Tag: Corruption
Avoiding Corruption and Tax Evasion in Belarus’ Construction Sector
This brief summarizes our research on the problem of corruption and tax evasion in the construction sector in Belarus. We conducted a survey of construction companies, asking them to estimate the extent of different dimensions of tax evasion and corruption within the sector. The results show the most problematic directions in the sphere. Based on international experiences, we develop recommendations of how to reduce corruption and tax evasion in construction of Belarus.
Shadow economy and the construction sector
The problem of a shadow economy is real for many countries in the world. Many countries try to minimize the level of this illegal activity. But it is very difficult to liquidate tax evasion or envelope wages fully.
In Belarus there is a lot of discussion about corruption and tax evasion limitation. The country ranked 79th in the Corruption Perception Index 2016. The situation in Belarus is much better then in Russia or Kazakhstan, but worse than in Sweden, Finland and Switzerland.
There is lack of systematically updated knowledge about the situation with corruption and tax evasion in the different economic spheres of Belarus. At the same time, there are sectors, which are more prone to develop a shadow economy. One of them is the construction sector. Multilevel chains of relations between contractors and subcontractors, numerous suppliers, and complicated procedures for facility acceptance create possibilities for illegal schemes.
Construction plays an important role in national production. In 2016, the construction sector corresponded to more than 6% of Belarusian GDP. In 2014, this indicator was above 10%. The decline can be explained by a reduction of preferential lending in housing construction and a recession in the economy. Despite the reduction in the share of GDP, around 8% of the total labor force works in construction. More than 90% of the legal entities in the sphere are presented by privately owned enterprises [8].
Taking into account the importance of construction it is necessary to emphasize that reducing the size of the shadow economy could create a better business environment, reduce companies’ expenditures for resolving issues in informal ways, and increase budgetary revenues.
In this brief we present a short summary of our research “Problems of corruption and tax evasion in construction sector in Belarus”, which is forthcoming in the International Journal Entrepreneurship and Sustainability Issues. The project was made in the framework of the project “Corporate engagement in fighting corruption and tax evasion”, financed by the Nordic Council of Ministries.
Method
In order to understand the main issues and challenges in construction sector, we surveyed 50 Belarusian construction companies. We took 20 companies from Minsk and its surrounding region, and 6 organizations from each Belarusian region (Brest, Grodno, Vitebsk, Gomel, and Mogilev). The survey was based on the method used in Putnins and Sauka (2016). This method includes a questionnaire, which helps understanding the actual situation with the shadow economy in the sector. The questions of the survey were divided into three parts.
The first part included neutral questions about economic characteristics of the company, such as number of employees, profit level, the year of establishment, wage levels, and form of ownership.
The second part include more sensitive questions, but which can help us understanding the most problematic issues concerning to corruption and tax evasion. These questions concern such indicators as the level of underreported business income, the degree of underreported number of employees, the percentage of revenue that firms pay in unofficial payments to ‘get things done’, and main barriers to business development. In order to make the answers easier for participants, all the questions deal with the situation in the sector as a whole, and not the company in particular.
The third part of questions concerns the situation in public procurement, and includes the perception of main problems in the sphere.
Survey results
The first part of the survey shows that there has been a decline in many of the economic indicators during the last two years. This may be one factor stimulating the sector’s development of informal activities. Indeed the results of the second part of survey demonstrate that level of shadow economy has significant dimensions. More then 60% of the respondents agree that some firms in the sector received hidden income. More than 50% of the interviewed companies believe that some organizations in the construction sector hire part of their employees unofficially. Wages in “envelopes” is also a problem for the construction companies.
Unregistered firms are a big threat to having a well-developed construction sector. More than 60% of the interviewed companies agree with the existence of unregistered companies. Such non-official organizations create unfair competition in the sector and decrease the level of budget revenues. Many of the unregistered companies work in the sphere of home improvements and renovations.
Figure 1. Estimation of the approximate level of hidden salaries (“wages in the envelopes”) in construction industry
Notes: X-axis is the percentage of respondents that agree with the statement. Source: Results of the survey
The survey results allow us to conclude that the state budget loses part of its corporate income taxes, taxes on wages and social contributions due to the existence of hidden incomes, wages in envelopes, and unregistered companies and employees.
The last, but not the least, question in the second part of the survey was about main obstacles and barriers for operating in the construction sphere. Most of the respondents underlined three groups of barriers. One of them is the administrative challenge, including high level of taxation, inconsequent business legislation, and attitude of the government towards business in general. The second barrier includes economic problems such as lack of funds for business investments, payment behavior of clients, low product or service demand from customers, low access to credits, and inflation. The third group of problems in the construction sector is related to the shadow economy. A large part of the enterprises experiences a problem of high competition from illegal business and corruption. At the same time, a positive thing is that the majority of respondents does not consider crime and racketeering as a threat for the sector.
Figure 2. Estimation of approximate share of unregistered firms production in the total output in construction industry
Notes: The X-axis is the percentage of respondents that agree with the statement. Source: Results of the survey
In the third part of the survey, companies were asked about their participation in public procurement tenders. About 42% of all respondents did not have this experience over the past two years. One of the questions was about competition among construction companies. About 40% of all respondents underlined that they have lost at least one public tender because of unfair competition. Given that only 58% of the companies participated in tenders, we can conclude that unfair competition is a widespread problem for the majority of public procurement auction participants. Imperfect legislation is another problem for the companies. 46% of all respondents believe that the quality of legislation in the sphere is unsatisfactory. Only 12% of the companies did not see any problems in the national legislation.
At the end of the interview, companies were asked to list three main problems in the sphere of public procurement. The answers are shown in Figure 3.
Figure 3. Main problems that companies face when participating in public procurement tenders
Notes: The X-axis is the percentage of respondents that agree with the statement. Source: Results of the survey
The most common answer was corruption. Unfair competition and nepotism were also quite common problems in the public procurement sphere. Among administrative barriers, companies emphasized the complexity of documentation preparation and imperfect legislation. Important economic problems were inflation and unequal conditions for public and private enterprises.
International experiences and recommendations in fighting corruption and tax evasion in the construction sector
Corruption and tax evasion can be stimulated by different factors. One of the main preconditions of the shadow economy in the Belarusian construction sector is inconsistent and frequently changing legislation. For example, public procurements are regulated by the Presidential Decree (Ukaz) on procurement of goods (works, services) in construction. However, this regulation document expires at the end of 2018. Before 2017, such operations were regulated by several legislative acts. Developing understandable and sustainable legislation, which creates clear rules for participants of the market, is very important to increase transparency and openness of the market [11; 12; 13; 15; 18].
Another problem concerns the relations of contractors and sub-contractors. In many cases negotiations between parties are closed and non-transparent. So, it is very difficult to estimate the effectiveness of costs and proper use of funds.
Modern E-Government system adoption can support increased transparency between contractors and sub-contractors, as well as improve the quality of state services. One of the directions in this sphere is the transition towards full electronic document management. [3; 4; 6].
Another risk is related to public procurement procedure. Direct communications between public tender participants and organizers create possibilities for unfair competition. There is substantial international evidence showing that full digitalization of the process would improve the transparency of the public procurement procedure [3; 4; 21]. For example, good reference points for implementation of such digitalization can be the Georgian or Ukrainian experiences of electronic tenders. These two countries have relatively similar institutional environment and heritage as Belarus.
The problem of tax evasion is often related with payments in cash. Such transactions are less transparent and visible for authorities. According to national legislation operations between legal entities should be in cashless form. But there are exceptions to the rule [20]. In this regards the level of tax evasion would be decreased if payments in cash will be minimized.
Another concern is the efficiency of the public procurement procedures. During public procurement auctions in construction, price plays the most important role. The share of “Bid Price” criterion in total volume of all criteria can be up to 50%. The project with the lowest price has the best chance to win the tender. This is not always reasonable. Moreover, some companies hire disabled people that allow them to obtain preferential treatment in the public procurement procedure – for example, apply special correction indicators to the final price. In many cases it is better to install more expensive but high efficiency (more qualitative or ecological) equipment instead of buying cheap but low quality ones. Of course, even in EU legislation, the cost or price of projects is a very important criterion. But then it is often defined as a price-quality ratio. In this regards, the quality of the project can be estimated from the environmental, qualitative or social side [12; 19].
One more issue according to survey results is the problem of unregistered labor force in construction. It can be partly resolved by ID card implementation for all workers and employers in construction sector. In Finland, for example, all workers in construction must have such cards during workdays. Tax authorities can check the availability of the cards at any time [17].
Conclusion
Our survey of Belarusian construction companies confirmed wide exposure of the sector to tax evasion and corruption. The majority of the respondents agreed that some companies hire unregistered workers, pay wages in envelopes, or have hidden income. The most common answer to the main problems in the public procurement sphere was corruption. Based on international experience and national peculiarities, it is advisable to propose the following measures to reduce corruption and tax evasion in construction sector:
- Adoption of sustainable legislation.
- E-Government system development.
- Modernization of the electronic tender system to require no direct contacts between organizers and tender participants.
- Reduction of the possibilities of making payments in cash.
- Implementation of a price-quality ratio as one of the main criteria for choosing the winner of tenders.
- Introduction of ID cards for all employees and employers in the construction sector.
These and other measures are likely to significantly improve the business environment in the construction sector.
References
[1] Anderson, E. 2013. Municipal “Best Practices”: Preventing Fraud, Bribery and Corruption, International Centre for Criminal Law Reform and Criminal Justice Policy. Available on the Internet:http://icclr.law.ubc.ca/sites/icclr.law.ubc.ca/files/publications/pdfs/Municipal%20Best%20Practices%20-%20Preventing%20Fraud%2C%20Bribery%20and%20Corruption%20FINAL.pdf.
[2] Fazekas, M., Toth, I.J., King, L.P. 2013. Corruption manual for beginners: “Corruption techniques” in public procurement with examples from Hungary, Working Paper series: CRCB-WP/2013:01 Version 2.0, Budapest, Hungary. Available on the Internet: http://www.crcb.eu/wp-content/uploads/2013/12/Fazekas-Toth-King_Corruption-manual-for-beginners_v2_2013.pdf.
[3] Krasny, A. 2014. Georgia E-Government. Available on the Internet: https://www2.deloitte.com/content/dam/Deloitte/ua/Documents/public-sector/e-government/Electronic%20government%20of%20Georgia.pdf.
[4] Luzgina, A. International experience of the e-Government System development/ A. Luzgina //Journal of the Belarusian State University. Economics. – Minsk, 2017. – P.76-83.
[5] Luzgina, A., Laukkanen E., Larjavaara I., Viavode I., Volberts J. ,Corporate engagement in fighting corruption and tax evasion in construction sector”, forthcoming in “Entrepreneurship and sustainability issues”
[6] Naumov, A. 2014. Georgia E-experience for Belarus. Available on the Internet: http://e-gov.by/best-practices/elektronnyj-opyt-gruzii-dlya-belarusi.
[7] Official website of Transparency International. Available on the Internet: https://www.transparency.org/.
[8] Official website of Belarusian National Statistical Committee. Available on the Internet: http://www.belstat.gov.by.
[9] Official website of the European Commission. Available on the Internet: https://ec.europa.eu/commission/index_en.
[10] On procurements of goods (works, services) [Electronic source] // Decree of the President of the Republic of Belarus/ 20.10.2016 # 380. Rus.: О закупках товаров (работ, услуг) при строительстве, Указ Президента Республики Беларусь от 20.10.2016, №380. – Mode of access: http://www.pravo.by/document/?guid=3871&p0=P31600380.
[11] On public procurements of goods [Electronic source] // Law of the Republic of Belarus/ 13.07.2012, # 419-З. Rus.: О государственных закупках товаров, работ услуг Закон Республики Беларусь от 13 июля 2012 г. № 419-З. – Mode of access: http://www.pravo.by/document/?guid=3871&p0=h11200419&p1=2.
[12] On organization and conduct of the procurement of goods (works, services) procedures and settlements between customer and contractor in facilities construction [Electronic source] // Resolution of the Council of Ministers of the Republic of Belarus / 31.12.2014, # 88.: Rus: Об организации и проведении процедур закупок товаров (работ, услуг) и расчетах между заказчиком и подрядчиком при строительстве объектов, Постановление Совета Министров Республики Беларусь №88 от 31.12.2014. – Mode of access: http://www.pravo.by/document/?guid=3871&p0=C21400088.
[13] Putnis, J.T., Sauka, A. 2016. Shadow economy index for the Baltic countries 2009 – 2016. The Center for Sustainable Business at SSE Riga. – 47 p.
[14] Pelipas, I., Tochitskaya, I. 2016. Problems of corruption in the assessments of small and medium enterprises. Available on the Internet:
[15] Procurement in construction, what has been changed since January 1, 2017. Available on the Internet: http://www.mas.by/ru/news_ru/view/zakupki-v-stroitelstve-chto-izmenilos-s-1-janvarja-2017-goda-852/
[16] Preventing corruption in public procurements. 2016. OECD Publishing. Available on the Internet: http://www.oecd.org/gov/ethics/Corruption-in-Public-Procurement-Brochure.pdf.
[17] Briganti, F., Machalska, M., Steinmeyer, Heinz-Dietrich, Buelen, W. 2015. Social Identity cards in the European construction industry, edited by Buelen W. Available on the Internet: http://www.efbww.org/pdfs/EFBWW-FIEC%20report%20on%20social%20ID%20cards%20in%20the%20construction%20industry.pdf.
[18] Zaiats, D. 2015. The authorities will strengthen the fight against the shadow economy [Electronic resource]. – Mode of access: https://news.tut.by/economics/465337.html.
[19] On public procurement and repealing Directive 2004/18/EC [Electronic resource]// Directive 2014/24/EU of the European Parliament and of the Council / 26 Februay 2014. – Mode of access: https://news.tut.by/economics/465337.html.
[20] On making amendments and alterations to Instruction on the procedure of conducting cash transactions and the procedure of the cash settlement in Belarusian rubles on the territory of the Republic of Belarus // Resolution of the National Bank of the Republic of Belarus / 31.03.2014. #199. Rus: – О внесении дополнений и изменений в Инструкцию о порядке ведения кассовых операций и порядке расчетов наличными денежными средствами в белорусских рублях на территории Республики Беларусь. Mode of access: http://pravo.by/document/?guid=12551&p0=B21428983&p1=1&p5=0.
[21] Prozorro [Electronic source]. – Mode of access: https: //prozorro.gov.ua/en.
Rewarding Whistleblowers to Fight Corruption?
Whistleblower reward programs, or “bounty regimes”, provide financial incentives to witnesses that report information on infringements, helping law enforcement agencies to detect/convict culprits. These programs have been successfully used in the US against procurement fraud and tax evasion for quite some time, and were extended to fight financial fraud after the recent crisis. In Europe there is currently a debate on their possible introduction, but authorities appear much less enthusiastic than their US counterparts. In this brief, we discuss recent research on two commonly voiced concerns on whistleblower rewards – the risk of increasing false accusations, and that of crowding out other motivations to blow the whistle – and the adaptations these programs may need to fight more general forms of corruption. Research suggests that the mentioned concerns can be handled by an appropriate design and management of the programs, as apparently done in the US, and that these programs can indeed be a cost effective instrument to fight corruption, but only in countries with a sufficient quality of the judicial system and administrative capacity. They may instead be problematic for weak institutions environments.
Corruption and fraud seem to remain highly widespread in almost all countries. For example, a recent survey of over 6,000 organizations across 115 countries shows that one in three organizations, both worldwide and in the US, experienced fraud in the past 24 months, prevalently in the form of asset misappropriation, cybercrime, corruption, and procurement and accounting fraud (Global Crime Survey, 2016).
Whistleblower (protection and) reward programs are a possibly effective tool to combat fraud and corruption, at least in the light of the US successful experience, where for a long time whistleblowers reporting large federal fraud have been entitled to up to 30% of recovered funds and sanctions under the False Claims Act. The US Internal Revenue Service (IRS) also allows whistleblower rewards in the tax area, and the Dodd-Frank Act introduced them for financial and securities fraud, apparently also with success (c.f. Call et al., 2017, and Wilde, 2017).
In Europe and the rest of the world, instead, rewards are absent and whistleblowers are still poorly protected from retaliation from employers. Some countries have taken encouraging legal steps to at least improve protection, and a discussion is ongoing at the G20 level on how to further improve the situation (G20 report, 2011).
Although many praise whistleblowers, there has been a large range of objections raised against introducing rewards (and even against improving whistleblower protection); mostly by corporate lawyers and lobbyists, but also by regulatory and law enforcement agencies (see Nyreröd and Spagnolo, 2017, for an overview).
In the rest of this brief, we focus on two often voiced concerns, the risks of eliciting false/fraudulent reporting and of crowding out of non-financial motivation, on which recent research has shed light that should be taken into account in the current policy debate. We then discuss some problems linked to the use of whistleblower rewards programs in a more general corruption context.
Fraudulent reports
One concern commonly raised in the discussion of whistleblower rewards is that they may create incentives to fraudulently report false or fabricated information in the hope of receiving a reward. Although clearly an important concern to take into account, we only know of very few anecdotal cases of malicious or false reporting, and fraudulent reporting does not appear to have been a major problem in the US (see again Nyreröd and Spagnolo, 2017 for an overview of the empirical evidence).
A recent paper by Buccirossi, Immordino and Spagnolo (2017) analyzes this concern within a formal economic model and shows that it is not a ground (or an excuse) for not introducing appropriately designed and managed protection and reward programs in countries with sufficiently effective court systems. In these countries, stronger sanctions against lying to the court can (and should) be introduced to balance the incentives for manipulation that may be generated by large bounties. Most legal systems already have defamation and perjury laws, which means that a whistleblower is already committing a crime by fraudulently reporting false information, that can easily be strengthened where necessary without giving up whistleblower rewards. According to this study, the balancing of incentives is what allows the US to effectively use large financial incentives for whistleblowers, besides a very strong protection from retaliation, with little problems in terms of fraudulent reports.
However, the study also shows that this is only possible if the precision (effectiveness, independence) of the court system is sufficiently high. Where court systems are imprecise, the interaction between courts’ mistakes in the legal case based on the information reported by the whistleblower and in the following case for perjury/defamation against the whistleblower if the first case is dismissed, incentives for fraudulent reports, and courts’ adaptation of the standard of proof to account for these incentives, make it impossible to appropriately balance the two incentives. Therefore, whistleblower reward programs should not be introduced in environments where the law enforcement system is ineffective, independently from why it is so (bureaucratic slack, incompetence, political interference, corruption, etc.).
Crowding-out non-financial motivation
Another concern is that whistleblower rewards may have a “crowding out” effect on intrinsic motivation. The problem is that “the commodification of whistleblowing via the provision of bounties may render would-be whistleblowers less likely to come forward by reducing the moral valance of the wrongdoing” (Engstrom, 2016:11). Recent experimental evidence suggests that this concern is overstated. In particular, Schmolke and Utikal (2016) investigate the effects of whistleblower rewards in an environment where one subject may increase his payoff at the cost of harming the group, and find rewards to be highly effective in increasing the number of crimes reported. Data from that experiment suggests a little role for crowding out of non-monetary motivation, if any. Another recent study by Butler, Serra and Spagnolo (2017) investigates if and how monetary incentives, expectations of social approval or disapproval, and the salience of the harm caused by the reported illegal activity interact and affect the decision to blow the whistle. Experimental results show that financial rewards significantly increase the likelihood of whistleblowing and do not substantially crowd out non-monetary motivations activated by expectations of social judgment. The study also finds that public scrutiny and social judgment decrease (increase) whistleblowing when the public is less (more) aware (aware) of the negative externalities generated by the reported crime. All in all, most the recent studies we are aware of suggest that crowding-out of non- financial concerns is not a first-order problem for whistleblower reward schemes as long as there is a clear perception of the public harm linked to the illegal behavior reported by the whistleblower.
Whistleblower rewards and corruption
Although whistleblowing can occur in any sector, firm, or government, an area of particular interest is corruption. Corruption in public procurement is estimated to cost the EU 5.3 billion Euros annually. Hence, corruption deterrence through increased whistleblowing could save the EU significant resources annually (EC Report, 2017).
Contrary to fraud, corruption always takes at least two parties, a bribe taker, typically a government official or politician, and a bribe giver, which may be a firm or an individual. The fact that at least one additional party is involved than in the standard case of fraud, should make whistleblower rewards programs even more powerful since they may deter corruption by increasing the fear that a (potential or real) partner in crime may blow the whistle, even when no third party witness observes the illegal act (Spagnolo, 2004).
When the reported wrongdoer is an individual, as is often the case with corruption, there may be an issue in the use of rewards for whistleblowers linked to the funding of the rewards (c.f Nyreröd & Spagnolo, 2017b for an overview).
In the current US schemes, rewards for whistleblowers are ‘self-financing’, as they constitute a fraction of the funds recovered thanks to the whistleblower or/and of the fines paid by the culprits. An individual and a government official involved in a corrupt deal may, however, not be wealthy enough for the fines and the recovered funds to amount to a sufficiently strong incentive to blow the whistle, given the loss of future gains from the corrupt relationships and the various forms of retaliation whistleblowing may lead to. This problem is of course also relevant for fraud when an individual with few or well-hidden assets is the culprit, rather than a corporation, but it seems particularly relevant for corruption.
Whistleblower reward programs are also malleable to the concerns at hand. If the priority is to combat higher-level corruption, then setting a monetary threshold for when a claim is to be considered is appropriate to limit administrative costs for the program. Indeed, a concern with utilizing whistleblower rewards programs for combating lower-level corruption is that the administrative burden required looking through the whistleblower claims and the costs of limiting abuses may outweigh the benefits gained in detection and deterrence. This concern is also valid for small fraud and tax evasion, which is why all the US programs have a minimum size for cases eligible to whistleblower rewards, but the problem is likely to be more relevant to the case of ‘petty’ corruption. These programs are more suited for ‘large cases’ in which the amount of funds recovered is large enough to pay for rewards and administrative costs, making these programs self-financing even without calculating the benefits for the deterrence/prevention of future infringements. However, when focusing on large corruption cases, other issues become relevant.
An issue particularly important for the case of ‘grand’ corruption is how independent the judicial system is from political pressure, and how able it is to protect whistleblowers against politically mandated retaliation. If corrupt politicians can importantly influence courts, the police or other relevant administrative agencies, then protection can hardly be guaranteed and inducing witnesses to blow the whistle through financial incentives may put their life at risk, although sufficiently large rewards can partly compensate for this risk and help escaping part of the retaliation.
Conclusion
On the whole, whistleblower rewards, in general and in the corruption context specifically, remain a promising tool to detect and deter crime. Careful design and implementation are necessary, because as for any powerful tool, these programs can be well used to do great thing, but also misused to do great damage. As the US experience has shown, along with sufficiently independent and precise courts and an effective administration of law enforcement, well designed and administered whistleblower reward programs hold the promise of greatly improving fraud and corruption detection and of being self-financing through recovered funds and fines.
Of course, even in a very good institutional environment, a poor design and/or implementation can lead to poor performance and do more harm than good (c.f. the case of leniency policies in China discussed in Perrotta et al., 2017). Moreover, in poor institutional environments, where the court system is not sufficiently precise and independent and other law enforcement institutions are not effective, even well-designed and implemented whistleblower reward schemes may bring more problems than benefits. Whistleblower rewards, as any other high-powered incentives, need good governance to ensure that the potentially very high benefits they can generate will be realized. Third parties like international courts and organizations could potentially provide for some low institution environments, the independent safe harbor necessary to protect whistleblowers and a check on court effectiveness for the award of financial incentives.
References
- Global Economic Crime Survey, 2016. Available at: https://www.pwc.com/gx/en/economic-crime-survey/pdf/GlobalEconomicCrimeSurvey2016.pdf
- Buccirossi, P., Immordino, G., and Spagnolo, G., 2017. “Whistleblower Rewards, False Reports, and Corporate Fraud”. SITE Working Paper No. 42, available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2993776
- European Commission Report, 2017. Estimating the Economic Benefits of Whistleblower Protection in Public Procurement, Milieu Ltd.
- Engstrom, D., 2016. “Bounty Regimes”, in Research Handbook on Corporate Criminal Enforcement and Financial Misleading (Jennifer Arlen ed., Edward Elgar Press, forthcoming 2016)
- Butler, J., Serra, D., and Spagnolo G., 2017. “Motivating Whistleblowers.” Unpublished manuscript. Available at: https://www.aeaweb.org/conference/2017/preliminary/1658
- Schmolke, K.U., Utikal, V., 2016. “Whistleblowing: Incentives and Situational Determinants.” FAU – Discussion Papers in Economics, No. 09/2016. 2016. Available at: https://ssrn.com/abstract=2820475
- Call, A.C., Martin, G.S, Sharp, N.Y., Wilde, J.H., 2017. “Whistleblowers and Outcomes of Financial Misrepresentation Enforcement Actions.” Journal of Accounting Research, forthcoming.
- Wilde, J.H., (2017). “The Deterrent Effect of Employee Whistleblowing on Firms’ Financial Misreporting and Tax Aggressiveness”, The Accounting Review, forthcoming.
- Nyreröd, T. Spagnolo, G., 2017a “Myths and evidence on whistleblower rewards”, SITE Working Paper No.
- Spagnolo, G., 2004. “Divide et Impera: Optimal Leniency Programs.” CEPR Discussion Papers 4840, 2004.
- Nyreröd, T. Spagnolo, G. 2017b. “Whistleblower Rewards in the Fight against Corruption?” (in Portuguese), forthcoming in the book Corrupção e seus múltiplos enfoques jurídi
- Berlin-Perrotta, M., Qin, B. and Spagnolo, G., 2017. “Leniency, Asymmetric Punishment and Corruption: Evidence from China,” SITE Working Paper. Available at:https://ssrn.com/abstract=2718181 or http://dx.doi.org/10.2139/ssrn.2718181
- G20 Anti-Corruption Action Plan, Protection OF Whistleblowers Study on Whistleblower Protection Frameworks, Compendium of Best Practices and Guiding Principles for Legislation, 2011. Available at: https://www.oecd.org/g20/topics/anti-corruption/48972967.pdf
- Wolfe S., Worth M., Dreyfus S., Brown A.J., 2015. Breaking the Silence, Strengths and Weaknesses in G20 Whistleblower Protection Laws, 2015. Available at: https://blueprintforfreespeech.net/wp-content/uploads/2015/10/Breaking-the-Silence-Strengths-and-Weaknesses-in-G20-Whistleblower-Protection-Laws1.pdf
Expanding Leniency to Fight Collusion and Corruption
Leniency policies offering immunity to the first cartel member that blows the whistle and self-reports to the antitrust authority have become the main instrument in the fight against cartels around the world. In public procurement markets, however, bid-rigging schemes are often accompanied by corruption of public officials. In the absence of coordinated forms of leniency for unveiling corruption, a policy offering immunity from antitrust sanctions may not be sufficient to encourage wrongdoers to blow the whistle, as the leniency recipient will then be exposed to the risk of conviction for corruption. Explicitly introducing leniency policies for corruption, as has been recently done in Brazil and Mexico, is only a first step. To increase the effectiveness of leniency in multiple offense cases, we suggest, besides extending automatic leniency to individual criminal sanctions, the creation of a ‘one-stop-point’ enabling firms and individuals to report different crimes simultaneously and receive leniency for all of them at once if they are entitled to it.
Leniency provisions to fight corruption
It has been noted that leniency policies and other schemes that encourage whistleblowing — such as reward and protection policies — should work in the fight against corruption as it does in the fight against collusion (Spagnolo, 2004; Spagnolo 2008; Buccirossi and Spagnolo, 2006). Cartels, corruption, and many other types of multi-agent offenses depend on a certain level of trust among wrongdoers, which is precisely what leniency programs aim to undermine by offering incentives for criminals to betray their partners and cooperate with the authorities (Bigoni et al., 2015; Leslie, 2004).
Of course, for offenses not covered by antitrust law, such as corruption, relevant authorities may have their own ways of granting leniency and encourage reporting, such as plea bargaining, whistleblower reward programs, deferred prosecution agreements (DPAs) and non-prosecution agreements (NPAs). On the other hand, some countries have recently introduced explicit leniency programs for corruption (for example, Brazil and Mexico). Yet, we observed that those instruments do not always cover all types of sanctions, are seldom integrated with antitrust leniency, and are often under the responsibility of multiple law enforcement agencies. Hence, improvements in the legal frameworks seem to still be necessary.
Leniency in a multi-offense scenario: the case of corruption cartels
Cartel offenses may be connected to other infringements. A particularly frequent and deleterious example of a multiple offense situation is the simultaneous occurrence of collusion (bid rigging) and corruption in public procurement (OECD, 2010). While cartels are estimated to raise prices by 20% or more above competitive levels (Connor, 2015; Froeb et al., 1993), corruption may add 5–25% to total contract values (EU, 2014; OECD, 2014b). Since public procurement is a market amounting to 13–20% of GDP in developed countries (OECD, 2011), it is clear that collusion and corruption represent a serious waste of public funds, negatively impacting the quality of public infrastructure and services provided by a state to its citizens.
Authorities face then two distinct, yet inter-related, challenges to guarantee the effectiveness of public procurement: ensuring integrity in the procurement process and promoting effective competition among suppliers (Anderson, 2010). Considering that success in deterring cartels and corruption depends largely on the incentives provided to infringers to self-report, the interaction between leniency provisions for cartels and the legal treatment of corruption adds a powerful new channel to the above-noted interdependence and thus should be — and already is — a concern to antitrust and anti-corruption authorities (OECD, 2014a).
A member of a corrupting cartel that blows the whistle on the cartel and applies for leniency to the antitrust authority will likely have to disclose information on the other infringement. Such information may then be used by the relevant law enforcement authority to prosecute and punish the applicant. Thus, the risk of prosecution for other cartel-connected offenses (corruption in this case) may reduce the attractiveness of reporting the cartel (Leslie, 2006). This kind of uncertainty works against the leniency policy’s deterrence goals and may even stabilize the cartel by providing its members with a credible threat to be used to prevent betrayal among them.
Existing leniency provisions for corrupting cartels
Antitrust leniency provisions are very similar worldwide, differing mainly in terms of whether cartels are only considered administrative infringements or are also criminally liable offenses. Where there is individual criminal liability, leniency programs should cover it. Surprisingly, Austria, France, German and Italy, where cartel, or at least bid rigging, is a criminal offense, do not follow this guideline. In these jurisdictions the co-operation of an individual with the antitrust authority during the administrative proceedings may be considered a mitigating circumstance, reducing imposed penalties or even allowing a discharge, but at the discretion of the court or the prosecution, which is likely to greatly reduce the propensity of wrongdoers to blow the whistle.
On the other hand, countries do not usually have specific leniency programs for corruption. Nonetheless, self-reporting and cooperation in bribery cases are usually given great importance by authorities and may lead to leniency and even immunity, through other mechanisms such as plea agreements, no-action letters, NPAs or DPAs, but those instruments rely on prosecutorial or judicial discretion. Brazil and Mexico do have formal leniency programs for corruption, providing more certainty and thus being more attractive to an applicant, although restricted to administrative liability. Individual corruption-related criminal provisions are laid down in each country’s criminal code and follow the recommendations made by the United Nations, in the 2003 Convention against Corruption, and by the Organization for Economic Co-operation and Development, under its 1997 Convention against Corruption of Foreign Public Officials in International Business Transactions.
Since enforcement authorities for collusion and corruption differ in most cases, such an arrangement demands that the infringer seek non-prosecution through at least two separate agreements, one with the antitrust authority and the other with the anti-corruption agency. The difficulty in coordinating such agreements is an obvious issue and will vary according to the number of authorities involved and to the proximity among them, that range from divisions of the same agency, in the case of the United States (Antitrust and Criminal Divisions of the Justice Department), to organizations from different government branches (Executive and Judiciary) in most jurisdictions.
In Brazil and the United States, antitrust leniency programs can provide protection for non-antitrust violations, committed in connection with an antitrust violation. While in Brazil, this provision does not currently include corruption infringements, in the United States it does, but only binds the Antitrust Division and not any other federal or state prosecuting agencies, i.e. leniency agreements may not prevent other authority from prosecuting the applicant for the non-antitrust violation.
How to improve the current legal framework
Countries should follow Brazil and Mexico’s example and create ex ante, non-relying on prosecutorial or judiciary discretion leniency programs for corruption infringements. Unlike these programs, leniency should also cover individuals, especially in terms of criminal liability for bid rigging and corruption. The protection from lawsuits for managers and directors could then become a primary incentive for them to blow the whistle on their and their companies’ illegal acts.
Additionally, it is advisable not to depend on collaboration between law enforcement groups, but to establish clear legal provisions to allow wrongdoers to report all illegal acts simultaneously and to be confident that they will escape sanctions upon co-operation with the authorities and presentation of evidence, i.e. the creation of a ‘one-stop point’.
This ‘one-stop point’ should be available for applicants at every law enforcement agency and must prevent other agencies from prosecuting the leniency applicant. In other words, when someone approaches—as an individual or as a representative of a legal person—any authority to report crimes he is involved in, it is important to allow him to report any other crimes that he knows about in exchange for lenient treatment. In order to prevent conflicts among agencies, the authority first contacted by the wrongdoer must be obliged to immediately involve any other one who may be competent over other possible reported infringements. The self-reporting wrongdoer must be reasonably certain that he will be granted leniency for all reported wrongdoings, provided that he fulfills the legal requirements for each infringement, obviously. Failing to report all known involvement in infringements may be a reason to reduce or even revoke leniency altogether, creating a penalty plus-like provision over different areas of law and a more powerful incentive to a thorough self-report.
Information about the possibility of reporting several illegal acts at the same time, and of obtaining leniency for each one, must be consistently disseminated to minimize detection and prosecution costs, as well as to contribute to the deterrence of future criminal behavior.
Finally, we note that companies and individuals from jurisdictions where leniency provisions for corruption are highly discretionary or non-existent would be less inclined to report cartel behavior abroad when bribing foreign public officials. Despite existing confidentiality rules on leniency programs, they might not want to risk being prosecuted for corruption at home. This would possibly block antitrust leniency agreements by removing the incentives to self-report, undermining the ability to catch international corrupting cartels. To prevent that, laws should be amended to allow leniency for a company or someone that self-reports abroad, and further coordination and collaboration between agencies from different countries would be necessary to avoid stabilizing criminal collusion and undermining the effectiveness of leniency programs.
Conclusion
The fight against cartels and bribery requires efforts on a national level as well as multilateral co-operation.
Creating leniency policies to fight corruption, including foreign, and coordinating them with antitrust leniency policies, emerges as an important priority. The absence of formal leniency programs for corruption, besides hindering anti-corruption enforcement, reduces wrongdoers’ incentives to blow the whistle and collaborate in corrupting cartel cases through the risk of criminal prosecution for the corruption offense. These programs must be carefully designed, however, to avoid opportunistic behavior and thus to achieve their goal of deterrence.
In order to increase the effectiveness of leniency programs in multiple offenses cases, we suggest the creation of a ‘one-stop point’, enabling firms and individuals to report different crimes simultaneously and obtain leniency, provided that they offer sufficient information and evidence for their partners in crime to be prosecuted.
References
- Anderson, R. D.; Kovacic, W. E.; Müller, A. C., 2010. Ensuring integrity and competition in public procurement markets: a dual challenge for good governance, in The WTO Regime on Government Procurement: Challenge ond Reform (Sue Arrowsmith & Robert D. Anderson eds.).
- Bigoni, M., Fridolfsson, S.O., Le Coq, C., Spagnolo, G., 2015. Trust, Leniency and Deterrence, 31 J. LAW ECON. ORGAN., 663.
- Buccirossi P.; Spagnolo, G., 2006. Leniency policies and illegal transactions, 90 J. PUBLIC ECON., 1281.
- Connor, J. M., 2014. Cartel overcharges, in The Law And Economics Of Class Actions (James Langenfeld ed.).
- European Commission, 2014. Report from the Commission to the Council and the European Parliament—EU Anti-Corruption Report 2014.
- Froeb, L. M.; Koyak, R. A.; Werden, G. J., 1993. What is the effect of bid rigging on prices?, 42 ECON. LETT., 419.
- Leslie, C. R., 2004. Trust, Distrust, and Antitrust, 82 TEX. L. REV. 515.
- Leslie, C. R., 2006. Antitrust Amnesty, Game Theory, and Cartel Stability, 31 J. CORP. L. 453.
- OECD, 2010. Global Forum on Competition Roundtable on Collusion and Corruption in Public Procurement.
- OECD, 2011. Public Procurement for Sustainable and Inclusive Growth – Enabling reform through evidence and peer reviews.
- OECD, 2012. Improving International Co-Operation in Cartel Investigations.
- OECD, 2014a. 13th Global Forum on Competition Discusses the Fight Against Corruption, Executive Summary.
- OECD, 2014b. OECD Foreign Bribery Report: An Analysis of the Crime of Bribery of Foreign Public Officials.
- Spagnolo, G. 2004. Divide et Impera: Optimal Leniency Programs, CEPR Discussion Paper nr 4840, available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=716143
- Spagnolo, G., 2008. Leniency and Whistleblowers in Antitrust, in Handbook of Antitrust Economics (Paolo Buccirossi ed.), Cambridge MA: MIT Press.
- Stephan, P. B., 2012. Regulatory Competition and Anticorruption Law, 53 VA. J. INT. LAW 53.
- Waller, S. W., 1997. The Internationalization of Antitrust Enforcement. 77 BOSTON U. LAW REV. 343.
Traces of Transition: Unfinished Business 25 Years Down the Road?
This year marks the 25-year anniversary of the breakup of the Soviet Union and the beginning of a transition period, which for some countries remains far from completed. While several Central and Eastern European countries (CEEC) made substantial progress early on and have managed to maintain that momentum until today, the countries in the Commonwealth of Independent States (CIS) remain far from the ideal of a market economy, and also lag behind on most indicators of political, judicial and social progress. This policy brief reports on a discussion on the unfinished business of transition held during a full day conference at the Stockholm School of Economics on May 27, 2016. The event was organized jointly by the Stockholm Institute of Transition Economics (SITE) and the Swedish Ministry for Foreign Affairs, and was the sixth installment of SITE Development Day – a yearly development policy conference.
A region at a crossroads?
25 years have passed since the countries of the former Soviet Union embarked on a historic transition from communism to market economy and democracy. While all transition countries went through a turbulent initial period of high inflation and large output declines, the depth and length of these recessions varied widely across the region and have resulted in income differences that remain until today. Some explanations behind these varied results include initial conditions, external factors and geographic location, but also the speed and extent to which reforms were implemented early on were critical to outcomes. Countries that took on a rapid and bold reform process were rewarded with a faster recovery and income convergence, whereas countries that postponed reforms ended up with a much longer and deeper initial recession and have seen very little income convergence with Western Europe.
The prospect of EU membership is another factor that proved to be a powerful catalyst for reform and upgrading of institutional frameworks. The 10 countries that joined the EU are today, on average, performing better than the non-EU transition countries in basically any indicator of development including GDP per capita, life expectancy, political rights and civil liberties. Even if some of the non-EU countries initially had the political will to reform and started off on an ambitious transition path, the momentum was eventually lost. In Russia, the increasing oil prices of the 2000s brought enormous government revenues that enabled the country to grow without implementing further market reforms, and have effectively led to a situation of no political competition. Ukraine, on the other hand, has changed government 17 times in the past 25 years, and even if the parliament appears to be functioning, very few of the passed laws and suggested reforms have actually been implemented.
Evidently, economic transition takes time and was harder than many initially expected. In some areas of reform, such as liberalization of prices, trade and the exchange rate, progress could be achieved relatively fast. However, in other crucial areas of reform and institution building progress has been slower and more diverse. Private sector development is perhaps the area where the transition countries differ the most. Large-scale privatization remains to be completed in many countries in the CIS. In Belarus, even small-scale privatization has been slow. For the transition countries that were early with large-scale privatization, the current challenges of private sector development are different: As production moves closer to the world technology frontier, competition intensifies and innovation and human capital development become key to survival. These transformational pressures require strong institutions, and a business environment that rewards education and risk taking. It becomes even more important that financial sectors are functioning, that the education system delivers, property rights are protected, regulations are predictable and moderated, and that corruption and crime are under control. While the scale of these challenges differ widely across the region, the need for institutional reforms that reduce inefficiencies and increase returns on private investments and savings, are shared by many.
To increase economic growth and to converge towards Western Europe, the key challenges are to both increase productivity and factor input into production. This involves raising the employment rate, achieving higher labor productivity, and increasing the capital stock per capita. The region’s changing demography, due to lower fertility rates and rebounding life expectancy rates, will increase already high pressures on pension systems, healthcare spending and social assistance. Moreover, the capital stock per capita in a typical transition country is only about a third of that in Western Europe, with particularly wide gaps in terms of investment in infrastructure.
Unlocking human potential: gender in the region
Regardless of how well a country does on average, it also matters how these achievements are distributed among the population. A relatively underexplored aspect of transition is to which extent it has affected men and women differentially. Given the socialist system’s provision of universal access to education and healthcare, and great emphasis on labor market participation for both women and men, these countries rank fairly well in gender inequality indices compared to countries at similar levels of GDP outside the region when the transition process started. Nonetheless, these societies were and have remained predominantly patriarchal. During the last 25 years, most of these countries have only seen a small reduction in the gender wage gap, some even an increase. Several countries have seen increased gender segregation on the labor market, and have implemented “protective” laws that in reality are discriminatory as they for example prohibit women from working in certain occupations, or indirectly lock out mothers from the labor market.
Furthermore, many of the obstacles experienced by small and medium-sized enterprises (SMEs) are more severe for women than for men. Female entrepreneurs in the Eastern Partnership (EaP) countries have less access to external financing, business training and affordable and qualified business support than their male counterparts. While the free trade agreements, DCFTAs, between the EU and Ukraine, Georgia, and Moldova, respectively, have the potential to bring long-term benefits especially for women, these will only be realized if the DCFTAs are fully implemented and gender inequalities are simultaneously addressed. Women constitute a large percentage of the employees in the areas that are the most likely to benefit from the DCFTAs, but stand the risk of being held back by societal attitudes and gender stereotypes. In order to better evaluate and study how these issues develop, gendered-segregated data need to be made available to academics, professionals and the general public.
Conclusion
Looking back 25 years, given the stakes involved, things could have gotten much worse. Even so, for the CIS countries progress has been uneven and disappointing and many of the countries are still struggling with the same challenges they faced in the 1990’s: weak institutions, slow productivity growth, corruption and state capture. Meanwhile, the current migration situation in Europe has revealed that even the institutional development towards democracy, free press and judicial independence in several of the CEEC countries cannot be taken for granted. The transition process is thus far from complete, and the lessons from the economics of transition literature are still highly relevant.
Participants at the conference
- Irina Alkhovka, Gender Perspectives.
- Bas Bakker, IMF.
- Torbjörn Becker, SITE.
- Erik Berglöf, Institute of Global Affairs, LSE.
- Kateryna Bornukova, Belarusian Research and Outreach Center.
- Anne Boschini, Stockholm University.
- Irina Denisova, New Economic School.
- Stefan Gullgren, Ministry for Foreign Affairs.
- Elsa Håstad, Sida.
- Eric Livny, International School of Economics.
- Michal Myck, Centre for Economic Analysis.
- Tymofiy Mylovanov, Kyiv School of Economics.
- Olena Nizalova, University of Kent.
- Heinz Sjögren, Swedish Chamber of Commerce for Russia and CIS.
- Andrea Spear, Independent consultant.
- Oscar Stenström, Ministry for Foreign Affairs.
- Natalya Volchkova, Centre for Economic and Financial Research.
Leniency, Asymmetric Punishment and Corruption: Evidence from China
Since coming into office two years ago, Chinese President Xi Jinping has carried out a sweeping, highly publicized anticorruption campaign. Skeptics are debating whether the campaign is biased towards Mr. Xi’s rivals, and even possibly related to the current economic slowdown. What is less debated is the next stage of Mr. Xi’s anti-corruption strategy, which is going to alter the legal statutes. Amendment IX, proposed in October 2014, includes heavier penalties, but two important tools in the fight of corruption – one-sided leniency and asymmetric punishment – became more limited and discretional. We argue that studying a 1997 reform and its effects can shed some light onto why the Chinese leadership seems dissatisfied with the current legislation and the likely effects of the proposed changes.
What We Know about Leniency
In our context, leniency can be defined as the concession of reduced sanctions (or full immunity) to wrongdoers that cooperate by self-reporting and providing information against former partners in crime. Formal and informal exchanges of leniency against information and collaboration are normal features of law enforcement in most countries. Policies of this kind have been extensively and quite successfully used to fight the Italian and American mafias, drug dealing and other organized crimes, and have become the main instrument to fight collusion in antitrust since the US reform in 1993 (see Spagnolo, 2008).
For crimes in which multiple offenders cooperate, one-sided leniency conditional on being the first to self-report can be a very powerful tool of law enforcement: by playing the partners in crime against each other, it may elicit information, greatly facilitate prosecution and generate deterrence at a very low cost. A conspicuous scientific literature with theoretical, experimental and empirical contributions shows the great potential of these policies, when properly designed and administered, for deterring collusive crimes (Miller 2009; Spagnolo 2008; Bigoni et al. 2012, 2015). On the other hand, Buccirossi and Spagnolo (2006) show specifically for the case of corruption that, when poorly designed or administered, these same policies may become ineffective or even counterproductive.
Asymmetric Punishment
A related way of using leniency towards one party (to play it against the other) in the fight against corruption has been at the center of a recent intense policy debate after the popular note “Why, for a Class of Bribes, the Act of Giving a Bribe Should Be Treated as Legal”, by Kaushik Basu (2011). Then chief economist of the Indian government and now of the World Bank, Basu advocated asymmetric depenalization of bribe giving, which can be thought of as a form of unconditional, one-sided leniency. More precisely, the note proposed to legalize bribe giving in the form of harassment bribes (also called extortionary, or discharge-of-duty bribes) paid to obtain something one is entitled to, while strengthening sanctions against bribe taking. As with other forms of leniency, the idea is to create a conflict of interests between the partners in crime by increasing the temptation for one party to betray and report the illegal act, leading to a severe punishment of the other.
In the debate sparked by this note many different arguments have been put forward, both against it and in favor of it. Dufwenberg and Spagnolo (2015) discuss formally some of the issues raised by critics of the proposal, while Abbink et al. (2014) provide (mixed) experimental evidence on its effectiveness. Later, a blogpost by a Chinese law scholar, Li (2012), attracted our attention to the case of China, where asymmetric punishment (bribe-giver impunity) has been in place since 1997. She argued, probably reflecting the political debate in the country rather than based on factual evidence, that the system had not been successful. We felt this claim granted a deeper investigation into the details of the Chinese legal reform and the changes it introduced, and of course a careful inspection of the data to back it.
A Study in Red
In a new working paper, Perrotta Berlin and Spagnolo (2015), we set out to understand the evolution of the anti-corruption legislation in China over the last decades, and then to evaluate the effects of the policy changes occurring in 1997. Two new elements were given the strongest legal status in 1997: leniency for wrongdoers that self-reported and cooperated with investigators, and asymmetric punishment (no charge for bribe givers) for bribes paid to obtain something one was entitled to. Concurrently, penalties were decreased, in particular for bribe-takers.
To understand the likely effects of this policy change we would ideally look at correspondent changes in corrupt transactions. Data on the prevalence of bribery, however, are notoriously hard to come by because of the secretive nature of this activity. Instead, we use several data sources which capture on the one hand actual corruption cases tried in courts, and on the other hand surveys of corruption perceptions. In particular, we have collected the number of arrests and public prosecutions on the counts of corruption and bribery from the Procuratorates’ Yearly Reports for each Chinese province since 1986.
It is not straightforward to infer changes in total corruption, which is unobserved, from changes in discovered cases tried in court. The data on prosecutions mix together corruption and anticorruption activities, as they fail to distinguish occurrence of the criminal activity from detection. A policy that deters crimes but at the same time increases the fraction of those that are successfully prosecuted will have an ambiguous effect on the number of prosecutions. We adapt for this purpose the testable predictions developed by Miller (2009): he models the occurrence of criminal activity (cartel formation, in this case) and derives predictions for how changes in the rate of occurrence and the rate of detection affect the time series of detection.
The preliminary evidence we have so far points to a substantial and stable reduction in the number of major corruption cases around the 1997 reform, a result consistent with a positive deterrence effect of the 1997 reform. The evidence is suggestive, and some alternative interpretations of the patterns in the data, shown in the plot below, cannot be excluded at the moment. While a peak-and-slump pattern as in Miller (2009) would have been much stronger evidence supporting the success of the reform at deterring corruption, we cannot exclude that the drop in prosecutions is simply due to a general worsening in detection. Although we deem this unlikely in the light of the general political climate of the time, we need more and better data to support our interpretation. Still, claims that the reform did not have an effect appear not supported by the data.
Figure 1. Change in Corruption Prosecutions before and after law reform in 1997
Source: Perrotta-Berlin and Spagnolo (2015).
More to be done
A case study analysis is under way to corroborate and help the interpretation of these preliminary findings. We will analyze in depth a stratified random sample of prosecution case files between 1980 and 2010. Given that we sample a given number of cases, in this part of the analysis we cannot gain any insight about the incidence of bribery in general. We can instead observe the impact of the legislative reform on specific details of the corrupt behavior, and the mechanisms through which this behavior occurs or is deterred. In particular, we will be able to distinguish between cases of extortionary (harassment) bribes and bribes paid to obtain illegitimate benefits. Moreover, this will allow us to shed light on whether and how leniency and asymmetric punishment were applied in practice. The details of the case files might even allow us to gain insight into how the bribe-size and the value of corrupt deals evolved through the reform and even the selection into bureaucracy.
Conclusion
One-sided leniency, conditional on reporting an act first, or unconditional, as when bribe giving is depenalized, may be powerful corruption deterrence instruments if well designed and implemented in the right environment, but may also have negative effects. It has been argued that these instruments have been ineffective in China, after they were reformed in 1997, however, without data supporting the claim. Part of the reason lies in the difficulty to obtain good data on corruption. Another obstacle is the subtlety of interpreting them when they relate only to detected and convicted cases, rather than to the whole population of corruption cases.
We cannot solve completely the issue of data quality, as we also need to rely on official reports of counts of corruption cases. However limited, the exercise performed on aggregated data clearly shows that the 1997 Criminal Law reform did have an effect, consistent with increased corruption deterrence. To further support this finding we will collect and analyze micro-data from a randomized sample of these cases. This will allow us to isolate at a higher level of detail the changes in criminal behavior, reporting behavior and prosecution activity, and link them to the details of the legal reform to highlight the mechanisms at work.
China is home to a sixth of humanity, and currently undergoing a massive crackdown on corruption. Whatever we can learn about the effectiveness of their past and present anti-corruption policies is likely to have considerable welfare effects. Moreover, the 1997 reform was the object of a policy debate, and comments on its effectiveness came without data to support them. We believe our effort to use data to shed light on what this reform actually changed will be a valuable input to further research and policy discussion on this important topic.
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References
- Abbink, K., U. Dasgupta, L. Gangadharan, and T. Jain. “Let-ting the Briber Go Free: An Experiment on MitigatingHarassment Bribes.” Journal of Public Economics, 111,2014, 17–28.
- Basu, K. “Why, for a Class of Bribes, the Act of Giv-ing a Bribe Should Be Treated as Legal.” WorkingPaper 172011 DEA, Ministry of Finance, Governmentof India, 2011
- Bigoni, M., S.-O. Fridolfsson, C. LeCoq, and G. Spagnolo.“Fines, Leniency and Rewards in Antitrust.” RANDJournal of Economics, 43, 2012a, 368–90.
- Bigoni, M., S.-O. Fridolfsson, C. LeCoq, and G. Spagnolo.. “Trust and Deterrence.”. Journal of Law, Economics, and Organization (2015)
- Buccirossi, P., and G. Spagnolo. “Leniency Policies and Ille-gal Transactions.” Journal of Public Economics, 90,2006, 1281–97.
- Buccirossi, P., Marvão, C. M. P., & Spagnolo, G. (2015). Leniency and Damages. Available at SSRN 2566774.
- Dufwenberg, M. and Spagnolo, G., Legalizing Bribe Giving (April 2015). Economic Inquiry, Vol. 53, Issue 2, pp. 836-853, 2015.
- Li, X. Guest post: bribery and the limits of game theory – the lessons from China. http://blogs.ft.com/beyond-brics/2012/05/01/guest-post-bribery-and-the-limits-of-game-theory-the-lessons-from-china/, 2012. Accessed: 2015-05-20.
- Miller, N. H. Strategic leniency and cartel enforcement. The American Economic Review, pages 750–768, 2009.
- Perrotta Berlin, M. and G. Spagnolo, Leniency, Asymmetric Punishment and Corruption: Evidence from China, SITE Working Paper, 2015 (forthcoming)
Empirical Evidence on Natural Resources and Corruption
This policy brief addresses the relationship between resource wealth and a particular institutional outcome – corruption. We overview some recent empirical evidence on this relationship and outline results of an on-going research project addressing a particular aspect of resource-related political corruption: transformation of resource rents into personal wealth hidden at off-shore deposits. The preliminary results from this project suggest that at least 8 percent of oil and gas rents are converted into personal political rents in countries with poor political institutions.
Political Instability in Fragile Democracies: Political Cycles Kyrgyz Style
Democratization is rarely a straight and predictable process. Freedom House data from the Central and Eastern European Countries (CEEC) and the countries of the Commonwealth of Independent States (CIS) since 1991 reveals two distinct patterns. In one set of countries, democratization took root quite quickly and the transformation of political institutions seems quite deep and sustainable. In the other countries, the road to democratization, if ever started, has been much more partial and full of reversals. Among the CIS countries, none is regarded as free by Freedom House in 2012, four are regarded as partly free (Armenia, Kyrgyz Republic, Moldova and Ukraine), while the remaining seven countries (Azerbaijan, Belarus, Kazakhstan, Russia, Tajikistan, Turkmenistan, and Uzbekistan) are regarded as non-free. There has also been volatility over time within countries. Russia and Belarus have seen their score steadily deteriorating, while countries on the Balkan and south-east Europe have seen gradual improvements. With the lack of consolidated democratic institutions has also typically followed much political instability. Frequent changes in power, civil unrest, popular revolutions and military conflicts have pervaded countries like Ukraine, Georgia, and the Kyrgyz Republic. In other nations, repressive leaders have put a lid on visible instability, but at the cost of political rights and a fair judiciary system. In both cases, the economy has suffered as instability has deterred investors looking for a predictable environment guided by transparent rules of the game implemented equally for all. Corruption has flourished and political connections and nepotism has determined the opportunities for economic success.
New Tools to Fight Corruption and the Need for Complementary Reform
Corruption remains a serious problem for most developing countries, undermining state capacity and incentives to invest besides social cohesion and democratic institutions. It is also an increasingly important problem for many highly developed ones. In Italy, for example, corruption has increased in the last decades and the parliament is now finally struggling to pass a (rather mild)”anti-corruption law”. Even in Sweden, a country constantly considered among the least corrupt ones in the world, the problem seems to be increasing according to a recent report by the Agency for Public Management (Statskontoret), which also suggests that the current legislation needs to be improved, for example by offering some form of protection to whistleblowers.
In most Central and Eastern European countries, however, the problem appears particularly serious. Corruption seems to have been rapidly increasing in the region this last decade (The Economist, April 11, 2011 ; Nations in Transit, editions 2001-2012), although there are some virtuous exceptions (for example Georgia and Estonia).
Corruption is often caused by, and at the same time, an instrument for political developments towards autocracy, such as those recently observed in some of these countries (limiting judicial autonomy, democratic participation and the free press). This suggests that in countries where these political developments are taking place we may expect a further worsening of the corruption problem in coming years.
A country that is apparently taking the fight against corruption seriously is India, where a strong grassroots anticorruption movement has developed. The issue has become central in recent political debates and several proposals have been put forward and debated in the parliament. Among these proposals is one by Kaushik Basu, the finance minister’s Chief Economic Advisor. He suggests – for a specific class of bribes paid to obtain a service to which one is entitled for – to treat bribe paying as legal while doubling the sanctions against bribe taking (Basu 2011). The logic behind this proposal is to create stronger incentives for bribe-paying individuals to report it to law enforcers and expose corrupt civil servants: reporting should lead to the restitution of the bribe, besides the conviction of the bribe taker.
Since this proposal was made last year, there has been a lively debate both at the Indian as well as the international level. The debate has however been rather informal, and involved some (voluntary and involuntary) misunderstanding of the proposal (see Dufwenberg and Spagnolo 2011 for a short account of this debate). The proposal has been deemed as “radical” by the proponent, and has sometime been treated and dismissed as a theoretical curiosity. In fact, the proposal is similar to existing legal provisions against corruption that have been in place for quite some time in several countries. The proposal is also related to other legal provisions widely used around the world to fight related forms of illegal transactions, in primis leniency policies now used by most antitrust authorities to fight price-fixing cartels, but also accomplice-witness amnesty and protection program against mafia-like criminal organization (see Spagnolo 2008 for an overview).
We know from academic research on these related revelation schemes that they can be very powerful if appropriately designed and administered, but they may fail or even be counterproductive if they are poorly designed or run (see e.g. Spagnolo 2004, Buccirossi and Spagnolo 2006, Apesteguia et al. 2007, Miller 2009, Bigoni et al. 2009). The exact details how these subtle mechanisms are designed and then actually implemented are crucial to their success.
Asymmetric Sanctions, Leniency and Whistleblowers
As earlier mentioned, the main idea behind Basu’s proposal for India, treating partners in corruption asymmetrically is not a theoretical curiosity. It is already present in milder form in the Russian, Japanese and German (violation-of-duty) legislation, where bribe payers face lower sanctions than bribe takers and in the way prosecutorial discretion is used in Anglo-Saxon countries. An analogous provision seems to have also been introduced in China in 1997, and its effectiveness has recently been questioned by some observers, although in a very superficial way. Unfortunately we have no serious evidence of how these legislations have affected corruption.
More generally, the idea of deterring a collaborative crime by shaping the incentives of criminal partners so that one of them has the incentive to betray the others and report information to law enforcers is well established. The Prisoner’s Dilemma story, where each among the partners in crime are promised a light sentence in exchange for cooperation to convict the other criminal partners is familiar to most countries’ standard law enforcement practice.
These schemes have been the main and most successful tool in the fight against mafia and political terrorism in Italy and other countries, and they are currently regarded as the most important and effective instrument in the hands of competition authorities in their fight against cartels (US Department of Justice, Spagnolo 2008, Acconcia et al. 2009).
Apart from law enforcement, analogous “divide and conquer” schemes have been widely used ever since the Roman Empire in war-related situations to break down enemies’ coalitions. They are tools that many do not like on moral grounds, because they induce distrust and betrayal of partners, which some people see as bad even when the betrayed partnership is a criminal one and distrust prevents the criminal activity.
Still related but somewhat different are the whistleblower protection (from retaliation) and reward schemes aimed at inducing innocent witnesses to report a crime. Reward schemes for whistleblowers have been used in the US since the civil war to limit corruption in federal procurement and to fight government fraud (through the False Claim Act, sometimes called the Lincoln Law from the president that introduced it). They have more recently been introduced by the IRS against tax evasion and by the Dodd-Frank Act against financial fraud.
When witnesses are working in the same organization as the wrongdoers, or when the latter are powerful individuals (besides being prone to commit illegal acts, like violent retaliation), blowing the whistle typically generates very harsh consequences for the witness; ranging from various forms of harassment in the organization, to the loss of job, isolation and directly or indirectly induced death.[1] Legal action is typically slow and uncertain but immediate, certain, and very costly, while whistleblower protection provisions are typically imperfect (if present). This is why, even with a relatively efficient legal enforcement system like the American, large rewards are seen as necessary and justified to induce more whistleblowing and compensation for its consequences.
Trust, Distrust and Corruption
In some sense, one can see Basu’s proposal of legalizing bribe paying for services one is entitled to (while doubling sanctions for bribe taking) as transforming potential accomplice-witnesses into potential innocent whistleblowers. The question is then whether this scheme will induce more people to blow the whistle and consequently fewer bureaucrats to demand/accept bribes. Some observers have suggested that this provision might instead induce more people to pay bribes because it makes it legal and thereby may erode moral norms against bribe paying.
In Dufwenberg and Spagnolo (2011), we argued that amending Basu’s proposal in a way resembling leniency programs used in antitrust, where immunity is awarded only if the wrongdoing is reported to the law enforcement agency, is one way to avoid sending the signal that bribe paying is now legal. The real problem for these schemes is therefore whether at the end they will really induce bribe payers to report.
The way these revelation mechanisms deter corruption is by generating “distrust” among potential partners in crime (Bigoni et al. 2012). By making it very attractive to report to law enforcers for one party and very costly to be reported for the others, these schemes may deter illegal cooperation by ensuring that the parties cannot trust each other.
However, for these schemes to generate distrust and produce their potentially strong deterrence effects, the risk that accomplice-witnesses and other potential whistleblowers report must be a real one. For this to be the case, whistleblowers must trust the law enforcement agency to which they report. The example of leniency policies in antitrust is illuminating. In the US, as long as competition authorities retained discretion, colluding firms rarely applied for reporting under the leniency program. It was only when the Department of Justice gave up discretion by making immunity “automatic” – subject to an explicit set of conditions being satisfied – and committed to this policy through published rules that firms started to again to report information on cartels.
Besides a high risk of being reported, for these schemes to elicit reports and produce deterrence it is also necessary that sanctions for convicted parties are sufficient. To continue the parallel with antitrust enforcement, even after the authorities gave up discretion on the programs, they are not inducing cartel members to report in other countries than the US.
Indeed, the most serious problem for the success of the Basu proposal, as well as for that of the leniency-based modification put forward in Dufwenberg and Spagnolo (2011), remains whether witnesses/bribe payers will trust the law enforcement agency to which they should report the crime. If the law enforcement agency is inefficient or also corrupt, reporting may lead to further harassment or worse, rather than protection and justice.
When protection programs are poorly administered and law enforcement agencies inefficient or corrupt, so that potential witnesses don’t trust law enforcement agencies, it becomes very difficult to induce whistleblowers to report, as well as dangerous for the whistleblower.
A second important reason why these schemes may fail to generate reports and to produce the intended deterrence effects is, as we mentioned, the low sanctions against bribe takers. Recent experimental results (in Bigoni et al. 2012) suggest that reporting incentives provided by leniency programs are only effective in deterring collusion if the sanctions for the convicted partners are sufficiently strong. If not, these schemes may have no effects or even perverse ones (they reduce the sum of expected sanctions, and because of their complexity, they could be manipulated; see e.g. Buccirossi and Spagnolo 2006). Basu did suggest doubling the sanctions for the bribe payers. This, however, may or may not be enough for the case at hand, and would require a more thorough evaluation.
Note than in the case of corruption, there is an additional reason for sanctions to be reinforced, in particular by the requirement to always remove from office the convicted bribe taker. The reason is that if the bribe taker is not removed from office after the report, bribe payers may fear that after whistleblowing the bribe taker may retaliate in future interactions.
Conclusions
Asymmetric sanctions as proposed by Basu (2011) and leniency conditional on reporting as proposed by Dufwenberg and Spagnolo (2011) have the potential to deter corruption in a systematic way. Necessary conditions for this to happen, however, are that:
- Sanctions are sufficiently robust to ensure that the increased risk of being convicted because of a report by a whistleblower dominate on the lenient treatment offered to induce reports;
- Potential whistleblowers trust that the law enforcement institutions will act on the report and protect them from retaliation by the corrupt and their friends, rather than harass them.
Countries with sufficiently independent and efficient law enforcement institutions should definitely consider introducing or reinforcing their revelation schemes, asymmetric treatment or leniency conditional on reporting, to counter the current widespread increase in corruption.
Simply introducing these schemes in countries with weaker institutions, in particular with a low level of independence of law enforcement agencies, may do more harm than good: after all they imply reduced sanctions and their complexity makes them easily manipulated.
These schemes can be very useful for these countries, but only if they are introduced as part of a broader set of complementary reforms that include increased judicial independence and the creation of a specialized law enforcement unit with particularly high levels of accountability and independence, able to credibly offer to whistleblowers at least confidentiality and protection from retaliation, if not monetary rewards.
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References
- Acconcia A., Immordino G., Piccolo S., Rey P., (2009), “Accomplice-witness and organized crime: Theory and evidence from Italy”, CSEF Working Paper no. 232.
- Apesteguia J., Dufwenberg M., Selten R., (2007), “Blowing the whistle,” in Economic Theory.
- Basu K., (2011), “Why, for a Class of Bribes, the Act of Giving a Bribe should be Treated as Legal,” Working Paper, Indian Ministry of Finance.
- Bigoni, M., LeCoq C., Fridolfsson S.-O., Spagnolo G., (2009), “Fines, Leniency and Rewards in Antitrust: An Experiment”, CEPR Dp 7417, forthcoming in the Rand Journal of Economics, summer 2012.
- Bigoni M., Fridolfsson S.-O., LeCoq C., Spagnolo G., (2012), June 2012, “Trust and Deterrence”, CEPR Dp 9002.
- Buccirossi P., Spagnolo G., (2006), “Leniency policies and illegal transactions”, Journal of Public Economics, Volume 90.
- Dufwenberg M., Spagnolo G., (2011), December 19th, 2011, “Legalizing Bribes”, Eller College of Management, Working Paper No. 11-09.
- The Economist, April 14th, 2011, “From Bolshevism to backhanders”, www.economist.com.
- Miller N., (2009), “Strategic Leniency and Cartel Enforcement”, American Economic Review, Vol. 99.
- Nations in Transit, editions 2001–2012. NewYork: Freedom House, 2001–2010.
- Spagnolo G. (2004), “Divide et Impera: Optimal Leniency Programmes”, CEPR Dp 4840.
- Spagnolo G. (2008), “Leniency and Whistleblowers in Antitrust”, Ch. 7 of P. Buccirossi (Ed.), Handbook of Antitrust Economics, 2008, M.I.T. Press.
- Statskontoret, 2012, ”Köpta relationer – om korruption i det kommunala Sverige”, 2012:20.
- US Department of Justice, Leniency Program, Antitrust Division.
[1] The sad recent stories of Sergei Magnitsky in Russia and of S.P. Mahantesh in India clarify that this risks are real.