How Business Community Institutions Can Help Fight Corruption∗

This paper considers the possibility of collective action by the business community to counter corruption in the award of government licenses and contracts. The analogy is with contract enforcement institutions studied by economic historians and contract law scholars. The institution in this context comprises a no-bribery norm, a community system to detect violations, and a multilateral ostracism penalty upon conviction in a community tribunal. The requirements such an institution must meet if it is to be effective are analyzed. It is shown that an institution of sufficient quality—combining probability of correct detection and severity of punishment—can eliminate bribery. If the private institution is not sufficiently good, then in conjunction with the state’s formal apparatus it reduces the level of bribes demanded, but increases the probability of winning the license or contract through bribery. An improvement in the government’s formal anti-corruption mechanism, holding the private institution constant, reduces both the level of bribes and the probability of success through bribery. The two institutions together are shown to achieve substantially better outcomes than either can on its own. JEL classification codes: D02, D73, K42, P37, P48 Author’s contact information E-mail: [email protected] Web page: https://www.princeton.edu/ ̃ dixitak/home/wrkps.html Mail: Department of Economics, Princeton University, Princeton, NJ 08544, USA ∗This paper was written during a very pleasant month as a Visiting Research Fellow in the Development Economics department (DECVP) of the World Bank, and presented at the Bank’s ABCDE Conference in Washington, DC, June 2-3, 2014. I thank Toni Adlerman, Tito Cordella, Aslı Demirgüç-Kunt, Varun Gauri, Stuti Khemani, Aart Kraay, and Francesca Recanatini for useful conversations, and Kaushik Basu and Dani Rodrik for valuable comments on a previous draft. Of course the assertions and views expressed here are my own, and not those of the World Bank or any of its staff.