Does corruption hurt employment growth of financially constrained firms more than firms that are not financially constrained?

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Businessman giving bribe money in the envelope to partner in a corruption scam
Businessman giving bribe money in the envelope to partner in a corruption scam. Atstock Productions / Shutterstock.com

Limited access to finance has been one of the biggest problems faced by private firms in developing countries. The problem is likely to be even more severe in the coming years because of economic shocks created by the COVID-19 pandemic. The pandemic has exacerbated liquidity problems as corporate revenues have plummeted, cash flows have dwindled, working capital is depleted, and banks shy away from lending money to private firms (see Button et al. 2020Bircan et al. 2020, and Acharya and Steffen 2020). The impact of access to finance on the performance of private firms is well studied in the literature. Yet, important gaps remain. One such shortfall relates to the interplay between finance and other aspects of the business environment. Does poor access to finance magnify the problems imposed by a weak business environment? Alternatively, does better access to finance help firms overcome weaknesses in the business environment?

In this context, one of the most obvious business environment impediments is corruption. It is no secret that corruption imposes significant monetary costs on private firms. These costs include both the direct transfer of money (the need to pay bribes) and the indirect costs incurred through resources devoted to rent-seeking activities. For instance, firm-level survey data for several mostly developing countries (Enterprise Surveys) shows that bribes paid to public officials to “get things done” average over 2 percent of the annual sales of firms in those countries.

While the impact of such costs on firm performance has been analyzed in several papers, little thought has been given to its financial implications. Arranging money for bribe payment can be especially burdensome for firms that have limited internal funds or find it difficult to borrow externally. What this means is that the negative effect of corruption highlighted by the “sands the wheels” view of corruption that maintains that it impedes business is likely be larger (more negative) for firms that have poor access to finance and smaller (less onerous) for firms that have easy access to finance. The logic extends to the alternative “greases the wheels” view of corruption that posits that corruption can help speed things up in an otherwise slow bureaucracy. That is, greasing the wheels requires upfront payment of a bribe, which may be easy for firms that have good access to finance but difficult or more costly for firms that have poor access to funds.

This simple idea that access to finance can determine how much corruption impacts firms has not been discussed much in the literature. In fact, there is only a limited discussion of factors that magnify or mitigate the effects of corruption. The literature is almost exclusively focused on the overall effects of corruption, resulting in the two contrasting views discussed above - “sands the wheels” and “greases the wheels”.  

Theories apart, do firms that have poorer access to finance suffer more from corruption in terms of productivity, growth, job creation, etc.? What does the data say? In our recent study, Amin and Soh (2020), we attempt to answer this question. We use firm-level survey data for 135 mostly developing countries collected by the World Bank’s Enterprise Surveys between 2006 and 2018. The study estimates the impact of corruption on job creation by the firm over the last three years, and more importantly, how this impact varies as the financial constraints experienced by the firm become more severe. Exploiting the richness of the data, we use an overall measure of corruption, which is the amount firms pay to public officials to “get things done”, as well as measures of petty corruption that arises in accessing specific public services such as obtaining permits and licenses, electricity connections, etc.

As expected, we find that a firm’s financial condition determines quite significantly how corruption impacts it. Corruption has a much larger negative impact on employment growth for firms that are financially constrained compared to firms that are not financially constrained. In the baseline model, we find that a one standard deviation increase in the bribery rate brings about a decline in the annual growth rate of employment of financially constrained firms by 2.3% more than non-financially constrained firms. This is a large difference given that the mean employment growth is about 5.1%. Figure 1 illustrates the point graphically for the overall corruption measure. Similar results are found for petty corruption as well.

Figure 1: Impact of an increase in overall corruption on employment growth for firms that face low vs. high levels of financial constraints

Impact of an increase in overall corruption on employment growth for firms that face low vs. high levels of financial constraints

Source: Enterprise Surveys, World Bank.
Notes: The figure is a partial scatter plot of the residuals of growth rate of employment plotted against residuals of overall corruption and residuals of financial constraints variable.

The findings also have important implications for the overall impact of corruption. When firms face more than a critical level of financial constraints, corruption is associated with a significantly lower employment growth rate. In contrast, when firms face less than a critical level of financial constraints, corruption is associated with a significantly higher level of employment growth rate. Thus, depending on firms’ financial constraints, corruption “sands the wheels” for some firms and at the same time “greases the wheels” for others. This is sharp contrast to the existing view that corruption is of either the “sands the wheels” type (slows business) or the “grease the wheels” type (accelerates business) for everyone in the country.

Of course, several interesting issues remain to be explored. First, it is important to check if these results extend to other aspects of firm performance such as productivity, innovation, exports, etc. Second, there may be factors other than corruption whose effect may be mediated through access to finance.  This suggests a rich and fruitful line of future research. Third, it will be interesting to check if financial constraints play a similar role for corruption faced by individuals and households. Understanding these issues is especially important now as countries around the globe face economic contraction. Better policies with maximal impacts are more important now than before given the hardships imposed by the pandemic and the resource crunch that policymakers are facing across the globe.  We hope that our study helps motivate future research in the area.

Authors

Yew Chong Soh

Economist, World Bank Group

Mohammad Amin

Private Sector Development Specialist

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