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Corruption: Causes and its consequences for the economy

Muhammad Abdul Mazid | Published: February 15, 2019 21:30:50


Corruption has been around the globe for a very long time and it will be around in the future unless governments and organisations can figure out effec-tive ways to combat it.

Although studying the causes and consequences of corruption has a long his-tory, going back 50 years to seminal contributions on what economists call rent seeking, related empirical work on quantifying the extent of corruption and its economic effects has been limited. This is hardly surprising since most corruption is clandestine. As a consequence, corruption is notoriously hard to measure and empirical economic research on the subject is meagre.

The statements made at the multinational financial institutions' 1996 Annual Meetings by the Managing Director of the International Monetary Fund that governments must demonstrate their intolerance to corruption in all its forms and by the then-President of the World Bank who had said that the "cancer of corruption" must be prevented if not cured completely, were widely publicised.

Since much public corruption can be traced to government intervention in the economy, policies aimed at liberalisation, stabilisation, deregulation, and privatisation can sharply reduce the opportunities for rent-seeking behaviour and corruption. Where government regulations are pervasive, and government officials have discretion in applying them, individuals are often willing to offer bribes to officials to circumvent the rules and, sadly, officials are occasionally tempted to accept these bribes. Identifying such policy-related sources of corruption is obviously helpful in bringing it under control. The following sources have for some time been well known.

Trade restrictions are the prime example of a government induced source of rents. If importing a certain good is subject to quantitative restriction (for example, only so many foreign automobiles can be imported each year), the necessary import licences become very valuable and most importers will consider bribing the officials who control their issue. More generally, protecting a home industry (such as plywood manufacturing) from foreign competition through tariffs creates a semi-monopoly for the local industry. Local manufacturers will lobby for the establishment and maintenance of these tariffs and some may be willing to bribe influential politicians to keep the monopoly going. Studies have shown that a very open economy is significantly associated with lower corruption. In other words, countries tend to be less corrupt when their trade is relatively free of government restrictions that corrupt officials can abuse.

Government subsidies, social safety net transfers can constitute a source of rents. Studies show corruption can thrive under industrial policies that allow poorly targeted subsidies to be appropriated by firms for which they are not intended. The more such subsidies are available to industries and to local leaderships to handle or distribute, the higher is the corruption index.

Price controls, whose purpose is to lower the price of some goods below its market value (usually for social or political reasons), are also a source of rents and of ensuing rent-seeking behaviour. Price controls create incentives for individuals or groups to bribe officials to maintain the flow of such goods or to acquire an unfair share at below-market price.

Multiple exchange rate practices and foreign exchange allocation schemes lead to rent-seeking behaviours as well. Some countries have several exchange rates. For example, there may be one rate for importers, one for tourists and one for investors. Differentials among these rates can lead to attempts to obtain the most advantageous rate, although this rate might not apply to the intended use of the exchange. Multiple exchange rate or even interest rates systems are often associated with anti-competitive banking systems in which key banks can make huge profits by arbitraging between markets. Some countries have little foreign currency and distribute what they have through various schemes with varying degrees of transparency. If, for example, state-owned commercial banks ration scarce foreign currency by allocating it according to priorities established by government officials, interested parties may be willing to bribe these officials to obtain more than their fair share.

Low wages in the civil services sector relative to wages in the private sector are a source of corruption too. When civil service salaries are too low, civil servants may be obliged to use their positions to collect bribes as a way of making ends meet.

There are other reasons behind corruption as well.

Natural resource endowments (oil, gold, gasoline even exotic lumber) constitute a textbook example of a source of rents. These can typically be sold at a price that far exceeds their cost of extraction and their sale is usually subject to stringent government regulations to which corrupt officials can turn a blind eye. Resource-rich economies may more likely be subject to extreme rent-seeking behaviour than resource-poor countries.

Sociological factors may contribute to rent-seeking behaviour. An index of ethno-linguistic fractionalisation (social divisions along ethnic and linguistic lines) has been found to be correlated with corruption. Also, public officials are more likely to do favours for their relatives in societies where family ties are strong.

There is evidence that corruption slows economic growth through a wide range of channels. In a corruption-prone society, businessmen are often made aware that an up-front bribe is required before an enterprise can be started. Businessmen, therefore, interpret corruption as a form of tax -- though of a particularly pernicious nature -- given the need for secrecy and the uncertainty involved. This diminishes their incentive to invest. Empirical evidence suggests that corruption lowers investment and retards economic growth to a significant extent.

Where rent seeking proves more lucrative than productive work, talent will be misallocated. Financial incentives may lure the more talented and better educated to engage in rent seeking rather than in productive works, with adverse consequences for the country's growth rate.

Of particular relevance to developing countries is the possibility that corruption might reduce the effectiveness of aid flows through diversion of funds. Aid, being fungible, may ultimately help support unproductive and wasteful government expenditures. Perhaps as a result, many donor countries have focused on issues of good governance, and in cases where governance is judged to be especially poor, some donors have scaled back their assistance.

When it takes the form of tax evasion or claiming improper tax exemptions, corruption may bring about loss of tax revenue. By reducing tax collection or raising the level of public expenditure, corruption may lead to adverse budgetary consequences. It may also cause monetary problems if it takes the form of improper lending by public financial institutions at below-market interest rates.

The allocation of public procurement contracts through a corrupt system may lead to lower quality of infrastructure and public services. Corruption may distort the composition of government expenditure. Corruption may tempt decision-making politicians and government officials to choose government expenditures less on the basis of public welfare than on the opportunity they provide for extorting bribes. Large projects whose exact value is difficult to monitor may present lucrative opportunities for corruption.

Dr Muhammad Abdul Mazid is former secretary to the government and former chairman NBR.

mazid.muhammad@gmail.com

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