A Search-Theoretic Model of Bureaucracy and Corruption∗

We analyze bureaucracy and corruption in a market with decentralized exchange and “lemons. ” Exchange is modelled as a sequence of bilateral, random matches. Agents have private information about the quality of goods they produce and can supplement trade with socially inefficient bribes. Bureaucracy is modelled as a group of agents similar to private agents, but who enjoy centralized production and consumption. Transaction patterns be-tween the bureaucracy and the private sector are fully endogenous. Our main finding is that centralized production and consumption in the bureaucracy also gives rise to low power in-centives for the individual bureaucrats. As a result, we find conditions under which private agents bribe bureaucrats, while they do not bribe each other. An equilibrium with corruption and an equilibrium without corruption can co-exist. We discuss some welfare implications of the model