The Economics of Extortion

Patrick Barron and Ben Olken have a great paper out. Entitled The Simple Economics of Extortion: Evidence from Trucking in Aceh, it looks at corruption along trucking routes in Northern Sumatra. There are so many clever and original things that this study does that I can’t resist quoting a long slab from the introduction.

To investigate these payments, we designed a study in which enumerators accompanied truck drivers along their regular routes to and from Aceh. From November 2005 to July 2006, enumerators accompanied drivers on a total of 304 trips to and from Aceh, and directly observed more than 6,000 illegal payments along the routes. To the best of our knowledge, this represents the first large-scale survey that has ever directly observed actual bribes in the field.1 On average, drivers spent about US $40 per trip, or about 13 percent of the total cost of a trip, on bribes, extortion, and protection payments.

Using this data, we first examine whether the bribes charged at checkpoints respond to changes in market structure in ways consistent with each checkpoint behaving as a decentralized price-setter in a chain of monopolists. During the period we study, the Indonesian government withdrew over 30,000 police and military from Aceh province in accordance with a peace agreement signed earlier in the year to end a thirty-year civil war between separatists and the Indonesian government. Since the troops and police that were withdrawn previously manned many of the checkpoints that extract payments from truck drivers, this withdrawal represents a plausibly exogenous change in the market structure for illegal payments in this area. Moreover, the roads to and from Aceh pass through two provinces, Aceh province and North Sumatra province, while the military withdrawal affected only troops and police stationed in Aceh province. We can therefore use the change in average bribes charged in North Sumatra in response to the reduction in checkpoints in Aceh to measure the extent of double-marginalization in this market.

We find that the average bribe paid in North Sumatra increased slightly in response to the reduction in the number of checkpoints in Aceh; specifically, the elasticity of the average bribe paid at a checkpoint in North Sumatra province with respect to the number of checkpoints on the portion of the road in Aceh province is between -0.10 and -0.35. The fact that prices increase in response to the reduction in the number of checkpoints, but not by enough to fully offset the lost revenue from the reduction in the number of checkpoints, is consistent with decentralized price setting by a chain of vertical monopolists, and more generally, with the Shleifer-Vishny view that the market structure has an impact on the total amount of bribes charged.

Second, since a driver needs to successfully pass all checkpoints on a route in order for the journey to be completed, the amount of surplus to be extracted by officials at checkpoints at the beginning of the trip may differ from the amount of surplus to be extracted at the end of the trip. If there is bargaining over bribes paid, this will translate into systematic differences in bribes paid at different points in the route. Using information on how each transaction physically took place, we show that different officials have different bargaining power and, indeed, that bargaining does play an important role in determining bribe payments. Then, taking advantage of the fact that our data includes trips in both directions, we examine how the pattern of payments changes as the truck gets closer to its destination. We then find that, consistent with the theory, ‘downstream’ checkpoints – i.e., those that are closest to the final destination – receive higher bribes than ‘upstream’ checkpoints – i.e., those that are closer to the origin of the trip.

Given that market structure appears to matter in determining the levels of bribes, a natural next question is to what degree profit-maximizing corrupt officials can implement complex pricing arrangements. While firms are often able to use price discrimination mechanisms to increase revenue (e.g., Borenstein and Rose 1994, Shepard 1991, Varian 1989) , the illegal nature of corruption might make implementing price discrimination difficult.

We show, however, that corrupt officials do in fact practice several types of price discrimination. Officials at checkpoints, for example, appear to charge higher prices to those drivers with observable characteristics that indicate a higher willingness to pay, such as those driving newer trucks or carrying valuable cargo. Moreover, we document that officials at one weigh station have implemented a complex system of second-degree price discrimination, involving a coupon system whereby drivers self-select, before the trip starts, into one of multiple two-part tariffs. The fact that such types of price discrimination exist suggests that the illegal nature of the market does not prevent the emergence of quite sophisticated contracts.

While the pricing behavior described here may be privately optimal for decentralized corrupt officials, much of this type of pricing behavior serves to increase the efficiency costs from corruption. For example, decentralized pricing at checkpoints implies higher bribes charged, and thus a higher distortion on truck behavior, than if bribes were centralized. Moreover, the emergence of second-degree price discrimination at weigh stations means that the cost imposed by the weigh station is concave in the truck’s weight, rather than convex as would be socially optimal.

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4 Responses to The Economics of Extortion

  1. Kevin Cox says:

    I lived and worked in Sumatera from 1968 to 1973 immediately after the General’s takeover. Government in the provinces was decentralised with the army required to gain its income from local taxes and get no help or assistance from the Central Authorities.

    This system was efficient in the sense that the Army did provide the stability and control necessary for civil society to exist and they did it with the minimum of fuss. Fines, tolls and charges were not random and were normally negotiated well before they were required. It was a taxation system but in a different format. I suspect the current system 35 years later is essentially the same system and I dislike the terminology used in the article of the system being corrupt. The Army provides the necessary stability and in my experience they were very progressive in the way they taxed. If you had money then you paid more.

    It is unhelpful to call the Indonesian collection of taxes by road tolls corruption and the payments bribes. I would prefer that the authors had used the words local decentralised taxes.

  2. Derek says:

    Excellent article.

    I’m no economist, but regardless of whether you call it bribes or “local decentralised taxes”, the Barron and Olken paper is a fascinating study of the economy of border life.

    The whole essence of corruption is that it is usually unspoken, so a study of this nature is invaluable in understanding how things work in the real world of dog eat dog.

    It would appear the Sumatran dogs have a finely tuned sense of exactly how much cannibalisation is feasible.

    Ingenious study. We need lots more of these to understand how the world really operates. Would be intrigued to know how much the study cost in terms of the manpower required to finance the “enumerators”.

    Cheers,
    Derek

  3. kotika says:

    Nice, but it is passe to be amuzed at the sophistication of the behaviors and contracts in the shadow economy. Indeed, the contracts and price setting is more flexible is say USA than Europe because there are less regulations. Is it really surprising that when contracts are invented on the spot by actual counterparties are more flexible and sophisticated than those written by american lawyers , much less european beaurocrats?

  4. pablo says:

    The authors do not elaborate on how the ‘coffee money’ is paid but I recall it as being an amount that the driver would leave under the driver’s side floor mat. The collector would lift the mat and take the toll. Simple, off camera, efficient even. A great report with insight.

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