Understanding the economics of corruption

In the 1980’s, the prevailing view was that corruption can be good for growth.

Huntington said, “In terms of economic growth, the only thing worse than a society with a rigid, over-centralized, dishonest bureaucracy is one with a rigid, over-centralized, honest bureaucracy.”

In other words, it acted as the lubricant between the rusty wheels of bureaucracy.

But, now, several studies later, the consensus is that corruption is actually bad for growth. Many people compare taking bribes to taxes. However, it is worse than taxes, because taxes distort incentives but corruption goes one step further. It distorts incentives but the outcome is uncertain too. The only incentive to provide a good after taking a bribe for it is, if there is reputation cost involved. It may be better for growth if bribes were fixed and the outcomes certain. Then, corruption would simply be an additional tax.

Corruption is the misuse of public office for private gain. During Suharto’s regime in Indonesia, there was rumored to be widespread corruption and nepotism. Nevertheless, Indonesia recorded high growth during his tenure. This may have been because bribes were reportedly fixed at a constant proportion and the outcomes were generally certain. Suharto’s son, meanwhile, was running the biggest media conglomerate in the country. Of course, Suharto said that it was due to his son’s hard work and talent that he had reached where he had. Edward Miguel, a bright young economist, decided to investigate. What was the effect of being Suharto’s son on the firm’s value? He looked at the firm’s stock market price before and after Suharto fell ill (which happened on a number of occasions and was taken to mean that he may not be president with a greater probability) and compared the fall in the price of the son’s firm with a control portfolio of similar looking firms. What he found astonished him. There was a huge impact on the son’s firm but the control portfolio suffered only a blip. The difference-in-difference between the two stock prices before and after, would then give us a measure of the value of political connection or nepotism.

There are two types of corruption: with theft and without it. With theft, the government official just pockets all the money and provides say a driver’s license. Without theft, he gives the government the official price paid by the consumer, but takes an additional fee which he hides. In corruption with theft, corruption can propagate as price charged is usually lower than the official price. Interest of buyers and sellers are aligned, making corruption more persistent. An accounting system that limits theft may reduce corruption.

Banerjee argues that corruption is caused by bureaucrats wanting to make money and governments making laws to prevent them from doing so. Economists have models that try to model corruption as a way to get a product with a certain probability of getting caught. It is the marginal benefit and marginal cost (which depends on law enforcement) of doing so that determines the equilibrium level of corruption.

Sociological evidence suggests that corruption may also be a cultural phenomenon. In order to test if the sociological explanation holds water, Raymond Fisman and Edward Miguel had a look at the data for New York Parking tickets. Due to diplomatic immunity, foreign diplomats were not required to pay their fines until recently (until when the paper was published!). This meant that effectively the fear of punishment was zero for diplomats of all countries. So the only explanation of systematic patterns of unpaid parking tickets could be due to the cultural explanation. They found that countries that were more likely to be perceived corrupt (there are many indices that measure this including a World Bank index and a Transparency International index), were also more likely to have unethical diplomats.

Apart from trying to change the culture of corruption, there are two ways of reducing it. First, a bottom-up approach in which the locals are given the authority to supervise on projects. Second, the top-down approach, where the authority sends central representatives for monitoring. In a randomized experiment by Ben Olken in Indonesia that focused on road infrastructure, the top-down approach was found to be more effective in reducing over-reporting of use of funds. The grass-root level channel was subject to elite capture as has been found elsewhere in studies on aid and decentralization.

Therefore, it is very difficult to root out corruption. In a lighter vein, leaders of China, Russia and India went to meet God to know, ‘when the corruption will end in their country?' When the Chinese leader asked this question to God he replied, 'it will take 20 years.' The Chinese leader's eyes became moist as he felt sorry corruption will not stop. Then came the turn of Russian leader and God told him that it will take 50 years to end corruption. So the Russian leader started crying because it would not be possible to end corruption in his term. Now it was the turn of the Indian leader. Naturally, everyone understood that there will be longer period for him. So the Chinese and Russian leaders expected the Indian leader to cry but instead God himself started crying. When asked, 'Why are you crying?' God replied, ‘Corruption in India will not end in the term of Indian leader, but it will not end within my tenure also!’

References:

• Economic Gangsters: Corruption, Violence, and the Poverty of Nations (2008) by Fisman, Raymond and Miguel, Edward; Princeton University Press.
• Monitoring Corruption: Evidence from a Field. Experiment in Indonesia (2007) by Olken, Benjamin; NBER Working Paper.
• A Theory of Misgovernance (1997) by Banerjee, Abhijeet; Quarterly Journal of Economics.
• Corruption (1993) by Vishny, Robert and Schleifer, Andrei, Quarterly Journal of Economics.