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Corruption: Top Down or Bottom Up?

Article in Economic Inquiry January 1999
Impact Factor: 0.98 DOI: 10.1093/ei/40.4.688 Source: RePEc

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CORRUPTION: TOP DOWN OR BOTTOM UP?

CHRISTOPHER J. WALLER, THIERRY VERDIER, and ROY GARDNER*

This article studies the impact of corruption on an economy with a hierarchical

government. In particular, we study whether centralizing corruption within the higher
level of government increases or decreases the total amount of corruption. We show
that when the after-tax relative profitability of the formal sector as compared to that
of the informal sector is high enough, adding a layer of government increases the total
amount of corruption. By contrast, for high-enough public wages and/or an efficient
monitoring technology of the bureaucratic system, centralization of corruption at the
top of the government hierarchy redistributes bribe income from the lower level to
the upper level. In the process, total corruption is reduced and the formal sector of
the economy expands. (JEL D73)

centralized in the chief of state, who then

monitors lower-level officials in an attempt
to collect corruption rents. Bottom-up corruption refers to a setting in which corruption decisions are decentralized at the level
of lower officials. In this form of corruption,
the chief of state is simply one among many
collectors of corruption rents. A similar distinction, using the same language, is made by
Rose-Ackerman (1999), where bottom-up
refers to low-level officials collecting bribes
and sharing them with superiors, while topdown refers to corrupt superior officials buying the silence of subordinates by sharing
their ill-gotten gains.
There is evidence that both forms of corruption exist in practice, especially in various
parts of the Commonwealth of Independent
States (CIS). Quantitative evidence of the
importance of corruption to macroeconomic
performance is also available. In the latest
report of the European Bank for Reconstruction and Development (EBRD), the states of
the CIS are found to have substantially higher
levels of corruption than the states of Central
Europe, the Baltic republics, and the Balkans.

I. INTRODUCTION

Corruption takes many forms and can

arise at many levels, as pointed out by the
classic study of Wade (1985). A large literature has grown up since then, modeling
various aspects of corruption; see the surveys by Bardhan (1997), Organisation for
Economic Co-operation and Development
(OECD) (1997), and Schneider and Enste
(2000). One of the questions that this literature has yet to answer concerns the structure of corruption. Borrowing the language
of budgeting, we can think of two structures of corruption: top-down and bottomup, as in Gardner and von Hagen (1996) and
Cheung (1998). Top-down corruption refers
to a setting in which corruption decisions are
*We would like to thank Krister Andersson, Kaushik
Basu, Steve Lewarne, Rob Masson, Michael McGinnis,
Bruce J. Bueno de Mesquita, Elinor Ostrom, Eric Rasmusen, and an anonymous referee for helpful comments.
Any remaining imperfections are the sole responsibility
of the authors, who wrote this article as visiting faculty
members at Economics Education and Research Consortium, National University of Ukraine, Kyiv-Mohyla
Academy.
Waller: Gatton Chair, Department of Economics, University of Kentucky, Lexington, KY 40506-0034.
Phone 1-859-257-6226, Fax 859-323-1920, E-mail
cjwall@pop.uky.edu
Verdier: Professor, Department and Laboratory of Theoretical and Applied Economics (DELTA), 75014
Paris, France. Phone 33-1-43 13 63 98, Fax 33-1-43
13 63 10, E-mail tv@delta.ens.fr
Gardner: Chancellors Professor, Departments of Economics and West European Studies, Indiana University, Bloomington, IN 47405. Phone 1-812-855-6383,
Fax 1-812-855-3736, E-mail gardner@indiana.edu

Economic Inquiry
(ISSN 0095-2583)
Vol. 40, No. 4, October 2002, 688703

ABBREVIATIONS
CIS: Commonwealth of Independent States
EBRD: European Bank for Reconstruction and
Development
OECD: Organisation for Economic Co-operation
and Development

688
Western Economic Association International

WALLER, VERDIER, & GARDNER: CORRUPTION

In the former, firms report paying 5.7% of all

revenues as bribes; in the latter, only 3.3% of
revenues (EBRD, 1999). The report finds it
no coincidence that economic growth in the
latter, less corrupt states, is more than 2%
higher on average than growth in the CIS.
It goes without saying that states exhibiting either top-down or bottom-up corruption
get low marks from the various international
surveys of corruption. For instance, according
to Transparency International, the average
transparency ranking of ten Central European countries is 46, compared to 86 for ten
CIS countries. However, what is unclear is
how these different structures affect the economic performanceefficiency and growth
of the economy. Bardhan (1997) suggests that
corruption is more acute in Russia today than
in the former Soviet Union because it is now
decentralized, not under party control as in
the old days. He also compares Indonesia
with India and raises an important question:
The two countries are equally corrupt and yet
the economic performance by most accounts has
been much better in Indonesia. Could it be that
Indonesian corruption is more centralized and
thus somewhat predictable


whereas in India
it is a more fragmented, often anarchic system of
bribery? (Bardhan, 1997, 1325)

Bardhans question is one of second best:

Given that corruption exists, to what extent
is one structure of corruption to be preferred
to another? Informal arguments have been
offered to suggest that one or the other structure is to be preferred, as in Shleifer and
Vishny (1993) and Acemoglu and Verdier
(1998, 2000), but a formal analysis has yet to
answer this question. Our objective is to build
a principal-agent model of government corruption to determine when and under what
conditions centralized corruption is better for
the economy than decentralized corruption.
As we will show, the answer is not straightforward but depends on a large number of
economic fundamentals.
Our metric of preference is allocative efficiency. One of our results is that allocative efficiency is monotonically decreasing in
the total amount of corruption in monetary
terms. This provides considerable support for
allocative efficiency as a metric of preference. Another result characterizes the distribution of corruption payments, although, as
might be expected, the relationship between
distribution and allocative efficiency is quite

689

complex. This point is made forcefully, albeit

in a rather different model, by Bliss and
Di Tella (1997).
Our main result is that we can divide
the parameter space of the model into
three mutually exclusive sets and, using these
parameter sets, determine when top-down
corruption is the preferred corruption regime
and when bottom-up corruption is preferable.
Under one set of circumstances (roughly,
a government with high monopoly power
and lower public sector wages), centralization
of corruption increases overall corruption,
because it is simply adding an additional layer
of corrupt officials at the top. By contrast,
when there are high enough public wages
to motivate lower-level bureaucrats efficiently
(through an efficiency wage kind of reasoning), centralization of corruption solves the
double marginalization problem, improving
the allocation of resources.
The crucial parameters for dividing the
parameter space include the number of
lower-level officials, their official wage, and
their probability of being monitored. Previous studies have pointed to the importance
of these variables. Thus, Mookherjee and
Png (1995) give a central role to the official
wage and the probability of being monitored,
whereas the number of corrupt officials plays
a central role in Tirole (1996). In contrast to
the latter model, however, all (not just some)
lower level officials are corrupt in our decentralized regime.
We also study the comparative statics of
total corruption with respect to these parameters within a particular corruption regime
as well as across corruption regimes. Here
again the relationship between these parameters and allocative efficiency is complex. For
instance, increasing the official wage (a popular policy recommendation among international donor organizations) may reduce neither the total amount of corruption, nor the
number of corrupt officials. Such a reduction depends on the structure of corruption, as well as other parameters in the
model. Results such as this suggest how sensitive empirical studies are to the specification of corruption. They also help explain
why empirical results are so often inconclusive concerning the role of variables, such as
the official wage of lower level officials.
This article has implications as well for
the closely related literatures of crime, rentseeking, endogenous growth, common-pool

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ECONOMIC INQUIRY

resources, and the economics of transition.

Basu et al. (1992) show that issues arise in
complex corrupt settings that go well beyond
the standard economic model of crime. Rentseeking, as in Acemoglu (1995) and Olson
(1995), is what motivates officials playing
in either of the corruption structures studied here. Our officials are rent-seekers, with
rents being generated by expected gains from
investments made in the economy; the autocrat in our model is likewise a rent-seeker. To
the extent that corruption results in allocative
efficiency losseshere, lost investmentswe
also get endogenous growth effects. These
growth losses provide a formal explication of
the concepts of social capital, as in Putnam
(1993), and social breakdown, as in Hirshleifer (1995).
Next, one can interpret the demand for
investments in an economy subject to corruption as a common-pool resource, as in
Ostrom et al. (1994), where the commons
is man-made and those using the commons
are the bureaucrats (and possibly autocrat)
charging bribes. Absent institutions to prevent tragic outcomes, one can expect such a
commons to exhibit serious efficiencies in the
presence of a large number of bribe-takers.
This connection was first noticed by Shleifer
and Vishny (1993).
Finally, because some of the successor
states of the former Soviet Union rank
among the most corrupt in the world, our
results apply to the economics of the transition of those states from planned to market economies. Thus, for instance, we would
expect the Tanzi effectincreases in the price
level have a negative impact on real taxes
collected due to corruptionto be present
in the data generated from such countries.
Moreover, we would predict considerable
transition costs involved in restructuring a
corrupt regime into a more transparent and
open economic system. The financial crisis of
summer 1998, whose effects still linger in the
CIS, partly reflects the failure of international
aid programs to achieve such a restructuring
of these economies. Such is increasingly the
view of the EBRD after a decade of aid programs in the CIS.
The article is organized as follows. Section
II lays out the basic principal-agent model.
Section III contains the results on bottom-up
corruption; these turn out to be straightforward compared to those on top-down corruption. Section IV studies top-down corruption

under the assumption that the participation

constraints for lower-level officials is satisfied.
Section V is devoted to a detailed examination of the participation constraint question.
Section VI concludes.

II. MODEL

Our model has three players: entrepreneurs, bureaucrats, and an autocrat.

Entrepreneurs undertake investment projects
but need permits from the government to
operate. The autocrat is at the top of the government hierarchy; the bureaucrats occupy
the lower level of government responsible
for day-to-day operations. Our government
hierararchy has only two levels, and our
autocrat is not accountable to the electorate,
an assumption reasonable for many developing countries. Bag (1997) develops a model
in which the public is the principal, monitoring the autocrat who in turn monitors
the bureaucrat. We abstract from real-world
complications by assuming at most two levels
of corruption. Of course, in the real world
there may be many layers of corruption. (See
Guriev [1999] for an example of a three-tier
government.) We assume bureaucrats have
power to grant permits that private agents
need to carry out business in the formal
economy.
Corruption occurs when a bureaucrat
demands a bribe from a private agent in
return for the permit. The autocrat, if
involved in the bribery, either receives a kickback from bureaucrats or chooses a level of
bribe for the bureaucrats to demand. In our
model, we do not impose any restrictions on
the morality of the autocrat, that is, he or
she does not oppose corruption on moral
grounds, nor do we assume that the people
are able to force the autocrat to oppose corruption via electoral competition. Again, we
do not impose any restrictions on the morality
of the bureaucrats; if taking bribes maximizes
their utility, they take bribes.
The basic question in which we are interested is whether having the autocrat involved
in the bribe process: (1) simply adds another
bribe-taker or (2) reduces some inefficiency
that arises from letting the bureaucrats determine bribes on their own.

WALLER, VERDIER, & GARDNER: CORRUPTION

Entrepreneurs
Individual entrepreneurs are endowed
with two possible investment projects: one in
the formal sector of the economy and one
in the informal sector. The formal projects
have idiosyncratic payoffs, and the informal
sector projects do not. In short, the informal projects are homogeneous; each project
offers the same fixed-return, as opposed to
the heterogeneity inherent in formal sector projects. Operating in the formal sector
requires the payment of taxes. The value of a
formal sector project drawn by entrepreneur
i is
(1)

ViL

= V t + i 

where t is a lump-sum tax paid by each

entrepreneur in the formal sector of the
economy and i is the idiosyncratic return on
the investment project, uniformly distributed
on the interval [0, a]. If all entrepreneurs
operate in the formal sector, the size of the
formal economy is 1. The assumption that i
is uniformly distributed is made for technical
convenience only. Any continuous distribution will lead to the same qualitative results.
The informal project has a payoff
(2)

PiI = V I

for all i. Taxes do not apply to the informal

sector.
To undertake investment in the formal sector, entrepreneurs need to acquire a permit
from each of n > 1 different bureaucrats in
the government. In practice, this can lead
to a large number of permits. Even for a
small business in Ukraine, n = 10 is a typical number. Consequently, the net payoff to
entrepreneur i from investing in the formal
sector is given by
(3)

ViL = V L t + i Bi 

where Bi is the total amount of bribes paid

by entrepreneur i, the sum of bribes bi j paid
by i to each bureaucrat j. We distinguish
between taxes, t, which are determinate and
predictable, and bribes B, which even at equilibrium have an element of arbitrariness to
them. This interpretation is made forcefully
by Wei (1997).

691

Entrepreneur i will choose to enter the

formal sector of the economy when (3)
exceeds (2), which implies
(4)

i V L t V I Bi 

We will assume that V L t V I > 0. In

the absence of corruption, where Bi = 0 for
all i, there would be no shadow economy,
as (4) would hold for all i. This is the firstbest benchmark outcome. At this first-best
outcome, given our normalization, total taxes
collected equal t, a maximum.
Bureaucrats
Each bureaucrat chooses a bribe to charge
an entrepreneur who applies for a permit
from his office. He also receives a civil servant wage, given by w. We assume w exceeds
the bureaucrats reservation wage from nongovernmental employment, which we normalize to zero. This allows us to ignore modeling
the bureaucrats decision to work in the civil
service, as in Besley and McClaren (1993).
The bureaucrat chooses a bribe to maximize expected income. The bureaucrat is
not able to observe the idiosyncratic part
of the entrepreneurs project but does know
the distribution of i . By symmetry, a
bureaucrat charges the same bribe to all
entrepreneurs who request permits. Furthermore, he is aware that other bureaucrats are
also demanding bribes.
Given these assumptions, the demand for
permits Q, also the size of the formal sector, is piecewise linear

in bribes. Letting X =
a + V L t V I bj , where the latter sum
is taken over all bureaucrats j, one has Q =
X/a when X does not exceed a, and Q = 1
otherwise.
We also assume that the autocrat receives
a kickback from each bureaucrat, with q
denoting the fraction of the bribe income
paid to the autocrat. Alternatively, one can
think of q as the probability the autocrat detects whether or not the bureaucrat
charges a bribe. If the bureaucrat is found
to have taken a bribe, the autocrat takes the
entire bribe but does not fire the bureaucrat.
One could also model the problem as one
in which the bureaucrat risks being fired in
addition to losing the bribe income. As long
as the kickback tax rate does not exceed q,
the bureaucrats will be truthful in reporting

692

ECONOMIC INQUIRY

their bribe income to the autocrat under this

scenario also.
Under either of these interpretations, we
take q to be exogenous, admittedly an
extreme assumption made solely to better
focus on the main issue, centralized versus
decentralized corruption. For a method of
endogenizing q, see Besley and McClaren
(1993); our main results are robust to q endogenized in this way.
The bureaucrats problem is to maximize
bribe income, given by



max w + 1 qbj
1/a di
(5)
bj

Xa

= max w + 1 qbj X/a

bj

Notice that the bureaucrats problem is

degenerate if q = 1.

the International Monetary Fund (IMF) a

$100 million fine for bookkeeping and related
irregularities in 199798.
III. DECENTRALIZED CORRUPTION

Uncoordinated Bribe-Setting
In our decentralized equilibrium, the autocrat specifies q and lets the bureaucrats
choose whatever bribes they desire. At this
Nash equilibrium, bureaucrats are modeled
as players choosing their bribes simultaneously, taking the other bureaucrats bribes as
given. Consequently, the first-order condition
from (5), exploiting symmetry, yields the following Nash equilibrium bribe per bureaucrat
and total bribes paid by each entrepreneur:
(6)

where k = a + V L t V I

Autocrat
The autocrat levies taxes on the legal sector, pays civil servants wages out of the budget, monitors bureaucrats, and collects bribe
income from those bureaucrats detected taking bribes. The autocrats income z from
the bribe process is z = qnbj X/a. The budget deficit G T is given by G T = nw
tX/a. Under our assumptions of a fixed w
and n, government expenditures G are constant across all regimes. At the same time,
taxes T are proportional to the size of the
legal economy. Thus, at the first-best outcome, where the size of the legal economy
is 1, one has G T = nw t = 0, where the
last equality comes from assuming a balanced
budget at the first-best outcome. Corruption,
which reduces taxes collected, results in a
budget deficit. One could impose a balanced
budget constraint among the corrupt regimes
as well. Because corruption leads to a smaller
tax base, the need to cover a budget deficit
by taxing other sectors of the economy would
only be exacerbated in such a case.
A hallmark of corrupt regimes is the keeping of multiple sets of books. For instance,
the autocrat (or his agent) may keep one
set of books to satisfy international financial
institutions that the budget is balanced, while
keeping another set of books (the accurate
set) showing the true budget imbalance. Such
appears to have been the case at the Central
Bank of Ukraine, which in 2000 agreed to pay

bjd = k/1 + n

B d = nk/1 + n

where the superscript d denotes the decentralized equilibrium. These expressions have
a long history in economics, going back to
Cournots (1838; rpt. 1963) treatment of the
reverse monopoly problem. Given (6), the
size of the legal economy is Q = k/1 + n,
which we assume to be less than 1 for the
remainder of the article.
Total bribes paid in the economy are
(7)

total bribes = QB d = k2 n/1 + n2 

of which proportion q are paid to the autocrat:

z = qk2 n/1 + n2 

(8)

Coordinated Bribe-Taking
If the bureaucrats coordinate their bribes
and choose a common bribe, b, then the
optimal bribe maximizes the representative
bureaucrats income, now given by



1/a di
(9) max w + 1 qb
b

X a

= max w + 1 qbX/a
b

where X = V L t V I nb

WALLER, VERDIER, & GARDNER: CORRUPTION

Maximizing with respect the common

bribe b yields
(10)

b = k/2n
B = nb = k/2

The size of the formal economy is Q =

k/2a, and total bribes are
(11)

total bribes = BQ = k2 /4a

Comparing (10) and (6) we see that the

bribe price per entrepreneur is lower in this
case than in the uncoordinated case. Comparing (11) and (7) reveals that total bribe
income is larger in the coordinated case. Furthermore, the size of the formal economy
is larger when bureaucrats coordinate their
bribes. These results are shown in Figure 1.
This result generalizes that of Shleifer
and Vishnys (1993) two-bribe-setter model.
The reason for the high bribe price per
entrepreneur in the uncoordinated case is
that each bureaucrat fails to take into consideration how his bribe affects other bureaucrats bribe choices. When bureaucrat i
raises his bribe, on the margin he knows
that this will reduce the probability that an
entrepreneur will pay the higher bribe. However, he ignores the fact that by reducing the
entrepreneurs probability of paying bribes,
he reduces expected bribe income for all
other bureaucrats. This negative externality
results in asking for too large a bribe by all n
bureaucrats in the uncoordinated case.
In a sense, the investment demand under
decentralized corruption is like a commonpool resource, in which the entrepreneurs
are an investment commons being exploited
by the bureaucrats. As a result, a typical
tragedy of the commons problem arises and
the bureaucrats overuse (extract too much
rent) the resource. As pointed out by Ostrom
et al. (1994), in the absence of institutional
arrangements to prevent overuse from occurring, one expects very inefficient outcomes
as the number of bureaucrats grows large.
Here, as n gets large, investment demand
is extinguishedthe ultimate inefficiency, as
compared to the first-best benchmark.
All bureaucrats would benefit from forming a cartel and acting as a monopoly
bribe-setter. In addition, the legal economy
would be larger under the cartel arrangement. However, the usual problems with

693

enforcing cooperation apply here. Thus an

institutional arrangement that enforces the
monopoly bribe-setting outcome is needed.
This is where the hierarchical structure of the
government comes into playthe autocrat
can serve as the institutional enforcement
mechanism to maximize total bribe income.
It is to this arrangement that we now turn.
IV. CENTRALIZED EQUILIBRIUM

Now consider the case where the autocrat mandates that the bureaucrats charge a
bribe of a certain size, which is to be turned
over to the autocrat. The autocrat can then
redistribute all or part of the bribe income
back to the bureaucrats in the form of a
lumpsum transfer. However, bureaucrats may
decide to disobey orders by charging more
than the mandated bribe and keeping the difference. Hence, the autocrat and bureaucrats
are involved in a standard principal agent
problem. To enforce compliance, the autocrat
threatens dismissal if a bureaucrat is caught
charging more than the mandated bribe. If
the bureaucrat is caught taking an extra bribe,
the bribe is confiscated and he is fired from
his civil service job. Though the threat of job
loss is a standard argument for inducing honest behavior on the part of civil servants, in
our model, the threat of job loss is not used
as a tool to eliminate corruption. Rather, it is
used to ensure that bureaucrats produce the
autocrats desired amount of corruption.
By locating the bribe decision at the top
of the hierarchy, we are confronted with a
dilemma. Does centralizing the bribe decision
at the top increase total corruption by simply adding a layer of corruption to the process? Or, by internalizing the effect of total
bribes on legal activity, does centralization at
the top reduce total corruption? In the next
section, we show that either outcome can be
generated, depending on the parameters of
the model.
The Bureaucrats Problem
In the centralized equilibrium, the autocrat tells each bureaucrat to charge b per
permit and return the proceeds back to the
autocrat. Each bureaucrat must then decide
whether or not to charge more than b at the
risk of getting fired. If the bureaucrat does
not charge an amount above b, his income is

694

ECONOMIC INQUIRY

FIGURE 1
The Demand For Permits and Equilibrium Quantities

simply w plus his lump sum transfer . If he

does charge more than the mandated bribe b
his problem is

(12) max 1 qw + 
bj

+ 1 qbj


X a


1/a di

= max1 qw +  + bj X/a

where X = V L t V I nb bj , b is the
mandated bribe per bureaucrat and bj is the
additional bribe demanded by bureaucrat j
over and above that mandated by the autocrat. The first-order condition for this problem yields the following Nash solution for bj
in the centralized equilibrium
(13)

bjc

= k nb/1 + n

where the superscript c denotes the centralized equilibrium.

If k nb < 0, the net value of the project
is zero and no entrepreneurs will be in the
legal sector, which means no bribe income
or tax revenues for the government. Thus,
we will only consider solutions for which
(13) is positive. The bureaucrats will only
choose to demand bjc if their expected equilibrium income from asking for additional
bribes exceeds their civil service salary. Otherwise bjc = 0. The condition for the bureaucrats to comply with the mandated bribe and
set bjc = 0 is
(14) nb k 1 + naqw + /1 q1/2 
Note that (14) is more likely to hold, the
larger are q w , and b. Intuitively, bureaucrats are more likely to do what the auto-

WALLER, VERDIER, & GARDNER: CORRUPTION

crat tells them to do the larger the probability of getting caught and the more costly it
is getting fired. Furthermore, the larger the
mandated bribe b, the smaller the expected
number of entrepreneurs applying for permits. Because this reduces the expected payoff from asking for even more bribes, the
bureaucrats are more likely to comply with
the autocrats orders. Because the bureaucrat cares about the sum w + , we set  = 0
and simply rescale the value of w to account
for this. As we argue later, the autocrat has
strong incentives to reward the bureaucrats
in this fashion.
The Autocrats Problem
The autocrat wants to choose b to maximize his expected bribe income, denoted
Y nb, taking the bureaucrats bribe decision
as given. However, from (14) we see that his
choice of b affects the bureaucrats decision
to cheat on the mandated bribe or not.
Let nb0 = B0 denote the value that makes
(14) hold with equality,
(15) B0 = k 1 + naqw + /1 q1/2 
This is the value of nb0 that makes the
bureaucrat indifferent between cheating or
not. Hence, the bureaucrats bribe decision is
(16) bj = k nb/1 + n

when nb < B0

bj = 0 otherwise
Now, depending on whether bureaucrats
ask for bribes or not, the autocrats expected
income can be computed as follows. When
bureaucrats comply with the autocrats bribe
orders, bj = 0, the autocrat becomes a
monopolist bribe-setter. In this case, his
expected income Ym nb is given by
(17) Y nb = Ym nb = k nb/anb
The first term in (17) is the measure of
entrepreneurs who apply for permits k
nb/a and the second term nb is the level of
mandated bribes.
When bureaucrats charge more than the
mandated bribe, the autocrat merely becomes
the n + 1 bribe-setter. Hence his expected
income in this case, denoted Y2 nb, is the
sum of his expected mandated bribe income
plus his expected income from confiscating

695

the additional bribes from bureaucrats he

catches cheating:
(18) Y nb = Y2 nb
= k nb/a1 + n
qnk nb/1 + n + nb
The first bracketed term in (18) is the measure of entrepreneurs who apply for permits,
and the second bracketed term is the sum
of confiscated bribes and mandated bribes.
Figure 2 plots the two functions Y2 nb and
Ym nb. The autocrats expected income with
bureaucrats corruption Y2 nb has a maximum at B = nb = $k/2, where $ = 1 + n
2qn/1 + n qn < 1.
His monopolistic expected income Ym nb
has a maximum at B = nb = k/2 > B .
Because being a monopolist is clearly better
than being an n + 1 bribe setter, one also gets
that Ym B  Y2 B .
Figure 2 plots these two payoff functions
for the autocrat. Let B be the value of B for
which the autocrats income in the monopolistic bribe-setting regime equals his maximum income in the bureaucratic corruption
regime. Any value of B in [k/2, B ] yields
higher bribe income for the autocrat than the
regime with bureaucratic corruption.
The problem of the autocrat is then to
maximize his payoff function Y nb over B =
nb given the incentive constraint for bureaucrats given by (14). Three possible regimes
can emerge, depending on where the boundary point of the incentive constraint lies. It
turns out that the optimal value of B can
be reached at B = $k/2, B = k/2, or the
threshold point B0 . We consider each regime
in turn.
Regime 1: Bribes at Both Levels
of Government
This case, represented in Figure 3, occurs
when B0 > B > k/2. The autocrat maximizes
his expected income at B . As a result, this
is a regime with corruption at both levels
of government. Because entrepreneurs pay
bribes to both bureaucrats and the autocrat,
total bribes per entrepreneur are
(19) total bribes per entrepreneur
= nb c + nb = 2n + $k/21 + n

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ECONOMIC INQUIRY

FIGURE 2
Autocrat Income in Monopoly and nth Bribe-Setter Equilibrium

Total bribes paid in this regime equal

FIGURE 3
Autocrat Income with Bribes at Both Levels
of Government

(20)

total bribes = nk2 /a1 + n2 

$k2 n 1 + $/2
/2a1 + n2 

and the autocrats bribe income in this regime

is Y2 B  = k2 /4a1 + n1 q.
Comparing (19) to (6) we see that total
bribes per entrepreneur is higher than in
the decentralized corruption case. However, the total amount of bribes paid to
the government in this regime is lower
than in the decentralized corruption equilibrium. The reason is that the total number
of entrepreneurs applying for permits falls
enough to more than offset the increase in
bribe payments per entrepreneur, that is, the

WALLER, VERDIER, & GARDNER: CORRUPTION

FIGURE 4
Autocrat Income with Monopolistic
Bribe-Setting

demand for permits is bribe-elastic at this

level of equilibrium bribes per entrepreneur.
This is a result of the distributional assumption on i ; permit demand is elastic for B >
k/2. Thus, the formal economy is smaller
in this regime than in the decentralized
regime. Adding a layer of government to the
corruption problem leads to a worse outcome than in the uncoordinated decentralized equilibrium.
Regime 2: Monopolistic Bribe-Setting
by the Autocrat
Figure 4 shows this regime, which occurs
when B = k/2 B0 . The autocrat has a maximum income at the point: B = nb = k/2,
which is also the total bribe per entrepreneur,
as this is the regime with monopoly corruption.
The autocrat sets a higher mandated
bribe if he is a monopolist bribe-setter than
he does in the regime in which bureaucrats cheat and charge additional bribes.
However, despite the fact that the autocrat mandates a higher bribe in regime 2
than regime 1, comparing B to (10) and
(20) shows that total bribes actually paid
per entrepreneur are lower in this case than
in regime 1 or the decentralized corruption
equilibrium. Nevertheless, equilibrium bribe
income is highest in this regime. By centralizing the bribe process and becoming a monopolist bribe-setter, the autocrat internalizes
the externality associated with uncoordinated

697

FIGURE 5
Autocrat Income in the Constrained
Monopoly Bribe-Setting Equilibrium

decentralized bribe-setting into account. As

a result, total bribes per entrepreneur are
reduced.
Regime 3: The Constrained Monopolist
Bribe-Setter
This is the regime that reflects the fact
that the autocrat is constrained in his maximization of monopolist bribes and is shown in
Figure 5. This regime occurs when B > B0 >
k/2. The autocrat cannot choose the monopolist bribe because it is not high enough to
deter the bureaucrats from charging an additional bribe. However, by choosing B = B0
in this case, the autocrat makes the mandated
bribe high enough to deter additional bribes
and still earn more income as a monopolist
bribe-setter than reverting to being the n + 1
bribe-setter. Consequently, in the regime the
autocrat is at a corner. Total bribes paid
per entrepreneur are higher than in the case
where B = k/2. The total bribes paid per
enterpreneur will be lower than in the decentralized case when 21 + naqw/1 q1/2 <
k < 1 + n2 aqw/1 q1/2 .
Figure 6 summarizes the ordinal ranking
of each regime compared to the decentralized Nash bribe-setting regime. We see that
the two-level bribe equilibrium is the worst
outcome, followed by the decentralized Nash
equilibrium, the constrained equilibrium and
the monopoly bribe-setter equilibrium.

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ECONOMIC INQUIRY

FIGURE 6
Equilibrium Bribes and Permits

Discussion of the Three Regimes

It is useful to investigate the parameters
conditions under which the different regimes
prevail. To do this, let y = aqw/1 q1/2
and thus B0 = k 1 + ny.
The conditions for regime 1 are B0 >
k/2 and k B0 B0 /a < k2 /4a1 + n qn.
These can be rewritten as k > 21 + ny and
k > 21+nAq ny, where Aq n = 1/1
n1 q/1 + n1 q1/2  > 1. Hence the
two-level bribe regime will prevail under the
condition
(A)

k > 21 + nAq ny

Similarly, the condition for the monopolistic

centralized bribe regime (regime 2) is given
by B0 < k/2, which can be rewritten as
(B)

k < 21 + ny

Finally the constrained monopolist regime

(regime 3) occurs when
(C)

21 + ny < k < 21 + nAq ny

The three regions (A), (B), and (C) are represented in Figure 7 in the plane y k. The
value of k represents the measure of how
many high return investment projects there
are in the economy. When this number is
large, asking for a bribe has a small effect
on driving entrepreneurs into the informal
sector. The value of y reflects the expected
cost of getting fired. The monopolist bribe
regime is more likely to prevail when y is
large relative to k, which is likely to be satisfied when the cost of getting fired is relatively high. In this region, the autocrat is able
to implement the monopolist bribe because
he is able to efficiently monitor his bureaucrats through the stick (the probability of
control q) or the carrot (the wage rate w).

WALLER, VERDIER, & GARDNER: CORRUPTION

FIGURE 7
Parameter Support of The Various
Bribe Regimes

On the other hand, the regime with bribes

at both levels is more likely to occur when
k is largenamely, when the after-tax relative return of the legal sector as compared to
the informal sector is high or there are many
high-value investment projects in the economy (a large value of a). In this region, the
temptation for bureaucrats to ask for an additional bribe is quite high, making it difficult
for the autocrat to fight corruption at that
level of the bureaucracy. Hence his optimal
response is to choose the two-level corruption regime. Finally, for intermediate values
of k and y, the constrained monopolist bribe
regime prevails. The autocrat would ideally
want to be a monopolist briber but, given the
fundamentals of the economy, his monopolistic bribe level is not high enough to deter
bribe-taking at the lower level of the bureaucracy. Therefore he prefers to choose a constrained monopolistic bribe level.
An increase in the size of the bureaucracy n shifts counterclockwise the two rays
k = 21 + ny and k = 21 + nAq ny in
Figure 7. This has the effect of enlarging the
monopolistic bribe region and reducing the
two-level bribe region. The effect on the constrained monopolist bribe region is ambiguous. The reason is that as n increases, bribing
becomes less profitable for bureaucrats, as
fewer entrepreneurs choose to enter the formal sector by paying bribes. Hence it is easier
for the autocrat to sustain the monopolistic

699

bribe regime or the constrained monopolistic

regime.
The previous discussion provides also
some cross-country predictions on the implications of having an additional layer of corrupt administration on corruption and its efficiency costs. In particular, it suggests that
an additional layer of corrupt bureaucracy is
more likely to have corruption efficiency costs
on output for rich economies, which presumably are also the ones with large corporate opportunities for business in the formal
sector. On the other hand, poor economies
in this second-best world may be better off
in terms of production with a corrupt autocratic government hierarchy able to capture monopolistic rents and deter lower-level
corruption.
Interestingly, this also suggests that any
liberalization or economic reform, which
increases the profitability of the private legal
sector, should be accompanied by intensive administrative reforms against corruption. Otherwise, liberalization without reform
at the top level of the bureaucracy may
well move the corruption equilibrium from a
monopolistic bribe region (B) to a two-level
bribe situation (A), increasing corruptioninduced inefficiencies and thereby stripping
away the potential economic gains of the liberalization process.
The Correlation of Corruption
with Economic Activity
Which of the bribe equilibria has the lowest level of corruption? To answer this question, we must construct a metric of corruption.
However, such a construction is problematic
given the above results. If we measure corruption as the bribes paid per entrepreneur
(or investment project), then corruption is
highest in the centralized regime 2 and lowest in the centralized regime 1. On the other
hand, if we measure corruption as total bribe
income, then corruption is lowest in regime 1
and highest in regime 2. Hence, depending on how one wants to measure corruption, the monopoly bribe-setting equilibrium
may be viewed as the lowest- or the highestcorruption equilibrium. But regardless of how
corruption is measured, the legal sector of the
economy is largest in this regime, as is per
capita income.

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ECONOMIC INQUIRY

This result is interesting because it ties

into a long-standing debate regarding the efficiency implications of corruption. On the one
hand, it is argued that corruption reduces private market efficiency by creating frictions
that inhibit private sector investment. Hence,
corruption is sand in the wheels. On the other
hand, it is also argued that corruption is often
the only way to get things accomplished;
without it, nothing gets done. According to
this line or argument, corruption greases the
wheels.
Our results show that whether or not
corruption is correlated with private sector
investment depends to some extent on how
one measures corruption. In the monopoly
bribe-setting equilibrium, bribes per investment project are the lowest, hence there is
more private sector investment. But because
more entrepreneurs choose to operate in
the legal sector and acquire permits from
the government, total bribe payments in the
economy are high. Hence, by the first measure, corruption exhibits a negative correlation with private sector activity; by the second
measure, corruption is positively correlated
with private sector activity. This suggests that
empirical studies purporting to estimate the
correlation between corruption and private
sector activity must be very careful in how
they measure corruption.
For our purposes, because the regime with
the lowest bribe per entrepreneur has the
largest legal sector and, thus, the largest level
of per capita income, we believe this is the
most relevant measure of corruption. Consequently, in regime 1 we find that adding
a layer of government to the bribe process
simply leads to more corruption, whereas
in regime 2 we find that adding a layer of
government actually lowers the amount of
corruption.
Welfare Analysis of the Different Regimes
Clearly the regime with corruption at both
levels is the worst equilibrium possible for
all involved, except the bureaucrats. In this
equilibrium, bribes per entrepreneur and the
shadow economy are at their highest values
and tax revenues and the autocrats bribe
income are at their lowest values. Adding the
autocrat into the bribe process simply adds
a layer of corruption that worsens economic

efficiency. On the other hand, the monopolist regime may be welfare-improving compared to the decentralized (one-layer) corruption equilibrium. As we already noticed,
in a second-best world in which corruption is
unavoidable, centralized corruption internalizes the negative externality of corruption by
other bureaucrats on investment decisions in
the formal economy. This tends to improve
the efficiency of allocation of resources in
the economy. On the other hand, a monopolist in corruption has more monopoly power
to set bribes, hence asking for a larger bribe
per project. Whether the centralized monopolist corruption equilibrium is more efficient
than the decentralized corruption equilibrium depends on which effect is stronger.
Here the externality effect is stronger than
the monopolization effect, as total bribes
per project in the decentralized equilibrium
nk/1 + n is larger than total bribes per
project under monopolization. Hence, from
an efficiency point of view, centralized regime
2 provides the best corruption equilibrium.
The third corruption regime can be analyzed similarly. Total bribe per project is B0 ,
which is smaller than the bribe with centralized corruption, nk/1 + n, as long as
k < 1 + n2 y holds. In this case, this regime
provides a larger legal economy than does
decentralized corruption and so leads to a
more efficient allocation of resources.
V. ENSURING BUREAUCRATIC COMPLIANCE

Up until now we have assumed that the

parameters affecting the bureaucrats compliance with the bribe mandate, q w n, and
k, were constant. However, all four of these
parameters are under the control of the autocrat to some extent. The parameter q is a
function of the autocrats monitoring technology and effort. The civil servants salary, w,
can be set by the autocrat. The size of the
bureaucracy, n, is also under the control of
the autocrat. Finally, k is affected by the taxes
imposed on entrepreneurs by the autocrat.
Because the autocrats most preferred
bribe equilibrium is the interior monopolist
bribe-setting solution, he has a strong interest
in ensuring that bureaucrats comply with the
mandated bribes. Combining the equilibrium
bribe under monopoly B with the incentive
compatibility constraint (14) yields
(21)

k 21 + ny

WALLER, VERDIER, & GARDNER: CORRUPTION

Because he has control of the parameter values of k q n, and w, the autocrat can adjust
these four parameters to ensure that (21)
always holds. He can do this by
1. raising tax rates to lower k (the net
value of legal projects);
2. increasing the bureaucrats salary;
3. increased monitoring of bureaucrats
(increase q); or
4. increasing the size of the bureaucracy
(increase n).
Although the autocrat can ensure that (21)
holds using any one of these instruments,
he will not be indifferent to which of these
parameters is used. In the sections that follow
we discuss the attractiveness of using each
of these variables to ensure the bureaucrats
compliance with the mandated bribes.
Raising Taxes
Increasing taxes on firms will lower the
value of all projects and the demand for
legal projects. By lowering the expected bribe
income for bureaucrats, the autocrat ensures
that they are less willing to ask for bribes
and risk being fired. Unfortunately, lowering
k also reduces the autocrats bribe income.
Sacrificing income to induce bureaucrats to
behave seems to us to be an unattractive
method for inducing cooperation.
Raising Civil Servant Salaries
By raising civil servant salaries, the autocrat increases the penalty of getting caught
taking an additional bribe. Because civil servant salaries are paid for out of the public budget rather than the autocrats bribe
income, this is essentially a free tool for the
autocrat to ensure compliance with his bribe
orders. In a sense, this is a key difference
between an autocrat and a mafia chieftain.
Mafia chieftains are the residual claimants
to enterprise profits whereas autocrats are
not typically the residual claimants on government tax surpluses. Increasing the pay
of underlings reduces the residual profits of
the mafia enterprise and thus the income of
the chieftain, but paying higher salaries to
civil servants out of public revenues does not
reduce the autocrats income. So unless the
autocrat is able to use tax revenue surpluses

701

for his own use, raising civil servant salaries

to induce compliance with his demands seems
to be a relatively costless method for maximizing his bribe income.
Of course, if the autocrat gets utility from
public spending projects, such as more education, highways, or monuments glorifying him,
then the reallocation of tax revenues from
these types of projects to civil servant salaries
will impose a cost on the autocrat. The form
of corruption and preventive measures may
affect the allocation of government revenues
on public goods. Mauro (1998) finds that corruption is negatively correlated wtih government spending on education. Thus, the question becomes, Which is more important, his
personal bribe income or the warm glow he
gets from improving the government capital
stock? Our suspicion, based on casual observation of autocratic governments around the
world, is that the former is more important
to autocrats than the latter.
Increased Monitoring
The autocrat can also undertake more
intensive monitoring of the bureaucrats to
ensure that they abide by his bribe mandate.
But if this requires expending utility reducing effort by the autocrat, he may opt for
another method of enforcement, as in Bac
(1996a, 1996b). On the other hand, if the
autocrat can use public funds to increase
compliance, then we have the same situation as with raising salaries. For example, if
he creates a watchdog group of civil servants
responsible for enforcing compliance with the
autocrats demands and pays them with tax
revenues, then the autocrat has a free method
of increasing monitoring. However, this simply creates another principal-agent problem
for the autocrat because the bureaucrats may
pay bribes to the internal police to avoid dismissal. In short, who monitors the monitors?
Increasing the Size of the Civil Service
By increasing the size of the bureaucracy, the total amount of bribes increases,
thereby reducing the demand for permits and
the expected bribe income of an individual
bureaucrat. Hence, as an individual bureaucrat becomes a smaller part of the government bureaucracy, he is less likely to risk

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ECONOMIC INQUIRY

being fired to receive a small amount of bribe

income. Once again, the bureaucracy is paid
for out of public funds, so this is a free
method for the autocrat to ensure compliance with his orders. However, this assumes
that the probability of detection remains the
same as the number of bureaucrats increases.
In general, this is not true; as the size of the
bureaucracy increases, detection of additional
bribe-taking is reduced. Hence, increasing n
will typically be associated with a reduction
in detection, which increases the payoff from
asking for an additional bribe. As a result,
increasing the size of the bureaucracy may
actually backfire and lead to a greater likelihood of an individual bureaucrat asking for
additional bribes.
VI. CONCLUSION

In summary, it appears that increasing civil

servant salaries is the best option for the
autocrat to ensure that bureaucrats ask only
for the bribes they are told to collect. All of
the other methods appear to impose nontrivial costs on the autocrat.
If the economically optimal amount of
corruption is not zero, then an interesting
question is where should the corruption be
allocatedat the top of the government hierarchy or the bottom? Having built a hierarchical model of government, we explored the
question of whether centralizing corruption
at the top simply increases the total amount
of corruption in an economy or reduces it by
generating an organizational efficiency gain
(via a principal-agent relationship between
levels of government). We have argued that
if corruption is measured by the amount of
bribes paid per investment project, then centralizing corruption at the top of the government may lead to a more efficient allocation of corruption. Furthermore, the top
level of governmental hierarchy has many
tools at its disposal to ensure that this outcome prevails. However, if corruption is measured as the total volume of bribes paid in the
economy, then centralizing bribe decisions at
the top of the hierarchy leads to more corruption in the economy, even though there
is a larger private sector in this corruption
regime. Thus, our theoretical results provide
an important caveat for doing empirical work
on the effects of corruption on private sector
activity. In either event, the EBRDs concern

with the amount of corruption in the CIS is

well founded. Indeed, the CIS would seem to
be an area where centralizing corruption does
not seem to yield good economic results.

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