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Journal of Money Laundering Control

Money laundering and corrupt officials: a dynamic model
Cassandro Mendes Jailson Oliveira

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To cite this document:
Cassandro Mendes Jailson Oliveira, (2012),"Money laundering and corrupt officials: a dynamic model",
Journal of Money Laundering Control, Vol. 16 Iss 1 pp. 55 - 61
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Money laundering and corrupt

officials: a dynamic model

Corrupt
officials

Cassandro Mendes

Federal University of Rio Grande do Sul, Porto Alegre, Brazil, and

Jailson Oliveira

55

Federal University of Paraiba, Porto Alegre, Brazli

Abstract
Purpose The purpose of this paper is to develop a theoretical model to study the impact of
corruption on money laundering.
Design/methodology/approach The relationship between corruption and money laundering has
been modelled by using differential games.
Findings The authors model suggests that corruption increases the quantity of dirty money
laundered in the formal economy. It was also found that, jointly with the anti-laundry regulations, the
government should create a better salary policy, as a way to control corruption of federal officials.
Originality/value To best of the authors knowledge, this is the first theoretical paper that studies
the link between money laundering and corruption.
Keywords Mathematical modelling, Corruption, Money laundering, Public
administration, Differential games
Paper
type
Research
paper

1. Introdu
ction
The globalization of the financial sector increases the prospect of money laundering.
This paper aims to study the effects of corruption on money laundering. We aimed to
develop a theoretical model that analyzes how corruption may increase money
laundering in a given country. We present two main contributions to the current
literature, namely:
(1) we show how the effectiveness of the anti-money laundry regulation is
closely correlated with corruption; and
(2) through our model, we describe the dynamics between corruption
and the quantity of illegal money laundered in the legal economy.
The theoretical connection used to perform such a model, and neglected in others
paper, is the salary system used in the public sector. Our model is based on one
representative agent, and we used hierarchical differential games to derive our results.
The main result of this paper shows that the existence of corruption may
undermine all the control policies implemented by the legal institutions. In the model
we highlight how the salary system, settled by the government, may play an
important role in the effectiveness of the anti-money laundering policies. Usually a
salaried professional makes the surveillance and implementation of the antimoney laundry regulation.
Hence the effectiveness of such regulation, announced by the central government,
depends on the level of corruption in the economy. This relationship has been verified
in many developing countries where the salary paid, in the public sector, is relatively
low.

Journal of Money Laundering Control

Vol. 16 No. 1, 2013
pp. 55-61
q Emerald Group Publishing
Limited
1368-5201
DOI 10.1108/13685201311286850

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JMLC
16,1

56

In some less developed countries, e.g. Guinea-Bissau, there has been an increasing
problem of corruption related with the narcotraffic (Horta, 2007).
The existence of corrupt government officials boosts the organized crime, and,
therefore, increases the money laundering. This is a reality faced in many countries,
namely Western African countries (Horta, 2007). Due the existence of corruption in
the public sector, all the coercive policies, implemented by the international
organization,
may be innocuous.
We built a model that deals exactly with corrupt officials, i.e. they already made
their decision on being corrupt. The model displays how the money laundering
increases due the relationship between the criminal agent (CA) and the corrupt
government official.
Beyond this introduction, the paper is organized as follows: Section 2 presents the
model, Section 3 presents the results and dynamics of the model, and final
conclusions are presented in Section 4.
2. The
model
In the present model, we suppose that there is a corrupt official with the task to make
surveillance on the anti-money laundry regulation. Characteristically, this official is a
worker in the government institution, responsible for the financial sector and/or the
federal department for crime.
There are two players in this game, the corrupt government official and the CA.
The third passive agent, the judges, defines the laws and the penalties. We choose
to
use differential game, where the state variable is defined as the quantity of dirty
money laundered in the formal sector, namely, the dynamic kinematic equation is
written as:

Z l xt
where Z(t) represents the stock of money laundered in the legal sector at each time t.
x(t) represents the quantity of illicit product, for example, the quantity of drugs or
arms trafficked. The parameter l represents the monetary index the figure that
converts to monetary values the quantities of the illicit products sold[1].
The CA aims to maximize his profit, which we define, at each time, t, as:
p t pt* xt kZ t 2 cxt

where p(t) presents the price in the market of the illicit product[2]. The cost of the
illicit trading at each t is denoted by c(x(t)). Z(t) represents the amount of money
laundered in the formal sector, therefore, kZ(t) represents the profits earned in the
formal sector (by the application of the dirty money in a formal activity), and k
represents the average profitability rate in a given formal sector. Explicitly, the CAs
cost function can be written as:
ct f Ft Ftt1t

where F(t) denotes the monetary penalties paid at each time, and (t) represents the
subjective probability associated. Hence equation (2) represents the expected cost of
punishment that the CA would incur in case of detection[3]. Note that as increases
(t), the cost of the illicit activity will increase as well. 1(t) denotes the effort applied
by the official. The effectiveness of the anti-money laundering policies has
already been

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investigated in the literature (for instance, Moreira, 2007; Fanta and Mohsin, 2010)).
However, none of the previous studies has highlighted the effects of corruption.
We suppose at a 100 percent, the probability that the AC is discovered, that is,
(t) 1, ;t [ [0,T ]. However, we suppose that there is a corrupt official in the
relationship. Hence the CAs cost function is assumed to be:

Corrupt
officials

ct Bt
where B(t) denotes the bribe paid to the corrupt official at each time, t. Intuitively, it
is appealing to consider that the bribes, paid to the corrupted official, depends on
his salary. That is, the higher the salary received by a public worker, the lower is
the probability of being corrupted. Literature on corruption has highlighted this
inverse relationship between corruption and the salary paid in the public sector
(see for instance Tanzi, 1998). We suppose that the salary have a positive impact in
the officials bargaining power. The bribe function is denoted by:
Bt r wtFt1t

where r(w(t)) denotes the officials bargaining power, and F(t) the monetary penalties
at each t. We suppose that the salary received by an official is constant over time.
Hence, the officials bargaining power can be written as:
r w t
rwt rwC

. 0
w
Thus, the bribe function can now be written readily as:
Bt rwC Ft1t

Consequently, the CAs objective function can be written as:

p t pt* xt k Z t 2 rwC Ft1t
By using the inverse demand function, the CAs objective function is given by:
p t qxt 2 a x 2 t k Z t 2 rwC Ft1t

where q,a denotes positive parameters of the inverse demand function. We suppose
that the monetary penalty depends, positively, on the quantity of illicit product
detained. Thus, it can be written as:
Ft dxt

where d denotes a positive parameter. Hence, the CAs dynamic problem, can be
written as:
Z T
V 1 max
qxt 2 a x 2 t k Z t 2 rwC dxt1t]dt 7
xt

s:t:

lxt
Z

Z 0 z0
where Z(0) denotes the value of the state variable at beginning of the period.

57

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JMLC
16,1

The other player, in the game, is the corrupt official. We suppose that the official
aims to maximize his consumption, C(t), over a finite period of time. At each time, t,
his consumption is defined as:
Ct wC Bt

58

where w and B(t) was previously defined. According with equation (8), in the case of
no bribe, the official would have a constant consumption over time. However, at each t,
he may increase his consumption by receiving a non-negative amount of bribe from
the CA. The official will choose his effort to maximize his consumption over
time. Therefore, his maximization problem can be written as:
V 2 max
1t

wC rwC dxt1t 2 1 2 t]dt

The officials control variable is the effort applied in the detection of the illicit
2
activity. We suppose that effort implies in a non-linear cost (1 (t)), to the official.
3. Solutions of the model and dynamics
To solve the model we used a dynamic differential game. In the game, we consider
the CA as the leader and the official as the follower. The information structure
used, to solve the game, is open-loop Stackelberg equilibrium. Also, we used, to solve
the game,
backward induction. To archive the dynamics of the model, we applied the
Pontryagins maximum principle. We first solved the officials maximization, and
later on, the CAs optimal control problem.
As discussed above, the official aims to maximize his consumption over a finite
period of time. Hence the Hamiltonian of his problem, can be written as:
H : wC rwC dxt1t 2 1 2 t ttlxt

10

where t (t) denotes the co-state

variable.
The sufficient conditions (given that the Hamiltonian is concave in 1(t)) for this
maximization, are given by:
r wC dxt 2 21t 0

t0

II

Z lxt

III

Therefore, the control solution for the official can be written as:
1 * t

1
2

rwC dxt

11

Note that as a follower, the officials strategy depends on the strategy used by the CA,
namely, the optimal path for x(t). Therefore, to obtain the officials optimal choice,
we first need to find the CAs optimal choice. As a leader, the CA will include the
optimal officials strategy in his maximization. The Hamiltonian of the CAs
maximization, can be written as:

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r 2wC d 2 x 2 t
H : q xt 2 a xt
2 t kZ
x tl xt
2
t 2
where x(t) denotes the co-state variable. Thereby, by applying the maximum
principle, we find the following conditions:
q 2 2a xt 2 r 2 wC d 2 xt x tl 0

x 2k

12

I0
0

II

Z l xt

III0

x T 0

IV0

And the transversality condition:

By using the conditions above (I0 -IV0 ), we found some results, which are listed and
discussed below.
Result 1
The Stackelberg equilibrium is constituted by the pairs of time-dependent strategies,
namely:
lk T
xt 2 q
13
2
d t 2a r 2 wC
q lk T 2 t
1 * t 2r 2wC d 2 rwC d
14
4a
Proof. By solving the officials maximization, we obtain:
1 * t

1
2

r wC dxt

Also, the CAs optimal choice, can be written as:

xt t q lx
15
2a r 2 wC d 2
Thus, to find the final solution of the game, we need to obtain the full optimal path of
the co-state variable (x(t)). This can be done by using the transversality condition:

x 2k
Thus:
x t B 2 kt
Where B is a constant. Thereby using x (T) 0, the solution can be stated as:
x t k T 2 t
Substituting this result in equation (15) and substituting the CAs strategy in the
officials optimal strategy, the result follows.
A

Corrupt
officials

59

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16,1

Result 2
The dynamics of the quantity of money laundered, in the formal sector, is represented,
explicitly, by the following equation:
2ql 2l 2 kT]t 2 l 2 kt 2
16
Z t Z 0
2r 2 wC d 2 4a

60
Proof. By substituting the CAs control variable in the kinematic equation we
obtain:

ql l 2 kT 2 t

r 2 wC d 2 2a

Therefore, the solution for this first-order differential equation can be easily obtained:
l
Z
ql l 2 kT 2 t
Z t Z 0
dt
17
r 2 wC
d 2

2a

where Z(0) is the initial stock of dirty money laundered in the formal economy. After
some calculus, the result follows.
A
After the results above, we are able to perform some static comparative to analyze
the effects of some variables in the dynamics of the money laundered in a given
economy. An increase in the bargaining power of the official increases the cost of the
illicit activity, and therefore, decreases the quantity of illicit product commercialized.
Hence an increase in the bargaining power of the official decreases the quantity of
dirty money laundered in the formal sector. Formally, this result can be obtained by
using
simple
calculus:
22lq 2l 2 kT]t 2 l 2 kt
Z t
, 0
18
2

]4rwC d 2
r
2r 2 wC d 2 4a]2
As assumed earlier, the officials bargaining power depends on the wages paid in the
formal sector. Therefore, the salary received, by the official, has an important role in
fighting money laundering. It is straightforward to find that:

22lq 2l 2 kT]t 2 l 2 kt
Z t
, 0
19
2
2
r

]4rwC d
w
w
2r 2 wC d 2 4a]2
These results suggest that the presence of corruption may increase the quantity of
money laundered in the formal sector. The salary policy, in the public sector, used by
the government is an important tool to fight corruption, and consequently, money
laundering. Higher salaries impose higher bribing costs to the CA thus it decreases
the profitability of the illegal activity, and consequently, less dirty money is
laundered.

Note that the increase of the monetary penalties also increases the cost of the
illegal activity. However, the cost perceived by the CA is lower, because the bribe
paid, to the
official, is less than the penalties that he (the CA) would pay directly to the
government.
Therefore, the effectiveness of the anti-money laundry regulations depends on the
government policies to change the bargaining power of the public worker.

These anti-money laundry regulations are innocuous, if the government decreases the
real salary in the public sector.
4. Conclusion
In the present paper we developed a model to study the dynamics of money
laundering in the presence of corruption. Our results suggest that corruption, in the
public sector,
increases the quantity of money laundered in the formal economy. The core variable
here is the bargaining power of the federal official, which depends of his salary.
Therefore, the salary policy used by the government is an important tool to fight
trafficking, and consequently, the money laundering.
Notes
1. This index, not necessarily, is the price of the illicit product. We supposed that the CA
can use, directly, his own illicit product to the laundering process. That would be the
case of illegal diamonds, trafficked in many regions of the world.
2. We define as a crime, any illicit activity associated with the trade of illegal goods,
for example drugs, arms, illegal diamonds, etc.
3. We suppose that the CA, in case of detection, would just pay monetary penalties.
This assumption does not change the results of the paper, if any other type of
penalty is used,
e.g. prison. Its estimated monetary value could be incorporated in the bribes paid.
References
Fanta, F. and Mohsin, H. (2010), Anti-money laundry regulation and crime: a two-period model
of money-in-the-utility-function, Working Paper [25773], MPRA, Germany, 10 October.
Horta, L. (2007), Guinea-Bissau: Africas first narcostate, available at:
www.africa.upenn.edu/ Articles_Gen/guinbisauhorta.html (accessed 17 May 2012).
Moreira, T.B. (2007), A two-period model of money laundering and organized crime,
Economics Bulletin, Vol. 11 No. 3, pp. 1-5.
Tanzi, V. (1998), Corruption around the world causes, consequences, scopes, and cures,
International Monetary Fund Staff Papers, Vol. 45 No.
4.
Corresponding author
Cassandro Mendes can be contacted at: cassandromendes@hotmail.com

Corrupt
officials

61

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