Part two of Raj Nallari's note on corruption.
Costs and Benefits of Corruption. There is no evidence that corruption has any positive benefits. The argument that ‘speed money’ or ‘grease the wheels’ or ‘grist that helps grind’ is ultimately beneficial by cutting down red-tape and bureaucratic inefficiency has no empirical basis. It only creates opportunities at every level of bureaucracy and even honest officials are tempted to increase red-tapism by spreading and slowing down the processing of requests as the honest officials do not want to be responsible for any decision that they might regret in the future. If corruption was beneficial to society, one would have legalized such corrupt practices!
How does one explain the high level of corruption in a large number of countries despite repressive laws to control it? Everyone now accepts that some level of corruption is inevitable in every mix of market and government. Politicians and bureaucrats have vested interest in increasing and over-extending themselves into market place to maximize corruption. Therefore, a minimalist state would be helpful in curbing corruption and corrupt practices.
There appears, however, to be a trade-off between government corruption and market failures. Governments intervene with the best of intentions in the case of ‘market failures’ and use subsidies and transfers as mechanisms to divert resources from gainers of market failures to losers or vulnerable groups. This creates corruption opportunities but corruption undermines the very purpose of government intervention. Government intervention requires bureacrats (agents) to collection information, make decisions and implement policies and programs. This situation gives rise for self-interest of bureaucrats to kick-in by virtue of their information gathering duties and makes it hard to monitor their action properly. In addition, if the government is keen to control corruption, it will hire officials to prevent corruption. As such, there is a misallocation of talented individuals away from productive activity towards corruption control. All this means that corruption in the form of rents for bureaucrats induces a misallocation of resources and rapidly expands the size of the bureaucracy. Corruption is difficult to eliminate completely, which means that we are living in a ‘second best’ world, in which some bureaucrats will always be taking bribes.
Causes of Corruption. First, the motivation to earn higher income is extremely strong, compounded by poverty and by low and declining civil service salaries. Second, opportunities to engage in corruption are numerous. Given the government intervention in several aspects of economic life, rent-seeking and the discretion of many public officials is broad in developing countries. Third, accountability is typically weak, political competition and civil liberties are restricted, laws and penalties are poorly developed and enforced.
Low wages of government employees is often cited as a major inducement for corrupt behavior in the government. First, when low paid employees meet wealthier private sector clients, the wide difference in living standards between the two groups provides an inducement for corruption so as to climb the social ladder (catch up with Jones’). Second, high wages if paid to the government employees effectively work as fines for bribe-taking and act as ‘efficiency wage’ that could deter corrupt behavior. However, in a country, where corruption is harder to eliminate, there may be higher public sector wages and more bureaucracy (and high corruption) all at the same time. Another cause not related to wages, is whether governments intervene to redress market failures or for furthering their own careers and wealth.
The causes can be quite complex, including rational but inconsistent human behavior (as proclaimed by behavioral economists). For example, if by paying a bribe, I can avoid non-compliance with pollution regulations or tax payments, I will be tempted to try this approach. Similarly, if I am an honest firm and the inspector is trying to extort a bribe, I will be equally tempted to evade paying taxes. Also, there may be several layers in government and collusion between supervisor and inspector combined with an inept judiciary will leave the citizen with little choice but to pay bribes.
What is the optimal wage and commission rate to prevent bribery and ensure higher monitoring and truthfully reporting (say of pollution levels or tax evasion)? When greed exceeds penalty for taking bribes or compensation for truthful reporting, what is the outcome? Only large penalty for bribery tends to contain corruption because providing commission or incentives can induce truthful reporting or can lead to over-reporting by the corruption inspection about the firms’ pollution level (leading to extortion). Rijckingham and Weder (1997) find that in a study of 28 countries when wages were higher then in the manufacturing sector, there was a lower level of corruption. Other studies did not find a strong support for this negative relationship between relative wages and corruption.
There is some evidence that countries dependent upon extraction of natural resources have higher economic rents which is a breeding ground for higher corruption. Similarly, highly-aided countries (higher per capita aid flows) generate rents and lead to corruption. While one study has found that higher educational spending does not coincide with higher corruption, other studies indicate that social sectors and infrastructure sector (compared with agriculture, industry, services sectors) are prone to higher corruption because these are largely financed by aid and involve ‘brick and mortar’ activities.
Corruption varies across countries as well as within countries. In a study of 8 countries to explain the pattern of corruption across public agencies using micro-data, Recantini et al (2005) found that (i) the internal design of the organization is systematically associated with perceptions of corruption, both by agency insiders and by its customers; (ii) corruption is lower when internal decisions on budget, procurement and personnel are regularly audited, and when these same decisions are taken with open and transparent procedures. Corruption in personnel is also lower when such decisions are based on merit and clearly stated professional criteria.
Decentralization. Different organizational structures create different opportunities for corruption. While a centralized state may reward the bribe-paying rich in the country, a decentralized system could also be favoring the local rich people. Decentralization may not necessarily reduce corruption because capture of state by local elites is an obvious possibility. However, in a randomized experiment in India, Duflo et al find little state capture by powerful elites in villages and that inclusion of minorities in decision making increases the likelihood of ensuring minimum redistribution to disadvantaged groups.
Moreover, at all levels of organization it is easier to lobby for a particular design of law or policy because then there is no need for paying bribes regularly to avoid rules and regulations. Prevention is better than cure and offense is the best defense. So corruption at upstream design stage may be more effective for the giver then at the enforcement stage. Further, in several countries you now find that rather than even engage in paying lobbyists and bribes to corrupt officials, rich individuals and elites themselves run for political offices and influence policy design and enforcement (e.g. Italy’s Berlusconi)
Constitutional Design. Monarchies and oligarchic republics have more corruption compared with mature democracies. Countries with long periods of democratization are perceived to have less corruption. However, East Asian countries has achieved higher GDP growth rates with economically viable levels of corruption. So the direction of causation between democracy and corruption is ambiguous because higher corruption can destabilize democracy but more mature democracies have lower corruption!
Economic and Political Competition. Increases in competitiveness within an economy means that many firms are competing in the same market, which means lower profit rates and lower corruption (especially in pollution or other areas of market failure). However, firms could be operating in the product market while corruption could be happening in other markets of the economy. Competition among firms and relation to corruption is therefore not straight forward. For example, high-cost and low-profit firms having to pay bribes may exit the market, thereby reducing competition and leading to higher profit margins for the remaining firms. It is also possible that low-profit firms are willing to pay lower bribes to inspectors, who are willing to accept varying rates of bribes. Ande and di Tella (1999) find evidence of a negative relationship between competitiveness of firms and corruption perception index. When firms enjoy higher rents, bureaucrats will have greater incentive to engage in corruption. But one finds that in most countries, despite deregulation and price liberalization during the 1980s and 1990s under the adjustment programs countries have observed an increase in corruption. It is possible for greater competition to coexist with higher corruption.
The degree of political competition also matters. For example, proportional representative elections with lower weight for individual accountability are associated with higher corruption.