Quota regulation under corruption - Grand, petty and the cut-money culture

This paper examines the implications of various forms of corruption-namely, grand corruption, petty corruption, and the cut-money culture-on the formulation and enforcement of regulatory policies. Focusing on quota regulation in the context of natural resource extraction, it demonstrates the following. In absence of cut-money culture, upward distortion in extraction quota in the equilibrium under only grand corruption is less (more) than that in case only petty corruption is possible, when the reduction in the firms' expected effective price under petty corruption is less (more) than the `discounted net marginal environmental damage' to price ratio under grand corruption. Interestingly, in absence of cut-money culture, petty corrupt never occurs in the equilibrium regardless of whether the policy maker is honest or corrupt. The threat of petty corruption induces the policy maker to inflate the quota, unless the policy maker is corrupt and he sufficiently discounts environmental damage due to extraction. Grand corruption occurs only in the later case. In contrast, when there is cut-money culture, corruption of at least one type always occur in the equilibrium. While the presence of cut-money culture reduces the equilibrium quota in some cases, in each of those cases it results in higher total extraction, greater environmental damage and lower welfare. Our r esults have important implications for designing corruption control mechanisms and the governance of natural resource extraction.