Corruption

The consequences of corruption

Memorandum of expert: Lesotho Highlands Water Project, Corruption Case, Expert Testimony.

Qualifications of Ms Lala Camerer in the field of corruption

1. I am a policy researcher and analyst with particular expertise in the field of corruption and anti-corruption controls. 2. Over the past five years I have managed a number of donor-funded research projects at the Institute for Security Studies (ISS) in South Africa on corruption-related issues. 3. I am busy completing my PhD thesis through the University of the Witwatersrand on policy responses to controlling corruption in South Africa. I hold two Masters degrees in Social Policy (Oxford 1995) and Political Philosophy (Stellenbosch 1994). 4. During the past two years I have been employed as a consultant for the United Nations on two corruption-related projects, namely the UNDESA study on public service ethics in Africa and the UNODCCP Global Programme Against Corruption (in South Africa). 5. I have completed other consultancies on corruption-related matters for the South Africa Public Service Commission, the Open Democracy Advice Centre, the Institute for Democracy in South Africa, the Centre for Public Integrity and the World Bank. 6. During 1998/1999 I served on the board of directors of Transparency International – South Africa. 7. I am one of ten international academics appointed to a Panel of Experts as a resource person by the Utstein Anti-Corruption Resource Centre to be based at the Chr. Michelsen Institute in Bergen, Norway. 8. I have spoken at numerous international anti-corruption conferences and have published the following papers on corruption and related matters:

· Camerer, L. 2001. Controlling corruption in South Africa: Results of an expert panel survey. Pretoria: Institute for Security Studies. (ISS monograph; no. 65.)

· Camerer, L. 2001 Protecting whistleblowers in South Africa: The Protected Disclosures Act, no 26 of 2000. Pretoria: Institute for Security Studies. (ISS paper; no. 47.)

· Camerer, L. 2000. Terms of engagement for bilateral donors: A South African perspective from civil society, in The role of bi-lateral donors in fighting corruption: Proceedings of a conference held from April 25-27 2000, Maastricht, The Netherlands. Washington DC: World Bank:181-201.

· Camerer, L. 2000. Terms of endearment: Bilateral donor engagement in fighting corruption in South Africa. African Security Review, 9(5/6).

· Camerer, L. 1999. Tackling the multi-headed dragon: Evaluating prospects for a single anti-corruption agency, in Fighting corruption. Pretoria: Public Service Commission.

· Camerer, L. 1999. Whistle-blowing: An effective anti-corruption tool? Nedcor/ISS Crime Index, 3(3).

· Camerer, L. 1999. Budgeting for success: The cost of fighting corruption. Nedcor/ISS Crime Index, 3(2).

· Camerer, L. 1999. Fraud and corruption in South Africa’s first national victimisation survey. Nedcor/ISS Crime Index, 3(1).

· Camerer, L. 1999. Victims of serious economic crime: A South African perspective. Bloemfontein: Centre for Business Law, University of the Free State. (Transactions series; no. 31)

· Camerer, L. 1998. Human security in the southern African context: Law and the state: working paper, Pugwash meeting no. 236. Pugwash Newsletter, 35(2):52-55.

· Camerer L. 1998. Decriminalisation and non-criminalisation: Models for money laundering control in South Africa, in Money laundering control in South Africa. Bloemfontein: Centre for Business Law, University of the Free State. (Transactions series; no. 30.)

· Camerer, L & Shaw, M. 1998. Countering organised crime. South African Institute of International Affairs Yearbook 1997/1998.

· Camerer, L. 1997. Derailing the gravy train: Controlling corruption in South Africa. The Journal of Financial Crime, 4(4), June

· Camerer, L. 1997. Costly crimes: Commercial crime and corruption in South Africa. Pretoria: Institute for Security Studies. (ISS monograph series; no. 15.)

· Camerer, L. 1997. International fraud trends: South Africa at risk. African Security Review, 6.2.

· Camerer, L. 1996. Ethics and the professions: Blowing the whistle on crime”. African Security Review. 5(6):48-54.

· Camerer, L. 1996. White-collar crime in South Africa: A comparative perspective. African Security Review, 5(2):28-39.

· Camerer, L. 1996. Legislation to combat runaway corruption. Southern Africa Exclusive. December:14.

· Camerer, L. 1996. Suite vs street: Combating white-collar crime. Crime and Conflict, Indicator SA, 5. Autumn:1-5.

9. The facts contained herein are to the best of my knowledge true and correct and are, unless otherwise stated or indicated by the context, within my personal knowledge. 10. I have knowledge of the effects of bribery and corruption at high levels of government, particularly where this involves donor funds and in the context of an African country such as Lesotho. 11. I have knowledge of the social, political and economic impact of high level corruption in the southern African context and how this is likely to affect Lesotho as a country, its citizens, and the Lesotho Highlands Water Project itself.

Lala Camerer (Senior Researcher, Institute for Security Studies), February 2002, “The Consequences of Corruption”

Introduction

Corruption, defined as “the abuse of public power for private gain”, is of growing international and regional concern. In a context of political and economic globalisation we are all affected. Corruption is not a victimless crime but negatively affects a number of people, mainly the poor. While corruption is a feature of all societies to varying degrees, it has a particularly devastating impact on development and good governance in developing countries in Africa. This is because it undermines economic growth, discourages foreign investment and reduces the optimal utilisation of limited resources available for infrastructure, public services and anti-poverty programmes. It may also undermine political institutions by weakening the legitimacy and accountability of governments.

The consequences and long-term costs of corruption take many different and inter-related forms, including economic, political, social, environmental and cultural impacts. These are difficult to measure, although in recent years economists have tried to do this with some success. The relationship between cause and effect is complex when it comes to corruption: For example, does poverty facilitate corruption or is corruption an underlying factor prolonging poverty? Does a corrupt host country discourage foreign investment, or are international companies themselves guilty of bribery and promoting corrupt practices in developing countries?

In assessing the international literature which the study of corruption and its control has spawned over the last thirty years, and more intensely over the last five as the good governance agenda amongst international aid and financial bodies has taken root, there are a number of different schools with regard to the consequences of corruption. So-called “moralists” have long argued that corruption is harmful to societies and governments, impeding development and eroding legitimacy even of honest elites and well-run institutions. “Revisionists” by contrast, point to possible benefits of corruption, suggesting that it can speed up cumbersome procedures, buy political access for the excluded, and perhaps even produce de facto policies more effective than those emerging from legitimate channels. A third outlook suggests that the consequences of corruption depend in part upon the characteristics of political systems, such as the balance of political and economic opportunities, levels of economic development, national integration and government capacity or upon the relationships among key factions and elites.

Corruption is understood in different ways and comes in various forms with differing consequences. However, it is generally true that there are only ever a few “winners”, that corruption hurts most of the people most of the time, and that it is mainly the poor who suffer.

This paper examines the international academic literature and empirical (mainly economic) research available on the various consequences of corruption. First however, some background is provided to the international, regional and domestic initiatives and policy responses that, in recognising the devastating consequences of unchecked bribery and corruption, have been initiated in recent years.

Corruption in international transactions

The nefarious and deleterious effects of corruption have been recognised internationally, in particular with respect to international bribery. Peter Eigen, chairperson of the influential international anti-corruption NGO Transparency International, has noted: “The scale of bribe-paying by international corporations in the developing countries of the world is massive. Actions by the majority of governments of the leading industrial countries to curb international corruption are modest. The results include growing poverty in poor countries, persistent undermining of the institutions of democracy, and mounting distortions in fair international commerce”.

Foreign business people often blame their own illegal bribe-paying activities on the domestic environment – they say a culture of high bribery exists in emerging market countries. However, it is all too often the great willingness of firms to pay large bribes (the supply side) that has been a prime cause of poisoning the domestic emerging market economy. Without negating the important role played by the demand side of corruption – where corrupt public officials demand illicit compensation for performing their duties – many observers see the supply side of corruption by international business in the form of foreign-sponsored bribery as the most significant contributing factor to corruption. This has been recognised by multinational bodies such as the Organisation for Economic Co-operation and Development (OECD) as a key area for action.

In its preamble, the OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions recognises “that bribery is a widespread phenomenon in international business transactions, including trade and investment, which raises serious moral and political concerns, undermines good governance and economic development, and distorts international competitive conditions” and that “all countries share a responsibility to combat bribery in international business transactions.” The convention, which was born out of the conviction that bribery of foreign public officials in international business transactions is a serious threat to the development and preservation of democratic institutions, was signed by all 29 OECD countries and five non-member countries and came into force on 15 February 1999. All 34 countries have undertaken to introduce domestic legislation similar to the US Foreign Corrupt Practices Act, thus making it possible to prosecute the givers of bribes in their home countries as well as the country where the offence took place. A number of key signatories have yet to ratify the convention and there are serious questions about the extent to which individual countries will be willing to enforce it. In the past, fear of competition was one of the main justifications for paying bribes. Now, at least in theory, all companies from the major Western trading nations will be playing by the same rules.

Some empirical evidence on the degree of bribery by international business is provided for by the Transparency International (TI) Bribe-payers’ (BPI) survey conducted in 1999 as a pioneering effort to measure the supply side of bribery: the relative propensity to pay bribes from companies of the leading exporting states in emerging economies. Whilst recognising that bribery happens all over the world, the BPI survey was conducted exclusively in leading emerging market countries because of TI’s priority focus on the impact of international corruption on developing countries and countries in transition. In-depth interviews (n-779) were conducted with private sector leaders in 14 emerging market economies, including South Africa. Many of the questions relate to perceptions of bribe-paying in these economies by companies from the leading 19 exporting countries of the world.

Some key findings were the following: In response to the question “which are the sectors in your country of residence where senior public officials would be very likely, quite likely, unlikely to accept or to extort bribes?” on a scale of 0-10 where 0 represents perceptions of very high levels of corruption, public works contracts and construction fared the worst at (1.5) followed by the arms and defence industry (2). As is seen from the empirical evidence presented later, these are areas involving large amounts of money where there is the potential (more than in the education and health sectors) to extract large numbers of bribes.

According to the BPI, respondents shared similar views when it came to the issue of why senior public officials and politicians in many countries take bribes: The fact that many of even the most senior officials receive low salaries is widely seen as the main cause of bribe-taking (65%), followed by immunity of public officials from prosecution (63%). A common response in anti-corruption drives, where affordable, has been to narrow the gap between the salaries paid to high-level public sector officials and, for example, CEOs in the private sector in order to reduce the temptation of public procurement officials to accept or extract bribes. It should be noted that even though the salaries of senior officials are often low compared to the salaries of senior managers in the private sector, bureaucrats in developing countries, in general, have high salaries relative to the incomes of the average citizen. In Tanzania, for instance, “low” paid civil servants at the local level are often better off than most people in local communities. Low salaries are therefore not a sufficient reason for people to engage in bribe-taking, so greed is another factor to be considered.

Whilst corruption is a universal phenomenon, countries in Africa are particularly adversely affected by corruption. Corruption has a greater impact on often already fragile political and economic institutions and is a contributing factor to development failure. These countries are heavily reliant on both international investment as well as development aid. High corruption reduces the effectiveness of aid-funded projects and it weakens public support for assistance in donor countries. Increasingly, international funding agencies are making concerted action against corruption a precondition of aid, for example, the way the International Monetary Fund (IMF) has been dealing with Kenya.

Recognising this, countries within the Southern African Development Community (SADC) have recently adopted a protocol to fight corruption in order to ensure a corruption-free regional economic grouping attractive to foreign investors. In the preamble of the Protocol signed in Blantyre, Malawi in August 2001 by all 14 member countries, including Lesotho, the parties expressed their concern at “the adverse and destabilising effects of corruption throughout the world on cultural, economic, social and political foundations of society” and committed themselves to introducing the necessary legislation and mechanisms to combat all forms of corruption both within their own countries and regionally.

Both the OECD Convention and SADC Protocol rely on countries to take domestic action, both in terms of anti-corruption legislation and the political will necessary to act against corruption. Whilst international pressure is useful and should be applied whenever and wherever possible, domestic efforts and institutions ultimately determine whether reducing corruption is successful. Any external pressure should be regarded only as a supplement to domestically-based reforms. As the criminal case currently in the Lesotho High Court indicates, the Lesotho government has recognised the adverse consequences of not dealing appropriately with corruption, and is taking the necessary action to deal with high-level bribery and grand corruption in its public procurement projects. For this reason, and the fact that the prosecution is addressing both the supply and demand sides of bribery, anti-corruption activists and analysts around the world are observing this case closely.

The consequences of corruption – theoretical arguments

There is widespread recognition of the negative consequences of bribery and corruption internationally, regionally and domestically. It is generally recognised that corruption has the following effects: · it affects the economy by undermining growth and development through hindering or deterring foreign and or local investment; · it affects the quality and composition of public expenditure projects; · it undermines the fiscus through non-optimal collection of taxes and revenues as the unofficial underground economy flourishes; · it distorts policy and resource allocations, thereby increasing inefficiency; · it undermines trust and credibility in institutions and procedures; · it threatens human security through linkages with drugs and organised crime, and · because of the unjust access it facilitates to often limited social and political goods and services, corruption can create social and political unrest if it goes unchecked. In addition: · corruption takes its greatest toll on the poor; and · corruption bites into the moral fibre of society.

Crucially, it has been recognised that corruption is contagious, a “cancer”, and that it can grow exponentially if efforts are not taken to control it when it manifests itself. Osborne sums up the organic nature of corruption: Corruption spreads. Although it is difficult to measure the scale of bribery there is general recognition that bribery escalates unless efforts are taken to prevent it. If bribery that is a matter of individual choice goes unchecked, it leads to extortion that has to be paid to get jobs done. When corruption becomes systemic it brings new behavioural norms that differ from the former culture of the organisation or the nation. Systemic corruption is not necessarily systematic, it is a condition where the disease affects the whole body rather than causing only a local infection. But systemic corruption is less benign than it may appear. Corruption is itself a cause of escalating corruption, creating increased opportunity for further corruption as bribes reduce the risks of detection and conviction. The sight of people who get rich corruptly stimulates greed, giving incentives to other to maximize their profits. The public anger at corrupt riches brings political unrest.

There are a number of primary economic consequences of corruption that have been well-documented and are supported by empirical research. Before examining these in some detail, the “revisionist literature” on the beneficial consequences of corruption as “grease” will be referred to briefly, although this thinking has largely been dismissed in recent years.

Corruption as “grease”

One line of thinking in the corruption literature which has been largely discredited argues that the economic benefits of corruption outweigh the costs and that corruption may not be inconsistent with development and, at times, may even foster it. This functional theory of corruption argues that the buying and selling of political favours has political and economic advantages (at least for some), and that bribery “greases the wheels” by cutting through unnecessary red tape, thereby improving efficiency and speeding up the wheels of commerce.

While one may think of examples in which paying a bribe or the opportunity to pay a bribe makes some firms/people better off, the overall effect of corruption on economic development is negative. The enormous degree of discretion that many politicians and bureaucrats can have, particularly in corrupt societies over the creation, proliferation, and interpretation of counterproductive regulations means that instead of corruption being the “grease” for the squeaky wheels of a rigid administration, it can become the fuel for excessive and discretionary regulations. This is one mechanism where corruption feeds off itself.

As has been noted, corruption is contagious: it starts in one specific area, perhaps the area where the rules are in fact too rigid, and soon it begins to spread to other areas. In time, most activities become affected. When this happens corruption becomes like a distortionary tax levied with uneven and random rates. Then it is no longer just “oil for the mechanism” but it distorts economic decisions in ways that can be damaging to the economy. For example it may encourage unproductive public spending or economically unproductive activities, because of the bribes or the “commissions” that some public officials can get on such spending or protecting those activities.

Economic, political and administrative consequences – empirical evidence

There are a number of empirical studies providing overwhelming statistical evidence to show that countries with high corruption levels have poorer economic performance. There are several channels through which corruption hinders economic development and growth: briefly, it reduces investment (both domestic and foreign), distorts the size and composition of government expenditure away from education, health and the maintenance of infrastructure towards less efficient projects that have more scope for manipulation and bribe-taking opportunities, and it weakens the financial and tax system, strengthening the underground economy and encouraging links to organised crime groups. Most importantly, a strong connection has been demonstrated between corruption and increasing levels of poverty and income inequality.

The consequences of corruption will be dealt with under the following statements which are underpinned by empirical evidence:

· corruption negatively impacts on investment and growth · corruption negatively affects investment by creating uncertainty · corruption undermines revenue collection stimulating the underground economy · corruption distorts public expenditure and resource allocation · corruption impacts negatively on industrial policies and business development · corruption undermines efficiency · corruption exacerbates poverty and inequality.

Corruption negatively impacts on investment and growth

Corruption has been shown to have a negative and significant impact on foreign direct investment as well as local investment, including investments in public expenditure. Mauro presents the first systematic empirical cross-country analysis of the effects of corruption on economic growth by focusing on the relationship between investment and corruption. The study’s aim is to “identify the channels through which corruption and other institutional factors affect economic growth, and to quantify the magnitude of these effects”. The results of Mauro’s work support the claim that corruption has a negative impact on investment and, as a result, it negatively affects growth.

Using the Business International (BI) index of corruption – corruption is one of the BI risk factors defined as “the degree to which business transactions involve corruption or questionable payment” – he estimates the effects of corruption on the average ratio of total and private investment to gross domestic product (GDP) for the period 1960-1985 for a cross-section of 27 countries . From the data he finds that corruption lowers investment, thereby reducing growth. The negative association between corruption and investment, as well as its negative impact growth, is significant in both a statistical and economic sense.

A simple (bivariate) regression with “absence of corruption” as the independent variable yields a weakly significant correlation (revealing that an absence of corruption is indeed positively associated with growth). For example, Mauro finds that corruption has a negative impact on the ratio of investments to GDP – its investment rate: “if Bangladesh (with a score of 4.7) were to improve the integrity and efficiency of its bureaucracy to the level of that of Uruguay (score 6.8)…its investment rate would rise by almost five percentage points and its yearly GDP growth rate would rise by over half a percentage point”. That is, a corrupt country is likely to achieve aggregate investment levels of almost 5% less than one which is relatively ‘uncorrupt’, it it will lose about half a percentage of gross domestic product growth per year.

Mauro also constructs a “bureaucratic efficiency index” as the arithmetic average of three BI indexes: those of efficiency of the legal system and the judiciary, the amount of bureaucracy and red tape, and corruption. This composite index is again negatively and significantly associated with investment. Furthermore the effects are quite strong. A one standard deviation improvement in bureaucratic efficiency is associated with an increase in the investment rate by 4.75% of GDP.

A further study by Mauro of 67 countries covering data from 1960-85, found that corruption slows the growth rate of countries. For example, if a country such as Egypt were to heighten the efficiency of its administration and improve its corruption score of 4 out of 10 to the same level as Argentina’s 6, (again where 0 means total corruption and 10 means none at all), the rate of investment would increase by 3% and the growth rate would increase by 0.5%. If Bangladesh reduced its level of corruption to Singapore’s, its average annual per capita GDP growth rate over the period 1960-1985 would have been 1.8 percentage points higher, a potential gain of 50% in per capita income by 1985 (assuming growth of 4% a year).

Other empirical studies surveyed by Andvig and Fjeldstad support Mauro’s results: Using a different corruption indicator with observations from Political Risk Services, an empirical study by Keefer and Knack which includes “corruption in government” among other explanatory variables into one single index of “institutional quality” to explain economic performance, finds similar results. Brunetti, Kisunko and Weder, using a corruption index developed by the World Bank and the University of Basel for a sample of 41 countries, also find that corruption significantly reduces the ratio of investment to GDP. A similar conclusion is reached by Brunetti and Weder in a larger sample of 60 countries making use of corruption data by Political Risk Services.

According to Wei there is clear evidence that domestic investment, foreign investment and economic growth are lower in more corrupt countries. In terms of the effect of corruption on domestic investment, Wei points out how if the Philippines could reduce its corruption level to the Singapore level, other things being equal, it would have been able to raise its investment/GDP ratio by 6.6 percentage points – quite a substantial increase in investment.

In one paper, Wei explores the impact of corruption on foreign direct investment by using a database which includes bilateral capital flows between 14 source and 45 host countries in 1990 and 1991 and controlling for factors such as GDP per capital. He finds that corruption in a host country has a negative effect on inward foreign direct investment from all source countries in a way that is statistically significant and quantitatively large, that is, there is clear evidence that corruption in host countries discourages foreign investment. Investing in a relatively corrupt country as compared with an uncorrupt one is shown to be equivalent to an additional 20% (“private”) tax on the investment. For example an increase in the corruption level from relatively clean Singapore to relatively corrupt Mexico is the equivalent increase in the tax rate of over 20 percentage points. If India could reduce its corruption level to the Singapore level, its effect on attracting foreign investment would be the same as reducing its marginal corporate tax rate by 22 percentage points.

Corruption negatively affects investment by creating uncertainty

In another paper, Wei examines the effect of corruption-induced uncertainty on foreign direct investment by constructing measures of unpredictability of corruption based on unpublished individual survey responses on levels of corruption in host countries. He finds its effects on foreign direct investment (FDI) to be economically negative, statistically significant and quantitatively large. An increase in the uncertainty level from that of Singapore to that of Mexico, at the average level of corruption in the sample, is equivalent to raising the tax rate on multinational firms by 32 percentage points.

Corruption therefore discourages foreign investment more than a tax because corruption, unlike tax, is not transparent, nor preannounced, and carries a much poorer enforcement of an agreement between one who bribes and one who takes a bribe. As those who pay bribes have no legal recourse, contracts through bribery cannot be enforced; this is one reason why corruption is more harmful than taxes. Corruption embeds arbitrariness and creates uncertainty. It is well established that the level of uncertainty in the business environment significantly affects investment. By increasing uncertainty, corruption raises the effective costs of investment for the firm and countries having high levels of both administrative corruption and state capture.

Ms Lala Camerer, February 1, 2002

Categories: Corruption, Odious Debts

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