchange.

Corruption: norms, institutions and society

The phenomenon of corruption in society

Corruption is a global phenomenon. News on corruption is not bound to come from developing countries and transforming countries but is also easily found in leading industrial countries of the world. But corruption crosses more than geographical boundaries; it also crosses all periods of history. One of the oldest Indian sources on corruption dates back more than 2,300 years (Klitgaard 1988: 23). In China, the penal code of the Qin Dynasty (221–207 BC) already included the phenomenon of corruption and placed heavy penalties on it.

In the end, corruption seems to be a phenomenon manifesting itself in all societies that pass a certain degree of complexity (Fleck and Kuzmics 1985) and dates back to the very first instances of organized human life (Klitgaard 1988: 77). The problem of corruption seems to be closely linked to the institutional conditions of humans living together: once a constitution permits the escape from the Hobbesian jungle, this step also establishes and codifies the power of Leviathan and enables its (parasitical and self-seeking) exploitation in societal interaction (Hobbes [1651] 1985: 202, 228). Such institutional power over (economic) resources and transactions seems inevitably to lead to corrupt behaviour. The power of formal institutions to put order to social life within a society poses one of the oldest dilemmas: the Leviathan’s institutional power to protect transactions and (re-)distribute resources also means constituting a monopoly which enables this opportunistic exploitation of the institutional power (Greif, Milgrom and Weingast 1994: 745).

On the other hand, economists commonly wonder why levels of corruption are not even higher. With self-seeking being the presumed nature of human beings, opportunities for self-enrichment should always be followed; distrusting public decision-makers should be the natural consequence; trusting them appears to be a deplorably naïve attitude. Given that we sometimes have reason to wonder about astonishingly high levels of integrity, economists must confess that they are lacking a theoretical explanation. Also, in recent experiments researchers have found that rational self-seeking optimization is not universally followed and that an intrinsic motivation lowers an individual’s corrupt zeal (Schulze and Frank 2003). This puts the role of norms into the spotlight. Corruption is always closely interrelated with norms, formal and informal rules and of course the particular legal culture of a specific society (Goudie and Stasavage 1998: 131). Analysing, explaining and fighting corruption must consider these special circumstances. The New Institutional Economics and the New Economic Sociology have devoted themselves to the analysis of these formal and informal institutional arrangements and the resulting constraints that shape the interaction of human actors in every day life. In this volume corruption is analysed, focusing on these institutional arrangements, their ability to provide an infrastructure to conduct corrupt transactions and also on their power to prevent corrupt relationships from being established.

Analysing corruption: between New Institutional Economics and New Economic Sociology

Approaching corruption from an institutional economic perspective, as well as from a sociological one, 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, as well as economic sociology, 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. The case presented in Box 1.1 illustrates just one such incident, where a long-standing corrupt system suddenly breaks apart leaving one party enraged by the betrayal of his ‘business partners’. Such betrayal can be a good thing because it assures that corruption is a troublesome business and convinces others to refrain from corruption.

Although economics and sociology are separate and distinct sciences they have recently been found trying to work on very similar phenomena. One of these is the formal and informal institution. Reaching from the constitutional codices and legal systems to the informal norms and arrangements, social scientists agree that institutions matter in social and economic life. One of the most important functions of institutions is to safeguard transactions against opportunistic behaviour. Yet these safeguarding mechanisms can be used in two different ways: some can protect legal transactions and help to economize on transaction costs, while others are used to carry out transactions that run counter to the formalized canon of legal activities – corrupt transaction being one of them.

Box 1.1

Thai sex king sees staid new world by Seth Mydans

Bangkok: The sheer injustice. Nobody had worked harder to pay off the police with wine, women, wristwatches and sacks full of cash.

And now this.

‘I’m like a mad snow dog now and I’ll bite anyone,’ said Chuwit Kamolvisit, the owner of six industrial-size massage parlors who is proud to be known as Thailand’s sex tycoon.

‘I used to buy whole trays of Rolex watches for police officers,’ he said in one of his almost daily news conferences. ‘I used to carry cash in black plastic bags for them. But they are still harassing me.’

In the dim netherworld of Thailand’s black economy, it is hard to know just who is doing what to whom.

But somehow Chuwit seems to have lost his immunity, and the tell-all ruckus he is raising has the country transfixed.

All at once, after 10 years of bribes that he says added up to US$ 2.5m, Chuwit has been accused of involvement in the midnight bulldozing of a rival’s entertainment plaza and of procuring underage girls to perform what is politely called massage.

That is not how it’s supposed to work. If a corrupt society is to function smoothly, each party has to do its part. The protectors have to protect.

‘I have donated items for their comfort, including tables and chairs, not to mention computers and refrigerators,’ Chuwit told delighted local reporters.

Also car maintenance, home repair, boxing tickets, golf memberships, bowling and, of course, free pleasure at Victoria’s Secret, Honolulu, Hi-Class, Emmanuelle, Copacabana, and Sea of Love.

None of this comes as a surprise to anybody.

Holding news conferences, waving arms, kneeling in prayers, sealing his mouth with masking tape, saying he had been kidnapped by police officers and then rolling on the ground to show reporters how it happened – Chuwit, it turns out, is a one-man entertainment venue all by himself.

Chuwit may not be naming names – not yet – but tossing around broad hints in what one paper said had become a sort of national quiz show.

[. . .]

International Herald Tribune, 31 July 2003, S. 1–5

Most often, the boundaries between economics and sociology, and even more those between NIE and NES, are not clear cut (Velthuis 1999). Both tend to emphasize the role of norms, trust and reciprocity in economic transactions. Sociologists, though, rather tend to regard these institutions as being beyond individual human design and focus on the way they are socially constructed. In contrast, economists emphasize how individuals shape their institutional environment and how norms and trust may result from individual optimization. These differences will also be observed in this volume. Most economic writers ask how corrupt individuals shape their institutional environment so as to carry out a corrupt transaction securely. Sociologists, on the other hand, tend to investigate the normative preconditions that are favourable to the development of corruption.

Economics may explain the cost-utility calculus carried out by every single individual, while the New Economic Sociology can explain the social ties beyond the economic-rationale. Or, as Durkheim puts it in his sociological view of The Division of Labor in Society:

[economic actors] are . . . solidly tied to one another and the links between them function not only in the brief moments when they engage in exchange or service, but extend considerably beyond.

(Durkheim [1893] 1984: 21)

The NES points at the importance of informal and formal norms as a way to order social and economic life. The work of Granovetter discovers the importance of networks and relationships for social and economic action (Granovetter 1974). In re-discovering the importance of the social fabric for economic life, the discussion on the importance of networks, clans and families, social norms and values, as well as trust and reciprocity, has been revived (DiMaggio 1990; Granovetter 1985). But the ‘embeddedness’ of economic activities within social relationships and institutional arrangements poses a serious problem to neoclassical theory, as well as to some parts of neo-institutional theory: it is fundamentally incompatible with the model of economic man as a homo oeconomicus. If the social embeddedness of economic actors really does ‘influence and simplify the way we think and act, what we observe, how we interpret what we observe, our standards of evaluation’ (Brunsson and Olsen 1993: 21), then the free choice of individuals is limited by the institutions they face. This is what the New Economic Sociology lays emphasis on. Economic action is analysed within the social context it is situated in. Concerning the acting individuals, three analytical guidelines are created that distinguish NES from NIE (Granovetter 1992: 4):

1. the pursuit of economic goals is normally accompanied by that of noneconomic ones such as sociability, approval, status and power;
2. economic action (like all action) is socially situated, and cannot be explained by individual motives alone; it is embedded in ongoing networks of personal relations rather than carried out by atomized actors;
3. economic institutions (like all institutions) do not arise automatically in some form made inevitable by external circumstances, but are socially constructed.

Economic and social exchange – legal and illegal – is thus facilitated by being embedded in a social structure, something that is beyond individual control and motivation (Granovetter 1985). Such social structures also play an important role for corrupt transactions (Rose-Ackerman 1999: 98; Cartier-Bresson 1997: 163). The analysis of corruption must in this perspective start with the analysis of institutional preconditions that help to facilitate corrupt transactions.

Building on the basic principles of neo-classical economics the New Institutional Economics is accepting the importance of all kinds of formal and informal constraints placed upon the individuals by the institutional setting. In addition to this, institutional arrangements are used to economize on transaction costs; that is, they are set up and used by the actors to minimize the costs of transacting with each other and to safeguard transactions against opportunistic behaviour. Thus, institutions are created as a direct consequence of the maximizing behaviour of economic actors. NIE is focused on how institutions evolve, how they are designed and how they emerge as a consequence and result of maximizing behaviour, and thus, lastly, on how they economize on transaction cost. Nevertheless, a large amount of informal institutions are not the result of human design. As Hayek points out, these informal institutions play an important role in human civilization:

We flatter ourselves undeservedly if we represent human civilization as entirely the product of conscious reason or as the product of human design . . . Many of the greatest things man has achieved are the result not of consciously directed thought, and still less the product of a deliberately coordinated effort of many individuals, but of a process in which the individual plays a part which he can never fully understand.

(Hayek 1979: 149–50)

In this sense we must observe that economists sometimes consider institutions to be purposefully designed by humans, but that others regard them to be the outcome of evolution, competition and the market’s capacity to select superior institutional arrangements. It becomes more troublesome, henceforth, to establish a universally accepted dividing line between economics and sociology.

A broader understanding of individuals as economic and social actors departs from a narrow notion of a human as a homo oeconomicus. It is hardly possible, of course, to mention all the modifications made to homo oeconomicus and the economic theory in economics, sociology and cognitive science. There are numerous developments in these sciences that contribute to our understanding of humans as economic and social actors, and only few of them are mentioned within this book. If there is one main trend of theorizing, it is the one pointed out by Smelser and Swedberg, who show that ‘the sharp boundary between economics and sociology seems to be weakening’ (Smelser and Swedberg 1994: 17). The New Institutional Economics are contributing to this development with their presumption of bounded rationality, which modifies the pure economic man to become more realistic. At the same time, in sociology and of course in the New Economic Sociology, the introduction of the Rational Choice approach leads to stronger ‘economically’ oriented modelling of human behaviour.

Both traditions of economic thought emphasize that corruption is deeply interwoven with the norms of society. Understanding the underlying principles of corrupt transactions and their embeddedness in the web of relationships also helps to develop new strategies for combating corruption. Thus, within this book two views are combined: on the one hand, a sociological view of how norms and institutions arise, how they vary in different social settings and how they embed a corrupt transaction into a broader framework; on the other, an economically oriented analysis on how they are purposefully designed by corrupt actors.

The NES approach to norms and society

The interplay between self-seeking behaviour and (behaviour constraining) norms has a profound impact on corruption and may give rise to questions like: can norms survive in a highly corrupt environment? With little reason to trust one another, is it likely that corruption will be fought? Is it possible to make technical improvements to a country’s institutions and to improve the more informal aspects of trust and norms afterwards? The contributions collected in this volume are not affirmative to these questions. Generalized trust appears continuously to be a crucial factor for integrity and low levels of corruption. This emphasizes an issue that is easily overlooked when being ‘too technical’ in the fight against corruption. Improved administrative procedures may be helpful, more transparency and accountability in politics appear crucial, but anti-corruption must go deeper into understanding conflicts and a country’s system of norms. The sociological studies presented in this volume emphasize the role of particularistic norms in striking corrupt deals. Corrupt actors must find an environment that is favourable to carrying out illegal transactions. Networks have to be available, ensuring that favours are reciprocated even where this contradicts with other virtues. Corruption flourishes where institutions allow trust to relate only to conspirators rather than to the whole of society.

Two sociologists, Hartmut Schweitzer and Peter Graeff, discuss the relationship between corruption and norms. Schweitzer argues that corruption is not necessarily a violation of norms. Rather, conflicts between universalistic norms and particularistic norms are crucial to the emergence and spread of corruption. Universalistic norms compete against particularistic norms, creating situations of normative ambiguity. Corruption may emerge when particularistic norms are more binding than universalistic norms, for example. The varying strengths of particularistic norms and universalistic norms can cause the spread of corruption within societies. Graeff provides a more micro viewpoint to the role of norms in singular corrupt transactions, asking which situational aspects assure the fulfilment of mutual promises. In the case of an anonymous exchange between corrupt partners this fulfilment may be supported by norms, such as rules of fairness in dividing the corrupt gains or of reciprocity in sticking to one’s promises. He distinguishes these loosely binding norms from the strategic trust that can emerge in a more closely knit, long-term relationship between corrupt partners. Here, reciprocity can originate from the personal relationship between the actors. The prospect of dealing with each ot...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Figures
• Tables
• Contributors
• 1 Corrupt contracting
• 2 Corruption – its spread and decline
• 3 Why should one trust in corruption?
• 4 Corruption trends
• 5 Trust and corruption
• 6 Self-enforcing corruption
• 7 The use of intermediaries and other ‘alternatives’ to bribery
• 8 Corrupt relational contracting
• 9 The governance mechanisms of corrupt transactions
• 10 Private ordering of corrupt transactions
• 11 Inefficient property rights and corruption
• 12 Corruption in international trade – pleading for a responsible WTO
• 13 The case of corruption in Nigeria