Abstract
This paper illustrates a theory of the second best where the constraints to the achievement of the optimum are of institutional nature. We consider the effects of corruption and bad governance on the public decision to privatize the provision of a service when contracts are incomplete and there is asymmetric information. We show that both corruption and bad governance are detrimental to welfare, but that removing only one of the two is not necessarily beneficial if the other is still present. The theory supplies a possible explanation to the controversial empirical evidence on the economic effects of corruption.
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Notes
A list of economic applications can be found in the original Lispey and Lancaster’s article.
In particular, we consider the case \(b(e)=\delta e\), \(c(e)=\sigma \sqrt e\), \(\beta =0\), \(\lambda =1\).
Any asymmetric division where the public employee receives a share \(\alpha \) of the gains will lead to the same qualitative results as long as \(0<\alpha <1\).
As shown later, even if the private and public manager are ex-ante identical in terms of cost-reducing efficiency, the choice of provision might lead to endogenous differences between the two. This is why it is interesting to compare the two forms of provision allowing for differences in \(\sigma _{P}\) and \(\sigma _{G}\).
The alternative of having a noisy signal on \(\delta \), although more natural from a decision-theoretical point of view, adds no further insights on the question at hand.
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I wish to thank M. LiCalzi and R. E. Buia for helpful comments.
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Molinari, M.C. A Second Best Theory of Institutional Quality. Public Organiz Rev 14, 545–559 (2014). https://doi.org/10.1007/s11115-013-0244-9
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DOI: https://doi.org/10.1007/s11115-013-0244-9