New Tools Against CorruptionTaking Stock of What We have Learned

Giancarlo Spagnolo SSE-SITE, Tor Vergata, EIEF & CEPR

WORLD BANK Washington DC, Jan 19, 2016

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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

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Which Corruption Focus: “Bureaucratic Corruption” •  Legal Tools not effective against “Political

Corruption” Focus: “Corrupt Transactions” •  è Multiple Agents è Organized Crime

èCooperation among multiple criminals needed

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…

èMuch of what we say relevant to them, with appropriate modifications for specificities

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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

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How?

Corruption must be an equilibrium

èDesign Laws so that it is not

Organized crime needs cooperation

èMaximize asymmetry, conflicts of interests between criminal partners

There is always a witness / latent information

èLaw as “revelation mechanism” 6

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

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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

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

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Very briefly: Theory

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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

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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)

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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)

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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)

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Whistleblower rewards Pros

•  Retaliation against whistleblowers (protection difficult),

èsubstantial 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)

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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

Do they work?

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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

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Acconcia, Immordino, Piccolo e Rey (2014)

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Acconcia, Immordino, Piccolo e Rey (2014)

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Acconcia, Immordino, Piccolo e Rey (2010)

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Acconcia, Immordino, Piccolo e Rey (2014)

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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

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

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Indirect empirical methods

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On leniency

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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.

Miller (2009)

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Actual and estimated number of DOJ cartel cases

Not super robust, but statistically significant

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!

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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

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Perrotta Berlin and Spagnolo cont’d

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Test for structural break

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Consistent with significant deterrence effect of legal change(leniency and asymmetric punishment strengthened) in 1997 (redvertical line)

Test of structural break consistent with significant deterrence effect of legal changes in 1997

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

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

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%).

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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!

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Lab Experiments

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Leniency

Bigoni et al., “Trust, Leniency and Deterrence,” J. of Law Ec. and Org., (2015)

Strong deterrence effect with α=0 and F finite.

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

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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

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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

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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!

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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

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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

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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

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

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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

Butler, Serra and Spagnolo (in progress)

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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

Social judgment

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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

(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.

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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

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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

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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

Thank you for listening J

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