The Social Cost of Blackmail

Despite the fact that blackmail constitutes a voluntary transaction between two parties, it is deemed to be a criminal offense in most legal systems. The traditional economic approach to this so-called 'paradox of blackmail’ emphasizes welfare loss generated by the costly rent-seeking activities of potential blackmailers as the primary justification for its criminalization. This argument, however, does not extend to cases in which potentially damaging information about the victim was acquired by the blackmailer at no cost. It also does not seem to shed light on a related puzzle: why is it legal for a potential victim to bribe the other party with the purpose of achieving the same final outcome (suppression of information) as in the case of blackmail? This paper addresses these questions in a simple model of bargaining under asymmetric information, which is used as a unified framework for studying both blackmail and bribery. Under asymmetric information the bargaining outcome is not efficient, regardless of the distribution of the bargaining power. However, when the blackmailer is a monopolist seller of the information, inefficiency results from his demands being too high relative to the social optimum, providing justification for the practice of penalizing blackmail. On the other hand, when a victim is the monopolist buyer of the information, the equilibrium offer is inefficiently low, implying that its punishment would be counterproductive. These arguments provide further support for the claim that under reasonable assumptions the criminalization of blackmail can be justified on efficiency grounds.