Corruption in Developing Countries

1. Corruption in Developing Countries Bernard Gauthier HEC Montréal March 2011 Part 1

3. 1. Introduction Problems of corruption and bad governance are widespread, worldwide and over time. In developing countries, there are notorious cases: Ex: Indonesia: Suharto 1960-2000, Zaire/Congo: Mobutu 1960s-2000s, Nigeria: 1960s-2000s; Sierra Leone, Taylor In industrialized countries also: Ex: Enron, Madoff, Financial crisis; Société Générale; Irak war, Haliburton… Problems are linked to inadequate institutional arrangements (formal and informal), in particular structures of supervision, information asymmetry, collusion, etc.

4. Introduction Despite their importance, issues of corruption have essentially been ignored by aid organizations for most of their first 50 years of existence, while governance was viewed very narrowly as part of traditional public finance management reforms. The 1990s has marked an evolution. One of the first official recognition happened in 1996 in a speech by the World Bank president James Wolfensohn at the Annual meeting of the Bank and IMF, in which he condemned the “cancer of corruption”

5. Introduction Since then and especially in the last few years, issues of governance and corruption have taken the center stage in development. Development analysts, donor agencies, governments have recognized that development and poverty reduction strategies are greatly constrained by poor governance and corruption It has been recognized also that aid effectiveness is greatly hampered by poor governance and corruption

6. Introduction Governance and corruption are important for two main reasons: 1. Development outcomes Most analysts recognize that good governance and low corruption are fundamental factor for economic development 2. Effectiveness of foreign aid Good governance and institutions are fundamental for the success of bilateral and multilateral donors project and the quality and effectiveness of foreign aid.

7. Introduction In context of new aid approach (Rome agreement, Paris declaration, etc) emphasizing country autonomy and direct budget support, measurement and accountability should be at the forefront International and regional efforts to improve governance and combat corruption have intensified in the last decade.

8. Introduction There are increasing number of aid agencies involved in governance work and countries ratifying anti-corruption international conventions. We have also observed the development of anti-corruption international networks – such as Transparency International or U4 – which are evidence that the interest for good governance and fight against corruption has increased. The development of macro and micro data on corruption during the last decade or so, has helped identify and emphasize the extent of the problem.

9. Introduction These issues are indeed at the forefront of the debate about development policies. For instance, Obama in 2009 speech in Ghana at the occasion of his only travel to African soil. Obama emphasized good governance and anti-corruption at the forefront of US development assistance strategy:

10. Introduction “What we will do is increase assistance for responsible individuals and responsible institutions, with a focus on supporting good governance - on parliaments, which check abuses of power and ensure that opposition voices are heard , on the rule of law, which ensures the equal administration of justice; on civic participation, so that young people get involved; and on concrete solutions to corruption like forensic accounting and automating services, strengthening hotlines, protecting whistle-blowers to advance transparency and accountability. And we provide this support. I have directed my administration to give greater attention to corruption in our human rights reports. People everywhere should have the right to start a business or get an education without paying a bribe. We have a responsibility to support those who act responsibly and to isolate those who don't, and that is exactly what America will do.” Barack Obama, Ghana, July 11 2009; http://www.cbsnews.com/stories/2009/07/11/politics/main5152235.shtml

11. Introduction Despite these efforts and emphasis, still, worldwide, overall progress are slow In many countries, little progresses have been made with regard to governance Corruption has even worsened in some countries In Africa, no significant changes over last decade

12. Absence of trend in the evolution of corruption in Africa (WBGI)

13. 2. Definitions of Governance and Corruption How would you define governance and Corruption ? What are the difference between the concepts? In economics, political science and public administration, governance is a terms that is used often in different ways, still relatively ill defined. A current general definition: “the process of decision making and the process by which decision making are implemented” (UNESCAP, 2008) In economics, political science and public administration, governance is a terms that is used often in different ways, still relatively ill defined. A current general definition: “the process of decision making and the process by which decision making are implemented” (UNESCAP, 2008)

14. Definitions Public governance: refers to the environment of decision making at the political and economic level, the formal and informal rules and traditions. The organisation of the State and the interaction between the State and individuals/citizens, the structures and process that allows the functioning of society and management of public goods.

15. Definitions Corruption, on the other hand, is an outcome of poor governance. But it also contributes to weak governance by the endogenous nature of institutions Institutions, policies and regulations will be chosen to facilitate corruption activities.

16. Definitions There exists different definitions of corruption Legal approach The legal approach to defining corruption is based on the “personal criminal liability” principle, which is the legal obligation arising out of wrongs against a government or society in general. As a result, criminal law must provide precise definitions of corruption offences, so that individuals are aware of and able to foresee prohibited acts. However, worldwide and regional efforts to combat corruption are hampered by a variety of legal definitions for corruption-related offences, due to numerous and diverse legal traditions and social norms.

17. Definitions Economics approach One socio-economic definition of corruption states that corruption is: “The intentional non-compliance with the arm’s-length principle aimed at deriving some advantage for oneself or for related individuals from this behaviour” (Tanzi, 1998) Underlines 3 necessary conditions for corruption. First refers to the arm’s length principle, which states that personal or other relationships should play no part in the economic decisions involving more than one party (i.e. any bias towards particular economic agents would violate this principle). The second condition requires that this bias must be intentional. The third condition implies that there must be some advantages for all parties in violating intentionally the arm’s length principle.

18. Definitions Another set of definitions focuses on the public side of corruption. The World Bank’s definition of corruption is the most commonly used and cited, and defines corruption as, “The abuse of public office for private gain”, or - "the sale by government officials of government property for personal gain". Transparency International’s definition is more general: “the misuse of entrusted power for private gain” Langseth (1997) mentions: « the deviation of rules for personal ends »

19. Definitions It is an outcome of poor governance but could also contribute to design of inadequate rules Corruption can take different shapes: bribery Extorsion Fraud Traffic Money laundering nepotism patronage etc. Corrupt acts do not always imply monetary transactions. They also include influence peddling, gifts to obtain contracts, etc. “Public office is abused when an official accepts, solicits, or extorts a bribe and when private agents give or offer bribes to circumvent public policies and processes for competitive advantage and profit. It is also abused through patronage and nepotism, the theft of state assets, or the diversion of state revenues.” WB (2007) “Public office is abused when an official accepts, solicits, or extorts a bribe and when private agents give or offer bribes to circumvent public policies and processes for competitive advantage and profit. It is also abused through patronage and nepotism, the theft of state assets, or the diversion of state revenues.” WB (2007)

20. Forms of Corruption

21. Definitions Bribery. The legal definition of bribery considers is “the practice by which a person who can take decision or action on behalf of others by virtue of his authority or position is influenced by paying or offering monetary benefits for influencing him to take an action or decision which he would not have done otherwise” (EC, 2010) For instance, a custom official may accept bribes to ignore or reduce import duties or to allow prohibited good crossing national borders (e.g. smuggling, forgery, weapon traffic). Source EC 2010, see: www.legal-explanations.com/.../bribery.htm Source EC 2010, see: www.legal-explanations.com/.../bribery.htm

22. Definitions Fraud. Fraud points to “any behaviour designed to trick or fool another person or entity for one’s own or a third party’s benefit”[1]. Ex: a healthy individual can offer money to the public health department doctor to obtain a false medical report, and hence to escape his professional duties. Ex: intimidations or ballot box stuffing during local or national elections  [1] UNODCCP, “Anti-Corruption Tool Kit”, Version 3, revised, pp. 249-307, January 2002. Available at http://www.unodc.org/documents/corruption/publications_toolkit_sep04.pdf [1] UNODCCP, “Anti-Corruption Tool Kit”, Version 3, revised, pp. 249-307, January 2002. Available at http://www.unodc.org/documents/corruption/publications_toolkit_sep04.pdf

23. Definitions Embezzlement. The United Nations defines it as the “theft of resources by a person entrusted with authority and control over anything of value”[1]. This form of corruption can involve public officials, as well as private individuals/companies. For instance, it occurs when a public enterprise director employs company workers to build his own house; or when officials in charge of distributing food to a local village steal a portion of the food and sell it to other parties. In certain cases, embezzlement involves huge amounts of money, feeding networks of corrupt politicians and high-level officials [1] UNODCCP, “Anti-Corruption Tool Kit”, Version 3, revised, pp. 249-307, January 2002. Français: Détournement de fonds[1] UNODCCP, “Anti-Corruption Tool Kit”, Version 3, revised, pp. 249-307, January 2002. Français: Détournement de fonds

24. Definitions Creation or exploitation of conflicting interests. According to the OECD: “A ‘conflict of interest involves a conflict between the public duty and private interests of a public official, in which the public official has private […] interests which could improperly influence the performance of their official duties and responsibilities”[1]. For instance, a public official’s membership of a club, group or association could be the source of interests that might conflict with his public duties. . [1] The OECD, “OCED guideline for managing conflict of interest in the public service”, September 2005 [1] The OECD, “OCED guideline for managing conflict of interest in the public service”, September 2005

25. Definitions Favouritism, nepotism and cronyism. U4 defines favouritism as “the normal human inclination to prefer acquaintances, friends and family over strangers. […] [Corruption occurs] when public (and private sector) officials demonstrate favouritism to unfairly distribute positions and resources”. Nepotism refers to the case where a public official offers an unfair favour to a family member, while cronyism refers to the favourable treatment of friends. Illegal political party financing. Illegal contributions occur when political parties or a government receive bribes in exchange for non-interference with the affairs of the group or entity making the contribution. Illegal political contributions usually feed grand corruption and are channelled through large networks of corrupt politicians and high-level officials.

26. Definitions Extortion. Extortion refers to any person/company/institution forcing another party “to pay money or other valuables in exchange of acting or failing to act”[1]. For instance, a tax officer can threaten a citizen to over-report his level of income to force him to pay a bribe. Abuse of discretion. Abuse of discretion occurs when someone uses is “vested authority to give undue preferential treatment to any group or individuals, or to discriminate against any group or individuals for personal gain”[2]. For instance, an elected public official in charge of public service delivery (e.g. health, water, etc.) may prefer to delivering a service in areas where their constituents reside, and neglecting other areas. [1] Ibid [2] UNODCCP, “Anti-Corruption Tool Kit”, Version 3, revised, pp. 249-307, January 2002

27. Definitions Corruption affects both the public and private sectors. Private corruption can be interpreted as collusion or as an agent unduly imposing costs upon customers and investors for private gain, in the private sector. (Svensson, 2005). Ex : A firm remunerates (monetarily or not) the another firm’s procurement manager to increase its sales. The procurement manager uses his power to obtain a private gain (Argandona, 2003).

28. Definitions Public corruption refers to the abuse of a public position for private gain (Rose-Ackerman 2004). It refers to a situation where a bureaucrat captures public resources for private gain (ex. : bribes, fund diversion, influence peddling). « …activities in which public officials, bureaucrats, legislators and politicians use power delegated to them to further their own economic interests at the expense of the common good.” (Jain, 2001, p. 73)

29. 3. Forms of corruption  We can distinguish different forms of corruption. Shah (2006) for instance identify 4 categories: Administrative (“petty”) corruption Grand corruption (foreign vs. domestic origin) Executive and legislative (“state”) capture Patronage/paternalism/clientelism

30. 3. Forms of corruption  Administrative (“petty”)corruption Petty corruption” refers to routine, uncoordinated corrupt transactions e.g. police demanding bribes in exchange for non-enforcement of traffic (or pseudo) violations bureaucrats demanding “speed money” for processing files tax collectors “negotiating” for lower tax liability in exchange of bribes various forms of kickbacks, diverting public funds, or awarding favors in return for personal considerations Individual transactions are small, but petty corruption is significant in the aggregate.

31. 3. Forms of corruption  Grand corruption Involves theft or misuse of vast amounts of public resources by a relatively limited group of state officials typically associated with the political/administrative elite. Kickbacks in major public procurement deals and siphoning of foreign exchange into private offshore bank accounts are examples (World Bank 2004, p. 36)

32. 3. Forms of corruption  Executive and legislative (“state”) capture “Collusion by private actors with public officials or politicians for their mutual, private benefit is referred to influence the elaboration of rules and regulations is referred to as “state capture”) to as state capture” (Hellman et al., 2000). That is, the private sector “captures” the state legislative, executive, and judicial apparatus for its own purposes.

33. 3. Forms of corruption  Patronage/paternalism/clientelism “Using official position to provide assistance to friends, family members or clients (e.g. same geographic, ethnic or cultural origin) for them to receive preferential treatment in their dealings with the public sector (including public sector employment)”.

34. 4. Causes of Corruption  At its core, corruption is associated with situations where an agent abuses his professional responsibilities to obtain an illicit private benefit. Corruption is therefore related to agency problems. Taking advantage of asymetric information, an agent abuses of delegated responsibility to extract an illicit rent. Corruption models are based on the principal-agent model, where bureaucrats (agents) use the powers bestowed upon them by the population (principal) to extract private benefits from the sale of public goods or services (e.g. licences, public contracts) (Becker and Stigler, 1974; Rose-Ackerman 1975).

35. Causes of Corruption The New institutional economics consider public sector corruption as a result of interactions between three individuals: one who governs, called the principal, another who is governed, the agent (the corrupted), and a third party (the corrupter), who can be engaged with the agent in a corrupt transaction (see figure). The agent acts on behalf of the principal, and is supposed to advance the goals of the principal.

36. Principal-Agent Relationship

37. Such delegation of responsibility from the principal toward the agent is generally characterized by 2 elements: : Divergence of interest between the principal and agent Asymmetry of information between principal and agent: The agent has privileged information regarding his activities and actions to put forward.

38. Principal delegates responsibility Agent choses his action (effort) (a) The level of observed performance (x) is function of level of effort of agent (a) and other factors not under the control of the agent (?) Ex. : Owner-manager Investor- financial advisor This multiplicity of factors that influence the output create a situation in which it is difficult for the principal to attribute blame or success to the agent for a bad performance of the organization.

39. Causes of Corruption It is expected that the rational agent in presence of private information regarding his effort and action will not act completely in the best interest of the principal Appearance of shirking and rent capture by the agent

40. Causes of Corruption There are two main sources of imperfect information: Moral hazard occurs when the principal cannot perfectly observe agents behavior. Agents can thus exploit an informational rent for their private gain. For instance, a central government may not know if low local government revenues is due to a decline in local economic activities or to public fund embezzlement. Adverse selection occurs when the principal ignores agent’s specific characteristics. For instance, the head of the administration (principal) does not know if the public official (agent) he is about to hire is honest or dishonest, because honesty is individual’s private information. If public sector remunerations are too low and for instance based on average public official’s performance, then presence of dishonest officials will lower salaries, which can incite honest employees not to apply for positions. As a result, only dishonest officials join the administration.

41. Causes of Corruption As mentioned, corruption is at its root associated with delegation of responsibility in an asymmetric information context where an agent uses the powers invested in him to illicitly capture a rent. Corruption can be associated with a combination of three main factors: Monopoly power, Discretionary power Insufficient monitoring

42. Causes of Corruption Corruption generally appears when public agents hold significant discretionary powers (monopolistic power) and are not held accountable for their actions (lack of monitoring) Corruption = Monopoly + Discretion - Accountability As mentioned by Klitgaard (1998) : “ Corruption is a crime of calculation, not passion. True, there are saints who resist all temptations, and honest officials who resist most. But when the size of the bribe is large, the chance of being caught small, and the penalty if caught meager, many officials will succumb.”

43. Causes of Corruption Cost-Benefit analysis The likelihood of engaging in corrupt activities depends on the effectiveness of enforcement mechanisms implemented by the principal, the opportunity cost, as well as the type of agent. Corruption will take place if public officials expect to derive a net benefit from a corrupt transaction. They will engage in corruption if the expected utility outweigh the utility of being honest (1 – p) (w + b) + (p) (w0) > w + ? where p if the probability of being caught, w is the wage rate wo is the external salary , B is the bribe and ? the agent preference for honesty (that is good conscience, etc)

44. Causes of Corruption Ex: complex administrative rules/procedures give corrupt public officials opportunities to require third parties extra-payments, hence increasing the number of potential corrupt transactions. Also, higher tax rates allow tax officers to ask for higher amount of money when a third entity wants to evade taxation, hence raising the expected gain from corrupt transactions.

45. Causes of Corruption Corruption raises the question of control rights within society and organizations, as well as the State’s institutional and organizational structures’ ability to monitor individual behaviour. The implications for economic development and efficiency are very important: The violation of these rules is a symptom of the state’s inability to enforce collective rules (North, 1990)

46. Causes of Corruption The State, as presented in the neo-institutional perspective, must be a neutral third party in transactions, which reduces opportunism (i.e. the quest for selfish self-interest which goes against the common good, rules, contracts) and transaction costs. The State’s and institutional structures’ lack of efficiency increases transaction costs (negociation and contract enforcement). In such a case, there can be no adequate, efficient or impartial administrative, legal or judicial system.

47. Causes of Corruption By putting in place an inadequate institutional structure, the State can, instead of reducing transaction costs: Increase these costs if individuals who control the State use their position to pursue private gains against the best interests of the many. As we have seen, corruption is mainly due to an agency problem in the context in deficient institutions. ? See PPT Treisman (2000) Sources of corruption : Cross National Study ? See PPT Azam et al: Tax evasion ? See PPT Gauthier and Reinikka: Fiscal evasion ? See PPT Fisman and Wei: Custom Evasion

48. 5.Types of Corruption Shleifer and Vishny (1993) develop a simple principal-agent model in which they consider a good produced by the government. The agent can limit the supply with no risk of detection. The agent aims to maximize bribes received through the sale of the public good, whose price is p. The authors identify 4 types of public corruption:

49. Types of Corruption Cost-increasing corruption: (« without theft") (see Figure) Appears when the official holds monopolistic power through his control of licenses and permits. It could just as well occur with tax collectors. The official transfers the price of the good to the government, but keeps the bribe. The bribe is collected in excess of the cost of the sale. Therefore, the State is not penalized by the theft, the user is. The total price paid by the user is therefore superior to the cost of the public good when corruption is without theft, as it includes the cost of the public good, p, as well as the bribe.

50. Corruption increasing costs: (« without theft")

51. Types of Corruption ii) Corruption decreasing costs (« with theft") (see Figure) Situation where the bureaucrat decreases the cost of a public good under the officially prescribed amount. It is equivalent to a tax reduction or to an attenuation in the implementation of regulations. The bureaucrat diverts the proceeds of the sale originally destined to the state, and hides the sale of the good or service from the government (ex: customs tariffs) This type of corruption entails a diversion of public funds. From the user’s perspective, corruption with theft is always preferable, as the price paid is inferior to p. This type of corruption is more damageing as it is pervasive. Both agents’ incentives are aligned, and the firm has no incentive to report the corruption.

52. Corruption decreasing costs (« with theft")

53. Types of Corruption iii) Corruption increasing benefits Occurs when a bureaucrat transfers benefits to a private sector agent beyond what is prescribed by law (ex. overbilling, unused materials, etc.) iv) Corruption reducing benefits Bureaucrats divert benefits destined to other private or public sector agents (ex. fund leakage, etc.)

54. 6. Alternative views Some analysts have perceived corruption as beneficial, a form of «grease money», to make system more efficient « a payment to an official to do the work he is supposed to do » However, despite the inefficiencies of the public or regulatory system, the participation to a parallel market reduces the efficiency of the global system. It is sign of institution weaknesses of a society: incapacity to control and supervise exchanges and agreements to common rules

55. Alternative views Furthermore, while it could accelerate procedures for the individual at a certain point of time, it is leaving aside the dynamic nature of the game/relationships. ? increases incentives for greater demand for corruption ? Creates interest groups to increase regulation (« red tape ») ? Endogenous nature of corruption activities

56. 7. Measuring Corruption In the past 2 decades, many international data bases have been developed, which hold global cross-country corruption indicators, mostly with regards to public corruption. These datasets and indicators differ with regards to data used, as well as with regards to aggregation method. The data is mainly obtained through expert surveys; however, household and firm surveys are also used. The advantage of national household or firm surveys is the ability to measure the impact of corruption on public service beneficiaries’ activities. This method mostly focuses on administrative corruption. However, some firm surveys also contain questions on « state capture » obtained through questions on firms’ influence in altering the elaboration of laws and regulations.

57. Measuring Corruption Expert opinions are most frequently used to measure corruption and implement cross-country panel studies. For example, the International Country Risk Guide (ICRG) indicator published by the Political Risk Services Group is the best known among these (and is often used, e.g. Knack and Keefer 1995, Mauro 1995). (See Table 1) Since 1980, currently 161 countries. This indicator is built by aggregating data from a national network with national expertise; however, the final ranking is allocated by a small group of experts. (Knack, 2006). Probability the high-ranking officials request additional payments, as well as the level of illicit payments requested, i.e. political corruption. The Nations in Transit (NIT) group indicator is built the same way.

59. Measuring Corruption Household survey data on corruption is not as readily available as expert opinions and firms’ responses. Since 2003, Transparency International has subsidized the Global Corruption Barometer (GCB). The number of countries covered has increased from 44 in 2003 to 69 in 2005. However, the questionnaires have been completely overhauled between over the period.

60. Measuring Corruption The World Economic Forum’s (WEF) “Executive Opinion Survey” is another cross-country survey of firm managers. Cross-country rankingson several corruption questions from this survey are published for 117 countries in WEF’s annual Global Competitiveness Report (Lopez-Claros, Porter and Schwab, 2005). The World Competitiveness Yearbook (IMD, 2005) is also based on executive survey but is conducted in many fewer countries than the WEF survey, and it includes fewer questions on corruption. The World Bank’s Country Policy and Institutional Assessment (CPIA) is also a expert-based ratings. The ratings originate within World Bank country teams and regional offices and are then reviewed for cross-regional comparability by central units.

61. Measuring Corruption Aggregated index There are at least three possible reasons for constructing a single corruption index from multiple, distinct sources of corruption indicators. The first reason is that individual indicators, or even several indicators from one source, may be defined too narrowly for certain purposes (e.g. type of corruption studied). The second reason is to reduce measurement error. Given the obvious difficulties in measuring corruption, any one source may be highly inaccurate. However, if errors in measurement are largely independent across sources, the errors will tend to cancel out when data are aggregated from multiple sources. The third motive is to cover a larger number of countries. No one source covers all countries.

62. Measuring Corruption Transparency International’s Corruption Perception Index is built by aggregating the level of corruption perceived by risk analysts, as well as CEOs, households and NGOs. (www.transparency.org) Since 1995, currently 178 countries It is important to note that the sources of the index can vary across countries and years, making time-series analysis unreliable.

63. Measuring Corruption World Bank Governance Indicators Since 1996, the World Bank has set up six new governance indicators, including a corruption control index. The index relies on the aggregation of a wide range of variables, as well as expert, CEO and household perceptions. As is the case with most aggreagated indices, the World Bank index measures both the incidence and level of corruption. The incidence measure identifies the frequency with which corruption takes place, while the level measure identifies the monetary sums in play. The WBI index was intended to improve and expand on TI in several ways. First, the WBI index provides a value for any country with data available from even one source, while the official TI index requires three sources. Second, the WBI index incorporates data from more sources. Third, using many of the same data sources, WBI constructs five other broad “governance” indexes. www.govindicators.org http://info.worldbank.org/governance/wgi2007/sc_country.asp

64. Measuring Corruption These methodological differences in aggregation seem not to have a huge impact. Svensson (2005) shows that the correlation coefficient between the Bank’s corruption control index in 2002 and TI’s CPI index in 2003 is 0.97 The correlation between the TI and ICRG indices is 0.75.

65. Measuring Corruption Business surveys The Business Environment and Enterprise Performance Survey (BEEPS) is a nationally-representative survey of business firms assessing corruption and other problems faced by businesses in Eastern and central European countries. The BEEPS is sponsored by the European Bank for Reconstruction and Development (EBRD) and the World Bank, and has covered almost every country in the region, in each of three survey waves: 1999, 2002 and 2005

66. Measuring Corruption World Bank Investment Climate Survey First implemented in 2002. Data available on about 72000 firms in 104 countries Data include: Firm General information (e.g. ownership, start-up). Infrastructure and Services (e.g. power, water, transport, communication technologies) Sales and Supplies (imports, exports, supply and demand conditions) Degree of Competition (price and supply changes, competitors) Land (land ownership, land access issues) Crime (extent and losses due to crime) Business-Government Relations (quality of public services, consistency of policy, regulatory compliance costs, management time, bribes) Investment Climate Constraints (evaluation of general obstacles) Capacity (use of production capacity, hours of operation) Finance (sources of finance, terms, financial services) Labor (worker skills training, skill availability, employment, education levels of workers) Productivity (data sufficient to estimate productivity)

67. 8. Evidences: Levels of corruption Corruption levels observed with different indicators around the world: Transparency international (CPI and GCB) World Bank Governance Indicators

68. Corruption Perception Index 2010 of Transparency International

75. 9.Consequences of Corruption Macroeconomics Negative correlation between corruption and economic growth Economic growth is greatest in countries where corruption is least prevalent (see Figure 22-1) Corruption is evaluated to hinder national growth at a rate of 0,5 to 1% per annum (UNCJIN, 2006) Effect of corruption on growth mostly perceived through the investment channel (Mauro, 1995)

76. Corruption and per capita income

77. Consequences of Corruption Biased resource allocation The economic agents which obtain resources (licenses or permits) are not necessarily the most productive or efficient. Rather, these are allocated to the agents with the best networks, or to those who are willing to engage in illicit activities. Increases transaction uncertainty and costs, as well as transparency and regulatory clarity. (see Chart 1, Gray et Kaufmann) When corruption is prevalent, firms allocate more, rather than less time dealing with bureaucrats.

78. Consequences of Corruption

79. Consequences of Corruption Costs to businesses The public sector’s institutions, policies and behavior influence transation costs in an economy, which can then influence investment and growth. The costs associated with corruption, regulations, infrastructure failure and contract enforcement can represent in excess of 25% of firms’ turnover in developing countries; this represents more than three times firms’ fiscal burden. (World Bank, 2005, p22).

81. Consequences of Corruption Bribes The World Bank estimates that bribes represent in excess of 1000 billion $US yearly (World Bank, 2004b) The World Bank investment climate programme, which covers 26 000 firms in 53 countries, has shown that firms in developing countries generally expect to pay bribes when dealing with the state.

82. Table 1 : Bribes in developing countries, by region

83. Consequences of Corruption In some regions, bribe payments can affect up to ¾ of surveyed firms, and can represent 7% of annual sales (Table 1). Furthermore, the surveys reveal that firms perceive taxes and corruption as their main operational constraints, after macroeconomic issues (inflation, exchange rate) have been accounted for.

84. Consequences of Corruption Firm Size The costs of corruption vary based on firms’ size and the sector (formal or informal) of the economy in which they operate. The investment climate directly affects firms based on their size and ownership structure. For example, informal sector firms perceive more severe infrastructure and financing constraints, as they do not have access to such services. However, they appear less affected by political uncertainty.

85. Consequences of Corruption For smaller firms, fixed costs such as operating licenses or bribery can represent a disproportional financial burden. The difference in bribes as a share of sales can reach more than 50% between small and large firms. See Table 2.1 (WDR 2005 p40) For informal firms, the burden of bribery is even heavier. Formal firms which do not respect tax or other regulations can more easily be targeted by corrupt officials for harrassent.

86. Bribe payments by size and sectors

88. Consequences of Corruption Bribe incidence and levels ? PPT : Svensson 2003 : who pays bribes in Uganda PPT : Achkar (2009) To Bribe or Not to Bribe PPT : Fisman and Svensson 2007 : Are corruption and Taxation equally harmful to firm growth? Corruption is equivalent to an additional tax, or to an entry barrier. (Djankov et al. 2002, Fisman and Svensson 2007) Perception vs incidence of corruption Pontera Gonzalez