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The authors would like to thank Susan Rose–Ackerman and Vito Tanzi for valuable comments. Manzoor Gill, Philip Polsky and Stacy Maynes provided excellent research assistance.
Multiple equilibria result if (1) the profitability of corruption rises or (2) the probability of detection falls, as corruption increases. This occurs through various mechanisms, including the existence of search and auditing costs (combined with fixed budgets for enforcement agencies) and moral scruples (which diminish with the prevalence of corruption). For models with multiple equilibria, see Lui (1986) and Andvig and Moene (1990). Interestingly, models of multiple equilibria raise the possibility that the effect of wages cannot be detected across countries, since a given set of parameters is consistent with various degrees of corruption.
“The Causes and Effects of Police Corruption: A Case in Political Modernization,” in Rance P.L. Lee, ed., p. 190.
The anecdotal evidence on the link between tolerance of corruption and civil service wages is mixed. In Tanzania, for example, society was tolerant of private practice by public school teachers: a ban on private tuition in Tanzania drew hostile reactions from the public, notwithstanding the fact that teacher preparations for private tutoring detracted from time to prepare for public schooling, on the grounds that teachers’ salaries were too low. “The ban could affect the standard of education further. Let the teachers generate (sic) from tuition as they do not have another source of income …” (Daily News, 5 January 1991, as quoted by Doriye (1991), p. 14). The practice of diversion of public resources in the area of health and public administration, and of privatization of police protection was less accepted, however.
This requires corruption is observable to some extent.
The Thai experience provides a clear example of how the probability of detection and conviction may adjust to the level of penalties. Thailand had the death penalty for corruption, but this penalty was rarely enforced (see Rahman (1986, p. 133)).
Becker and Stigler examine optimal incentive schemes, broadened to include the posting of bonds and the granting of pension rights, which have the effect of requiring life time payments to law enforcers equal to (not above) what they could get elsewhere.
Whether civil service wages are judged fair or not by society may well reflect the budgetary situation. Telephone surveys conducted by Kahneman et al. (1986) indicate that (1) pay cuts by profitable firms are considered unfair even when unemployment is high; and (2) pay cuts which result from a worsening competitive position of the employer are considered acceptable.
See for example Rose–Ackerman (1975) and Mookherjee and Png (1995) for models where B is determined through simple bilateral bargaining and Flatters and McLeod (1995) for a model with coalition formation; see Bardhan (1996) for a discussion of why bribe levels in practice are small compared to the rents imparted.
We do not consider the possibility that civil servants can influence the probability of detection through bribes to enforcers. See Besley and McLaren (1993) for a brief survey of modeling approaches to this issue. See also Tirole (1986) and Andvig and Moene (1990) for applications.
The level of the bribe for a corrupt act (which is theoretically also linked to opportunities) is assumed to be constant and exogenously given, for simplicity. See above references for an explicit modeling of the level of bribes. The assumption that opportunities are constant is also made for simplicity, and could be relaxed so as to incorporate the idea that bureaucrats create opportunities to collect bribes.
The experiments (conducted with Austrian university students) involve a two–stage game between “employers” and “workers.” Employers offer wages in the first stage and workers respond by offering effort in the second stage. Monetary gains from the game to employers and workers depend in the usual way on effort and wage–levels. Reputation effects do not exist in this game, as employers change in each game. The results indicate that workers provide more effort when offered higher wages. These results are confirmed in experiments in Russia involving high monetary stakes (Fehr and Tougareva, 1996). One possible concern with the experiments is that reciprocity, while it can be costly to “workers” in absolute terms, is not costly relative to their expected payoffs in the games.
The sociological literature reaches similar conclusions. A classic example is Mathewson (1969) who notes, based in part on his experiences as a participant observer, that “occasionally workers have an idea that they are worth more than management is willing to pay them. When they are not receiving the wage they think is fair, they adjust their production to the pay received” (as quoted by Akerlof and Yellen, p. 261).
In this experiment, 44 percent of undergraduate students who found apparently “lost letters” containing $10, returned the letters.
Interestingly, experimental evidence shows that workers who are overpaid do not necessarily increase their effort, a result which may be explained by cognitive dissonance (Walster, Walster, and Berscheid, 1997, p. 124 as cited by Akerlof and Yellen, p. 258). In terms of the model, workers adjust their perceived effort when overpaid, not their actual effort!
When the probability of detection for any individual act is independent of the number of corrupt acts, the probability of detection of at least one act is 1- (1-p)C. For low p (below 0.1) and C (below 10), this is well approximated by the expression pC used in the model. For high p and C, the expression pC provides an overestimate of the probability of detection. Hence this model is not applicable to developed countries, as these would tend to have high probabilities of detection. Note also that the assumption of a fixed p abstracts from the possibility of multiple equilibria resulting from having fixed enforcement resources (under those circumstances, the probability of detection of an individual act would decline with the number of corrupt acts).
Published by Political Risk Services in the International Country Risk Guide (ICRG), for the period 1982–95. This data set was assembled by the IRIS Center (University of Maryland) from hard copies of the International Country Risk Guide.
See Dumont in Ekpo, ed. (1979) for a persuasive account of how wages of expatriates and funds needed to “receive guests properly” appeared to be the appropriate benchmarks for civil service wages following independence of a number of French-speaking African countries (p. 402 and 406). See Lee (1986) for a discussion of the role of “personal status–discrepancy”, i.e., a person’s comparison between his or her social and economic statuses in creating “wants” for corruption (p. 95).
Relative skill content in manufacturing may be expected to be higher in more developed countries. This turns out not to be the case for our sample of developing countries, as indicated by a regression of the relative civil service wage on GDP per capita and enrollment in secondary education, though it is true for a sample of industrial and developing countries combined.
Recent work by Evans and Rauch (1996) suggests that relying on internal promotions rather than political appointments for high–level positions tends to reduce corruption.
This is the typical kind of bribe called “speed money”. Some authors have implied that “speed money” may be efficiency enhancing because requests will be processed according to their opportunity cost. However, this argument ignores, the fact that bureaucratic red tape may not be completely exogenous. Bureaucrats may actively search to complicate procedures and increase red tape in order to increase their rents. (See Rose-Ackerman, 1997)
The original variable name in ICRG is “law and order tradition.” Scored 0–6.
We use an unweighted average of the index of political liberties and the index of civil rights (redefined so that an increase in the index reflects an improvement). Raw scores—corresponding to affirmative actions on a well–defined questionnaire—are translated into an index, which ranges from 1 to 7 (7 represents the least free).
The experience in tax administration suggests that the timeliness by which penalties are applied is of paramount importance to their effectiveness. This would have to be taken into account in comparisons involving statutory penalty rates across countries and over time.
The degree of competition is measured by a number of indicators: merchandise imports as a share of GDP, an index of import restrictions, “trade distance”—average distance to capitals of the world’s 20 major exporters, weighted by value of bilateral imports, land area, road density, an index of market dominance and an Anti Trust Laws index. The latter indexes are from the World Competitiveness Report, a publication of the EMF Foundation (Geneva).
Industrial policy is measured by a procurement index measuring “the extent to which public procurement is open to foreign bidders;” a fiscal index measuring “the extent to which there is equal fiscal treatment to all enterprises;” and subsidies to private and public enterprises. The first two indexes are from the World Competitiveness Report, a publication of the EMF Foundation (Geneva).
The sources for the black market and the official exchange rate are, respectively, International Currency Analysis, Inc., World Currency Yearbook (New York, various issues, December figures) and the IMF’s International Finance Statistics (Washington, various issues) line “ae”.
This index measures the probability that two randomly selected persons from a given country do not belong to the same ethnolinguistic group. This index is calculated by Taylor and Hudson (World Handbook of Political and Social Indicators, 1972) and is constructed based on raw data in Atlas Narodov Mira (Department of Geodesy and Cartography of the State Geological Committee of the USSR, Moscow, 1964) and refers to 1960. We would like to thank Paulo Mauro for sharing this data.
This applies to most independent variables. The shares of the within country variation is 12 percent for the “rule of law”, 12 percent for “quality of the bureaucracy”, 16 percent for “political rights and civil liberties”, 1 percent for real GDP per capita, and 82 percent for the black market premium.
When the true model involves a distributed lag, but only contemporaneous terms are included (for example), fixed effects estimation will provide an unbiased estimate of the contemporaneous term. This estimate will bear no relationship with the long–run multiplier on wages, which is the coefficient of interest, however.
The between estimator could nevertheless have a higher mean squared error than the OLS estimator given that the variance of the OLS estimator, being inversely proportional to the total variance of the independent variables, is smaller than the variance of the between estimator, which is inversely proportional to the (smaller) variance of the mean of the independent variables.
Thus, pay is likely to be related to the education of civil servants through either a compositional effect (a civil service which relies more or less on highly qualified staff) or the effect of pay on the ability to recruit well–educated personnel. Low pay acts on society’s willingness to accept corruption. Yet the causality could also be the other way around, with government pay decisions influenced by possibilities of corruption on account of society’s lack of policing.
Specifically, correction for heteroscedasticity on account of differing number of observations across countries is carried out in three steps. First, between estimation is carried out on the raw data. Second, the squared residuals from this regression are regressed on a constant and the number of observations available in a country. Third, the raw data is divided by the square root of the fitted values of the previous regressions (i.e. the estimated country-specific error variances), and between estimation carried out, with White–correction, using this weighted data.
In addition, the measurement error could be correlated with indicators of development and generate bias on the coefficients for these variables, if the manufacturing wage data capture child labor (given the likely correlation between indicators and development and the incidence of child labor). The scope of the manufacturing data is not sufficiently known to form a judgment on this.
Using government wages relative to GDP per person in the labor force would compound the problem of measurement error, if the level of development is not adequately controlled for in the regressions. This is because wages relative to GDP per person in the labor force tend to be higher in less developed economies (Kraay and Van Rijckeghem, 1995), where GDP per person in the labor force reflects productivity in agriculture and the human capital required in government is scarce. Thus this ratio tends to be very high in Africa where government employees are skilled relative to the average. There is no such correlation for government wages relative to manufacturing wages across the countries in our sample.
The sample size varies from 22 to 28 depending on the specification.
The significance of “political rights” in the existing literature also varies depending on specification (see Ades and Di Tella (1995a) and Ades and Di Tella (1995b)).
Other work also finds a relationship for opportunities (measured inter alia by an index of market dominance, an Anti–Trust Laws index, and an index indicating whether public procurement is open to foreign bidders. See Ades and Di Tella (1995)).
Few countries have relative wages at or above 1.7. Hong Kong and Singapore, with relative wages of 1.8 and 3.5, exhibit very little corruption. El Salvador and Korea, with relative wages of 1.7 and 1.9, exhibit relatively high corruption.
As explained in Section IV, the fact that the within estimates are not significant could also reflect a lack of power to reject the null or the omission of dynamics (reducing corruption through wage-policy is likely to require a consistent policy of high pay rather than one-time pay increases).
Homogeneity in terms of ownership structure (private or public) is not important for our purposes.