The document discusses models of quasi-corruption in public procurement. It defines a quasi-corruption model as examining the behavior of bona fide agents working under rules set by a mala fide principal. The document analyzes Russia's use of auctions in procurement and identifies issues like limited competition, irrational behavior, and risks of second-price bids, collusion and dumping that can incentivize quasi-corrupt behavior from bona fide agents. It argues that for homogeneous and differentiated goods, Russia's auction rules created incentives for agents to act in quasi-corrupt ways even if they were bona fide, due to problems like uncertainty around second-price bids.

1. VI International Public Procurement Conference, Dublin, Ireland
Aigust, 14, 2014
Andrew Ivanov
The Model of Quasi-Corruption:
Public Procurement Case

2. Corruption modelling: Three sources of the New
Typology of “Principal-Agent” Models
Jensen M. and Meckling W. (1976). ‘Theory of the Firm: Managerial Behavior, Agency
Costs, and Ownership Structure’, Journal of Financial Economics.
Jain A. K. (2001). ‘Corruption: a review’,
Journal of Economic Surveys, vol. 15(1).
Rose-Ackerman S. (1975) ‘The economics of
Corruption’, Journal of Public Economics, 4.

3. Methodology: dramatis personae of the
“Principal-Agent” Model in Public Sector
Position Actors Preferences
Basic Principal Populace BP ()
Principal Government, Legislator P ()
Agent Contracting Authority (CA) A ()
Definition 1. We call that the principal (agent) mala fide if its
preference order is different from the basic principal's preference
order: P  BP (А  BP), and bona fide if otherwise.
The main reasons of Principal’s mala fides:
Grand corruption
Bounded Rationality

4. The Mainstream
Principal Agent Model Title Pioneer references
Bona Fide
 P   BP
Mala Fide
A   BP
Classical Model
A   P
Rose-Ackerman S. (1975) ‘The
economics of Corruption’
Mala Fide
 P   BP
Mala Fide
A   BP
Efficient Corruption
A   P
Nye J.S. (1967) ‘Corruption and
Political Development: A Cost-
Benefit Analysis’
Totalitarian Model
A   P
Huntington S. (1968) ‘Political
Order in Changing Societies’
“In terms of economic growth, the
only thing worse than a society
with a rigid, over-centralized, dis-
honest bureaucracy is one with a
rigid, over-centralized and honest
bureaucracy”
We have: BM, M1M2 (M1 ≠ M2), (M1 = M2).
We do not have: BB, MB.

5. The Typology of the “Principal-Agent” Models
Basic
principal
Principal Agent Model Title
Bona Fide Bona Fide
 P   BP
Bona Fide
A   BP
Ideal Model
A   P
Mala Fide
A   BP
Classical Model
A   P
Mala Fide
 P   BP
Mala Fide
A   BP
Efficient Corruption
A   P
Totalitarian Model
A   P
Bona Fide
A   BP
Quasi-Corruption
A   P
Def. 2. Bona fide agent’s actions violating the rules of regulation created by
the mala fide principal will be called quasi-corruptive behavior.
Def. 3. The model, which examines bona fide agent’s behavior in institutional
conditions created by mala fide principal, will be called quasi-corruption model.

6. Algorithm of modeling of corrupt behavior
Step 1. Set up the investigated problem, define alternatives
Step 2. Model the BP’s preference order  BP
Last step. Propose amendments to public policy and regulatory rules
Step 3. Identify the Principal and the Agent
Step 4. Use the regulation rules to model the P’s preference order  P
P is bona fide:  P   BP
Step 5. Apply classical model
P is mala fide:  P   BP
Step 5. Identify the existence of the
‘Principal  Agent’ problem
No: A   P
Step 6. Apply
totalitarian model
Yes: A A   P
Step 6. Identify the existence
of the bona fide agents
No: A   BP
Step 7. Apply quasi-corruption model
Yes: A A   BP
Step 7. Apply efficient corruption model

7. Case: Some Lessons from the Russian Experience of
Applying Auctions in Public Procurement
There are two main criteria: quality
and price.
For simplicity: Quality of the
purchased object can be determined
by the only numeric parameter.
The Instruments to Obtain Contracts
• Single-source procurement
• Negotiations
• Competitive Procedures: Tenders, Auctions (English, Dutch, first-
price, Vickrey)
Step 1. The Main Problem of Procurement

8. Step 2. Basic Principal’s preference order
The case of homogeneous goods
The Basic Principal is assumed to be able to formalize the supplied good as a bundle
of its specifications and to point out the feasible sets for every specification:
.
~~~~
,,,2,1,
~
21 niii DDDDniDDq  
     
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



 21
21
21
21
022
2
11
1
~
:,,,
aapp
aapp
qqpqapqa i


9. Step 2. BP’s preference order: the case of differentiated goods
BPPO is reflexive, complete, transitive, “monotonic”, convex and is not dependent
from the third alternative: preference in any pair of contracts does not change when
the set of contracts is changed (leaving affordable the compared contracts):
BP(A)  BP (A*), A  A*.
Assumption Definition Reasons
Reflexivity Identical contracts are indifferent
each other
Completeness For every two contracts BP knows
how much additional money he is
ready to pay for additional quality
Transitiveness From any finite set of contracts BP
can choose the most preferable
one
“Monotony”
Convexity The BP do not pay more for the
extra quality
212121
~:, aaaaaa 
      21
21
2121
22
2
11
1
:,,, aa
pp
qq
aapqapqa 




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
    


 12
21
22
2
11
1
:,,,
aa
aa
pqapqa


31
32
21
321
:,, aa
aa
aa
aaa 







  convexisaBa:

10. Step 2. BP’s preference order: the case of differentiated goods
Given assumptions, basic principal’s indifference curves are the
graphs of strictly monotonically increasing, continuous, concave
functions:

11. Politicians
Legislator
Federal
Bureaucrats
Make public policy
Appoint
Takes a legislation
Contracting
Authority
Suppliers
Coordinate
Monitor
Purchase
Society
Coordinate
Monitor
Regional
Bureaucrats
Elect
Elect
Step 3. The Identification of the Principal and Agents
Basic Principal, Principal and Agent
in the simplified Model of the RF PPS

12. Auction as the preferred procurement method (2006-New PPL)
• Discretionary Power
• Rent extraction behavior
• Weakness of the Institutions
The three necessary conditions of the corrupt behavior
Step 4. Principal’s preference order: the main tool of last Russian PPL
Russia is a country with transitional economy:
• the institutional system is formed,
• elite are changing.
Corruption level is
getting higher
Samuel P. Huntington, Political Order in Changing Societies, 1968.
• There is an Auction list consists of homogeneous (paper, cleaning and so on) and
differentiated (cars, engines, drugs and so on) goods, services and works
• For goods and services from the AL impossible to award contract by the criterion
of the most economically advantageous offer, Agent must apply an action
• Agent can apply the reverse (an English) auction in any case (second-price)
• Agent can apply the first-price sealed-bid auction for small contracts
• Agent cannot apply the Dutch or Vickrey auction in any case

13. Step 4. The Principal’s bona fides identification (1)
Agent defines the set of acceptable goods as BP and there are N suppliers
who can deliver the goods from this set:
 .,,1,
~
NIiDx i

Each supplier knows what his own production and delivery costs will be if
he wins a contract:
  .,
~
, IiDxxCc ii
ii 
Main assumptions
The set of suppliers S is a union M (1  M ≤ N) of disjoint sets (classes of
suppliers):
  ,,,2,1,,,,21 MjijiSSnSSSSS jiiiM  
and all the bidders of each class appear to be the same to the buyer and to each
other. Assume that suppliers of each class independently draw their costs from
the probability distribution Fi(i, i), i=1, 2, …, M, defined on the intervals
  .,,1,1,,2,1,:, MijMicCCc jiii  

14. Step 4. The Principal’s bona fides identification (2)
• All suppliers are supposed to be rational and risk-neutral.
• There is no collusion among suppliers.
• There are no dumping suppliers (nobody bids lower his costs).
Proposition. If the Principal prescribes to the contracting authority to
procure indivisible goods by the English auction, then given assump-
tions the Principal is mala fide.
• The auction is designed in such a way that each supplier has no informa-
tion on the participation / non-participation in the auction other suppliers.
• Agent sets the initial (maximum) contract price p0 such a way that the following
inequality is satisfied:
.,max 0 Iipci
Ii



15. Step 5. The Identification of the ‘Principal  Agent’ problem
The Performance of the live outcry auctions
2007 2008 2009
Competition in the auction (bids/auction) 9.05 2.88 3.64
Average price reduction (%) 15.02 12.19 10.5
The Performance of the e-auctions in 2010
Suppliers
Bids
ETP Auction WnrCA
AdmissionPart 1
ETP CA
Part 2 Admission
M-etp S-etp T-etp Total
Competition in the auction (second parts
of bids/auction)
1.5 1.6 1.8 1.6
The auctions did not take place (%) 75 69 71 72
Average price reduction (%) 6 4 4 4.7
Suppliers
Bids
CA
Admission
Auction Winner
Corruption Collusion Dumping

16. Step 5. The Identification of the ‘Principal  Agent’ problem
!
The questions are:
 Who has limited the competition
 Why the competition had been limited
 How the competition had been limited
Who
The Suppliers: in the course of transition from outcry auctions to e-
auctions collusion problem cannot be sharpened.
Who can limit the competition in the auctions:
 Principal (Regulator)
 Agent (CA)
 Supplier
 ETP
The Agent has limited the competition in the auctions

17. Step 6. The Identification of the bona fide Agents
The Agents: there is “mala fide” corruption (bribes or “kickbacks”) and there is
“bona fide” corruption (no bribes, no “kickbacks” ).
Who
Russian economic report: recovery and beyond’. (2013) The World Bank in Russia, №29, Spring.

18. Step 7. The application of the quasi-corruption model
• The irrational behavior
Цена
(Издержки)
Качество
O
p0
q0
   2
1
1
1
,, cxcx BP

110 3 p
    1,, 2
1
icxcx i
i
P
P  BP
    2,, 2
1
icxcx i
i
BP
x1 x2
c1
c2
cN
xN
• The second-price curse
• The second-price risk
M=1, 1<<1
     


N
i
NicPcPcP
2
11111212 .36
2
1
111 
Homogeneous goods: incentives to quasi-corruption

19. Homogeneous goods: incentives to quasi-corruption (2)
• The collusion risk
.,,2,1,6 1100 Nicpcp i  
• The dumping risk
j

?
111 6cccc Nj
!

20. Basic Principal: the best contract
The set of feasible to BP contacts:   .,,, Iicppx i
i

BP’s Pareto set:
  .,, IicxAA i
i
ABP 
(xj, cj) (1  j  N)
Contract
price
(Costs)
Quality
O q0 x1 xj
c1
cj
xN
cN BP’s best contract:
M1, 1<<1
Differentiated goods: incentives to quasi-corruption
M=N

21. Differentiated goods: incentives to quasi-corruption
    .,,2,1,, 2
1
Nicxcx i
i
 
A bona fide customer from a variety of alterna-
tives available to him does not choose the most
preferred.
• The risk of irrational behavior
• Every time he obtains worst-
quality bid
• Sometimes he awards contract to
the worst bid.
Why
Price of
Contract
(Costs)
Quality
O q0
p0
x1 x2 xN
c1
c2
cN

22. Differentiated goods: incentives to quasi-corruption (2)
• The second-price risk • The second-price curse
M-etp S-etp T-etp Total
The auctions did not take place (%) 75 69 71 72
Why
• The collusion risk • The dumping risk

23. Price
(Costs)
Quality
O q0
p0
HQ-suppliers go to the
private market
Differentiated goods: Long Run auctions risks
set»«quality),[
~
0  qD
HQ
LQ
There is a private market for supplied goods
Some information of bidders is available for them.
x1
c2
The “Lemon’s market” mechanism is launching.
• The risk of Information Transparency

24. Last step. Policy implications
WHEREAS the [Government] [Parliament] of ... considers it desirable to
regulate procurement so as to promote the objectives of:
(a) Maximizing economy and efficiency in procurement;
(b) Fostering and encouraging participation in procurement proceedings by
suppliers and contractors regardless of nationality, thereby promoting
international trade;
(c) Promoting competition among suppliers and contractors for the supply of
the subject matter of the procurement;
(d) Providing for the fair, equal and equitable treatment of all suppliers and
contractors;
(e) Promoting the integrity of, and fairness and public confidence in, the
procurement process;
(f) Achieving transparency in the procedures relating to procurement.
WHEREAS the [Government] [Parliament] of ... considers it desirable to
regulate procurement so as to maximizing economy and efficiency in
procurement.
To maximizing economy and efficiency in procurement … : (b) -(f).

25. Juraj Nemec, Prof. Dr., Masaryk University Brno, Czech Republic. –
IRSPM2014 Conference, Ottawa, April.

26. Last step. Policy implications (2)
1. The applying of the English auction for purchasing the
differentiated goods must be approved by a designated organ.
2. To award contract to the most economically advantageous bid by
the auctions which give the possibility of compensating the higher
contract price by the higher quality of the purchased goods:
• Scoring auctions,
• Handicap auctions.
3. To introduce the Dutch auction into the list of acceptable
procurement methods. This auction:
 The first-price auction
 A proven means of limiting opportunities for collusion of suppliers
 Does not demand the establishing of initial price
 Does not demand the auction step
 Need not the shutting time
 Decrease the time of auction procedure.

27. Corruption modelling: Four sources of the New Typology
of “Principal-Agent” Models
Jensen M. and Meckling W. (1976). ‘Theory of the Firm: Managerial Behavior, Agency
Costs, and Ownership Structure’, Journal of Financial Economics.
Becker G. (1968) ‘Crime and Punishment: An
Economic Approach, The Journal of Political
Economy, Vol. 76, No. 2.
Jain A. K. (2001). ‘Corruption: a review’,
Journal of Economic Surveys, vol. 15(1).
Rose-Ackerman S. (1975) ‘The economics of
Corruption’, Journal of Public Economics, 4.