How does market competition affect the prevalence of corruption? Some people think that increasing competition could decrease corruption (see here and here). The intuition is that increased competition lowers firms’ profits, meaning that public officials cannot extract as much money out of the firms through extortive threats (e.g., a threat to falsely report noncompliance with safety regulations unless the firm pays a bribe). As the saying goes, you can’t squeeze blood from a turnip. By contrast, the argument continues, in less competitive markets firms have higher profits, and officials, knowing this, can use threats to extract some or all of this surplus for themselves. However, others have argued that increased market competition may lead to more corruption. Those taking this position tend to emphasize collusive rather than extortive corruption (see here and here) and point out that increased market competition makes collusion—which is, of course, a risky proposition—more attractive to firms, because the firms have more to gain from a leg up on their competitors. For example, an importing firm that pays a bribe to avoid paying customs duty will receive greater benefit from this competitive advantage when competition is fierce, since it will allow the firm to reduce prices and increase its market share more extensively. A monopolistic importer, by contrast, has less of an interest in paying the bribe to avoid the import duty, since a monopolist can offset much of the duty by raising consumer prices without needing to worry about losing much market share.
So, one can construct plausible theoretical arguments in both directions. What does the empirical data say about which story is closer to the truth? There have been a handful of studies so far, but they provide contradictory or equivocal results—some studies find that more competitive markets are associated with less corruption (see here, here and here), but others have found the opposite. But these studies focus on “corruption” generally, while the theories sketched above suggest that the effect of market competition on corruption may differ depending on the type of corruption—coercive or collusive. One prominent study, by Alexeev and Song (2013), explicitly incorporates this distinction and finds—based on analysis of data from the World Bank Enterprise Surveys of manufacturing firms in different countries—that increased competition increases the prevalence of collusive corruption. While this is an important step in the right direction, the survey data used here is still not ideal: the measure of “collusive corruption” is based on the respondent firms’ answer to a question about the amount of money firms in their line of business typically need to pay to public officials each year “to get things done,” which seems both vague and potentially overinclusive.
Luckily, later on the World Bank Enterprise Surveys expanded the range of corruption measures collected as part of its Investment Climate surveys in developing countries, recently publishing the latest of these surveys (get the data here), that may shed new light on this debate. The attractive feature of this more comprehensive survey data is that, in contrast to the data used by Alxeev and Song, the new surveys ask not only about the one vague measure of corruption, but ask separately about four different kinds of informal payments: to tax officials (hereinafter tax bribe); to secure government contracts (hereinafter contract bribe); to secure an import license (hereinafter import bribe); and to secure an operating licensing (hereinafter operating bribe). The survey, both in its current and older version, further asked every firm to report the number of competitors that it faces in its market of operation, which provides a ready firm-specific measure of market competition.
A thorough analysis of the competition-corruption link using this new data will need to await future work, but as a first step, I conducted some preliminary, exploratory quantitative analysis of the Investment Climate survey data. The results were surprising, and suggest not only that asking whether “corruption” is positively or negatively correlated with market competition is too crude, but also that even the proposed collusive-coercive distinction does not adequately capture the nuances of the relationships between competition and various forms of corruption.
My preliminary analysis consisted of a multivariate statistical regression, where the primary explanatory variable of interest is the degree of market competition, and the primary outcome variables of interest are each of the four types of corruption noted above. (The regression also includes a set of control variables drawn from Alexeev & Song’s prior study.) My findings were as follows:
- Higher levels of market competition have a statistically significant positive correlation with paying contract bribes and import bribes.
- Higher levels of market competition have a statistically significant negative correlation with paying tax bribes and operating bribes.
This seems like strong evidence that the relationship between market competition and corruption depends crucially on the type of corruption, but at the same time, these results do not seem consistent with the simple version of the coercion-collusion theory. It does not seem plausible that contract bribes and import bribes are clearly forms of collusive corruption, while tax bribes and operating bribes are forms of coercive corruption. Indeed, paying bribes to reduce taxes and to get operating licenses could be seen as collusive, as they advance the firm’s interests. Furthermore, even if these practices include instances of coercive interaction, there is no apparent reason to think coercive tax and operating bribes would be more common than coercive contract or import bribes. So what is going on?
I would suggest that the emphasis on the coercion-collusion distinction in this context is premised on the mistaken conjecture that the relationship between market competition and corruption depends entirely on whether the firm benefits from the corrupt behavior (as in the collusive case) or is harmed by the corrupt behavior (as in the coercive case). While it is true that collusion occurs when there is a benefit to the firm from engaging in the corrupt interaction, there are different types of benefits, and only some of them are related to market competition. Specifically, we must distinguish (1) benefits that improve the firm’s competitive standing, from (2) benefits that aid the firm but do not improve its competitive standing. It is only the former types of corrupt practices that we should expect to be positively correlated with market competition. Recognizing this distinction helps account for the otherwise surprising pattern I found in the Investment Climate survey data, as follows:
- Both contract and import bribes straightforwardly grant the firm that pays them a competitive advantage. Import bribes directly reduce a firm’s production costs, allowing it to lower prices and secure a larger market share. Similarly, contract bribes directly increase the firm’s market share by granting the firm a larger slice of the (finite) government contracting “pie.” So, greater market competition means that these forms of corruption (whether we frame them as “collusive” or “coercive”) are more valuable for firms, and they become more widespread. And this is consistent with my findings in the data.
- By contrast, tax bribes, even when collusive, do not necessarily create a competitive advantage. Colluding with a tax official to lower a firm’s tax liability entails sharing the “profits” from this collusive deal with the public official at the expense of the state’s treasury, not other firms. This sort of corruption increases a firm’s profits, but it does not lower its production costs or allow the firm to do anything to lower its prices or obtain a larger market share. When the market is more competitive, firms have lower profits, and therefore there is less gain to be had from bribing tax officials. So, even when tax bribery is collusive, increased competition would be expected to result in less corruption of this type, which is consistent with what I found in the data.
- Operating bribes are harder to categorize because they might enable a firm to enter a new market. But the costs associated with entering a new market are sunk once the firm enters it, and therefore decreased entry costs do not give a firm any competitive advantage once it has entered that new market and is competing. Therefore, there’s no reason to expect that even collusive operating bribes would be positively correlated with market competition. But what explains the negative correlation that I found in my preliminary analysis? One possibility is that the coercive nature of many of the operating bribe interactions (public officials extorting money to issue licenses to firms that meet all of the requirements) provides the explanation.
Two final notes: First, because the measure of market competition here is not a policy measure, but rather a measure of actual (and self-reported) competition, care must be taken in interpreting the results, and in deriving conclusions for policy. While the discussion here has focused on the ways in which market competition may affect the level of corruption, it’s certainly possible that the causal arrow runs in the other direction as well. For example, certain markets might be less competitive in practice because the public officials in charge of granting operating licenses demand bribes, thus erecting artificial barriers to entry. Or it could be that in countries with very high tariffs, import bribes might increase market competition by allowing a larger set of firms access to important production components. Again, the analysis here is preliminary; further research, and more rigorous statistical testing, will be needed to nail down the causation question. Second, market competition is undoubtedly important for numerous reasons unrelated to corruption, and so the findings here, even if they prove robust, should not be interpreted as standalone arguments for or against attempts to foster more competitive markets. Nonetheless, it is useful for legislatures and administrative agencies tasked with promoting anticorruption policies to be more aware of the possible effects that competition may have on the prevalence of corruption, accounting for the unique economic characteristics of each corrupt practice.