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This article studies the impact of corruption on an economy with a hierarchical government. In particular, we study whether centralizing corruption within the higher level of government increases or decreases the total amount of corruption. We show that when the after-tax relative profitability of the formal sector as compared to that of the informal sector is high enough, adding a layer of government increases the total amount of corruption. By contrast, for high-enough public wages and/or an efficient monitoring technology of the bureaucratic system, centralization of corruption at the top of the government hierarchy redistributes bribe income from the lower level to the upper level. In the process, total corruption is reduced and the formal sector of the economy expands. (JEL D73)
ABBREVIATIONS
CIS: Commonwealth of Independent States
EBRD: European Bank for Reconstruction and Development
OECD: Organisation for Economic Co-operation and Development
I. INTRODUCTION
Corruption takes many forms and can arise at many levels, as pointed out by the classic study of Wade (1985). A large literature has grown up since then, modeling various aspects of corruption; see the surveys by Bardhan (1997), Organisation for Economic Co-operation and Development (OECD) (1997), and Schneider and Enste (2000). One of the questions that this literature has yet to answer concerns the structure of corruption. Borrowing the language of budgeting, we can think of two structures of corruption: top-down and bottomup, as in Gardner and von Hagen (1996) and Cheung (1998). Top-down corruption refers to a setting in which corruption decisions are centralized in the chief of state, who then monitors lower-level officials in an attempt to collect corruption rents. Bottom-up corruption refers to a setting in which corruption decisions are decentralized at the level of lower officials. In this form of corruption, the chief of state is simply one among many collectors of corruption rents. A similar distinction, using the same language, is made by Rose-Ackerman (1999), where "bottom-up" refers to low-level officials collecting bribes and sharing them with superiors, while "topdown" refers to corrupt superior officials buying the silence of subordinates by sharing their ill-gotten gains.
There is evidence that both forms of corruption exist in practice, especially in various parts of the Commonwealth of Independent States (CIS). Quantitative evidence of the importance...