Competition between mafia and the government

The presence of a criminal organisation affects the allocation of resources and the surplus they produce in several different ways. The most obvious way in which criminal activity affects the economic decisions of other agents is through the imposition of externalities of different kinds. Many times, however, criminal organisations carry out production activities that can actually generate surplus. This production activity can take the form of direct production of a consumption good or production of inputs that are used in turn for the production of consumption goods.

Grossman's purpose is to study how the production of input services by the mafia affects the government's fiscal policy, i.e. how the amount of production services produced by the government and the tax rates it sets are affected in equilibrium when another organisation can produce alternative production services and can impose ‘taxes’ on the people that use such services.

The model employed in the paper is a static representative agent model in which a government produces ‘public services’ that are an input for the private sector that can engage in the legal or extralegal production of a final good.

Grossman first deals with the case in which the government is a monopolistic supplier of the public services needed for legal production. In this case, if the tax rate is too high, private agents will use all their labour inputs and all government-produced public services in extralegal production even though marginal productivity in extralegal production is lower.