Costs of Corruption

Division State and Democracy
Supporting the Implementation of the UN Convention against Corruption (UNCAC)
Costs of Corruption: Everyone
Pays – And the Poor More than
Others
Eschborn 2008
Deutsche Gesellschaft für
Technische Zusammenarbeit (GTZ) GmbH
Supporting the Implementation of the
UN Convention against Corruption
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65760 Eschborn / Germany
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I www.gtz.de
Division State and Democracy
Supporting the Implementation of the UN Convention against Corruption (UNCAC)
Costs of Corruption: Everyone
Pays – And the Poor More than
Others
Eschborn 2008
Published by:
Deutsche Gesellschaft für Technische
Zusammenarbeit (GTZ) GmbH
P.O. Box 5180
65760 Eschborn
T
F
E
I
+49 6196 79 – 0
+49 6196 79 – 1115
[email protected]
www.gtz.de
Division State and Democracy
Supporting the Implementation of the UN Convention
against Corruption (UNCAC)
Editor: Dr. Dedo Geinitz
Head of UNCAC Team
Author:
Dr. Frédéric Boehm, Member of UNCAC Team
Johanna Joerges, Member of UNCAC Team
Contact: [email protected], [email protected],
[email protected]
Table of contents
I. Corruption – A Stumbling Block for Sustainable Development
2
II. Problems of Assessing Costs of Corruption
2
III. Effects of Corruption
3
IV. Conclusions and Policy Implications – The Role of UNCAC
11
References
13
Suggested Links
14
1
I. Corruption – A Stumbling Block for Sustainable Development
In order to reach the Millennium Development Goals (MDGs) and to fight effectively against
poverty, the international community in the Monterrey Consensus has agreed to scale up aid.
It has also been acknowledged that the scaling-up of Official Development Aid (ODA) alone
will not suffice to reach the MDGs but moreover demands to improve the effectiveness of aid,
as developing and donor countries have agreed on in the Paris Declaration on Aid
Effectiveness.
However, this paper argues that corruption has to be understood as a direct threat to the aid
effectiveness agenda and as a major stumbling block for achieving sustainable development.
To do so, it provides an overview on the wide variety of costs arising because of corruption.
Of course, scientific research has shown in an impressive way during the last 15 years that
corruption is not just a minor problem and there is a broad consensus now in literature and
amongst practitioners that corruption, usually defined as abuse of entrusted powers for
private benefits (see Transparency International or World Bank), is not a zero-sum game or
even ‘greases the wheels of an economy’. Rather, corruption imposes important economic,
social, and political costs on society as a whole and thereby undermines development. The
time of defending or playing down corruption should definitely belong to the past.
II. Problems of Assessing Costs of Corruption
The problem with corruption is that unlike other crimes, those that are hurt by corruption are
often not directly linked, neither in space nor in time, with the corrupt activities. Of course, a
government official extorting a bribe imposes a direct harm on the one that has to pay. Also,
it is sometimes possible to put a number on looted money by some kleptocrat. For instance,
according to Transparency International, Nigeria’s former president Sani Abacha embezzled
about 2 to 5 billion US$ between 1993 and 1998. And there are also estimates of overall
bribes paid worldwide. According to the World Bank Institute, more than $1 trillion dollars
(US$1,000 billion) is paid in bribes each year.
But corruption has more far-reaching and damaging consequences for society and the
economy as a whole as one can tell based on such estimations. For instance, the money
looted, e.g. by Abacha, usually leaves the country and is thus not available there anymore for
other productive or redistributive purposes. Also, the possibility to extort bribes biases the
incentives for government officials and has detrimental effects on overall governance, and
thus on quality and availability of public services, for example. And bribes and embezzlement
are just two aspects of corruption. Non-monetary and monetary effects of favouritism and
nepotism as well as fraud (e.g. manipulation or falsification of information) have to be added
to the picture. A further problem with assessing the costs of corruption, in particular of high
level (‘grand’ or political) corruption is the iceberg-phenomenon: While some cases of
corruption are reaching the surface, most of corrupt deals are likely to remain undiscovered.
Furthermore, it has to be differentiated clearly between the supply and the demand side of
corruption. Focusing only on the public side is too narrow, and would impede an adequate
approach to fighting corruption.
These aspects and the complexity of the phenomenon ‘corruption’ as well as the rather
diffuse and indirect consequences of corruption make the cause-effect relationship difficult to
establish—not only for determining the actual amount of costs but also for the assessment of
anti-corruption policies’ effectiveness.
But then, how to measure costs of corruption if we do not even dispose over data on the
magnitude of corruption? Unfortunately, it can be observed that where ‘hard data’ is lacking,
a problem does not receive due attention, is not taken serious, or even said not to exist.
2
Without data, it is not possible to verify or refute empirically hypothesis from theory, and not
at least it is more difficult to reach the general public or politicians. However, even though
dimensions such as corruption, social capital or good governance may be difficult to
measure, they are still key for development and the fight against poverty. Reported cases of
corruption, as provided for example by the Crime Prevention and Criminal Justice Division of
the United Nations Office on Drugs and Crime (UNODC) are not the solution. This data
rather reflects the quality of prosecutors, courts and/or the media in exposing corruption, the
effectiveness of the judicial system, but certainly not the extent of corruption in a country or
region (Lambsdorff, 2005). Moreover, such data is biased, since these are cases of
corruption that failed—‘successful’ corruption is just not included in these statistics.
Instead, to measure corruption, research recurred to subjective data built on the experience
and perceptions of those who are directly confronted with the realities of corruption in a
country. That is, experts in and outside a country, government officials, managers from
national and multinational firms operating in a given country, donor staff, NGOs and citizens.
The most prominent examples are the Corruption Perception Index (CPI) from Transparency
International (see http://www.icgg.org, or http://www.transparency.org), and the World Bank
Worldwide Governance Indicators (http://www.govindicators.org). Based on these and other
indicators, econometric studies are increasingly able to assess and estimate the effects
corruption has on specific variables, putting numbers on the costs of corruption, and an
extensive branch of literature emerged. 1
III. Effects of Corruption
Impact Channels of Corruption
Before presenting the findings, some preliminary aspects can be highlighted. For instance,
economic theory can provide insights on why and how corrupt activities arise and what
effects they are likely to have. First of all, a public official disposing over discretion and
having a monopoly over a certain decision (e.g. deliver a licence or a passport) has also the
possibility to behave like a monopolist and to maximize his incomes from extortion and
bribes. This means that irrespective the nature of the regulation (‘red tape’ or socially
beneficial), he can ‘sell’ his decision and will create artificial bottlenecks in order to increase
willingness-to-pay. In other words, the public official will create inefficiencies. This aspect
shows that the argument in favour of speed money as an informal incentive payment for
public officials is erroneous. The possibility to extract speed money sets incentives to work
even slower—the larger the queue, the more people will be willing to pay the bribe. Besides
being inefficient, such behaviour is also socially harmful since those whose ability-to-pay is
lower than their willingness-to-pay will just not be able to pay the bribe and are left aside. The
poor are disproportionably hurt by such low-level corruption.
Second, resources will not be allocated efficiently because of corruption. Opportunities for
corruption may bias decisions of public officials or politicians towards transactions offering
more opportunities to strike corrupt deals. Opportunities for corruption are particularly
present in one-shot purchases of non-standardised goods or services, with complex, diffuse
or ‘soft’ specifications. Typical examples are construction contracts, big infrastructure
projects, with the risk to become ‘white elephants’, or arms procurement (‘national defence’ –
secrecy required!) and the like. Resources that would have had more efficient use elsewhere
could thus be wasted into such projects. One may remark that investments into infrastructure
are needed, especially in developing countries, so what’s the problem with building them?
1
Of course, as with all statistics, a sound degree of caution should remain when interpreting and
generalising these (and other) findings.
3
Corruption might just be a certainly annoying but somehow necessary and only temporary
transaction cost for getting things done. But this argument misses out that corruption also
reduces expenditures for operation and maintenance, comes along with poor quality, and
usually to high service prices. White elephants are thus likely to have a short life compared to
their living pendants in nature – what good is a road that becomes impassable just one year
after inauguration?
Third, corruption raises the costs of doing business and of public-private contracting, thereby
also undermining efforts to promote private enterprises, since small businesses are likely to
be hurt more (they are likely to have less bargaining power than large firms). On the one
hand, firms will waste more time negotiating with corrupt public officials, thereby augmenting
the transaction costs of making business. Svensson (2005: 29), for instance, finds that the
level of corruption increases the number of days needed for a business to be set up. This, of
course, may deter investments (see below)—according to the UN firms lost at least 37 % of
management time dealing with governments. 2 These costs may become so high that small
firms are condemned to stay in the informal sector, limiting thereby their access to capital
and possibilities to grow.
On the other hand, delivery of services and products will be suboptimal and the value of
contracts will be higher with corruption. Hobbs (2005) estimates that 10-15 % on average
contract value is taken as kickbacks on World Bank projects. Also, 5 % of investment and
maintenance costs in infrastructure are lost because of corruption (Kenny, 2006:4). 3 Of
course, firms will try to amortise these additional ‘investments into corruption’ either through
higher prices of procured goods and services, or lower provided quality (a disguised higher
price)—or both. Even if control mechanisms are designed to ensure that an adequate quality
is supplied, quality controls can be easily circumvented by bribing corrupt supervisors for
turning a blind eye on low quality—and who supervises the supervisor? These inefficiencies
persists in time, since firms won’t, of course, reduce prices or improve quality once costs of
corruption are recovered. Also, investments into corrupt networks and savoir-faire become
an asset to the firm, which is then able to benefit from economies of scale: once corrupt, it is
rational to stay corrupt and keep on using established corrupt channels and savoir-faire.
At the same time, however, corrupt contracting comes along with considerable transaction
costs and risks for the firm. For example, politicians may extort favours after firms have sunk
their investments (‘hold-up’ problem), a public official may menace to blackmail or denounce
the corrupt deal in order to extract more benefits for himself, corruption scandals may mine
the reputation of a firm and come along with sanctions from capital markets (see, for
instance, the case of Siemens), or managers with corrupt savoir-faire may abuse this
knowledge for embezzling money from their own firm. Also, Lee and Ng (2006) show that
firms from countries with high levels of corruption are valued less by international investors.
Being corrupt may backfire, and virtue may pay-off. Firms may thus increasingly realise that
there is actually a business case for fighting corruption.
But corruption also undermines the confidence of citizens in their government, which may
lead to a disenchantment regarding political and administrative processes, deligitimising the
state, and offsetting the monitoring function citizens could play – thereby worsening even
more the debility of institutions. Corruption then undermines legitimacy of the state and rule
of law, and may weaken the states’ ability to defend its system of values. Once a governance
situation is deteriorated it becomes extremely difficult to restore the rule of law, good
governance, and trust between citizens and the state. The system becomes trapped into a
2
3
4
http://www.un.org/events/10thcongress/2088b.htm
According to the author, the financial burden alone may add up to about US$ 18 billion a year in
developing countries (for comparison this corresponds with the amount of the 2005 GDP of Ghana
and Tanzania taken together).
vicious circle of bad institutions favouring corruption, leading in turn to a further going
weakening of institutions. Cynicism such as ‘when they can rob money, I can do it too’, and
even a positive connotation of certain types of corruption (‘ser vivo’ – ‘be smart’, in some
Latin-American countries) are the consequence, which are particularly difficult to address by
anti-corruption policies. Countries get caught in a corrupt situation from which it is extremely
costly and difficult to deviate: the problem of path dependence (Della Porta and Vanucci,
2005: 157).
These, and other, perverse effects of corruption on economic, political, and social aspects
have been tested in a wide variety of studies. We now present some of them.
Growth, Productivity, and Investments
Corruption negatively affects productivity. An indicator for productivity is the ratio of a
country’s GDP to its capital stock. We can observe a significant impact of corruption on this
indicator. Estimations by Lambsdorff (2003) suggest that an increase in corruption in the CPI
by one point lowers productivity by 4% of GDP, whereas a 6-point improvement, for example,
an increase in Tanzania's level of integrity to that of the United Kingdom, would increase
GDP by about 20 %.
Corruption deters investments. One of the reasons for this is because the effects of
corruption are comparable to a tax on investments. A firm wishing to make an investment
has to take into account the costs of bribery for setting up a business and keeping it running
(see De Soto, 1989: 134, or Djankov et al, 2002). Theories related to this argument of
corruption preventing from doing business are usually called tollbooth-theories. Indeed,
sometimes regulations may be abused to extort bribes. It is estimated that an increase in the
CPI by about one point has the same effect as a 7.5 percentage point’s increase of the tax
rate, or an increase of corruption from the level of Mexico to the level of Singapore is
equivalent to raising the tax rate by over 20 % (Wei, 2000, and Smarzynksa and Wei, 2002).
Also, Mauro (1997: 9) finds that if a country improves on the BI corruption index by 2 points,
investments increase by 4 %. There are also tremendous costs for development when firms
are condemned to remain at the level of the informal economy just because they cannot
cope with the costs of setting up a legal business – sometimes a considerable part of these
costs are related to extorted bribes.
Foreign Direct Investments (FDI) are also negatively affected. In particular FDI involving
sophisticated technology suffer from corruption because investors fear for the leakage of
technological know-how to opportunistic and corrupt local partners. According to Mauro
(1995: 695), a one-standard deviation improvement in the corruption index is associated with
an increase in the investment rate by 2.9 % of GDP, controlled for red tape. Smarzynska and
Wei (2002), using a firm-level data set on FDI in Eastern Europe and the Former Soviet
Union in the early 1990s, find the following relationship:
“A decrease in corruption incidence from the level found in Azerbaijan (high) to that
prevailing in Estonia (quite low) is associated with an increase in the probability of
foreign investment from 4 to 19 percent.”
However, corruption is a very broad, complex phenomenon, and not every type of corruption
may have the same deterring effect. Indeed, Lambsdorff (2005) argues that investors are
deterred above all by low-level (“petty”), unpredictable corruption in administrations, whereas
grand corruption is not so problematic for (corrupt) investors. By becoming ‘insiders’, firms
are able to ‘manage’ this type of grand, political corruption and divide gains from corrupt
agreements with politicians or government officials. This, however, in no way means that
grand corruption is less problematic because deals between firms and high level public
officials are carried out at the expense of society at large (paying, for instance, higher prices
5
for electricity due to a corrupt power purchase agreement) and of honest competitors which
will be driven out of these markets.
Because of these effects on productivity and investments, corruption is likely to affect growth.
However, the impact is more difficult to assess, and the studies often suffer from theoretical
and empirical weaknesses (Lambsdorff, 2007: 75). For instance, one of the first contributions
using datasets to measure effects of corruption is the study by Mauro (1995) and deals with
growth and investments. The author uses the corruption index from Business International
(BI) and finds a significant negative association between corruption and investments, but
only weak statistical support for the hypothesis that corruption lowers growths. Mauro (1995:
704-5) further supposes that most of this effect on growth is due to the negative investment
effect. In a later study, Mauro (1997:9) shows that if the corruption index (here the average
between the index from BI and the Index by the International Country Risk Guide, ICRG)
improves by one standard deviation (equal to 2.38 in this case), the investment rate
increases by more than 4 % and the annual growth rate of per capita GDP increases by over
a half %.
It should be noted anyway that growth measured as GPD, or even GDP per capita, is a very
limited indicator for development and should thus be handled with caution.
Education, Health and Environment
As emphasised above, corrupt governments and corrupt political systems are likely to
allocate more to military purposes and arms procurement and less to education and health. It
is simply easier to extract corrupt gains from such type of deals as from labour-intensive
projects in schooling or hospitals. 4 Obviously, such an allocation of resources is at odds with
societies’ desires and human rights and is particularly harmful for long-run sustainable
development of an economy. Also, corruption of course diminishes the efficiency of what is
spent by governments in health.
Looking at data, Mauro (1998) finds a very strong negative correlation between corruption
and government expenditures on education, even when controlling for GDP per capita: “[…]
this result implies that if a given country were to improve its ‘‘grade’’ on corruption from, say,
a ‘‘4 out of 6’’ to a ‘‘5 out of 6’’, on average 2 its government would increase its spending on
education by about 0.6% of GDP.”
But researchers have found other interesting connections between corruption and education.
For instance, corrupt societies significantly distract students from studies and jobs aimed at
increasing production, such as engineering, towards those jobs where legal opportunities
and loopholes are sought-after, such as law (Tanzi and Davoodi, 2001). Although such type
of results have to be handled with caution, they are nevertheless interesting. Also, student
drop-out rates can be considered as a proxy for the quality of public education, and they are
five times as high in corrupt countries.
In African countries, between 30 and 76 % of non wage funds going to primary education are
lost (Reinikka and Svensson, 2005). Svensson (2005: 27-30) finds a positive relationship
between corruption and the number of years in school. An increase in the index of corruption
4
6
This, of course, does not mean that the sectors of education or public health are free of corruption.
On the contrary, examples from these areas abound. An interesting example is the case of collusion
between the three major French construction firms, Bouygues, Suez-Lyonnaise, and Vivendi. The
three firms participated in a corrupt cartel for construction works in schools in Ile-de-France between
1989 and 1996. The contracts that were shared among the firms were worth about 28 billion Francs.
Additionally, this collusive agreement involved political corruption to stabilize the cartel: 2 % on all
contracts were paid to political parties in the region (Le Monde, 12/10/1998, "Un système d’entente
mis au jour dans l’affaire des lycées d’Ile-de-France", by Jacques Follorou).
by one point reduces school enrolment by almost 5 % and life expectancy by about 2 ½
years (Dreher and Herzfeld, 2005:11, and Mo, 2000).
Life expectancy is of course closely related to public health policies, and as mentioned
before, corruption is likely to diminish government spending on health. Also, within the health
sector, investments may tend to favour construction of hospitals and purchase of expensive,
high tech equipment over primary health care programs such as immunization, HIV
prevention programmes, and family planning. These, however, have much higher marginal
effects on the health situation of the population, in particular the poor. And corruption has
also measurable effects on other health indicators as life expectancy, even when adjusting
estimations for income. Child mortality rates in countries with high levels of corruption are
about one-third higher than in countries with low corruption. Infant mortality rates and the
share of low-birth-weight babies are almost twice as high. And again, the poor are
disproportionably hurt by corruption. Anecdotic evidences from around the world report from
bribes that have to be paid to get medicine, to get access to hospitals, or to be treated by the
doctor. The Global Corruption Report 2006 cites a study carried out in Azerbaijan. About
35% of births in rural areas take place at home because of high charges for care in facilities
where care was supposed to be free.
And even from this biased too low budget, much is lost because of corruption. In the Global
Corruption Report 2006, TI reports that in the US, Medicare and Medicaid estimate that 5 to
10 % of their budget is lost due to corruption. In the United Kingdom, the National Health
Service’s (NHS) anti-fraud unit reports it has stopped corruption totalling more than £170
million (US $300 million) since 1999, and the total financial benefits to the NHS (which also
includes recovery of losses due to fraud and reduction in measured losses due to
intervention by the counter-fraud service) have been four times that. But how much remains
undiscovered? There are huge potential returns on investing in anti-corruption strategies. For
instance, the Government of the Philippines has been able to save 53 % of costs for various
drugs and medicines as a result of posting procurement opportunities on its electronic
procurement system (Philippine government Electronic Procurement Service in OECD DAC
2005). Along these lines, a study from Argentina showed that the variation across hospitals
in prices paid for medical supplies dropped by 50 % after the ministry began to disseminate
information about how much hospitals were paying for their supplies (Di Tella and
Schargrodsky, 2003).
Environmental quality also suffers from corruption, and corruption undermines effectiviness
of environmental policies. Indeed, pollution increases due to a less effective environmental
regulation which can be circumvented through bribes. Pellegrini and Gerlagh (2006), for
example, find that corruption significantly impacts on the strictness of the environmental
policies. Welsch (2002) analyses the impact of corruption on a variety of pollution indicators.
For instance, ambient pollution of air (the urban sulphur dioxide and suspended particulate
concentration) and water (dissolved oxygen demand and suspended solids) increases. The
author underscores that the relationship between corruption and environment is particularly
strong at low income levels; developing countries could thus considerably improve both their
economic and environmental performance by reducing corruption. According to Smith et al
(2003), corruption undermines trade bans of endangered species (as under the Convention
on International Trade in Endangered Species of Wild Fauna and Flora, CITES) and thus
contribute to reducing biodiversity. The authors find that countries with high levels of
corruption tend to experience decreases in the population of elephants and black
rhinoceroses, as well as a lower variety of species and a reduced total coverage of forest.
7
Box 1: An Illustration for the Link between Corruption and Environmental Deterioration
Regulation of public utilities has been decentralized substantially in China both to the regional agencies and to the
sectoral agencies. While no conclusion can be drawn whether centralized or decentralized agency is more
susceptible to capture, there are some institutional factors that make regional regulation less robust to corruption.
On the one hand, the local regulatory agencies are subject to no effective control of the central government while
the local governments can easily affect their policies. Such institutional arrangement will necessarily cause
concerns of market segmentation or favoritism to local players. On the other hand, social networks are more
developed and effective which imply that local regulations can be captured more easily than national regulations.
A case in point is the development of many small-sized power stations. As a result of relaxed regulation on entry,
in many regions small coal-fired plants and hydro plants have been built. These plants with below-efficient sizes
are not only inefficient but also produce heavy pollutions. Indeed, the sizes of these plants are in general below 5MW and they produce on average three times more than those produced by the more efficient plants with a
minimal capacity of 30-MW. To solve this problem and to create a more efficient industrial structure, the
government has issued strict regulations to close down these plants.
Unfortunately, these regulations are not strictly implemented. To the contrary, the number and installed capacity
of small generation plants continues to increase and crowds out more efficient generation capacity. The problem
is that the local governments exert their influence on the local regulatory agencies for not implementing the
restructuring policies initiated by the central government. In some cases, the local governments simply collude
with these plants against the central government through hiding information and false reporting. In other cases,
when the central government checks on site the situation, the local government sends a warning in advance to
the plants and then the informed plants close the plants temporarily to avoid being caught. When the checks
finish, business is as usual.
The local government's incentives to help local generation plants come from the fact that local production help
increase employment and local tax revenues which contribute to local officials' promotion. So by keeping silence
and collaborate with local plants on this matter, the local government has an easy life.
Source: Laffont (2005)
Inequality and Poverty
The foregoing paragraphs already showed that the ones who suffer most from corruption are
the poor. Even if rich and poor would be equally confronted with corruption (which is unlikely)
the impact on the individual budget of the poor as percentage of their income would be much
higher. While comparatively rich persons might reluctantly pay the bribe extorted by a public
official, for a poor person this same bribe request may signify that he has no access to the
service. Further, higher tariffs for public services related to grand corruption, as noted above,
also have a higher impact on the poor’s budget. Corruption works like a regressive tax, the
poor tend to be more affected. Rose-Ackermann (1996) reports that case studies showed
that illegal payoffs can lower the quality of public works projects and increase costs by as
much as 30–50 %. Lovei, Alastair and McKechnie (2000) analyse the various costs of
corruption arising for the poor in the energy sector.
It is not surprising that the correlation between corruption and GDP per capita is very strong.
40% of all countries in the CPI 2007 that are scoring less than 3 points are rated by the
World Bank as "low income" countries. However, as emphasised by Lambsdorff (2007: 71)
and already noted above, the causality is quite difficult to determine: does poverty induce
corruption (e.g. to augment a too low salary to survive), or does corruption increase poverty
(e.g. through exclusion, poor infrastructure etc.)? For sure, causality is likely to run both
ways. Furthermore, as mentioned before, GDP per capita is only a very limited indicator for
development, and for instance does not tells us anything about the distribution of incomes
within a county (inequality). Nevertheless, the study by Gupta et al (2002) finds a significant
impact of corruption on the Gini coefficient, a standard measure for inequality, and the
authors are able to show that it is corruption that affects inequality and not the other way
round. Furthermore, the authors find that income growth of the bottom 20 % of a country is
particularly low due to corruption.
8
The transnational aspect of corruption adds another detrimental effect on a country’s
development. Corrupt individuals, from inside or outside the country, will usually hide the
looted money in ‘safe havens’. The amount of money extorted and stolen each year from
developing countries is estimated to be over 10 times the approximately $100 billion in
foreign assistance that is provided by all governments and civil organisations worldwide (U4
Brief, February 2007, No. 2). This sheds light on the highly relevant issue of asset recovery
addressed in Chapter V of the UN Convention against Corruption (UNCAC); one of the
instruments that has generated high expectations. For instance, Nigeria recovered over $700
million of the money extorted by Abacha, and over $600 million was returned to the
Philippines from the loot plundered by Marcos (U4 Brief).
Democracy and Good Governance
The word democracy derives from the ancient Greek dēmokratia (δημοκρατία) (literally, rule
by the people) and in a general understanding democracy is still linked to ruling by the
people. That means that mechanisms of decision-making regarding rules and their
implementation have been established to ensure that the governed have an influence on
these decisions and that the political system provides for checks and balances. Both rule
definition and implementation ideally take place under public scrutiny. But corruption, hidden
by nature, is a violation of agreed rules and affects democracy and good governance, i.e.
basically the way decisions are taken, through various channels.
A core function of a democratic state is the control over public funds through the public
finance system. Corruption can undermine this system in three ways. First of all, in most
countries a social and political consensus has been established that private wealth is subject
to a redistributive system to guarantee the provision of public goods and to prevent
excessive social inequality. Therefore, income is taxed. Through bribing tax officials or
through tax evasion, corrupt practices undermine the ability of the state to tax private wealth
and revenues. Second, public expenditure is agreed on in the budget usually approved and
controlled by parliament, by central audit authorities and by civil society and media. But, as
already mentioned, corruption distorts the budget towards expenditures offering the highest
corrupt opportunities, undermining thereby the democratically wished use of resources
favouring narrow interests over public interest.
Finally, corruption may also directly seek to influence the policy making and the rules and
regulations of a society, thereby undermining democratic processes as well as the legitimacy
of the state. This perhaps most sophisticated form of corruption is often called state capture
or ex ante capture. This is a quite elegant form of corruption, since firms afterwards can
comply with the regulations they paid for without having to bribe administration for evading
them. For example, technocrats in the Food and Drug Board can be bribed to manipulate the
definition of standards and requirements for a new drug to be registered in favour of a
specific supplier/drug. Also, infrastructure regulations governing private-sector-participations,
for instance in water provision, can provide huge monopolistic gains to private firms, or
tender processes in public procurement can be influenced to the benefit of a bribe paying
contractor (for corruption in tender processes see for instance Boehm and Olaya, 2006).
In a very innovative study, Fisman (2001) uses stock market and accounting data from the
Jakarta Stock Exchange (JSX), combined with data on the group affiliation of all JSX firms, a
measure of political dependence of a subset of firms and information released on the health
of Suharto in order to estimates the value of such high-level political connections for firms.
The idea is that when rumours about Suharto’s health would point towards a possible regime
change, stock prices for firms with close ties to Suharto would drop. Fisman’s finds that
political connection to Suharto accounted for a quarter of the value of well-connected
Indonesian firms. Good connections are thus vital for business. It is questionable whether an
economy that is so dependent on personal relationships is really able to unfold the potential
9
benefits of the market mechanism and does not lead to an entrenchment of vested interests
on the cost of society as a whole.
A second basic principle of democracy is the restriction of power through a system of checks
and balances. This is often implemented through an independent judiciary, the parliament
and through civil society and especially the media. The case of Montesinos – the secret
police chief of former Peruvian President Fujimori - who videotaped and recorded his bribepaying activities illustrates how corruption undermines democratic control mechanisms. As
McMillan and Zoido (2004) found the highest bribes were paid to the media. However, each
check reinforces the other. With accumulation of powers – executive, legislative judicial and
media – through Montesinons’ corrupt techniques he was able to undermine democratic
control tools. This conclusion is supported by data from the Freedom House Index. Peru was
ranked as partly free in the index during the Fujimori regime and figures on political rights
and civil liberties improved after his dismissal. 5
Last but not least, corruption in appointments of public officials (nepotism) and as source of
political power are often interrelated and can have negative effects on the states’ ability to
satisfy citizens’ needs and on its legitimacy. Manifested in incompetence of office holders,
bad performance and weak governance these costs of corruption are, however, hard to
measure. Corruption in party and campaign financing has far reaching consequences as it
affects the roots of later governing administration.
Box 2: Two Examples of a ‘Corrupt Privatisation of Public Roles’
An example from Colombia illustrates the corrupt relationship in the process of appointment of public officials. A
business man makes a campaign donation to a politician who in reward appoints a bureaucrat that helps the
businessman winning public contracts. The bureaucrat - appointed through a corrupt deal - thus feels more
accountable towards the involved businessman and politician than towards the public he is supposed to serve by
law.
Source: Lambsdorff/Fink 2006:18.
Another example shall illustrate the huge potential dimension of such corrupt relationships. A network and a
clutter of incidences of political corruption came to light during the investigation into former state oil firm Elf
Aquitaine (now renamed Total). In Transparency International’s Global Corruption Report 2004 Nicholas Shaxson
(author at Economist Intelligence Unit) gives an overview over the corrupt networks involving private and public
actors.
“Elf was state-owned until 1994. Graduates of elite French institutions regularly rotate between political
and diplomatic posts, state firms like Elf, big private companies and the secret services. (…) Details of Elf’s
payments, the court has heard, were even sent for approval to French budgetary authorities, the presidency and
5
This points out to the
10
customs. The Elf ‘system’, in place since the 1960s, had two other purposes, essential for its survival. One was
the covert financing of France’s main political parties and secret services. The second, also essential in
preserving silence, was personal enrichment (...)”
Having the network system in place, players were able to manipulate political decisions and extort funds. Shaxson
writes:
“The trials have identified many corrupt or questionable mechanisms: overpayment for asset generating
hidden subsidies, payment through chains of offshore accounts, the use of Gabon as an offshore financial
turntable for generating hidden payments, and the use of secrecy and commercial intelligence as keys to financial
success. There are ‘revolving door’ problems; the use of politically networked intermediaries to win deals;
specialised trading companies that confuse revenue flows; persisted links between oil and the covert arms trade;
and the assumption by oil firms of diplomatic functions”.
IV. Conclusions and Policy Implications – The Role of UNCAC
This paper illustrates the enormous costs that corrupt practices generate and indicates the
negative effects and impact on the quality of governance and public policies, the business
environment as well as the individual lives of the people, in particular the poor. Corruption is
one of the major risk factors affecting efforts to achieve sustainable development, stabilize
governance systems, and reduce poverty. Tackling the issue of corruption is indeed not an
end in itself, but helps directly to secure the path towards sustainable development. And
much is at stake. Critics pointing to countries that achieved growth with high levels of
corruption are missing the point: these countries grew despite of corruption, and the question
is how sustainable can it be to look at one sole indicator, GDP, while it should be clear that
development involves much more. And, moreover, corruption makes business inefficient; the
economy as a whole could grow even more in a clean environment.
Acknowledging these damaging effects of corruption on achieving sustainable development,
it is important to underscore once again the effects corruption may have on aid effectiveness.
Of course, corruption undermines the effectiveness of aid in reaching its target groups: the
poor. But moreover, and to make it more complicated, the relationship between foreign
(financial) aid and corruption is complex and might yield unpopular results. Aid itself may be
one cause of corruption and therefore contribute to actually increase the problem in a country
and prevent from development. Djankov et al (2005) finds that foreign aid has a negative
impact on democracy—actually the regressions show that aid is even a bigger curse than oil.
One explanation, just as for the case of oil, is that aid is a rent like manna from heaven,
easily to appropriate. The U4 Anti-corruption Resource Centre states in its contribution on
the causes and consequences of corruption point into this direction:
“…the flow of aid can increase the levels and costs of corruption. Most obviously, it
provides new resources to plunder but, more subtly, it is fungible, interchangeable,
which simply means that money going in for one purpose frees up other money for
another, potentially corrupt use.”
Thus, one the one hand, development cooperation must be aware of these risks, especially
regarding the scaling up of aid but also with respect to the changing modes of aid delivery as
a consequence of the Paris Declaration. General budget support, for instance, fits quite well
to the ‘manna from heaven’ scenario described above, and taking account of corruption in
such schemes becomes a key issue to secure the desired outcome of aid (on this, see
Kolstad, 2005, and other research carried out by U4). Technical cooperation as a support to
budget support could play an important role to achieve this. On the other hand, supporting
the fight against corruption in partner countries should be placed high on the agenda of
development cooperation. Corruption is no longer a taboo, and internationally widely
accepted instruments such as the UN Convention against Corruption (UNCAC) enable to
include the topic of corruption into the dialogues between donors and partner countries.
11
Of course, fighting corruption and overcoming inherent dilemmas and trade-offs is not an
easy task; it requires grassroots knowledge of the specific situations in sectors, countries,
and regions – there is no ‘one size fits all’ solution. Key concepts are of course the
introduction of transparency and accountability, sanctions and control, but recent research
pointing to the rather disappointing results of these traditional anticorruption measures
highlights the inherent instability of corrupt deals and puts forward the idea of promoting
opportunism and betrayal amongst corrupt partners – the ‘principle of the invisible foot’ (see
Lambsdorff, 2007). Also, focusing only on reducing red tape emphasises the private sector
as the victim of corruption (e.g. extortion) and ignores that often corruption is induced by the
firms in order to reduce costs (e.g. evade quality regulations) or enable undue benefits (e.g.
obtain market power through regulatory protection). Anticorruption has to take into account
both aspects – demand and supply side of corruption. Fighting corruption further requires a
broad coalition of public sector, private sector and civil society; also capacity development,
training and education (on this see, for example, Boehm and Nell, 2007) are crucial issues
for a prospective and sustainable fight against corruption in a society.
Moreover, due to the often international dimension of corruption, fighting corruption may
become difficult, if not impossible, for national prevention investigation and prosecution
systems alone. This aspect has been acknowledged in the United Nations Convention
against Corruption (UNCAC) which entered into force in 2005 and is by now ratified by 104
countries. Indeed, state parties to the UNCAC have pointed out in the preamble of the
Convention that “corruption is no longer a local matter but a transnational phenomenon that
affects all societies and economies, making international cooperation to prevent and control it
essential”. In consequence, the convention tackles the problem of bribe paying, of money
laundering, of bribe tacking and moreover the need for international cooperation and asset
recovery. The UNCAC in its preamble further clearly links the fight against corruption to good
governance and states that corruption is:
“(…) undermining the institutions and values of democracy, ethical values and justice
and jeopardizing sustainable development and the rule of law,”
UNCAC also acknowledges in its preamble the important issue of coordination and civil
society involvement:
“Bearing in mind that the prevention and eradication of corruption is a responsibility of
all States and that they must cooperate with one another, with the support and
involvement of individuals and groups outside the public sector, such as civil society,
non-governmental organizations and community-based organizations, if their efforts
in this area are to be effective”
But the convention does not stay on abstract levels but also proposes straightforward
guidelines for anticorruption prevention (chapter II), law enforcement (chapter III),
international cooperation (chapter IV), asset recovery (chapter V), and technical assistance
and information sharing (chapter VI). 6 But furthermore, as mentioned above, the UNCAC has
the potential to provide a basis and entry point for both political and technical discussion, and
may achieve a level playing field between developed and developing countries in the fight
against corruption.
6
See, for instance, GTZ UNCAC Project Factsheets: Factsheet No. 2 “UNCAC highlights”, No. 6
“Bangalore Principles”, No. 16 “Asset Recovery” and No. 20 “Making TA work”.
12
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Suggested Links
www.gtz.de/en/themen/politische-reformen/korruption/885/htm
www.u4.no
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www.icgg.org
www.transparency.org
www.govindicators.org
www.freedomhouse.org
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www.icgg.org
www.transparency.org
www.govindicators.org
www.freedomhouse.org
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