VI. Incentive Payments for Civil Servants - 1

VI. Incentive Payments for Civil
Servants

Let us now turn to the important policy
issue of an incentive pay structure in
public administration that is often cited
as one of the most effective ways of
fighting corruption. In imperial China
under the Ch’ing dynasty district magistrates
were paid an extra allowance
called yang-lien yin (“money to nourish
honesty”). Klitgaard (1988, p. 81) cites
a quote from the historian Macaulay’s
account of Robert Clive’s attempt to reduce
the corruption rampant in the
British East India Company in 1765:
“Clive saw clearly that it was absurd to
give men power, and to require them to
live in penury. He justly concluded that
no reform could be effectual which
should not be coupled with a plan for
liberally remunerating the civil servants
of the Company.” In recent times both
Singapore and Hong Kong have followed
an incentive wage policy for public
officials with a great deal of success.
Current reforms in tax enforcement in
many countries, which include a bonus
to the tax officer based on the amount
of taxes he or she collects, have often
been associated with significant improvements
in tax compliance (see, for
example, Dilip Mookerjee 1995). In
some cases (like in Singapore) a wage
premium above private sector salaries
has been found useful, consistent with
the efficiency wage theory. The potential
cost of job loss (including the wage
premium and seniority benefits) on detection
may stiffen official resistance to
temptation for corruption. International
agencies pushing for structural adjustment
policies sometimes ignore that,
while deregulation reduces opportunities
for corruption, another part of the
same policy package aimed at drastic reductions
of public spending may result
in lower real wages for civil servants increasing
their motivation for corruption.
One should also keep in mind that
when today’s rich countries had beaten
the worst of corruption in their history,
the average salary of an official was
many times that of what obtains in most
poor countries.
While the argument for incentive
payment is clear, the relationship between
public compensation policy and
corruption can sometimes be quite
complex. This is because our objective
is not merely to reduce corruption in an
official agency but, at the same time,
not to harm the objective for which the
agency was deployed in the first place.
Much of the theory of rent-seeking does
not worry about this, because the presumption
often is that government is
nothing but organized theft and the less
of it the better. But, as we have already
seen in the case of rationed distribution
of food to the poor, if we have another
valued social objective, there may be
cases where the corrupt administered
system is preferable to the market. We
shall now discuss the compensation policy
for corruptible enforcers of a regulation
when the latter has a valued social
purpose. Let us take, for example, the
case of public inspectors charged with
monitoring pollution from a factory. We
shall follow the theoretical model of
Mookherjee and I. P. L. Png (1995) to
understand the nature of the tradeoff
among corruption, pollution, and en-

forcement effort and consider the consequences
of strategic interaction between
the polluting factory and the corruptible
inspector.
Suppose the regulator can directly
control neither the inspector’s monitoring
effort nor his underreporting of the
factory’s pollution for which he gets
bribed, a double moral hazard problem
in a principal-agent model. The regulator
has three instruments: a rate of reward
r for the inspector (a percentage
commission based on the fines for pollution
collected from the factory), a
penalty p (depending on the amount of
underreporting of pollution) on the inspector
when corruption is discovered,
and a penalty q (a mark-up over the
usual fine for the evaded pollution ) on
the factory for bribing the inspector.
The probability that the inspector will
unearth the factory’s true pollution
level (assuming, of course, that he will
not overreport) depends on the monitoring
effort exerted by the inspector.
There is also an exogenous probability
that the inspector’s underreporting and
the bribe paid are discovered by the
regulator. Given the regulator’s policy
package (r, p, q), the factory and the
inspector simultaneously choose the
pollution level and the monitoring intensity
respectively. The two parties
(assumed risk-neutral) then jointly determine
the bribe, if any, as part of a
Nash bargaining solution.