In Discussion Paper No. 1494, Daron Acemoglu and Thierry Verdier consider an economy in which property rights - enforced by otherwise unproductive public employees - are necessary to ensure sufficient rewards to ex-ante investments. Therefore, the larger the public sector, the better property rights are enforced. Because enforcement of property rights influences the ex-post distribution of rents, however, there is room for corruption. Also, the more individuals work in the public sector, the less are left to take on private sector activities. On this basis, the optimal degree of property rights enforcement and the optimal organization of society is characterized, embedding the standard principal-agent approach of corruption in a general equilibrium framework.

The study's main findings are that three frequently mentioned 'government failures' arise quite naturally as part of the optimal mechanism: Rents to government employees, corruption, and misallocation of talent. Hence, these observations cannot by themselves be proof of government failures. It is also discovered that the general equilibrium aspect of the model employed leads to a number of new and intriguing results: Over a certain range, it appears to be possible to simultaneously reduce corruption and the misallocation of talent, and thereby increase investment. Moreover, the paper finds that frequently, bureaucracies will impose a certain amount of self discipline.

Property Rights, Corruption and the Allocation of Talent: A General Equilibrium Approach
Daron Acemoglu and Thierry Verdier