07/12/2013 02:06 pm ET Updated Sep 11, 2013

The Economics of Corruption

A few years ago, economists Ben Olken and Patrick Barron decided to visit some toll road truckers in Aceh, Indonesia. The truckers would pay bribes to pass weigh station attendants and police officers at checkpoints, and the two researchers were interested in learning about the economics behind this extortion with a before/after scenario.

They took clever advantage of a natural situation that arose when the Indonesian government withdrew police officers and troops from the checkpoint during the study, and measured the impact of that withdrawal. They found that price setting for bribes was conducted in a decentralized fashion; the officials at different checkpoints would not communicate with each other to standardize extortion fees.

In line with this, the two economists observed that officials at checkpoints closer to the final destination had more market power to set high bribes than those near the starting point. Consider a truck driver who reaches Checkpoint 3. If he decides that he is sick of paying bribes and wants to turn around, he has to pay bribes on his way back at the first two checkpoints. So the bribe at Checkpoint 3 only has to undercut the sum of the bribes of Checkpoints 1 and 2, and will thus be higher than both of them individually. This problem is called "double marginalization."

While it may seem that Olken and Barron are a couple of esoteric academics, perhaps unwittingly, they are actually part of one the latest trends in economics: forensic economics. Forensic? Are we going to be seeing Paul Krugman on the next episode of CSI?

Forensic economics seeks to use economic tools to detect and describe hidden, sometimes illicit behavior. In 2011, Eric Zitzewitz of Dartmouth College published a meta-analysis of studies that employ forensic economics, and he discusses some reasons why economists might be called in as third-party consultants for these problems.

In some cases, like bond funds altering their portfolios near disclosure dates to make the funds seem safer to investors than they actually are, the problem is inherently economic. In other cases, we'd expect officials to be monitoring their corrupt workers, but sometimes, the officials are complicit in the corruption scheme. A notable example of this is Steve Levitt's (of Freakonomics fame) study on prostitution in Chicago; the Chicago police is "more likely to have sex with" prostitutes than arrest them.

But in these other cases, why are the third-party consultants economists and not... violinists or something? Even if the situation isn't economic in import, corruption taken generally is an example of a market failure. Specifically, bribes are an incentive problem; corrupt workers are divested from the impact of bribe-taking on the whole economy, and they are not effectively monitored because they can enter into contractual bribe-sharing agreements with their bosses.

So what were Olken and Barron trying to do? Bribe-taking is an illicit activity, so they suspected that perhaps it could not be accurately predicted with standard economics. They modeled the scenario on Industrial Organization (I/O) theory. In fact, the concept of double marginalization traditionally refers to a middleman firm raising prices even further for consumers to ensure it a profit. Surprisingly, their model was predictively accurate, and established that even bribe networks can have complicated market structures.

A number of interesting results from forensic economics have emerged in recent years. Schools are more likely to suspend their low-performing students near test days. When abortion restrictions were relaxed in Taiwan, hospitals demanded more ultrasound machines capable of determining a fetus' sex, but female infanticides correspondingly decreased. Paul Niehaus of UCSD and Sandip Sukhtankar of Dartmouth College have authored a paper in which they discuss the Golden Goose Effect: Essentially, if they anticipate high corruption rents in the future, workers would rather not be very corrupt in fear of being shut down (killing the goose that lays the golden egg). This sort of self-monitoring provides hope for future anti-corruption policy.

It is clear that forensic economics is not really a separate field unto itself, but a mass agglomeration of different economic tools and concepts. Yet, as we've seen, the results of this research are particularly important for developing economies, where hidden behavior and graft can account for large chunks of lost surplus. Not bad for an ivory tower pursuit.