Corruption is a serious problem in the developing world. In Galiani and Weinschelbaum (2013), we study the interaction between frequently ignored social and economic incentives in determining the level of corruption in a given society. Monetary and social rewards simultaneously play an important role in determining individual behavior and their interaction determine the corruption level of the society.

We view social status as a substitute for money, in line with the long-standing theory of compensating wage differentials. Thus, high-status occupations would pay lower wages, ceteris paribus.  This was already suggested by Adam Smith: “Honor makes a great part of the reward of all honorable professions. In point of pecuniary gain, all things considered, they are generally under-recompensed… The most detestable of all employment, that of public executioner, is, in proportion to the quantity of work done, better paid than any common trade whatever” (The Wealth of Nations).

In our analysis we focus on a particular case of corruption: collusion between tax collectors and taxpayers to evade taxes. We build upon the interesting model developed by Besley and McLaren (1993), which evaluates alternative payment schemes for tax inspectors in the presence of the threat of corruption. In this setup, there are problems of both moral hazard (because the acceptance of bribes cannot be monitored without a costly surveillance system) and adverse selection (since inspectors cannot be individually identified as being honest or dishonest). We depart from Besley and McLaren (1993) by assuming that a mix of private and social rewards is used by the society as incentives for tax collectors. Individuals derive utility both from money and social status. A person may gain social status in several ways. In our paper, we follow Fershtman and Weiss (1993) in assuming that social status is conferred through occupational association.

In particular, we assume that the social status of tax collectors varies inversely to the rest of the society’s perception of corruption in this group. Thus, it is assumed that the social status of the tax collectors is determined by their average level of honesty as perceived by society (since we also assume that the behavior of each civil servant is not observable). The emphasis on perceptions of society is not arbitrary. Social status rests on collective judgment or rather on a consensus of opinion within a group. No one person, acting alone, can confer status on another, and if everybody whom a given individual meets were to assess that individual’s social position differently, then the person’s social status would be entirely indeterminate (Marshall, 1977). In this sense, social status could also be called “collective reputation” as in Tirole (1996). Tirole’s work focuses on the dynamics of “collective reputation” and how it interacts with reputation at the individual level while our paper studies the effects of social status in the optimal monetary payment scheme and the level of corruption.

We show that if a society uses social rewards to provide incentives for civil servants, then the “optimal” level of corruption, ceteris paribus, will be lower than it would be in a society where social status is unnoticed. This holds true because in societies that coordinate their efforts to use social rewards to provide incentives for civil servants, payment schemes that prevent corruption will be less expensive (since part of the payment is made through social status) and payment schemes that induce high levels of corruption will be more expensive than they would be in societies that do not have recourse to social rewards. Thus, there are more economies (i.e., parameter values) for which payment schemes that deter corruption are implemented. Ignoring social rewards could lead to obtain wrong conclusions and implement erroneous policies.

Combating corruption improves government finances not only because of the increase in revenues brought about through its direct effect, but also because it allows the government to pay lower wages, since inspectors will be getting higher payments in the form of social-status rewards. The status effect complements the use of efficiency wages, since at least part of the wage premium is “paid” by social rewards. In contrast, if capitulation wages are used, workers will need to receive a higher payment in order to compensate them for the negative status effect.

Social incentives introduce the possibility of having, for the same wage level, different configurations of population and/or behavior of tax inspectors. Thus, a possible policy for reducing corruption is a purge (or razzias), in which the entire pool of civil servants (or politicians) is fired at once, as an instrument for switching from an unsatisfactory configuration of tax collectors to a better one. These ideas apply to governments but also to any organization in which agents can act dishonestly. In general terms, instead of considering bribes that are more common in the public sector, we could think in terms of rent seeking by agents. This can be the case, for example, at international organizations in which there might be units with a high proportion of agents holding rents, discouraging honest and competent agents. In that case, a razzia could bring balance back into the unit, considerably improving its functioning. 

Another possible policy against corruption according to our model is to raise wages to such a level in which there is no corruption. Once the level of corruption is reduced, and the social status is raised, the government could reduce wages, substituting monetary wages by social incentives, without changing the level of corruption.

Finally, societies in which social-status rewards are powerful will tend to have less corruption because they will use efficiency wages more frequently and capitulation wages less frequently. Thus, inducing the importance of social status would lead to reduce the level of corruption.

References:

Besley, T. and J. McLaren 1993. “Taxes and Bribery: The Role of Wage Incentives”, The Economic Journal, 103, No. 416: 119-141.

Fershtman, C. and Y. Weiss 1993. “Social Status, Culture and Economic Performance”, The Economic Journal, vol. 103, No. 419:946-959.

Galiani, S. and F. Weinschelbaum 2013. “Social status and corruption”. Nordic Journal of Political Economy, Volume 38, pages 1-16

Marshall, A. 1890. “Principles of Economics”, reprinted, Macmillan, London, 1962.

Smith, A 1976. “The Wealth of Nations”, reprinted, Modern Library, New York, 1937.

Tirole, J. 1996. “A Theory of Collective Reputations (with Applications to the Persistence of Corruption and to Firm Quality)” Review of Economic Studies, vol. 63, No. 1, pp. 1-22.