Sofiia Gavryliuk/ ID 100137763 BUS211

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Governance and Business Strategy

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Word count- 1648 words excluding reference 6) Assess the effects that corruption may have on economic development. How do you reconcile the anecdotal evidence with the theoretical ideas?

We need to deal with the cancer of corruption. 1 James D. Wolfesohn, 1996

Introduction

Corruption is defined as the abuse of public office for private gain.2 This subject is a major global issue, concerning every country around the world, effecting peoples lives on a day-to-day basis. According to the annual index3 given by the Transparency International4- the most corrupted countries are North Korea and Somalia, followed by LEDCs5, such as Iraq or Kenya.6 It is believed that corruption is a major barrier to development7; and poor economic development leads to social issues like: low literacy rate, low incomes, high mortality rate, etc. Corruption in particular is believed to play a critical role in generating poverty gaps.8 The general idea is that corruption creates disorganization and inefficiencies.9, while Schleifer and Vishny (1993) introduce a term, which describes corruption as a grabbing Hand.10 In order to analyze the effect of the corruption on economic development- a few example of the

Annual Meetings Address by James D. Wolfensohn, President of the World Bank October 1, 1996 2 Definition given by the World Bank World Bank, Helping Countries Countries Combat Corruption: The Role of the World Bank, 1997 3 The current Corruption Perceptions Index was launched 1 December, 2011 4 Transparency International- governmental organization devoted to fight corruption worldwide 5 LEDC- Less Economically Developed Country 6 Corruption Perceptions Index, Transparence International, December 2011 7 Mauro P. (1995) 8 Andvig, J. C., and Moene, K. O. (1990), How Corruption May Corrupt 9 Rose-Ackeraman 1999 10 Shleifer, A., and Vishny, R. W. (1993), Corruption, Quarterly Journal of Economics

Sofiia Gavryliuk/ ID 100137763 BUS211

areas that corruption takes place in should be presented. There is no need to distinguish between micro and macro effects because they are interrelated.

Domestic

There are various domestic effects of corruption on firms, enterprises, and households, which differ among the countries. An interesting cross- country data analysis carried out by Bhardan (1997) showed that even though the level of corruption in the countries like Indonesia and India are relatively the same- firms and households have an immensely different experience with corruption and bribery. One of the major problems of identifying the level of corruption and its effects is that there is no realistic way of measuring it and inferring its consequences. The nature of corruption is mostly unobserved. Moreover, bribery is an illegal activity and an individual who decides to perform one- prefers not to disclose the information. This in turn creates a major uncertainty for firms, whether it is an existing business or someone who wants to open one.11

Another existing but hardly proven consequences, due to the reasons mentioned above is the fear that corruption may create for firms and local people. Money can buy it all means that people who simply cannot afford to pay bribed have little power and right in the country. For instance, in the Post- Soviet Union region, there are many cases when a business cannot simply operate because the government officials are not letting, because they want to get bribes, even though the business hasnt broken any law or rule whatsoever.

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Kaufmann (1999)

Percentage of companies who have to pay bribes- 15 per cent of all companies in industrialized countries have to pay bribes to win or retain a business. In Asia this figure is at 40%. In countries of the former Soviet Union 60 per cent of all companies must pay bribes to do business.12

Trade

One of the effects of the corruption is trade restriction. The fact that import licenses and permits for importing goods as well as exporting may be very valuable due to many reasons (government regulations or the type of the good)- creates an opportunity for the bribery of the officials who control this area. This means that custom charges can be avoided; by just maintaining these tariffs or bribing influential politicians monopolies can be created. This leaves no space for competition and thus no opportunities for new businesses and economic activity. Countries with lower trade and government restrictions seem to be less corrupt.

Government expenditure

Another major consequence is poor government expenditure. The availability for government subsidies creates the opportunity for robbery. This means that the subsidies will be available to industries and firms for which they are not intended. The

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United Nations World Development Report 1997

Sofiia Gavryliuk/ ID 100137763 BUS211

study shows that the higher the availability of subsidies is- the higher the corruption rate.13 50% loss in health funds- this is the estimated percentage of allocated funds that do not reach clinics and hospitals in Ghana.- 2006 Global Corruption Report.

Tax evasion

Tax evasion is considered one of the biggest issues concerning corrupted countries. One argues that high tax rates are considered to be one of the main obstacles for the creation of the new business; therefore industries are strongly inclined to avoid taxes. This is also linked to the previous point- subsidies availability- when enterprises choose to hide incomes and reduce the tax virtually in order to get the implied subsidies. One of the recent cases of tax evasion in Russia is the case against Sergei Magnitsky 14, who is under suspicion of helping Hermitage Capital evade 17.4 million of dollars in taxes.15 Tax evasion is hard to identify and quantify, therefore it is hard to identify the full effect that it has on the economy, its development and growth, but without any doubt it is a huge loss in tax revenue.

Foreign Direct Investment

The relationship between corruption and foreign direct investment is negative. The study carried out by Wei (1997)16 suggests that corruption discourages foreign direct investment. The example he uses- are Asian countries, which make flexible tax rates for foreign invested forms, for instance China offers two years of tax holiday and
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Toshihiko SHIOHARA (2001) Russia: Tax Evasion Case Against Sergei Magnitskiy (2012) 15 Russia Plans to Retry Dead Lawyer in Tax Case- the New York Times 16 Wei, Shang-Jin, 1997, "How Taxing is Corruption on International Investors?"

three subsequent years of half a normal rate. Wei (1998)17 argues that those countries would attract same or even more foreign investment by just taking local corruption under control.

Giving an example of few of the many corrupt activities it is easier to see that the full affect to the countries economic development simply cannot be illustrated. But it is certain that corruption reduces growth by decreasing tax revenue, misusing government expenditure, minimizing the quality and quantity of public infrastructures and services as well as engaging the population into rent seeking rather then beneficial and productive for the economy activities. Moreover it automatically triggers the problem of inequality and poverty, making it even harder for the population to get a proper educated and to be employed, which in turn reduced the employment and literacy rates.

To summarize the point it is important to consider the main factors that contribute to economic growth. These factors are mainly focused around the GDP18. First factor is the growth of the labour force. With an increase in the employment rate- the output of goods and services increases, this contributes to the GDP growth. This factor is limited by monopolies and bribed trade restrictions. Second one is the growth of the national stock capita- this is limited by tax evasion and bad government expenditure.

The cost of corruption in Africa- is estimated at more than 148 billion of US dollars a year. This is thought to represent 25% of

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Wei, Shang-Jin, 1998, Foreign, Quasi-foreign, and False-foreign Direct Investment in China, 18 Gross Domestic Product

Sofiia Gavryliuk/ ID 100137763 BUS211

Africas GDP and to increase the cost of goods by as much as 20 percent.19

Another factor is the rate of growth of productivity of labour and capital, which is achieved by making markets more competitive. As discussed before- corruption damaged the competitiveness severely. Technological improvement is an important component too- they reduce the read cost of supplying goods. New technology requires investment, which in corrupter countries is often not available.20

Corruption- good

On the other hand, some may argue that corruption is a good thing when it comes to development. One of the biggest works on this subject is Leff (1964), when he argues that corruption may have beneficial effects in developing countries suffering from oppressive state intervention21. This means that by allowing businesses to disobey some laws and rules, it would create bigger growth and productivity. Moreover it can provide the growth by allowing trades that would not happen otherwise and thus is beneficial to the economic efficiency. The term speed money is used to describe a speed up of bureaucratic procedures. However, Myrdal (1968) argued that by creating the possibility of bribery, the incentive to make more restrictions and rules is created. This is due to the fact that government officials would seek more opportunities for more bribed. Besides, Leff was highly interested in the African region and was mainly

19 20

Bunt E., Corruption cost Africa billions, BBC news the assumptions about the economic factors are taken from the AS Macroeconomics on tutor2u.net 21 Leff N. (1964)

basing his theory on it; low rate of the economic development can still be seen in Africa.

Measuring corruption

As mentioned before it is very hard to measure the corruption level. This is due to the fact that the very nature of it is secret. But how does one recognize and collect the anecdotal evidence so that it could be linked to theoretical ideas and projects put into life. Survey is one way to collect statistics about corruption level, which different organizations carry out. Among those only several include a wide range of countries, for instance a Business International (BI) Index or a Global Competitiveness Report (GCR) Index. One of such is Transparency International Index (TI), which is produced each year. It puts countries in 1 to 10 scale according to the level of corruption22. Approximately ten surveys are carried out and then summaries, giving the average figure.23 Even though this Index is believed to be on the most accurate ones- it still has its disadvantages. One of the examples would be the usage of different surveys in different areas of the country-, which would produce an error when trying to have an average for the whole country.

Conclusion

While an individual may consider the opportunity to pay a bribe- as a benefit, the analysis shows that the overall effect of corruption on economic development is
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1 is the highest level of corruption while 10 is the lowest Transparency International UK, http://www.transparency.org.uk/

Sofiia Gavryliuk/ ID 100137763 BUS211

damaging. There are many reasons why corruption slows the growth of an economy: misuse of government expenditure, reduced domestic investment, reduced foreign direct investment, higher unemployment rate, because of the lack of business opportunities, worse public infrastructure.

Even though it is hard to identify and quantify corruption, the fight against it is very live. The fight should be multi-fronted; the role of the government in the economy should be reformed, along with the discretionary power that government officials hold. But the most important part of the fight is to change an individual- the change should start within every single one of us, not waiting for anyone else to do it first.

Reference:
Anonymous, (1997), Helping Countries Combat Corruption: The Role of the World Bank, The World Bank Anonymous, (2011), The Current Corruption Perceptions Index, Transparency International, available at: http://www.transparency.org/policy_research/surveys_indices/cpi Anonymous, (1997), United Nations World Development Report, Oxford University Press Andvig, J. C., and Moene, K. O. (1990), How Corruption May Corrupt, Journal of Economic Behaviour and Organization, 13(1), 6376. Bardhan, P. (1997), Corruption and Development: A Review of Issues, Journal of Economic Literature 35, pp. 1320-46. Blunt E., (2002), Corruption costs Africa billions, BBC News, available at: http://news.bbc.co.uk/1/hi/world/africa/2265387.stm Busse, Eva, The Embeddedness of Tax Evasion in Russia, Economic Crime in Russia, Kluwer Law International, pp. 129-143, 2000 Friedman, E., Johnson S., Kaufmann D., and Zoido-Lobaton P. (2000), Dodging the Grabbing Hand: The Determinants of Unofficial Activity in 69 Countries, Journal of Public Economics 76, 459-493. Kramer Andrew E., (2012), Russia Plans to Retry Dead Lawyer in Tax Case, The New York Times, available at: http://www.nytimes.com/2012/02/08/world/europe/russia-toretry-sergei-magnitsky-posthumously.html Leff, N. (1964), Economic Development through Bureaucratic Corruption, American Behavioral Scientist 8, no.3 Lidelow M., Kushnarova I., Kraiser K., (2006), Measuring corruption in health sector: what we can learn from public expenditure tracking and service delivery surveys in developing countries., Transparency International, Global Corruption Report, p. 30 Mauro, P. (1995), Corruption and Growth. Quarterly Journal of Economics, 109, 681-712. Rose-Ackerman S. (1999), Corruption and Government, Causes, Consequences and Reform, Cambridge, Cambridge University Press, available at: http://books.google.co.uk/books/about/Corruption_and_government.html?id=XBA1cZl B5AoC Shleifer A., Vishny R. W., (1993), Corruption, Quarterly Journal of Economics, 108, 599 618. Shleifer A., Vishny R.W., (1998), The Grabbing Hand, Government Pathologies and Their Cures, Harvard University Press Toshihiko SHIOHARA, (2001), Various Problems concerning Corporations, available at: http://www.esri.go.jp/en/tie/russia/russia8-e.pdf Transparency International UK, http://www.transparency.org.uk/

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Sofiia Gavryliuk/ ID 100137763 BUS211 Wei, Shang-Jin, 1997a, "How Taxing is Corruption on International Investors?" The National Bureau of Economic Research Working Paper 6030 Wei, Shang-Jin, 1998, Foreign, Quasi-foreign, and False-foreign Direct Investment in China, Paper prepared for the Ninth East Asian Seminars on Economics, organized by Takatoshi Ito and Anne O. Krueger, in Osaka, Japan, June 25-28. Wolfensohn James D., the President of the World Bank, (1996), Annual Meetings Address, available at: http://web.worldbank.org/WBSITE/EXTERNAL/EXTABOUTUS/ORGANIZATION/ EXTPRESIDENT2007/EXTPASTPRESIDENTS/PRESIDENTEXTERNAL/0,,content MDK:20025269~menuPK:232083~pagePK:159837~piPK:159808~theSitePK:227585, 00.html !"#$%&$, '., (#)&*+ $ ,#--.. $#/*#0&1 2&/3.-"#$45 '(")"*+(+, No. 11, p. 134-152, 2000 +6#7 #8 19%#:#$, !"#$"%&

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