Law Enforcement Corruption and Economic Development: the Case of Bulgaria

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13 March 2016

Supervisor: Prof. Dr. Jos C.N. Raadschelders

Second reader: Dr. Anchrit Wille

Leiden University, the Netherlands

Law Enforcement Corruption and

Economic Development:

the Case of Bulgaria

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It is widely agreed upon that in Bulgaria corruption has a significant impact on the economic development, but little is said about the way and extent to which this phenomenon occurs, especially when it comes to the corruption among law enforcement officials. Moreover, much of the measurements on corruption in the public sector are based on the perception of local people who ground their opinion mostly on their personal experience, which is mostly with (as I termed in this paper) police officials. To fill that void, this paper strives to provide the means for measuring the effect of corruption among police officials on economic development. This paper exposes the gaps and weaknesses in the existing figures and analyses on the relationship between corruption and economic development, and it ultimately calls for a better measurement of corruption in the public sector. From the three main measurements of police corruption used in this study, the number of public officials sentenced for bribery appears to confirm the hypothetical logic of this paper.

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1. INTRODUCTION

According to the Business Anti-Corruption Portal's1_{country profile of Bulgaria,}

corruption within law enforcement agencies (also referred to as police corruption - or PC - in this paper) is pervasive. Firstly, business owners and executives have reported various corruption practices where Bulgarian law enforcers have failed to protect the competitive environment, thereby raising business costs for foreign and domestic investors to levels higher than expected. Moreover, this gives a way to the development of an anti-competitive market driven by organized criminal groups (OCGs). Secondly, domestic firms tend to poorly comply with the Bulgarian tax regulations due to the "remunerations" and/or the various "gifts" they give to tax inspectors and other revenue officials. Since annual tax contributions paid by businesses is less than expected, this might create a gap in government budget, thereby affecting the economic development (ED) of Bulgaria. Finally, customs authorities (and traffic police, for that matter) is another law enforcement authority whose work might have an impact on the economic development as corrupt officers may "impose" additional fees and/or complicated procedures., In particular, during the import or export of goods through Bulgarian border crossings, customs officials could engage in corrupt activities to protect the interests of specific private companies by obstructing their competitors' trading activities. In addition, corrupt customs officers could facilitate the activities of OCGs by allowing the free transiting of goods for which excise duty has not been paid (e.g. tobacco products and alcohol), illegal substances (e.g. drugs), or counterfeit goods. The statements above are widely supported by the Global Competitiveness Report2_{(Schwab et al., 2014), in}

which, through statistical analysis, the authors demonstrate that corruption is the main obstacle to doing business in Bulgaria.

The dynamics presented above are only a fraction of the entire omnipresence of corruption practices in Bulgarian law enforcement institutions (and in other institutions) that led to freezing of EU development funds (including socio-economic development programs) in several occasions. Since the levels and sources of corruption tend to vary, and due to the

1_{The Business Anti-Corruption Portal is a government-sponsored one-stop shop for anti-corruption} compliance resource aimed at the business community: http://www.business-anti-corruption.com/about/about-this-portal.aspx

2_{Global Competitiveness Report (2014-2015) provides an overview of the competitiveness} performance of 144 economies produced for the World Economic Forum

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wider impact they may have on economic development, this paper will grapple with the following research question: To what extent and how does corruption in law enforcement influences economic development in Bulgaria?

The current research paper will develop a theoretical model that is closely re lated to the works of Andvig & Fjeldstad (2008) and Andvig & Attila (2010), in which corruption in law enforcement is considered related to the economic development of a state. In particular, their theoretical assumptions will be applied to the Bulgarian context. With regards to the empirical case of Bulgaria, this paper will examine law enforcement authorities and the ways in which corruption within these structures may impact economic growth. The argument I put forward here, is when relevant (law enforcing) institutions employees act in a corrupt manner results in additional costs for society, business and government. Hence, the attempt is to provide a comprehensive awareness of a country's economic situation by examining prevailing corruption practices and their impact on the national economy.

The analyses of this paper are limited as the data available for previous years is highly inconsistent. Moreover, empirical data and other important academic information are scarce and result in weaker clarification of conditions surrounding the relationships between the variables. This study, also, as most of the researches suffer from the potential exclusion of a key factors that might help for better explanation of the results. Nevertheless, the findings in this paper provide a clear direction for the measurement and analysis of cer tain aspects of police corruption, which scholars and policy makers should pay close attention to.

1.1 Theoretical Relevance

This paper will strive to be relevant to the study of corruption, especially in the field of law enforcement. Light will be shed on the problems associated with the system of administering constitutional laws, which comes close to the notion of "street-level bureaucracy"3_(Lipsky

2010). Lipsky defines street-level bureaucrats as public officials who are directly engaging (by granting access to government programs and provide services within them) with citizens in the course of their work, and who possess significant level of discretion in the execution. Hence, this paper can be used as a point of departure towards a more in-depth exploration of the economic impact of different street-level bureaucracies.

3 _{Lipsky (2010) distinguishes and emphasizes several types of street-level bureaucracies (e.g.} policemen, teachers and public service lawyers)

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This research project suggests that the institutional structure of police agencies may play a role as a facilitator of corruption, which in turn influences the economic development in Bulgaria. The design of various law enforcing departments within the state and the way they cooperate may provide a better perception of the problems related to the police services (Ostrom et al., 1973). In addition, as one investigates the different activities of policing, it might get even more complex and unclear to determine what would constitute service efficiency (Ostrom, 1973). Therefore, one could use this paper as a point of reference when examining the size, different functions and/or effectiveness of a particular law enforcement agency.

The theoretical relevance that this research presents is based on the macroeconomic effects of corruption at the micro level (i.e. street-level bureaucracy). The firms that engage in bribing activities are likely to spend more organization time with bureaucrats negotiating regulations, and face higher costs of capital (Kaufmann & Wei, 1999). This is particularly relevant in the cases of petty corruption and extortion (Lambsdorff, 2004), where the police officials are usually one of the parties in the transaction. Consequently, this type of cooperation is usually at the expense of third parties such as government and other businesses (Wei, 2000). Thus, the paper may be used in comparative or cross-national studies that emphasize corruption's impact on state’s macroeconomic character.

1.2 Practical Relevance

From a societal perspective, this research will aim to provide an understanding of how corruption exists within the given context. Since there is a broad consensus that the corruption among public officials has a negative impact on the economic development (Bardhan, 1997; Mauro, 1998; Wei, 2000; Anderson and Tverdova, 2003), the study will help to understand how and why corruption discourages foreign investments, brings market uncertainty and insecurity, and decreases legitimacy and credibility of the law enforcing systems in the citizens’ eyes.

The study contributes to an awareness of the economic threats that derive from corrupt activities among law administering officials. This awareness is necessary as it advances the overall understanding of how and why corruption presents itself, which is a crucial element for confronting it amply. By revealing indirect and direct effects on the economy, the anti-corruption strategies could be formulated and implemented better, or at least prevent the

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relevant authorities from acting out of the established ethics and norms. Hence, I believe that the findings in this study could support context-based advices that would deliver policy solutions modified to the specific needs of a particular country’s anti-corruption efforts.

1.4 What is to be covered?

The remainder of this paper is structured as follows: In Chapter 2 I define the central concepts of police corruption and economic development and provide an overview of the aspects that fall within these main concepts. In Chapter 3 I examine the existing literature on the topic in order to develop a consistent theoretical framework. This framework is the foundation of the hypotheses that I try to deduce and formulate in a comprehensive manner. In Chapter 4 I present the research approach, the data collection methods and the methods of analysis and I provide an overview of the employed variables. Here, I also discuss the certain criteria for validity and reliability of the research. In Chapter 5 I introduce the findings and the interpretations of them. In this chapter I also strive to elaborate on the difference between the assumption-based arguments and empirical statements that derive from the study. In chapter 6 I provide with a general summery of the paper, where I also discuss the main contributions to the relevant scientific field. In addition, in this chapter I suggest some alternatives for a future research.

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2. THEORETICAL FRAMEWORK

This chapter addresses both the specific meaning behind the main variables used in the study and the theoretical relationships between these variables.

2.1 Conceptual Definition of the Main Variables

In this sub-section I will try to provide clear and precise definitions of the main terms employed (i.e. police corruption and economic development) to the empirical environment in which they will be examined (i.e. Bulgaria).

2.1.1 Economic Development (ED)

According to Todaro and Smith (2014), Economic Development (ED) is preferably used to refer to the continuous, rigorous processes of public and policy actors that strive for better standards of living and economic conditions within a specific area. Furthermore, they argue that such improvements are possible through an improvement of living conditions, societal confidence factors and perceived level of justice. In order to measure the extent to which a particular development has affected the economy, they suggest, that the Human Development Index could suffice adequately. This method involves such rates as literacy, income and life expectancy which have direct influence on productivity, and ultimately on economic growth (other measurements such as GDP and gender related indicators could also be applied). Nevertheless, Todaro and Smith (2014) claim that the term ED does not refer only to quantitative changes, but also to qualitative ones. This means that ED includes improvements in all areas that provide for improved overall welfare of the citizens (e.g. human capital, infrastructure, healthcare and stability). The authors also make clear distinction between economic development and economic growth. Here, ED is a governmental process aimed at improving the economy, the welfare state and foster political stability. Thus, economic growth is rather a fraction of the overall economic development that represents the level of increase in the production of goods and services within the state.

In this paper, therefore, ED is seen as the overall improvement in the standard of living and economic conditions of the state, and not as a synonym of economic growth. This rather short definition helps to focus on the potential and actual impacts on the Bulgarian economy that will be hypothesised later on.

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2.1.1.1 Standards of Living

This dimension, in general, relates closely to the quality of life of the average Bulgarian citizen. It is usually expressed by the goods, security, wealth and other necessities (as well as the level of access to them) available to the average citizens. More specifically, there is a number of factors that fall within the scope of this dimension that I see as inherently crucial to this research. For example, the average income that is received within the country; the perceived minimum level of income in Bulgaria (how appropriate is defined this level), or what is the poverty threshold and level (also compared to the neighbouring states); the qual ity and access to affordable accommodation by those with average income; the overall work conditions which relate to work load (physically and mentally), rest periods and the respective remuneration (e.g. minimal wage); the quality and access to healthcar e; the quality and access to education and what is the illiteracy level; the average life expectancy within the region; the purchasing power and the cost of goods and services affordable. Other important factors are the environment, political and religious freedoms, political and economic stability, and the perceived level of safety. This set of factors, which are by no means exhaustive, will play an important role in the arguments laid in this study as they relate to the microeconomic environment of the country.

2.1.1.2 Economic Conditions

This second dimension refers to the dynamic nature of a state’s economic environment. Roughly, this means that economic conditions change over time due to social, political and market forces, as such they push the economy either towards expansion or contraction. The effects of such processes are usually observed through macroeconomic aspects such as labour (supply and demand), investments (from foreign and domestic sources), import and export of services and commodities, tax policies, governmental expenditures and budgeting (surpluses and deficits), overall consumption, Gross Domestic Product (GDP), Gross National Product (GNP), inflation rates, and unemployment. Once again, this is not a complete list of all macroeconomic aspects that exist, however these are the ones that will be utilized in the development of this research.

In sum, the term ED in this study is meant to encompass the most relevant aspects from the macro- and micro-economic level, as well as consequences for individuals and for the state. This helps the process of examining different stances of corrupt activities, as it is possible that some arguments and findings might zoom in on a particular economic and/or social aspect. By doing so, more clarity will be provided to the construct of the paper. Thus, it was

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important to establish the determinants that will be looked for while constructing the theoretical framework about the issue at hand. In other words, when the corruption process are observed in a given context, it will be explored the implicit and explicit effects on a specific (or set of) economic and/or social aspect(s).

Moreover, the identification of these economic and social aspects provides with directions

towards relevant statistics and empirical data that could be useful in the analysis section. 2.1.2 Police Corruption (PC)

Since one of the two main variables in this study has been conceptualized, now I take upon the task to do the same for the second. The term of police corruption in this article does not relate only to the traditional understanding of corrupt activities by officials that keep the peace, protect people and properties, and investigate crimes (and carry weapons, badges and cuffs for that matter). To avoid the limitations related to a strict conceptualization of the term, corruption is instead considered as a social phenomenon encompassing a number of ele ments of abuse of power/office by public official that is endowed with the legitimacy to regulate, control and keep in order with any official body.

2.1.2.1 Police/ police official

By police or policing in this paper is meant any process that is entails determining when someone behaves outside the legal boundaries, issuing warnings and imposing other corrective measures. In other words, every activity that is defined as law enforcing falls within the main definition adopted by this paper. Hence, a police official is every public employee that is warranted with the legal right to enforce a particular law. In order to alleviate any confusion with regard to my definition of a police official and the traditional one, I will refer to the traditional policemen as conventional (or orthodox) police officials. As a result this meaning comes close to the notion of public official, however, the difference is that police officials are only those who are situated in the executive branch of the government. They do not have the power to draft, assess and pass legal documents, their tasks are rather related to the implementation of the legal prescriptions, provided by the legislative branch. This means that employees from the judicial branch do not fall under the category of police officials either.

Since the term of policing, in this paper is treated as synonymous to the process of law enforcement, it is important to define what this is about. According to Lodge and Wegrich

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(2012), enforcement is crucial element in the governing of a state, where the use of coercion is legitimized in order to compel particular parties to behave in a manner they would otherwise not. Simply put, Lodge and Wegrich argue that it is about the question of how rules could be made ‘stick’. Another key question they link to the topic of enforcement is about whether such activities should be focused on prevention or act as the moment of wrongdoing. The combination of these questions imply that the enforcement of law might be in the form of detection (gathering and assessing information) and effecting (modifying and sanctioning inappropriate behaviour). Hence, police (law enforcing) officials are all public servants who are endowed with the task to detect and affect the inappropriate actions of parties within their jurisdictions.

2.1.2.2 Corruption among public officials

The conceptualization of corruption is a highly disputed topic. Therefore, in order to arrive at a comprehensive meaning for this study, it is imperative to present the definition of corruption as observed in the Bulgarian context, as well as the reasons for its challenging character. As consequence, this will help in formulating the working definition for PC in this study.

Corruption as a term within the legal framework of Bulgaria can be found in numerous documents. For example, in some acts of the National Assembly, in amendments to normative decisions by the government, in some decisions of the National Court, or other agreements where Bulgaria is a member (Boyadjiev et al., 2000). If we dig deeper in the topic of corruption we can find information on how the totalitarian regime during the Cold War described the term. However, I will refrain from such historical retrieval as this might bring more vagueness to the definition that I am trying to present, because in spite of the number of occurrences, corruption had no definite legal definition whatsoever. Thus, the focus is on the description that emerged during the post-communist period (or the period of democratic transition). More specifically, in 1999, after Bulgaria had ratified the Council of Europe ’s Civil Law Convention on Corruption4_{. Under Article 2 of the Convention the corruption is}

defined as “…when committed intentionally, the requesting, promising, offering or giving by any person, directly or indirectly, of any undue advantage to any of its public officials, for himself or herself or for anyone else, for him or her to act or refrain from acting in the exercise of his or her functions”. On one hand, this is a fairly clear and precise definition of

4_{Council of Europe: Criminal Law Convention on Corruption; in European Treaty Series - 173,} Strasbourg

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the process of corruption and the role of public official within. On the other hand, however, according to OECD (2008: 22) this not a definition but rather list of offences for a range of corrupt behaviours (referring to Article 2 and the subsequent articles all together). Hence, the interpretation of this term is dependent on the relevant policy makers’ common perspective and supports the view of problematic nature.

The challenge of incorporating a variety of definitions, first, is due to the need that one should take into account the unclear boundaries between corruption, abuse of office/power and other categories of deviant behaviour by police officials. For instance, according to Punch (2009), some definitions suggest that inappropriate behaviour (e.g. improper collection of information/evidences) is not always an illegal act, as this involves violations only under the code of conduct but not the criminal law. Hence, this implies that corruption is strictly crime related action. Second, as Miller (2003) and Newburn (1999) imply, public officials who are involved in organized criminal groupings or activities (OCGs) does not qualify as “corruption”. Here corruption is seen as an individualistic act, not a collective one. Third, Punch (1985) argues that corruption occurs only when public official receives substantial benefit (from a third party) to deviate from the prescribed duties. Such definition suggest that the amount of benefit itself convey corruption, if it is provided by non-government (third) party. It also suggests that corruption is a relationship between public official and private party, ignoring the possibility of corrupt relationship among public officials. Fourth, it is very important to attach a social perception about the issue. Since public officials are granted with particular status it is assumed that they also have the duty to act with exemplary behaviour. Thus, when a public official commits an inappropriate act it is considered as corruption in the eyes of the public (regardless of the motives), this official conveys principles opposite of the morals he/she is supposed to protect.

Overall, the available definitions for corruption focus on different dimensions of corruption and they usually overlap. For that reason, in this study, I will stick with the broad notion that corruption is a form of “…deviant, unfair, disproportionate, unethical or criminal conduct…” (Barker and Roebuck, 1974: 423) of a police official.

So, what is police corruption in Bulgaria? It is another term that is difficult to define in a straightforward manner due to its relation to the general term of corruption and the actual lack of legal formulation of such term in the Bulgarian Constitution. Therefore, deriving from this initial set-up, and with the addition of other scholarly works (Sayed and Bruce 1998;

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Punch 1985; Punch 2009; Miller 2003; Newburn 1999), the general context of the Bulgarian legal definition of corruption will be disregarded in order to allow studies in other countries to present relevance in this research. This is the case because the l egal definition of police corruption might not account for some crimes committed by police officials (e.g. drug trafficking and human trafficking that might fall under the definition of organised crime). In sum, police corruption in Bulgaria will be regarded as the four-dimensional definition suggested by Andvig and Fjeldstad (2008). This definition grasps four aspects that can be directly linked to economic growth in Bulgaria: 1) Conflicting Loyalties - advancing the interests (friends, ethnic group etc.) of network/s outside the police in an abusive manner by utilizing police resources; 2) Embezzlement - using authority, labour time, access to information and assets of the police department for personal gains (this includes nepotism); 3) Extortions - the predatory activities of forcing individual to transfer resources from the police department to private and/or criminal organizations; 4) Engaging in other crimes (sexual crimes, organized crimes, thefts etc.).

2.2 Literature Review

Even though there are not many empirical studies that reflect the extent to which the corruption among law enforcing officials affects the current and potential economic conditions in Bulgaria, there are sufficient relevant studies outside this country-specific context. Therefore, the purpose of this paper is to explore the tendencies of whether some specific occurrences of delinquent behaviour of police officials have influence over the security of property, social freedoms and stability, and to what extent such influence affects economic development. In the remainder of this section I emphasize several aspects of socio -economic development and what the typically occurring corrupt activities associated with law enforcing officials are. Moreover, I try to present relevant studies along with some context related examples and other evidences in order to consistently deliver a comprehensive overall picture.

2.2.1 Investments (Hypothesis 1)

Investment as a term stipulates that a decision or set of decisions to put resources into an endeavour today will potentially bring satisfactory benefit within a particular period of time. The innate risks associated with investing, particularly in the private sector, are typically regarded as costs that are part of the larger dynamic of commerce. Some examples to such

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costs of risk derive from the demand side where consumers might respond differently to what is expected, or the competitive environment where a rival organization might offer a better (substitute) product and pricing. However, other risks such as security of property rights and stable competitive environment are mitigated entirely in cooperation with the state apparatus devised within the particular region.

According to a report, by the World Bank (2005), governments are able to increase risks and uncertainties that affect potential investments directly. The most prominent concerns about governmental activity gravitate around the policy uncertainty that could lead to possible macroeconomic volatility. The notion, here, is that firms are not able to predict the way in which regulatory bodies will interpret the established rules and norms. Thus, as the regulatory and administrative burdens could not be predicted, firms might fear the security of their properties’ rights. When this fear is coupled with a perception of overwhelming corruption in law enforcement, organizations tend to become apathetic towards the idea of investing in the region. Furthermore, the report by World Bank also suggests that corruption among lower echelons of government (or police official as I termed them in this paper) pose a threat to the prospective investments. It could be in the form of tax on entrepreneurial activity, diversion of public funds, and the ability to bring upon and keep redundant bureaucratic procedures5_.

These dimensions might all take place simultaneously, individually or in certain combinations.

For example, the government tax collectors and auditors who are corrupt might provide false information, causing fewer tax revenues for the government to operate with. According to the same report (World Bank, 2005), the high level of discretion in law enforcement together with propensity of maladministration and corruption, also causes serious disproportionate burden the compliant parties and negatively impacts the competitive climate. In addition to this, the underlying insufficient public budget might invoke an increase in the taxes and procedures, which will inevitably lead to an even higher burden to those who actually pay and comply. This combination of the power to ‘red tape’ and corruption in the tax policing leads to discouragement in the compliance with formal rules of taxation. Therefore, it is safe to assume that taxation is the most tangible direct cost for organizations when it comes to evaluating the investment environment (inducing potential burdens of corruption), as foreign

5_{This line relates to the notion of “red tape” and to the extent to which police official might conform to} formal rules that are considered redundant and halts the decision making

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investment tend to decrease when corruption and/or taxation increases (Wei, 1997; Wei 1997a).

Another illustration which can pose a serious problem to investments is the corruption in customs administration. The simplest examples are when such police officials administer heavy costs on importers or procedures that delay the travel time out of proportion (particularly in the cases of perishable goods). Related to the second example, as most of the goods are transported by road or other infrastructure channel at some point, the country’s “...physical components of interrelated systems providing commodities and services essential to enable, sustain, or enhance societal living conditions” (Fulmer, 2009: 32), appears to be another crucial determinant for the investment environment. The infrastructure is crucial in this study because, more often than not, it is an immobile asset and the associated services are seen as natural monopoly that needs to be maintained constantly. Thus, the underlying relationship between infrastructure and corruption among police officials is based on the notion that providers might overcharge the consumers and/or the government might incur unbearable regulatory burden. The inherent difficulties and susceptibility of corrupt police officials presents a very unattractive perspective to potential investors in the sector. Without the investments in the infrastructure this leads to challenging environment for the transportations of goods, and ultimately for the economic development.

Lambsdorff (2004) identifies two types of corruption: petty and grand. He argues that petty corruption is the actual deterrent for foreign investments. The definition of petty cor ruption, according to him, is the routine street-level type of corruption which includes activities like immediate payments and tips among people low in hierarchy. This relates to the definition that I adopted for police officials as petty corruption implies the direct involvement of public official with another party. Petty corruption imposes extra burden to investors, particularly by consuming time. This is also suggested by Kaufman and Wei (1999), who present a study with a positive relationship between high level of corruption and time used by a manager to deal with bureaucrats and public officials. In addition, Lambsdorff argues that petty corruption involves extortion, ‘additional fees’, different methods for harassment and other cooperative corruption practices that affects third parties, all of which falls within the definition for corrupt police official by Andvig and Fjeldstad (2008). Moreover, petty corruption is more deterrent than grand corruption because it appears to be beyond the direct control, predictability and voluntary involvement of the investors (assuming that potential investors usually engage in such ‘unethical calculations’).

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Andvig and Fjeldstad (2008) link conventional police corruption to economic development through crime. They argue that, as crimes have substantial influence over the investment climate and economic growth, all together, this impact is immediately experienced by organizations’ increase of costs due to theft and other security-related expenses incurred by them. In some cases, these costs lead to a decrease in the opportunity for businesses to sustain competitive positions, thus overwhelming corrupt activities might lead to disinvestment or economic boycott that presses for change in the governance. Hence, it is logical to assume that such dynamics leads to both economic and political instability that would unavoidably reflect negatively the overall economic development.

To what extent do such forces occur in Bulgaria? A report by the Centre for the Study of Democracy (CSD)6_{(2009), argues that in Bulgaria there is hardly a commercial organization}

that did not receive or gave payment to police officials that remained hidden/unregistered. Thus, corruption associated with law enforcement could be regarded as part of the overall value-added scheme for doing business in Bulgaria. Furthermore, the report suggests that since unfair competition practices are identified and utilized by the majority of the firms, corruption is an instrument for gaining unfair competitive advantage. Such an environment present a major drag on the country’s competitive landscape which pushes away foreign investment, and consequently slows the economic development down (Pook, 2008). In the same year, the report mentions that the biggest constrains for doing business in Bulgaria are informal practices, political instability and corruption. Moreover, the removal of most of the customs checkpoints within the state and on the borders resulted in a significant decrease of corruption victims and unreported income among traders. The report refers to corrupt police officials in Bulgaria as ‘deviant entrepreneurs’ who employ bribing methods to freely operate in violation of the law and to cause damages to business competitors (e.g. custom officials seize particular competitors’ goods or decide to audit the cargo thoroughly and with ‘extra caution’)7_.

An interesting finding that the CSD (2009) report makes is that in Bulgaria local oligarchs tend to capture not only the local government, but also the activities of local police officials and, in some extreme cases, the local judiciary system as well. This picture shows the

6_{Centre for the Study of Democracy (CSD) is a non-governmental/non-partisan organization based in} Sofia, Bulgaria. The Centre deals with studies on economics, law, security and sociology climate in and outside Bulgaria.

7_{Such type of violations fall within the understanding of organized crime as the corrupt officials} engage in cooperation with another party which requires a certain level of coordination.

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obvious assumption that potential foreign investors would rather not get involved, as the chance to face serious economic and administrative obstacles is significant (Nesterov, 2009). An empirical study by Nemski et al. (2007) on the corruption in the traffic police and vehicle administration8_{shows how multi-layered and interrelated corruption could be among police}

officials in Bulgaria. Together, both administrations are present all over the country road infrastructure, which means that there are a substantial number of police officials. Thus, the study indicates the importance of this type of officials, as they enforce the law in gre at number and frequency. Moreover, they are a key part of the state’s infrastructure governance. Not surprisingly they find that these very same police officials (including conventional police officers) form part of the perceived top three most corrupt officials. The corrupt practices among these officials are very similar to the ones among their colleagues in customs. However, while customs officials might impose such “additional tax” as a one-off payment (either for import or export), traffic and vehicle administration officers are able to do that multiple times. For example, the in-land transportation of goods might undergo several checks as it goes through different jurisdictions (i.e. different regional governments), thus officials might charge ‘the fee’ on multiple occasion and even with different rates. Therefore, once again, this makes for an unpredictable business environment, which connects infrastructure capacity and corruption, and rather makes the investment unattractive endeavour.

In sum, the behaviour of police officials influences the costs of making business and thus the variety of options for investments that would bring profits. The increase in investments provides more production capacity and employment, higher wages and income, and thus an increase in the GDP and overall economic development (Anwer & Sampath, 1999). However, corruption among public servants might drive away and decrease potential investments.

Law enforcement officials have several crucial roles that relate to the i nvestment climate in a country: providing public goods, supporting the provision of infrastructure, and mitigating other market failures. The corruption among this layer of public servants creates weaknesses in the state’s performance where organizations and individuals might opt for purchasing “more expedient access” to particular utilities, procedures for faster clearance of goods

8_{This administrative body deals with control and regulation over the on-road transportation of people} and all kinds of goods; the technical condition licences another relevant checks of the transporting vehicles, in Bulgaria.

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(typically through customs so that they can enter or leave the country), or registering a business. This could significantly increase the potential costs for other investors and turn any investment possibility seem very unprofitable. Moreover, this could also create large competitive instability by pushing policies that are in favour of certain organizations and at the expense of the rest.

Considering Lambsdorff’s findings (2004) about the influence of petty corruption on investors’ reluctance to engage in such regions9_{, I put forward the following hypothesis in my}

study: Foreign investment will decrease as the perceived petty corruption increases, which will negatively affect the economic development in Bulgaria.

2.2.2 Governmental Budgeting (Hypothesis 2)

This state activity, roughly said, is about the intended revenues (as taxes are the main instruments to generate them) and expenditures by the government. Normally, a government would tax and spend through an established fiscal policy in order to regulate unemployment rates, inflation, economic cycles and other macroeconomic conditions. Therefore, it is important to identify to what extent corruption among police officials affects government expenditures and revenues. Isaksen (2005) argues that corruption among public officials tends to affect government budget as it diverts resources from public coffers, produces significant discrepancies between actual and expected expenditures, and decreases government legitimacy.

Liu and Mikesell (2014) study the effects of corruption among public officials on the size and distribution of state expenses in the United States. They hypothesize that such corruption would result in increase of the total governmental expenditures. Their results support the hypothesis by presenting corrupt public officials as self-interested individuals driven by the motives of personal gain. They, further, argue that such motivations incur additional costs to the governmental budget, which result in expenses that exceed the necessary need of the public. In addition, the effort of a state to balance these budgetary discrepancies would inevitably push towards (higher) budget deficits.

Since the governmental budget relies mainly on the amount of levied taxes and tariffs, it would be safe to assume that tax officials would play a key role in this study. Tanzi (1998)

9_{Lambsdorff’s study on 102 states from around the world shows that African states’ investment tend to} be affected by petty rather than grand corruption.

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claims that clear and precise tax rules with absence of direct contact between taxpayers and tax police officials would create a less corrupt economic environment. Conversely, he argues, this becomes highly problematic within both tax and customs agencies. He points out several key aspects for this to be problematic: low salaries among tax officials; vagueness of the rules and the natural level of discretion among public officials; the unavoidable direct (and routine) relationship between taxpayers and tax officials; the degree to which corruption among such officials is marginalized; and the level of state control over the relevant officials. Tanzi also converts these aspects into three main ways through which they might have an effect on the budget. First, this type of corruption instantaneously reflects on the budgetary condition by forcing the state to engage in needless and unfruitful public ventures, thus making public spending inefficient. Second, public projects might result in payment of excessive amount(s) while purchasing certain necessary goods/services. Third, such corruption might divert budgeted resources towards third parties that are not legally entitled to any sort of compensation. As this demonstrates that tax and customs officials seem to represent a significant part of the overall study-specific corruption related to the state budgeting, presumably there would be fewer payments collated from the private sector.

According to Mauro (1998) the corruption that stems from public officials and affects governmental budget, also, distorts the planned composition of governmental expenditures. In his cross-national study he finds that there is a significant relationship between corruption and state expenses on education. He argues that this is a reason for concern as education is a crucial determinant of economic growth. This, however, does need to be in combination with, as Tanzi and Davoodi (1997) suggest, prevailing ‘grand’ corruption where spending decisions by the government push for higher public investment, but at the same time decrease is observed in the state revenues, operations and maintenance, and quality of public infrastructure. Consequently, economic development might suffer significantly as distortions in the governmental budgeting might steer away resource for maintenance and improvement meant for vital state functions.

Kaufmann et al. (1997) present a study on the unofficial economy as part of the GDP, which is defined by the level of management rights controlled by politicians and bureaucrats in former communist countries. In this study the unofficial economy is closely related to the notion of corruption which has staggering fiscal implication in some transition states towards democracy. The authors proclaim that any type of production for the unofficial economy is considered concealed revenues from the state, or tax evasion. In short-term, this might

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provide certain competitive advantages over the honest market rivals, but in long-term the unfair market competition would drive competitors away which would be detrimental to the economic climate of the state. Moreover, such injustice would increase corruption, thus the fiscal capability will undergo contraction (Kaufmann et al. 1998). Here, the bureaucrats, which includes all police officials, comes close to the definition set by Niskanen (1971). Niskanen suggests that bureaucrats tend to increase governmental expenses and control budgets due to their possession of information vital to the legislators10_{. With such}

unchallenged informational dominance over the true cost of public goods and services, the bureaucrats enable themselves to speculate in order to be granted with larger budgets. Thus, when corruption among bureaucrats is prevailing and they push for higher budgets, this would significantly affect the economic development.

To what extent do such dynamics occur in Bulgaria? A study by CSD (2012) on border control suggests that the Bulgarian government sustains revenue losses due to goods that have been imported or exported illegally as no duty fees were paid. However, this report also suggests that similar practices occur among officials within the tax administration and other government agencies. The term that denotes the overall price of corruption on the state budget is defined as ‘corruption costs’. In that sense, Nesterov (2009) also supports such argumentation, however he focuses on the entirety of public servants. According to him, police officials are able to make public services and projects harder to attain, as the propensity of corruption creates channels for resource diversions which needs to be cover up. As a result, false information has been fed to the legislators and unrealistic budget plan has been established. This resonates greatly on the public procurement, because it is not only prices that are overestimated, but, in their effort to decrease costs, the providers (who participate in corrupt endeavours) tend to decrease the quality of the end-product. Therefore, corruption among police officials might foster an enormous budgetary gap, as they will allow through informational asymmetry the state to buy overpriced product at low quality.

In Bulgaria, the Public Procurement Agency is the institution that has the main task to guarantee the efficiency of the public procurement procedures that abide by the principles of free and fair competition, equality, transparency and publicity of the process by which public authorities purchase and grant services from/to private companies (Trifonov and Popova,

10_{However, Raadschelders and Vigoda-Gadot (2015) argue that such an assumption is somewhat} stereotypical as bureaucrats may simply strive to maximize personal utility which is a human condition rather than a unique trait of bureaucrats.

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2010). According to Pashev et al. (2006) public procurement in Bulgaria is the most picturesque example of organized corruption among police officials from all levels. In contrast to other law enforcement related corruption, public procurement usually includes officials from higher level in the particular public agency, as such public managers are able to award public procurement contracts unilaterally. However, they further argue, the corrupt contracts would not withstand if lower level police official are not involved in the scheme, as they make sure that the reporting of misinformation is consistent with the managerial recommendations. Moreover, if the public procurement project present with complex and numerous necessities, the procurement process might involve consultants. In corrupt schemes such allowance for council, usually by third party, presents with opportunity for expanding the scheme. Pashev et al. argue that, in Bulgaria, the employment of a consultant might occur at the very early public procurement phase (the criteria setting). Thus, when a corrupt structure is present, a consultant could be used to guarantee advantageous conditions for certain bidders in the course of the public procurement contest. In general, Pashev et al. conclude that this field of corruption is driven by well-structured networks of ‘targeted investments’ that reaches the political elite, thus it relates with the present political corruption as well. Hence, their argumentation that such corruption rarely presents with someone that is directly responsible, as the corruption is well spread throughout the entire governing framework which gives the opportunity for facile blame avoidance or shift towards the different levels of the government. Nevertheless, in a later study on public procurement by Pashev et al. (2010), he argues that law enforcement plays a crucial role in this field as it monitors if the subsidized processes are in line with the prerequisites. Here, police officials are the gatekeepers for organized corruption schemes to be exposed, where if they are not corrupt will be powerful anti-corruption instrument. Therefore, as the organized corruption creates significant budgetary gaps, the law enforcers enable the state to detect such gaps and efficiently react to and curb them.

With regards to public procurement in Bulgaria, the CSD report (2009) on corruption and organized crime suggests that this sector does not only incur losses to the state budget but it generates additional economic costs to the privet sector, which would have even greater effect on the country’s macroeconomics. The argument, here, is that genuine market actors who are potentially more efficient and productive, than those who are awarded with the public procurement, are ignored which creates market distortions. These distortion stems from the assumption that corruption disables public officials to grant and law enforcers to

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identify the potentially better market actors. This dynamic creates a disincentive climate in the supply side and thus the damages might result in higher prices for the consumers. Another argument that is presented in this report illustrates public procurement as a tool for creating oligopoly on a particular market. The produced exorbitant revenues from the public sector allow the corrupt organizations to dump prices or use other predatory methods to drive out the market competitors, especially small and medium-size enterprises. In addition, public procurement in Bulgaria closely relates to the allocation and absorption of EU funds. On several occasion the public-private relationships, in Bulgaria, presented with inaptness as EU funds were misused by corrupt officials for personal gains, indulge in favours, retain political power and boost party financial condition (Levitz and Pop-Eleches, 2010). Consequently, EU funding has been suspended which resulted in lesser budget for economic development, especially infrastructure.

In sum, the fiscal weakness of governmental budgeting is deepened significantly by the corruption among police officials that would eventually affect the macroeconomic performance. While accumulating private revenues, corruption leads to disproportionate public funds allocation and distorts domestic market forces. The ways through which governmental expenditures increase and revenues decrease due to corruption are numerous. However, if police officials are involved in organized corrupt schemes (as in the public procurement in Bulgaria), that leads to a devil’s circle where corruption causes macroeconomic instability, which fosters even more corruption. As the government is forced to curb corruption, it will divert funds towards tackling the issue thereby neglecting other important sectors (e.g. welfare). In the presence of organized corruption scheme such funds may well end up in possession of the actors that are aimed to get rid of.

Hence, I devise the following hypothesis to guide my study: The fiscal deficit of Bulgaria will increase as the perceived level of corruption among police officials increases.

2.2.3 Poverty, unemployment and income inequality (Hypothesis 3)

According to a Transparency International report (2008) on the relationship between corruption and poverty the term poverty does not only refer to a particular drop of income under certain level. Poverty is pictured as a multi-faced phenomenon which is triggered by a variety of factors, most of which are related to the notion of equal access to basic public services (e.g. education, health and security), basic civil rights, empowerment and human

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development. The corruption itself appears to be a great demoraliser when it comes to development of living standards. Corruption, in that sense, weakens any effort to protect individual’s basic entitlements that are also codified within the legal framework, hence enables inequalities to grow out of proportion. The resources projected to lighten poverty, in the presence of corruption, could end up in the wrong pockets. Since corruption tends to siphon off state capital, it does not only compromise governmental budgeting plans and investments climate, but poverty reduction efforts also (Davoodi et al. 1998). More specifically, poverty and inequalities are affected by corruption among police officials as people (and mostly the poor) are forced to engage in corrupt activities in order to gain access to certain services or/and basic entitlements (e.g. health treatment), or not to be excluded from such (e.g. receive employment, buy/rent accommodations, adequately participate in the community).

Similarly, a report by the World Bank (2000), which combines several studies on poverty, income inequalities and corruption, suggests that corruption among administrative officials have significantly contributed to the failures in transitional states’11_{social safety nets. The}

innate direct effect on the living conditions of the poor and the empirical relationship to low economic growth rates, the corruption results in reducing the state’s capacity to handle domestic poverty. Moreover, this report demonstrates another relationship where income inequality gap enlarges as the level of corruption increases. The studies lay out three particular situations where law enforcement officials participate in corrupt activities and affect poverty, income inequality and employment levels. First, the access to certain services is greatly restricted by corruption as police officials are able, due to their high level of discretion, to misdirect employment programs and obstruct the eligibility for certain benefits as to server personal gain (e.g. discriminatory practices, nepotism), which is mostly at the expense of the poor (Shankar et al. 2010). Hence, this affects the trust in the social system among the poor and discourages them to pursue their basic rights in other social service providers. Second, administrative corruption increases significantly the propensity to bribery among households, especially the accommodations provided by the state. The empirical data suggests, that poor are the least income group to be able to fully invoke their rights and recognize when an official abuses his/her position, thus most susceptible to mistreatment and to involvement in corrupt activities. Andvig and Fjeldstad (2008), relatedly, suggest that in a society where the powerful interest tend to bribe the police agents to chase poor residents out

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of their accommodations (for reasons such as unpaid debts, industrial building projects, etc.), for the households meant a toss into a deeper poverty. Third, corruption among administrative officials tends to highly influence small and micro businesses. The report claims that such businesses might incur higher costs compared to their revenues, thus drive them out the sector and increase unemployment among the poor. Since these types of enterprises hire local people, particularly the microbusinesses that tend to employ unofficially, are prime target for corrupt officials. Here, the corrupt officials prevent small businesses to develop due to the regressive ‘taxes’ they impose that inevitably lead to letting go some of the employees (especially the unofficial ones that are usually representative of the poor). This is not to imply that unofficial economics help the small businesses and the poor, but rather to show how corruption impairs the poor to help themselves out of poverty (Loayza and Rigolini, 2011). The assumption, here, is that corrupt officials drain the financial capacity of such businesses and at the same time they misreport (not fining the employers) and deprive the government from revenues. Hence, corruption among police officials might lead to higher unemployment and more poverty among the poor.

Palifka (2002) takes a different perspective on how corruption among public officials tends to develop. According to his study police officials engage in a sort of self-selection process into public sector positions, both with and without propensity to bribery. The findings in this paper emphasize that in the presence of such separating symmetry, the public jobs with higher propensity to bribery would attract disproportionate amount of potentially ‘corrupt’ employees, while the ‘candid’ ones would generally avoid such public sectors when seeking employment. In addition, the author concludes that as some of the jobs in the public sector appear crooked, it also influences the public-private wage gap to increase (which is often held responsible for police officials becoming corrupt in the first place). Beenstock (1979) takes a similar approach on corruption among police officials and examines corruption as decision-making process under uncertainty. He argues that corrupt individuals in corruption sensitive occupations have the readiness to operate under low legal payment conditions because they also tend to be ‘immoral calculators’ assuming that there is great opportunity to supplement their pay by illegally acquired variety of commissions. Palifka (2010) also concludes, when hiring and supervisory officials are highly prone to corruption, the labour market would sustain certain damages, as the supply side would need to ‘bend the rules’ too. The findings of Andvig and Moene (1990), support such dynamics as some states tend to engage more frequently into polices of austerity in order balance the governmental budgets. When public

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employee wages are cut more frequently than those in the private sector, the incidences of corruption among police officials are expected to increase as there will be higher disposition to such behaviour. However, Andvig and Moene argue that in the presence of overwhelming corruption that includes higher ranking public officials, the cuts in public spending might decrease corruption levels.

To what extent do such effects occur in Bulgaria? In Bulgaria, inequality and poverty entered into a new dimension as the communist regime ended in 1989. Ever since, the social, political and economic conditions had to undergo certain changes if the country was to catch up with the western states. One of the most prominent necessities for such a country was to adopt free-market and privatization policies. In the view of privatization, Bulgaria has delegated various production and delivery of service to private actors due to the assumption that market forces, like competition, would be more efficient in providing them to the public. However, these changes where not without their drawbacks when applied on states with a weakened institutional structure. A report by the European University Institute (2015) argues that in countries like Bulgaria those modifications and the institutional set-up allowed for radical changes in the service quality and employment conditions, domestic predatory pricing and monopolies, and created bigger inequalities within the society. In the presence of corruption among public servants, such negative effects amplify disproportionately as the public assets and activities were delegated with ease to private entities of suspicious origin.

Inequality and poverty increase as tax payers with high income tend to under -report their revenues more than the tax payers of lower incomes (Pashardesa and Polycarpou, 2008). In Bulgaria, according to Pashev (2006), VAT12_{fraud is one of the gravest challenges}

associated with tax and customs administrations as many private businesses (high income tax payers) tend resort to VAT violation whenever possible. VAT fraud might take the form of tax evasion or abuse of tax return entitlements resulting in under-reporting of revenues and financial outflow from the Treasury. The corruption scheme, in this case, involves ‘real’ (individuals, private sector businesses and other legally established organization) and ‘fake’ (criminal organizations) entities that mainly depends on the collusion with police officials. A common practice in VAT falsifying is the abuse of the right to VAT credit. Here, an export transaction is documented and tax credit on the inputs is claimed, while the real trade has occurred in the domestic market without issuing of invoices, thus not taxed. This example shows both the tax evasion and the abuse of VAT credit at once, and the obvious

12_{Value Added Tax}

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concentration of income in particular private pockets. Logically, the capacity of the state to help lower income citizens by certain tax reliefs or social benefits will be lower, thus increasing inequalities. Another example of VAT fraud is when a hollow (or phantom) firm is created on the name of or sold to a person from the poorest social class. This person overtakes the underlying liabilities and debts in exchange for a small amount of remuneration. This shows how poverty is exploited to benefit the private interest with the help of the people who were supposed to work toward less inequality.

According to a CSD (2011) report, the practice of hiring workers without formal employment contract or only with under-reported payment contract, in Bulgaria, has significant impact on the social security system’s development (which relates to the development of poverty and economic inequalities). The lack of detection in a timely manner of under-reported payments will result in lesser contributions and government will be forced to impose unpopular and rushed policy decisions. Therefore, on the forefront to overcome such issues are tax officials who, if corrupt, will depress any feasible policy towards better social system that would produce positive employment climate and decrease the income inequalities. In addition, Levitz and Pop-Eleches (2010) argue that almost half (44%) of the Bulgarians who migrated out of their country think that the government did a very bad job at overcoming corruption and identify corruption among public officials as the main problem for the country. Hence, Levitz and Pop-Eleches, logically assume that the migration is a way for the citizens to hold the government responsible for the inability to deal with corruption tendencies and the associated weak law enforcement within the country. In other words, the corruption among police officials which leads to continuous revenue under-reporting that affects (uncertain future and insecurity) the lower income class will create more migrating out of the state. Since the typical economic driven migration comprises people within their labour capacity, it means that the domestic labour force will be affected and consequently the macroeconomic climate in Bulgaria.

In sum, the negative effects of corruption among law enforcers tend to reflect on the most vulnerable social classes both directly and indirectly. Inequality grows disproportionately as the safeguards of the democratic principles tend to exploit their position and try to squeeze the poor out of their entitlements for private gain. The hidden employment tendencies that stay deliberately undetected by the law enforcers have a significant impact on the state capacity to take care of the poverty levels. Moreover, overwhelming corruption in certain law enforcing institutions deters people to seek employment there, which results i n greater

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income inequality between private and public sector employees which in turn might result in further corruption among police officials. In response to the inadequate living standards due to such dynamics, people will tend to move towards a more prospective region, usually abroad.

Henceforth, I suggest the following hypothesis to supplement my study: The poverty and inequality levels will tend to increase as the perceived corruption among law enforcing officials increases.

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3. RESEARCH DESIGN

The existing data on corruption is produced on the basis of capturing the perception of it, which applies to the corruption among police officials as well. The collection of data is derived from secondary data (analysis) and official statistics on corruption, and the same method will be used for gathering the required macroeconomic data. The years after the accession of Bulgaria in the European Union (2007-2013) will be taken under consideration while bringing together all relevant data.

First, the paper sets the definitions and processes of measurement associated with each variable in this study. This is followed by a part where I explain the concrete choice for my analysis, as well as the particular time period. After that I describe the method of data gathering that is employed, together with the associated underlying assumptions for doing so. This chapter concludes with an overview of potential pitfalls and limitations to the validity of the findings.

3.1 Concepts and Operationalization

In this study, the apparent relationship between police corruption and economic development stipulates that PC (as an independent variable) imposes a considerable influence on ED (dependent variable). Deriving from the findings of Andvig and Attila (2010) the PC - ED relationship could be seen as conventional police corruption that contributes to the influence that crime rates may have on economic development. This helps to suggest that PC (as I define it) may be directly linked to the economic development of Bulgaria. Therefore, this drives the research to take a closer look at the links between PC and EC, excluding the crime rates as a relevant variable. These links will come into play as different aspects of PC that will be utilized to explain how PC may impact ED in Bulgaria.