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Unformatted text preview: m “.wj’ww.mmvfiwgnng r w w Fenvmvm a,» m,“ The Elusive Quest for Growth Economists’ Adventures and Misadventures in the Tropics William Easterly q <9 2 \ UNIVERSITY OF ROCHESTER The MIT Press Cambridge, Massachusetts London, England «I 12 Corruption and Growth There is no distinctly American criminal class, except Congress. Mark Twain The urge to steal everything not bolted to the floor is the most obvious growth-killing incentive that government officials face. Requiring private businesspeople to pay bribes is a direct tax on production, and so we would expect it to lower growth. Corruption is one of the problems most likely to be mentioned by casual visitors to poor countries or by investors in those countries. In a poll commis— sioned by the agency Roper Starch International in nineteen devel- oping countries, corruption was the fourth out of fifteen top national concerns of citizens, after crime, inflation, and recession.1 Despite the obvious importance of corruption in economic devel- opment, it has not attracted much attention from economists until recently. The prestigious four-volume Handbook of Development Eco— nomics, published from 1988 to 1995, does not mention corruption anywhere in 3,047 pages of text. A recent leading textbook on devel- opment, economics does not mention corruption (or politics for that matter) anywhere.2 Moreover, the international financial institutions like the World Bank and International Monetary Fund paid virtually no attention to corruption for decades. Only recently has corruption become a hot issue for these institutions. Even then we are often reluctant to utter the word corruption; problems with governance is the bureaucratic jargon we use instead. ,. Once we acknowledge the importance of corruption to growth, there are unresolved questions. Why do some governments face ; l 1 , 242 Chapter 12 stronger incentives to steal than other governments? Why is corrup- tion more damaging in some countries than in others? In this chapter, I discuss the scale of corruption, its effect on growth, its determi- nants, and some possible solutions. Life on the Run When I lived in Mexico City for a year, I played a constant cat and mouse game with the Mexican police. I was the mouse, and the very corrupt Mexican police were the cats. Driving my car with its American license plate in Mexico City was like having a sign, “I’m an American tourist. Please extort bribes from me.” "Before I caught on to how corrupt the police were, I actually stopped and asked a policeman for directions. When I told my Mexican friends that I had done this, they exploded in laughter. As they surmised, the policeman whom I asked for directions immediately shouted, “Alto” (halt) and ran to get several fellow officers to share in the booty. I used the time-honored technique of pretending not to under- stand the language. I pretended that I thought alto meant ”proceed in your car at a high rate of speed away from the corrupt policemen, who are fortunately on foot.” I wasn’t so lucky in my next encounter with the police. This time a motorized policeman pulled me over. Asking him what my infrac- tion had been, he told me I had committed the serious offense of transporting books without a license. The offending cargo was a box of books in my trunk. I had the nerve to carry these in my Volkswagen Rabbit. What did I think I was? A professional moving company? This serious offense required a trip to the station house (my Mexican friends told me, “Never let them get you to the station house"). I offered to pay the fine for my outrageous offense on the spot, and that resolved matters. (I’m embarrassed to tell you how much I paid for the bribe. I got caught with only large denomination notes on me.) After that I developed several techniques for evading police sting operations. I continued to act like an idiot as far as comprehension of Spanish went whenever the policeman was on foot. The next time I encountered a motorized policeman, I simply refused to pull over and kept driving until I got to the private university I was going to. Private property was apparently safe refuge, and the policemen gave up the chase at the gates. Corruption and Growth 243 Things were not so amusing for poorer inhabitants of Mexico City, whom the police regularly shook down for bribes. Supposedly each precinct had a quota of bribes to collect every month, from which the higher-ups would get a cut. Everyone knew about this corruption, but attempts to deal with it proved futile. This phenomenon of venal police is not limited to Mexico; in countries ranging from Jamaica, Uganda, India, to Moldova, the poor report police brutality and cor- ruption as one of their main worries.3 The All-World Corruption Tour Corruption occurs in rich countries and poor countries, tiny coun- tries and gigantic countries, Christian countries and Islamic coun- tries, African countries and Asian countries, Old World countries and New World countries. Although it appears everywhere, there are some careful measures of the severity of corruption across coun- tries that we can use. I will first give some anecdotes to illustrate the ubiquity of corruption and then present some measures to distin- guish corruption across countries. Denver brewery owner Joseph Coors was a big financial backer of Ronald Reagan. When his beer can manufacturing plant had to dis- pose of some hazardous waste, Reagan appointed several members of the Coors clan to the Environmental Protection Agency, which then lifted restrictions on dumping of toxic waste in Colorado. There was a public outcry against Coors for his buying the right to dump toxic waste, if not for his watery beer.4 The psychologist Dr. Don Soeken alleged in 1988 that he had been asked to ,declare as mentally unbalanced American civil servants who had uncovered corruption in the State and Defense Depart- ments. Their superiors were trying to discredit them by claiming they were insane (the civil servants, not the superiors).5 In Japan, a government prosecutor uncovered a scheme where businessmen'who needed a government favor would provide ex- pensive free entertainment for the officials concerned. Showing their determination to stamp out corruption, the Japanese government re- assigned the prosecutor in August 1998 to a remote coastal city.6 In Ecuador in February 1997, agents for President Abdala Bucaram allegedly walked off with $3 million in Ecuadorian currency from the Central Bank. They delivered the loot to his office shortly before his term of public service was to expire? 244 Chapter 12 The brother of Mexican president Carlos Salinas was implicated in payoffs for drug running, which may explain the $132 million in his Swiss bank account. Meanwhile, the personal secretary of President Salinas, Iusto Ceja Martinez, was unable to explain how he accumu- lated $3 million from 1988 to 1994 on an annual salary of $32,400.8 In a South Indian state in the late 19703, corruption permeated the system of official irrigation. Among the many types of corrupt pay- offs, there was one euphemistically called “savings on the ground.” A government contractor would do less work than called for in his contract—like removing only 1 inch of silt from the irrigation canal instead of 3 inches of silt. The contractor would split the “savings on the ground” with the government’s executive engineer, who had already gotten a kickback of 2.5 percent of the contract for awarding the contract to that particular contractor. The savings on the ground and kickbacks ranged from 25 to 50 percent of the value of what was supposed to be put on the ground. The executive engineer’s earnings from corruption were as much as nine times his official salary. Little wonder that these lucrative posts were bought and sold within the irrigation bureaucracy. The executive engineer in this example might pay a lump sum of five times his annual salary for a two-year post— ing, still leaving him an attractive net income. The rampant corrup- tion had more than a little to do with the poor performance of the irrigation system.9 In Korea, four unqualified bone setters paid the equivalent of $11,000 to the Bureau of Health and Social Affairs in one province for fake licenses. There has been no word on how their patients survived amateur bone setting.10 On a more spectacular scale, the former mayor of Beijing and member of the Politburo, Chen Xitong, was sentenced to sixteen years in prison for corruption. He allegedly diverted as much as $2.2 billion in Beijing city funds during his time of public service, using kickbacks on construction contracts and many other devices. Chinese television showed some of the trappings of the high-living Chen: “a gold ring, a gold tortoise, a silver carriage and horses, a house in the countryside equipped with massage chairs and an extensive bedroom complex.”11 One government agency in the Philippines was said to be so cor- rupt that even the janitors were receiving payoffs.12 Marcos initially promised to clean up corruption. His lack of success can be mea- sured in the zillions of dollars that he himself stole. To give one Corruption and Growth 245 example, Westinghouse allegedly paid Marcos $80 million to get the contract to build a new nuclear plant. A presidential commission approved General Electric’s much lower bid, but President Marcos overruled them. His secretary of industry complained that the country was getting “one reactor for the price of two.”13 (Nor has democracy been a panacea for corruption: the current democratically elected president is facing impeachment on corruption charges.) Nigerian dictator Sani Abacha allegedly accumulated billions of dollars from kickbacks on construction contracts and from diverting oil revenues to his personal account. He also diverted $2 billion from state oil refineries, leaving them unable to produce gasoline, and then, with real Chutzpah, pocketed commissions on imported gaso- line. Only his sudden death in June 1998 put an end to his imagina- tive plunder.14 In Zimbabwe, the cabinet awarded the contract for the airport at Harare to Air Harbout Technologies from Cyprus. In a startling coincidence, the local agent of Air Harbout Technologies was Presi- dent Mugabe’s nephew. The cabinet OVerruled the tender board that placed this company fourth. Two other facilitators allegedly received $1 million.15 President Mobutu Sese Seko of Zaire, not satisfied with his personal fortune of billions of dollars, stole the entire gold-mining region of Kilo-moto. Kilo—moto covers 32,000 square miles and has reserves of 100 tons of gold. In another transaction Mobutu, who never seemed to think small, gave the West German rocket company OTRAG the rights to an area of southeast Zaire as large as West Germany itself.16 Rating Corruption and Its Consequences This selection of anecdotes may suggest that government officials everywhere are no better than highwaymen on the road to growth. All countries can furnish anecdotes, but some countries are more corrupt than others.» The International Credit Risk Guide surveys businesspeople for their perception of corruption in countries around the world on a rating between 0 (most corrupt) and 6 (least corrupt). In 1990, the countries that distinguished themselves with a 0 for exceptional graft in the line of duty were: the Bahamas, Bangladesh, Indonesia, Liberia, Paraguay, and Zaire. (The Philippines under Marcos had earned a 0, but by 1990 the country under a reformist government had climbed 246 Chapter 12 all the way to 2.) The countries with a 6 are all industrial countries, although not all industrial countries have a 6 (the United States and Japan, for example, are both Ss). The data show that corruption and growth are inversely related. (This sample includes growth in the 19805 against corruption in 1982 and growth in the 19905 against corruption in 1990.) Similarly cor- ruption and the investment ratio to GDP are inversely related. (This sample is investment to GDP in 1982 on corruption in 1982 and investment to GDP in 1990 on corruption in 1990.) Nobody wants to invest in a corrupt economy, and nobody wants to do all the other things that make for a growing economy." Corruption not only has a direct effect on growth; it also has an “indirect effect because it makes other policies that affect growth worse. For example, many of the corruption anecdotes describe diversions of funds from public revenues or blowing up public expenditures through kickbacks. It’s not a surprise, then, that more corruption is associated with larger budget deficits. The average budget deficit in the quarter of the sample that is least corrupt is 3.1 percent of GDP; the average deficit in the most corrupt quarter of the sample is 6.7 percent of GDP. Still, the relationship of corruption with growth is not a simple one. Notice that the list of most corrupt in 1990 includes both growth disasters (Zaire) and growth miracles (at least a miracle until recently, Indonesia). Could the effect of corruption be different in different countries? The effect of corruption could even be different over time in the same country. The 1990 survey by the Internation Credit Risk Guide did not include much data on the postcommunist countries, since communism was not yet post- everywhere in 1990. A World Bank survey of sixty-nine countries in 1996 did include many post- communist countries. Firms in the sixty-nine countries were asked whether “irregular payments” were a common practice in their industry. The possible answers ranged from 1 (always) to 6 (never). While the communist countries had always had some corruption (the Soviet Union got a 4 on the 0—6 scale of the Credit Risk Guide in 1990), it was clear from this new survey that corruption had become more pervasive in the postcommunist countries. The two most corrupt countries were Azerbaijan and Bulgaria. Postcommunist countries accounted for 10 of the top 20 most corrupt in the 1996 survey, although they accounted for less than 30 percent of the sample. The Corruption and Growth ' 247 disastrous output decline occurring in the postcommunist countries, while having many other causes, is another hint that corruption is not good for growth. Varieties of Corruption Two different kinds of corruption could affect growth: decentralized corruption and centralized corruption. Under decentralized corrup— tion, there are many bribe takers, and their imposition of bribes is not coordinated among them. Under centralized corruption, a gov- ernment leader organizes all corruption activity in the economy and determines the shares of each official in the ill-gotten proceeds. Decentralized corruption is like the multiple roadblocks by sol- diers that one would encounter in traveling in, say, Zaire. Each sol- dier at a roadblock is an individual predator, without taking into account the effect of his actions on other predators. The wealth of the travelers is a common resource that all of the independent thieves try to appropriate. We have the classic common pool problem. The bribes demanded will be higher as each soldier thief tries to get as much revenue from the hapless traveler as possible before other thieves get it. The total "theft rate” implied by decentralized bribes will be higher than under centralized corruption. Indeed, the theft rate under decentralized corruption may be so high that total corruption revenues are lower than they would be with a lower theft rate. As the tax rate climbs, individuals put more effort into avoiding bribe opportunities for the military. thieves. They travel by roads with fewer roadblocks, carry less money with them, and conceal the wealth of goods they are shipping. Decentralized corruption ironically results in lower total bribe revenues than centralized corruption even though it has a higher bribe "tax rate” on private activity. Decentralized corruption creates the worst incentives for growth. There is yet one more reason that decentralized corruption is damaging. The likelihood that someone will be punished for corrupt behavior is positively related to the strength of state enforcement and negatively related to the number of corrupt officials. With decen- tralized corruption, the state is weak and many officials are corrupt. Even if the state prosecutes some corrupt officials, the likelihood of being caught is low because there are so many corrupt officials from whom to choose when the state prosecutes. There are thus virtuous E I i t «I 248 Chapter 12 and vicious circles in corruption. The virtuous circle occurs when, for whatever reason, decentralized corruption is low and so anyone who does steal will likely get caught. Thus, corruption stays low. The vicious circle occurs when decentralized corruption is high, and so the likelihood of being caught is low. Thus, corruption stays high. Under centralized corruption, one leader seeks to maximize the take from the corruption network as a whole. This leader is more solicitous of his victims’ prosperity, because he knows that stealing too much will cause the victims to take evasive action that will lower bribe collections. So the centralized corruption mafioso, like Suharto in Indonesia, will set the bribe “tax rate” at all of the roadblocks at lower levels that maximize the total take of the system. Under cen- tralized corruption, there is monitoring of the size of the rake-off at each level; anyone trying to rake off more than the center prescribes will be punished. Because of this supervision, there are no vicious circles. Centralized corruption is less damaging than decentralized corruption.18 More generally, a strong dictator will choose a level of corruption that does not harm growth too badly, because he knows his rake-off depends on the size of the economy. A weak state with decentralized corruption doesn’t have this incentive to preserve growth. Each indi— vidual bribe taker is too small to affect the overall size of the econ- omy, so he feels little restraint on getting the most out of his victim. This tale gives us insight into why corruption was more damaging to growth in Zaire than in Indonesia. Zaire is a weak state with many independent official entrepreneurs. Indonesia under Suharto was a strong state that imposed bribes from the top down. Zaire had neg— ative per capita growth, while Indonesia had exceptional per capita growth (until recently). There was also a shift in the type of corruption in the post- communist countries. The communist countries had always had some corruption, but under the centralized party dictatorship, it was mostly top down. The postcommunist countries, by contrast, have many‘independent power centers and so have shifted to decentralized corruption. This helps us to understand why corruption has been much more damaging after communism than during communism. Determinants of Corruption It is clear that the incentives for corruption are stronger in a decen- tralized government than in a centralized one. In a decentralized Corruption and Growth 249 government, such as a coalition government among interest groups, the theft rate will be higher. Moreover, any piles of money that become available through commodity windfalls or foreign aid are more likely to be stolen in a decentralized weak government than in a strong centralized government. I will discuss in the next chapter one circumstance that leads to multiple interest groups: a high degree of ethnic diversity. Stock- holm University’s Jakob Svensson has indeed found that corruption is higher with more ethnic diversity, as Paolo Mauro of the IMF also did in earlier work. Svensson also found that corruption increases with more for- eign aid in an ethnically divided society though not in an ethnically homogeneous one. Foreign. aid is a common resource that each ethnic interest group will try to divert to its own pockets. Svensson too found that countries that were both commodity (like cocoa or oil) producers and ethnically divided were more likely to be corrupt. Multiple ethnic interest groups will each try to steal as much as they can from the common pool of commodity revenues.19 . _ I already hinted in the previous chapter that one motivation for many bad policies is to create opportunities for graft. This is most obvious for a policy like the black market premium, where any gov- ernment official with a license to get dollars at the official rate can make a corrupt profit by reselling the dollars at the black market rate. It’s not a big surprise, then, that corruption and the black market rate are associated.20 Causality in this association likely goes both ways: there is incentive among the already corrupt to create a high black market premium and an incentive to be corrupt if there already is a high black market premium. In the same vein, restrictions on trade create opportunities for corruption. If there is a high tariff on an imported good, there is an incentive to bribe customs officials to import the good at a lower tariff. And, if a license is needed to import the good and the good is in great demand, the license seeker will have to pay a bribe. One study has found that countries that restrict the freedom of inter- national trade are indeed more corrupt.21 The quality of institutions in a country also affects corruption. A high-quality civil service organized on meritocratic lines will provide some checks on corruption. A government that itself obeys the laws rather than putting itself above the law will create a poor eco- system for corruption. The International Credit Risk Guide measures four aspects of the quality of the institutional environment for busi- 250 Chapter 12 ness: rule of law, quality of bureaucracy, freedom from government repudiation of contracts, and freedom from expropriation. Each of these captures a different aspect of the institutional environment that will affect corruption. To stamp out corruption and create good incentives for government officials to promote growth, each of these institutional aspects must be strong. The rule of law measure captures the ability of government official to enforce or ignore the law selectively so as to get payoffs. Govern- ment officials take corrupt payoffs to have the law interpreted crea- tively in the bribe payer’s favor. The Guide measures both it and freedom corruption on a O to 6 scale. For example, Haiti in 1982 was a place where the law meant about as much as the king’s dictates in Alice in Wonderland. Haiti had a 0 for rule of law and a 0 for freedom from corruption. Those with a 6 for rule of law are all industrial countries (except Taiwan). All of them except Portugal get either a 5 or a 6 for freedom from corruption. A low—quality bureaucracy is one where reams of red tape slow business to a crawl. The opportunities for decentralized corruption in such circumstances are obvious. The Credit Risk Guide measures this on a 0 to 6 scale, but no country in 1990 got a zero. Bangladesh got a 1 on the quality of bureacracy in 1990 and a 0 on corruption. In Dhaka, you can wait for a cold front in hell to get your business permit, or you can pay a bribe. The countries with a 6 for high— quality bureaucracy are all industrial economies, except for Hong Kong, Singapore, and South Africa. The United States, for example, gets a 6 on high-quality bureaucracy, which may come as a surprise to those who have stood in interminable lines at federal agencies. Still, everything is relative. Standing in line is not as bad as having to go to fourteen different departments to complete paperwork. All countries with a 6 for bureaucratic quality had either a 5 or a 6 for freedom from corruption (except Portugal again). Freedom from repudiation of contracts measures a different aspect of business and government relationships. A high expected rate of repudiation makes corruption more possible, as private individuals feel the need to bribe officials in order to have their contract honored. (And they will include the cost of this bribe in their contract, so the government winds up overpaying because it threatens not to pay.) Freedom from repudiation of contracts is measured on a 1 to 10 scale. The worst countries on this measure in 1990, with a 1 or a 2, are Myanmar, Liberia, Lebanon, Iraq, Haiti, Sudan, Zambia, and Corruption and Growth 251 Somalia—not exactly honest economies, as it turns out, with an average freedom from corruption score of 1.67 on the 0 to 6 scale. The countries with a 10 are all industrial countries, again with the exception of newly industrializing Taiwan. All of the 105 have a 5 or 6 on freedom from corruption, with the exception of Taiwan and Italy. Finally, freedom from expropriation strikes right at the heart of business-government relations. With a high risk of expropriation, corruption will flourish as businesspeople make protection payments to those who might expropriate them. The worst countries on this measure in 1990, with a 1 or a 2 on a 1 to 10 scale, were New Cale- donia, Iraq, and Namibia. Those with a 1 or a 2 in 1982 were Iran,. Libya, Syria, Iraq (again), and Lebanon. The average freedom from corruption score of these economies was 1.9. All countries with a 10 on the freedom from expropriation measure are industrial countries, and all industrial countries have a 10 except for Australia, which has only a 9. All of these industrial countries have a freedom from corruption rating of 5 or 6, except for Spain and Italy. In general, the data show a strong association between institu- tional quality and corruption. (This sample includes corruption in 1982 against institutional quality in 1982, and corruption in 1990 against institutional quality in 1990.) Countries with the worst insti- tutions have corruption that is between 2 and 4 ratings below coun- tries with the best institutions. Corruption is high in countries with any of the four kinds of poor institutional quality. It is low in coun- tries with any of the four kinds of the best institutional quality. These strong relationships need to be interpreted cautiously. They are subjective ratings, and so the businesspeople surveyed may simply perceive a worse bureaucracy in a corrupt economy than in an honest economy. There may be some third factor, like bad gov- ernment policies or low per capita income, that causes countries to have both corruption and poor institutions. Still, the strong associa- tion between institutions and corruption is at least consistent with the View that institutions can influence corruption.22 Policies to Control Corruption Institutional reform is difficult but not impossible. Ghana, for exam- ple, increased its quality of bureaucracy from 1982 to 1990 from 1 to 4 (on a 0 to 6 scale). It increased its rule of law from 1 to 3 (also on a 252 ' ' Chapter 12 0—6 scale). The government reduced the black market premium all the way from 4,264 percent in 1982 to 10 percent in 1990. So it was probably no accident that Ghanaian freedom from corruption in- creased from 1 in 1982 to 4 in 1990 on a 0—6 scale. The findings in this chapter point to a way out of corruption and its growth-killing effects. First, set up quality institutions. Eliminate red tape, establish rules that government honors contracts and does not expropriate the private sector, and create a meritocratic civil ser- vice. These institutions create checks and balances on officials instead of opportunities for payoffs. Second, establish policies that eliminate incentives for corruption. A high black market premium or a highly negative real interest rate practically guarantees massive graft. Eliminating both is not only good for growth, as we saw in the previous chapter; it is also good for controlling corruption. Too often we have treated government as if it were some benefi- cent agent that we could advise on how to benefit the public weal. The knowledge that governments are often corrupt gives pause to such an attitude. Knowing that governments are corrupt, we should be cautious about relying on them to do interventions on behalf of growth. For example, we wouldn’t want to recommend industrial policies that subsidize certain sunrise industries, because govern— ments are likely to take payments when they decide whose sunrise to subsidize. The best course would be to eliminate government’s discretionary power over households and businesses as much as possible and set up hard and fast rules of the game for government operation. Too long we have ignored corruption on the quest for growth. ...
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