After-effects of anti-corruption laws

Desierto, Desiree and Bologna Pavlik, Jamie, Bribe-Switching (May 10, 2021). Free Market Institute Research Paper No. 3843425, Available at SSRN: https://ssrn.com/abstract=3843425 or http://dx.doi.org/10.2139/ssrn.3843425

Strict anti-corruption laws are seen as the panacea to many of society’s problems. But like many other laws that are created with good intentions, there can be unintended consequences to anti-corruption laws as well. These consequences are initially unforeseen by the supporters of these laws.

“Bribe-switching”

“Bribe-switching” by American researchers Jamie Bologna Pavlik and Desiree Desierto looks into the unintended consequences of the strict implementation of the Foreign Corrupt Practices Act (FCPA). It should be noted that the FCPA was enacted to prohibit firms and people in the United States from bribing public officials in foreign countries. Most famously, the FCPA was used to prosecute Goldman Sachs for its involvement in Malaysia’s 1MDB scam. So, what have been the benefits of the FCPA?

Many assume that strict anti-corruption laws like the FCPA when enforced properly by government officials would lead to a fall in corruption and an improvement in the economy. The FCPA, which imposes heavy fines and other penalties on American firms engaging in corrupt practices, is in fact considered to be a law that is implemented well. The researchers, however, found that when the U.S. government went after certain U.S. firms that operated in other countries on charges of bribery, other interesting results followed. These results failed to satisfy the initial expectations of the legislators who framed the FCPA.

Growth of illegal markets

First of all, there was no real decrease in the level of corruption among foreign officials after the enactment of the FCPA. The researchers propose what they call the “bribe-switching hypothesis” to explain the failure of corruption to fall in foreign countries despite the enforcement of FCPA regulations.

They argue that public officials do not depend on only formal markets to earn bribes but may also depend on other illegal markets to earn bribes. Whether public officials receive bribes through legal markets or through illegal markets depends among other things on the relative cost of receiving bribes through each route. When the cost of extracting bribes in the legal market increases due to laws like the FCPA, this can cause public officials to resort to obtaining bribes from the illegal market instead. If so be the case, public officials may compensate for the loss of bribe revenues from legal markets with bribe revenues from the black or illegal economy. For example, after the enactment of the FCPA, certain formal investment projects that would have earlier received approvals from officials after the payment of a bribe may no longer receive official approval. Instead, officials may focus their efforts on approving projects in the illegal market that bring them bribe revenue at a lower risk of getting caught red-handed.

In countries where American firms could no longer offer bribes due to FCPA regulations, the size of the black economy increased by as much as 0.25 percentage points, the researchers found in their study. Other proxy markers of illegal activity such as homicide rates, tree loss, and trade misinvoicing also showed that the FCPA was leading to an increase in illegal activity in the black economies of these countries. This, the authors argue, happens because public officials resort to obtaining their bribe revenue from the illegal rather than the legal market. This will make them more likely to allow illegal activities to flourish in order to maximise their bribe revenues. So, for example, a powerful bureaucrat might allow the illegal sale of liquor in the black market to flourish in exchange for bribes when he can no longer easily obtain bribes for investment projects from established U.S. liquor firms due to the FCPA.

Illegal economies, an alternative?

More importantly, the authors note that there was no increase in a country’s GDP per capita after the FCPA moved against attempts to bribe their public officials while in fact there was a significant increase in the size of their black economies. The authors argue that the growth of the black economy is a significant negative development for these countries. Others, however, may argue that the black economy in these countries could be serving as a useful alternative to the highly restricted legal economy. In this view, bribes may actually be greasing the wheels of commerce in many economies where existing laws that govern the formal economy are not conducive to legitimate business activities.