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New Tools Against Corruption Taking Stock of What We have Learned

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by Prof. Giancarlo Spagnolo, SSE-SITE, Tor Vergata, EIEF & CEPR

Presented at WORLD BANK, Washington DC, Jan 19, 2016

Read more: https://www.hhs.se/site

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New Tools Against Corruption Taking Stock of What We have Learned

  1. 1. New Tools Against Corruption
 Taking Stock of What We have Learned Giancarlo Spagnolo SSE-SITE, Tor Vergata, EIEF & CEPR WORLD BANK Washington DC, Jan 19, 2016
  2. 2. 2 Overview of the Talk •  Introduction - Focus •  Crucial Characteristics of Corruption •  The “New” Legal Tools that Exploit Them •  How do They Work: Theory •  Pros and Cons •  Do They Work? How to Measure •  Experimental Evidence •  Empirical Evidence •  Where we need more research
  3. 3. 3 Which Corruption Focus: “Bureaucratic Corruption” •  Legal Tools not effective against “Political Corruption” Focus: “Corrupt Transactions” •  è Multiple Agents è Organized Crime èCooperation among multiple criminals needed
  4. 4. Different from individual crime 1.  Governance problem: contracts cannot be used to prevent internal hold-up/moral hazard 2.  There is always at least one witness: the partner Information already available that can be extracted THESE FEATURES CAN BE EXPLOITED Same features collusion, smuggling, trafficking (any “trading of bads ), large frauds and robberies, mafia… èMuch of what we say relevant to them, with appropriate modifications for specificities 4
  5. 5. Individual vs Organized •  Individual crime: decision of a criminal; •  Organized crime: equilibrium of a criminal game; è Not sufficient that expected gains are larger than expected fines/sanctions è More conditions needed to sustain a cooperative criminal equilibrium, can be exploited to deter it 5
  6. 6. How? Corruption must be an equilibrium èDesign Laws so that it is not Organized crime needs cooperation èMaximize asymmetry, conflicts of interests between criminal partners There is always a witness / latent information èLaw as “revelation mechanism” 6
  7. 7. Legal Tools that Do This •  Leniency/immunity policies: reduced sanctions in exchange for information/ collaboration •  Asymmetric punishment: legalization of one side, criminalization of the other •  Whistleblower rewards: protection & reward schemes for innocent and accomplice witnesses 7
  8. 8. Why “New”? Old cases… •  Ancient Roman’s “Divide et Impera”… •  XIII Century England’s Bounties… •  Common law’s prosecutorial discretion, plea bargaining and settlements… •  US False Claim Act, the “Lincoln law” since the Civil War... •  Accomplice-witness programs, e.g. against Mafia and Terrorism in Italy in the 80s and 90s 8
  9. 9. Isolated Episodes Most cases discretional and limited (apart from dictatorships that instead “overused” them) •  New 1: success in Antitrust in US after ‘93 reform, commitment to public rules è •  New 2: systematic economc research on optimal design and costs and benefits of these tools è •  New 3: systematic diffusion around the world of standardized design (for leniency) against collusion 9
  10. 10. Very briefly: Theory 10
  11. 11. 11 Cooperation Needed
 •  Becker’s B>αF only necessary for organized crime •  Agency problems, as in non-criminal organization or transaction, need governance •  Cooperation is needed (between briber and bribee, price-fixers, drug producer and retailer). –  There will be gains from defection , i.e. temptations to betray running away with the cash , not delivering after cashing a bribe, Stigler s secret price cuts… –  Court-enforced contracts not available
  12. 12. 12 Cooperation Must be Reached and Sustained
 •  Criminal organizations/transactions must be self-enforcing, requires repetition/reputation –  An additional constraint, the incentive constraint (IC) (also called self-enforcement or no deviation constraint) for equilibrium as in Stigler (1964); –  And with multiple equilibria + risk of defection, coordination/trust (CT) necessary (Spagnolo 2004)
  13. 13. 13 Leniency and Asymmetric Sanctions: Pros New deterrence channels: 1.  Increase gains from deviation/reporting crime to law enforcers, deter crime by violating the IC ensuring corruption is not equilibrium (as in Motta and Polo 2003, Spagnolo and Buccirossi 2006, Lambsdorff and Nell 2007, Basu 2011, Spagnolo and Dufwenberg 2015, Basu, Basu and Cordella 2015) 2.  Reduce ‘trust’/hamper coordination, deter crime by making CT harder (Spagnolo 2004)
  14. 14. 14 Leniency and Asymmetric Sanctions: Cons 1.  Require capable and non-corrupt law- enforcement to prevent retaliation (all) 2.  Complex/subtle, may easily be poorly designed and ineffective (all) 3.  May be manipulated and backfire (all, e.g. Buccirossi and Spagnolo 2006) 4.  May send the “wrong message” (asymmetric sanctions, e.g. Dreze 2011)
  15. 15. 15 Whistleblower rewards Pros •  Retaliation against whistleblowers (protection difficult), èsubstantial monetary rewards for whistleblowers essential to help against it •  Funded by fines and assets seized in convictions, as in US False Claim Act, SEC, IRS, and CFTS programs •  Paid to accomplice or innocent witnesses, increase deterrence through fear of beying reported (CT and α); •  Contrary to narrative rewards limit manipulations (Spagnolo 2004, Buccirossi and Spagnolo 2006)
  16. 16. 16 Whistleblower rewards Cons May induce “information fabrication” to cash rewards •  (but this is a crime, sanctions can be increased and courts are there to avoid this) Make whistleblowers less credible as witnesses •  (but better a weak witness than none; moreover, other witnesses can be found after the whistleblower has signaled the crime) Moral outrage (“rewarding snitches” as in dictatorships) Not needed/effective, may crowd out honesty/morality
  17. 17. Do they work? 17
  18. 18. Acconcia et al. (2014) Focus: •  Italian Mafia-related crimes with victims •  1991: Italian leniency/immunity program (D.L. 13/05/1991 n. 152) + protection program (D.L. 15/01/1991 n. 8) Well run programs work with analogous crimes 18
  19. 19. Acconcia, Immordino, Piccolo e Rey (2014) 2
  20. 20. Acconcia, Immordino, Piccolo e Rey (2014) 20
  21. 21. Acconcia, Immordino, Piccolo e Rey (2010) 21
  22. 22. Acconcia, Immordino, Piccolo e Rey (2014) 22
  23. 23. 23 For corruption more difficult
 “Victimless” in the sense of perception of crime: •  Directly observed only when detected/convicted •  But we interested changes in total crime population Ex: Increase in conviction rate after a policy change –  Good news, if caused by improved enforcement –  Bad news, if caused by reduced deterrence Perception measures help, but very noisy and culture- dependent
  24. 24. Focus Recent studies using: -  Indirect empirical methods that infer changes in total population from changes in convicted population -  Laboratory experiments where total crime population can be directly observed 24
  25. 25. Indirect empirical methods 25
  26. 26. On leniency 26 Miller (AER 2009): Stochastic model of industries transiting in and out collusive states, applied to US Cartel Detection Data 1985 – 2005 •  Hypothesis #1: If the 1993 leniency revision resulted in an increase in the probability of discovery then there is an immediate rise in the number of discovered cartels. •  Hypothesis #2: If the 1993 revision resulted in a decrease in the rate of cartel formation then the number of discovered cartels should adjust to a lower steady level.
  27. 27. Miller (2009) 27 Actual and estimated number of DOJ cartel cases Not super robust, but statistically significant
  28. 28. Perrotta Berlin and Spagnolo (20??) •  Adapt Miller approach to corruption, collect data on detected corruption cases in China, to evaluate: –  Basu’s (2011) proposal to legalize bribe-paying for extortionary (harassment) bribes –  Dufwenberg and Spagnolo’s (2015) suggestion to use leniency (immunity conditional on reporting) Both policies experimented in China in last decades! 28
  29. 29. Perrotta Berlin and Spagnolo cont’d •  Important: Amendment IX to Criminal Law proposed oct. 2014 has heavier penalties for bribery, but leniency and asymmetric punishment more limited and discretional. •  Introduced in 1997, it has been claimed that these policies “did not work” (Li, 2012) but no empirical evidence available 29
  30. 30. Perrotta Berlin and Spagnolo cont’d 30 Test for structural break ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742 t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5 10 20 30 40 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Year Population−adjustednumberofcases Actualandestimated−OLS Consistent with significant deterrence effect of legal change (leniency and asymmetric punishment strengthened) in 1997 (red vertical line) Test of structural break consistent with significant deterrence effect of legal changes in 1997
  31. 31. Caveats: much left to do •  We don’t know which cases are extortionary (harassment) bribes and which to gain illegitimate benefit •  We don’t know in which cases leniency was applied and in which asymmetric sanctions were •  For asymmetric punishments, potential denomination effect if briber-givers’ and bribe-takers’ cases recorded separately (However, in Guo (2008) 4-9% of cases) Ongoing case files analysis on a sample before and after Would love access to procurates’ data, can anyone help? 31
  32. 32. On Whistleblowers and Rewards
 Stylized facts: 1.  No big problems with US False Claim Act 2.  Small rewards ineffective (UK, Korea) 3.  Whistleblowing extremely costly –  Death is a frequent price paid in many societies –  Long unemployment, harrassment and social ostracism in the best of the cases 32
  33. 33. Dyck, Morse and Zingales (2010) Who brings corporate fraud to light? What motivates them? •  Study all reported fraud cases in large U.S. companies between 1996 and 2004. Legal and financial whatchdogs ineffective: •  SEC accounts for only 7% of cases, auditors only 10% •  Debt holders are absent, equity holders play trivial role Other agents play a key role: employees (17%), non- financial-market regulators (13%), the media (13%). 33
  34. 34. Dyck et al. (2010) cont’d Monetary rewards play a crucial role: •  In healthcare – where suits in which whistleblowers are typically rewarded – 41% of frauds reported by employees; only 14% in other industries •  Difference significant at the 1% level, effect robust to controls for industry characteristics Monetary incentives to blow the whistle work! 34
  35. 35. Lab Experiments 35
  36. 36. 36 Leniency Bigoni et al., “Trust, Leniency and Deterrence,” J. of Law Ec. and Org., (2015) Strong deterrence effect with α=0 and F finite.
  37. 37. Bigoni et al. (2015) Deterrence with α=0 and F finite è First Best achievable with organized crime and leniency •  Confirms Spagnolo (2004), contrast to Becker’s (1968) point for individual crime… •  Robust, replicated by Chowduhury and Wandscheneider (2015) and Kindsgrab (2015) è Leniency + robust sanctions (F) works against corruption/organized crime 37
  38. 38. Asymmetric punishment Two main lab experiments: 1.  Engel, Georg and Yu (2013) 2.  Abbink, Dasgupta, Gangadharan and Jain (2014) –  Use different corruption games, with and without the possibility of hold-up –  Obtain opposite results 38
  39. 39. Engel, Georg and Yu (2013) One-shot corruption game with governance problem: •  Payer bribes first, then receiver can deliver •  Receiver can hold-up payer not delivering Spagnolo (2000), Buccirossi and Spagnolo (2006) and Lambdorff and Nell (2007): reduced sanctions may become a governance tool reporting credible punishment against hold up 39
  40. 40. Engel et al. (2013) cont’d Results: More bribery with asymmetric punishment •  cheaper to punish hold-up and govern transactions •  both in session run in China and Germany As in Buccirossi-Spagnolo (2006): reduced sanctions used to enforce/govern occasional corruption! 40
  41. 41. Abbink et al. (2014) One-shot corruption without governance problem: •  Bureaucrat may ask for a bribe •  Citizen can refuse, pay, or pay and report No problem of enforcing agreement, as Basu (2011), Dufwenberg-Spagnolo (2015), Basu et al. (2015) •  Possibility that bureaucrat retaliates if reported 41
  42. 42. Abbink et al. (2014) cont’d Results: Less corruption with asymmetric punishment •  Somewhat fewer bribes proposed •  Somewhat more bribes reported Small effect It disappears when possibility of retaliation introduced 42
  43. 43. Whistleblowers rewards Apesteguja, Dufwenberg and Selten (2007) •  Experimental one-shot whistleblower game •  Weird effects of rewards, slightly hinders reporting in one-shot collusion game Bigoni et al. (2012) •  Repeated game with learning, rewards (only) very effective in eliminating collusion 43
  44. 44. Abbink and Wu (2013) Repeated bribery game between client and officials with governance problem (official may take bribe but not deliver) •  Three variations of report/reward mechanism: both can report, only the client, only the official •  Moderate size of reports Results Symmetric and last mover (official) report types mildly effective in deterring bribing with repeated corruption 44
  45. 45. Abbink and Wu (2013) •   All extremely effective without repetition •  Corrupt favors granted at lower rate only in periods where agents were uncertain whether the game would continue •  No manipulation to solve governance problems CONCLUSIONS (Moderate) rewards work very well, less powerful if corruption repeated, no point in restricting to one side (all as in Spagnolo 2004) 45
  46. 46. Butler, Serra and Spagnolo 
 (in progress)
 46 Lab experiment with strong frame on whistleblowers motivations •  multiple 3-person firms: one boss, two employees •  members of public (6 per session) Boss can corrupt, benefiting also employees, but imposing negative externalities on the public Employees may blow the whistle at a cost, harming boss but benefitting the public With and without monetary rewards for whistleblowers
  47. 47. Social judgment 47 Members of the public always informed about the manager’s law-breaking. We vary whether the public… •  …learns about the harm done to them or not (visible vs. invisible externalities) •  …learns about whistleblowing (public vs. private whistleblowing) •  In “public whistleblowing” treatments, each member of the public may judge the whistleblower by sending one of these costless messages
  48. 48. (Very) Preliminary results •  Result 1 (‘Rewards effect’): Monetary rewards work, though partly crowded out by visibility of negative externalities of corruption (sense of duty?). •  Result 2 (‘Traitor effect’): Making whistleblowing public reduces whistleblowing when externalities from corruption are invisible. •  Result 3 (‘Hero effect’): Making whistleblowing public increases whistleblowing when externalities from corruption are made visible. 48
  49. 49. Conclusions •  Theory works: most prediction of early models supported by empirical and experimental evidence •  These tools may work extremely well, potentially very strong corruption deterrence effects •  Subtle, easy to wrongly design them, details matter •  Can be manipulated and used to govern corruption •  Not so much if “high powered”: with large monetary rewards for wistleblowers, safer and more effective 49
  50. 50. Words of caution •  Require some independent law enforcers (FBI-like agencies) or other healthy third party •  Must be well designed and managed and adapted to countries’ insitutional situation (not always advised with low judiciary independence/high judiciary corruption) •  Can be used as monitoring tool by donor agencies, but carefully: poorly designed/managed programs may be counterproductive –  anonymity then crucial to avoid putting wistleblower’s life at stake 50
  51. 51. Other issues 1.  Risk of istitutional capture: mild forms of leniency without strong incentives reduce deterrence but increases number of succesfull convictions, making law enforcers appear “heros” while damaging society 2.  Multi-crime problem: if corruption combined with other crimes for which no leniency is available, the tools will not work (antitrust/corruption) 3.  Centralization needed: Mexico (2013), Brazil (2014)… decentralized… may be used as retaliation… 4.  ….. 51
  52. 52. Thank you for listening J 52