Economics of corruption

In a 1995 study of investment and loan risk data for 52 countries, Alberto Ades and Rafael Di Tella found that an increase of US$4,400 in per capita income would improve a country’s ranking on a corruption index (0 for total corruption, 10 for total integrity) by two points. An increase in exposure to competition would also lead to an improved ranking. Such findings not only show the links between underdevelopment and corruption (see article by Irène Hors), but they underline the extent to which corruption has a strong economic dimension.

For most economists, the root causes of corruption lie in the delegation of power. It is the discretionary use of that power and the often monopolistic position public agents enjoy when dealing with contracts which make corruption possible. The incentives and opportunities for corruption depend on the size of the rents, or the personal profit, which public agents can derive from allocating those contracts.

Corruption therefore occurs at those points where the political, bureaucratic and economic interests coincide. There is legislative corruption when politicians betray the electorate by selling their votes to pressure groups, and administrative corruption when public officials take payoffs to allow someone to secure a procurement contract or to gain immunity for tax dodging. In fact, opportunities for misdemeanour exist at every level, from grand corruption at the highest public office, to petty corruption at the lowest rung on the ladder.

Like any other market, corruption is based on a contract between different interests. Firms, pressure groups and citizens try to maximise their gains by paying bribes, while public officials try to maximise their illegal earnings and politicians their power and wealth. Bribe payers may seek to avoid or reduce costs, through illegal reductions in taxes, lax enforcement of regulations, underestimated rent for public housing or the dropping of criminal charges. Multinationals might pay bribes just to jump the queue in getting a house or a telephone line connected. Even obtaining a research grant often presupposes a bribe. Bribers may even be coerced to pay, which is called extortion.

Incentive bribes, payoffs and extortion happen to be rare in developed countries, but frequent in developing ones. Corruption is, of course, present in developed countries. The dubious funding of political parties is one example, and before the OECD Convention came into being, multinationals found it easier to receive government export assistance than they do now. But, with strict property rights, mature institutions and well-paid civil servants, developed countries can hardly be said to suffer from systemic corruption. Supply is plentiful enough to remove the incentive to jump queues. And the scrutiny that public governance is subjected to makes corruption in most OECD countries very difficult to get away with (see article on the Public Sector).

The picture could not be more in contrast with the situation in many developing countries, where weak governance and rights are endemic. Property rights are at best just being established and remain open to abuse, at least for a time. Young democracies often find it hard to break free of the clientism, patrimonialism or corporatism that afflict undemocratic regimes. Bribes continue to be collected, often to line the pockets of the elite and to buy political backing.

Making up the economic lag can lead to corruption. If there are natural resources to exploit, as in Mexico and Nigeria after the discovery of oil, they are likely to be sold for above-market prices, since bribes are usually needed to secure concession sales.

What cost? 

The costs of corruption are difficult to calculate, partly because of the secrecy involved and also because the distortions caused are hard to measure. But some effects seem to be beyond doubt.

One result is lower overall investment. A 1997 study by Paolo Mauro of 67 countries covering data from 1960-85, found that if a country such as Egypt were to heighten the efficiency of its administration and improve its corruption score of 4 out of 10 to the same level as Argentina’s 6, (again where 0 means total corruption and 10 means none at all), the rate of investment would increase by 3% and the growth rate would increase by 0.5%. Another study in the same year, by Shang-Jin Wei, argues that a worsening of Singapore’s perfect score of 10 to that of Mexico’s 3.25 would be the same as raising the tax rate by 21 percentage points.

Another effect of corruption is that it tilts public spending towards projects that make it easier to collect on bribes, at the expense of priority programmes. Hence the proliferation of "white elephant" projects. And typically, spending on defence is preferred over education. This is because it is difficult to benchmark prices of custom-built high-tech equipment.

Crucially, corruption can lower the quality of public goods and services and even threaten safety. The collapse of buildings in Seoul and during the earthquake in Turkey was partially blamed on substandard contracts and shabby construction. Corruption also distorts the redistri-butive role of the state. It fuels the informal sector and acts as an incentive to evade taxes. It also totally distorts programmes to combat poverty, undermining international aid and reconstruction programmes. It is important to distinguish between the political and economic effects of corruption, since they are by no means identical (see box). The corruption that accompanied agrarian reform in Morocco in the early 1970s may have contributed to political stability, but it undermined economic growth. On the other hand, the same political stability may have boosted growth over the longer term.

But it should not be concluded that all corruption damages growth. The World Bank has found that countries with more predictable corruption have higher investment rates. Thus, countries with endemic but predictable corruption, such as Thailand and Indonesia, have had strong investment growth.

Surveys carried out in 1998 and 1999 by the World Bank during administrative reforms have thrown up interesting patterns in Europe’s transition economies. A weak judiciary was found to be one of the main causes of corruption in Albania, but regulatory failures were more serious in Georgia and Latvia. Bribes were found to take 7% of firms’ revenue in Albania and Latvia and 15% in Georgia. Some 14% of Georgian households admitted to paying bribes and 11% in Latvia. Not surprisingly, the survey, which covered between 350 and 450 enterprises, also showed that businesses would be willing to pay additional taxes if corruption were eliminated.

The losses can be even higher. In Uganda, according to the World Bank, public spending on primary education trebled in 1991-93, but oddly, enrolment rates did not rise. A survey of 250 schools showed that over 70% of capital funding got misappropriated.

So how does this economic analysis help us? It provides some insight into the causes of corruption by examining the concepts of information, power, monopolies and rents. The causes in turn highlight the roles of poverty, civil-service pay and social cleavages. Unfortunately, most studies suffer from a serious lack of data, and most of the research to date has been on developing countries. Yet, as noted, corruption is not absent in developed countries, especially at a business-to-business level. More research on this would help to build a clearer, more complete picture of corruption generally, along with its costs. Until then, corruption will continue to be a rather murky business. 

References 

Ades, A. and R. Di Tella , "Rent, Competition and Corruption", Oxford University, mimeo, 1995.

Cartier-Bresson, J., "A Few Suggestions for a Comparative Analysis of Corruption in Western Europe", Revue Internationale de Politiques Comparées v. 4, n° 2, 1997.

Mauro, P., "The Effects of Corruption on Growth, Investment and Government Expenditure", in Elliot, K. (ed.), Corruption and the Global Economy, pp. 83-108, 1997.

Wei, S-J., "How Taxing is Corruption on International Investors?", NBER Working Paper, no. 6030, 1997.

World Bank, Using Surveys for Public Sector Reform, Premnotes No. 23, Washington, 1999.

©OECD Observer No 220, April 2000 




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