Does corruption hinder development?

Does corruption hinder development?

Sam Choon Yin (09/2004)

Prior to the Asian crisis, corruption and a lack of an effective legal framework did not seem to have halted inflows of foreign direct investments (FDIs) to the affected countries. This also appears to be the case, as at today, in China.

            Andrew MacIntyre offers an explanation. Based on his study on Indonesia, he argued that strong expected rates of return on investment had minimised cost associated with corruption. This may seem puzzling since FDIs are often injected for long-term purpose because of the heavy initial capital outlays. Why would the firms be willing to invest in Indonesia despite her seemingly corrupt environment? Wouldn’t that hinders the growth potential of their investment plans in the medium to long term?

To resolve this puzzle, MacIntyre provided two explanations. First, Indonesia’s former President Suharto was able to make sure that the cost of corruption on investors did not get too substantial and drive investments away. He had the ability to ‘monitor the behaviour of his core preferences, thereby minimising agency loss’ (MacIntyre, 2001, p. 26). Second, the political leaders provided a credible commitment about the future political environment to the investment community. The key being the decision to open-up the country’s capital account, and allow full convertibility of rupiah in 1970. This essentially allowed the investors to (1) take their money out of the country if things went wrong, and (2) help discipline the government to act properly. As MacIntyre explained, ‘By allowing capital to move freely, the government was in effect, enabling investors to punish it if the business environment deteriorated. Unlike other aspects of its policy behaviour, this commitment to guarantee an acceptable business environment had strong credibility’ (ibid, p. 39).

            With the benefit of hindsight, a corrupt political regime like the one in Indonesia could not last forever. The Asian crisis revealed flaws in the Indonesian system with the majority subsequently demanding political changes. Poor governance might not be a matter of concern to the majority when the country grew and jobs were plentiful. But it would be difficult to tolerate poor governance any further when crisis hit and people’s lifestyle and economic well being were affected.

            Corruption has been ‘credited’ for promoting entrepreneurship. The reason being that excessive regulations tend to hinder entrepreneurs from emerging and expanding. Corruption offers a solution. By bribing the public officers, one could avoid going through the official procedures and excessive paper work. It is generally true that excessive regulations breed uncertainty. It would be more costly, time consuming and troublesome in this case to get things done in the official way. Mohammad Yunus, founder of the Grameen Bank and the concept on microcredit, understood this (see Yunus, 1999 and http://www.grameen.com). He believes that government and foreign aids are generally not helpful in eliminating poverty because they tend to get ‘swollen up’ by public officers along the way. Instead, he believes in providing credit to the poor directly for everyone is a potential entrepreneur, but a lack of capital has prevented the person from taking off.

It has been argued that with corruption, resources could be diverted to relatively more productive sectors. Wong (1997) for example noted that corruption had improved the overall allocation of resources in China. Resources were directed from the low yield state sector to high yielding non-state sector leading to faster economic growth and improved general well being of the Chinese. In this respect, corruption may be deemed desirable as it lowers the transaction cost and frees up resources.

In an interesting study, Pranad Bardhan argues that corruption could improve efficiency and fosters economic development. Citing the Coasean bargaining process, Bardhan writes:

 

‘Even without pre-existing distortions, one may look upon corruption as part of a Coasean bargaining process in which the bureaucrat and the private agent may negotiate their way to an efficient outcome. If in a bribery game there is competitive bidding by private firms for a government procurement contract, and the corrupt official awards the contract to the highest bidder in bribes, then allocation efficiency is maintained, as only the lowest-cost firm can afford the largest bribe’ (Bardhan, 1997, p. 1322).

 

The author also claims that corruption could enhance administrative efficiency in the public sector for it reduces ‘delays in moving files in administrative officers and in getting ahead in slow-moving queues for public services’ (Bardhan, 1997, p. 1323).

All these cases highlight the fact that quality of governance matters. The issues emerged essentially because public officers have the opportunity and incentive to receive bribes and extort payments from others. What the country needs is a political system that allows for reforms, which should be administered in a systematic and democratic manner. A good political leader must exist to remove those who are corrupted regardless of their political status and influential power. To do this, the legal framework must provide him/her with the necessary power. More importantly perhaps is for him/her to have the support from the society to carry out the tasks. Absence from any of these supports will adversely affect the probability of success in raising the standards of public governance. 

The problems in the public sector are actually quite similar to those faced by private corporations. The agency problem for one is applicable in the public sector even though it is often discussed in the context of corporate governance in the private sector. In the public sector, the citizens represent the principals while the elected political leaders represent the agents (as opposed to the shareholders being the principals and company directors as agents in private corporations). It is the latter’s duty to maximise the interest of the principals (maximising the welfare of the society). In reality however, it is difficult to ascertain what constitutes as the society’s interest because the society comprises many individuals who have interests that could be conflicting with one another. In a democratic society, the political leaders are given the power and responsibility to represent the society. Their decisions therefore are representative of the society. The problem arises when the agents do not act to maximise the principals’ interest. Rather, they may use whatever means they can to cheat the principals and expropriate public funds.

Politicians or public officers do have contractual agreements with the principals to see that the former carries out their duties ethically and with the interest of the society in mind. But the contracts are often incomplete. For instance, it is technically not feasible for the principals to monitor the actions of the agents at all times. Curbing corruption in this context is almost similar to efforts aimed toward solving the principal-agent problem in the private sector.

What we want to argue in this essay is that corruption mitigates social and economic development. That is, corruption brings forth more harm than benefit to the society (so my answer to the question posed in the title of this essay is ‘yes’). International institutions like the World Bank and International Monetary Funds seem to support this claim in view of their continuous efforts to combat corruption. Corruption is essentially viewed as a form of theft of state assets where public officers misuse their power to expropriate public funds and disrespect state law and control. Corruption has resulted in more serious income inequality and poverty problems. The benefits from corruption are generally accrued to influential politicians, law enforcement officers and well off private individuals at the expense of the masses.

Evidences have showed that in recent years the society has become more disapproved of corruption. For instance, former politicians like Abdurrahman Wahid and Suharto in Indonesia and Joseph Estrade in the Philippines were removed from their post because of corruption allegations. Thailand’s Thaksin Shinawatra was indicated by the National Counter-Corruption Commission but was eventually acquitted in a controversial decision by the Constitutional Court. In 2002, the reputation of Korea’s Present Kim Dae-Jung was tarnished when his two sons were convicted of corruption charges.

Below, we offer three reasons why it is useful to curb corruption.

First, in the aftermath of the Asian economic crisis, good governance has been considered as an important criterion for investors to decide where to invest. Financial institutions and other borrowers also look at the country's level of corruption to assess the risk of lending to the country.  The country’s economic capability and reputation is judged very much by the county’s level of corruption. As such, international ranking on corruption provided by the Transparency International (TI) and the Political and Economic Risk Consultancy Limited (PERC) have been extensively used by the academics, investors and governments around the world. Table 1 provides the recent ranking on corruption tabulated by the TI.

Table 1

Corruption Perceptions Index Scores, Selected Economies in Asia (2000-2003)

Economy

2000

2001

2002

2003

Singapore

Australia

Hong Kong, China

Japan

Taiwan, China

Malaysia

Republic of Korea

China

Thailand

India

Philippines

Pakistan

Vietnam

Indonesia

Bangladesh

Regional Average

9.1

8.3

7.7

6.4

5.5

4.8

4.0

3.1

3.2

2.8

2.8

n.a.

2.5

1.7

n.a.

4.4

9.2

8.5

7.9

7.1

5.9

5.0

4.2

3.5

3.2

2.7

2.9

2.3

2.6

1.9

0.4

4.3

9.3

8.6

8.2

7.1

5.6

4.9

4.5

3.5

3.2

2.7

2.6

2.6

2.4

1.9

1.2

4.6

9.4

8.8

8.0

7.0

5.7

5.2

4.3

3.4

3.3

2.8

2.5

2.5

2.4

1.9

1.3

4.5

Source: Transparency International (http://www.transparency.org)

n.a. Not available

Note: Corruption Perceptions Index (CPI) relates to perceptions of the degree of corruption based on surveys of business people, academics, and risk analysts, and range between 0 (highly corrupt) and 10 (highly clean).

 

Second, corruption could intensify activities in the underground sector. Public officers for example may deliberately assist businesses or individuals to smuggle goods and human beings into the country. The politicians did this in exchange for votes during election and to earn commissions to supplement their income. As Phongpaichit, Piriyarangsan and Teerat (1998) has illuminated, it is common in Thailand for influential politicians and low ranking police law enforcement officers to be involved in illegal activities like gambling and prostitution. 

The illegal income must be laundered somewhere. In a recent study, Schneider (2002) estimated that at least 50% of the funds flowed to the Al Qaeda group was obtained from illegal and underground activities. It is imperative therefore to curb corruption and subsequently the growth of the underground economy so as to minimize flows of funds to the terrorist groups and lessen future attacks. Indeed, corruption has been accused of hampering efforts put in to fight against terrorism. Corrupt law enforcement officers for instance could have allowed weapons and terrorists to enter checkpoints. In Russia, it was believed that soldiers were bribed to supply arms and weapons to Chechnya fighters. Also, it was pointed out that two of the attackers in the recent hijacking incident at Beslan School (on 3 September 2004) were allowed to go free from police custody in Chechnya (prior to the incident) after offering bribes to the police.

Third, corrupt public officers may deliberately cause delays in transactions to extort payments. Corrupt public officers may attempt to entice company agents to work with them. The latter may choose to go ahead with the plan, first, to seek additional income and second, to ‘enhance’ the performance of the company and consequently reward themselves through stock options plan and other performance based remuneration schemes. Without reasonable standards of corporate governance, company agents may be tempted to act improperly. Thus, the problems on corruption could be derived from the demand side (extortions by public officers) as much as the supply side (company agents paying bribes to public officers to get things done). Together, they could impose very high external cost on the society (because of their powerful status in the society) if proper checks to contain the problem are lacking.

A recent document published by the World Bank has carefully assessed how the private sector could assist in curbing corruption. The document calls for efforts to raise the standards of corporate governance. There should also be a conscious effort to introduce ethics compliance program. The program should consist of three important components; (1) a clear statement of values strongly supported by top management, (2) training and dissemination grounded in the experience of company staff and (3) effective information and support systems (Arvis and Berenbeim, 2003, p. xx). It is generally believed that incentive measures are more cost effective than sanctions-based public enforcement measures. This is an important point. Organizations (and countries) with limited resources of law enforcement should focus their attention on improving their internal standards and monitoring mechanisms and getting good people to lead to organizations (countries), rather than relying more exclusively on sanctions-based measures like the use of threats and police force.

So far, this paper has argued that curbing corruption is a right step to take to make this world a better place to live in. Corruption mitigates economic development and degrades the standards of the poor. Many governments and international institutions have spent so much resource and carry out so many studies to resolve this problem. Were there any significant improvements? Apparently not if one is to agree with Vinay Bhargava and Emil Bolongaita. The authors have argued in their recent book:

 

‘….many governments have been prodded if not pressured to launch or reinvigorate anticorruption policies and programs. In this regard, the number of proposals or ideas on ways and means to combat corruption has grown… There is hardly any country in which no anticorruption agency exists and few anticorruption instruments are in place. However, the evidence from manifold sources more than suggests that these institutions and instruments are not getting the job done for most countries. In fact, either the counter-corruption policies are not working or the anticorruption institutions themselves are among the most corrupt’ (Bhargava and Bolongaita, 2004, p. 10).

 

It is not easy to get lower ranking public enforcement officers to act incorruptly if their superiors are themselves engaged in acts of corruption. Thus, any approach to eradicate corruption must start from the top, and trickle down to the middle ranking managers and low ranking officials. Only then would there be some chances of success in curbing corruption.

The political leaders (those in the top and middle positions) must initiate the changes and be willing to act incorruptly. However, experience has shown that unless some severe shocks are felt, the powerful can remain powerful for very long. External pressures imposed on the countries may be accused of meddling with the internal affairs thus rendering them less effective. It is also difficult to educate and reach out to the masses and those adversely affected by corruption (so that they will become more aware of the problem and vote out the corrupt incumbents). The powerful incumbents usually have strong control over the mass media thus reducing the amount of and level of truthfulness in the kind of news conveyed to the public. Moreover, members of the public may not wish to see changes in the status quo, unless they are personally affected by the shocks (as in the Asian crisis). If the powerful individuals were not pressured to change (either from the inside or outside), why would they want to turn over a new leaf and act incorruptly?

However, this does not imply that no pressures should be exerted on corrupt politicians. What I want to point out is that there must be a strong political will among the political leaders to inculcate a non-corrupt culture in their country. Its probability of success in fighting corruption ought to be higher than any other measures. The country needs good men to lead, men who are genuinely interested in maximizing the interest of the society.

 

References

Arvis, Jean-Francois and Ronald E. Berenbeim, 2003, Fighting Corruption in East Asia: Solutions from the Private Sector, The World Bank, Washington D.C..

Bardhan, Pranad, 1997, ‘Corruption and Development: A Review of Issues’, Journal of Economic Literature, Vol. XXXV (September 1997) pp. 1320-1346.

Bhargava, Vinay and Emil Bolongaita, 2004, Challenging Corruption in Asia: Case Studies and A Framework for Action, The World Bank, Washington D.C..

MacIntyre, Andrew, 2001, Investment, Property Rights, and Corruption in Indonesia, in Corruption: The Boom and Bust in East Asia, edited by J. Edgardo Campos. (Manila: Ateneo de Manila University).

Phongpaichit, Pasuk; Sungsidh Piriyarangsan and Nualnoi Teerat, 1998, Guns, Girls, Gambling, Ganja: Thailand’s Illegal Economy and Public Policy, Silkworm Books, Bangkok.

Wong, Yue Chim Richard, 1997, Reform and China’s Underground Economy, in The Underground Economy: Global Evidence of its Size and Impact, edited by Lippert, Owen and Michael Walker (Canada: The Fraser Institute).

Yunus, Mohammad, 1999, Banker to the Poor, Aurum Press, Great Britain.