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Corruption and public finance: an IMF perspective
European Journal of Political Economy Vol. 20 (2004) 1067 – 1077 www.elsevier.com/locate/econbase
Corruption and public finance: an IMF perspective Arye L. Hillman * Department of Economics, Bar-Ilan University, Ramat Gan 52900, Israel CEPR, London, UK CES-ifo, Munich, Germany Received 15 September 2003; accepted 16 September 2003 A review of Governance, Corruption, and Economic Performance, George T. Abed and Sanjeev Gupta, editors, International Monetary Fund, Washington D.C., 2002, pp 564, ISBN 1-58906-116-0 Soft cover Available online 28 July 2004
Abstract Public finance should be a means whereby governments in low-income countries are able to increase economic growth and end poverty. Corruption, however, reduces tax revenue and makes public expenditure policies ineffective for achieving social objectives. The papers in this volume, which is sponsored by the Fiscal Affairs Department of the International Monetary Fund (IMF), describe how corruption makes public finance ineffective in promoting economic development. D 2004 Elsevier B.V. All rights reserved. JEL classification: H11; H26; O17 Keywords: Corruption; Public finance; IMF
1. Introduction The people who can best describe corruption are those themselves engaged in corruption. After the perpetrators themselves, the next best placed to describe corruption are those who interact with the governments within which corruption takes place. Prominent among the latter are staff members of the International Financial Institutions. This book, edited by two staff members of the Fiscal Affairs Department of the International Monetary Fund (IMF) and with contributions principally by IMF staff
* Department of Economics, Bar-Ilan University, Ramat Gan 52900, Israel. E-mail address: [email protected] (A.L. Hillman). 0176-2680/$ - see front matter D 2004 Elsevier B.V. All rights reserved. doi:10.1016/j.ejpoleco.2003.09.004
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economists, demonstrates the extent to which issues associated with governance and corruption concern the International Monetary Fund. The studies in the book make clear why, when governments are corrupt, public finance is ineffective in increasing growth and reducing poverty.
2. Corruption within public finance In an introductory overview, the editors, George Abed, and Sanjeev Gupta, note the only relatively recent interest of economic researchers and also the IMF and World Bank in corruption. The attention that has come to be given to corruption is attributed to globalization through requirements of greater transparency by governments in poorer countries that have been recipients of private capital inflows. Previously, capital flows had been primarily official through governments and had been motivated by political influence sought by donors. Corruption under these circumstances was ignored: ‘‘many countries were governed by regimes that, to say the least, did not adhere to the strictures of good government, and most bilateral (and to some extent multilateral) donors and creditors often refrained from asking too many questions. The economics profession, with notable exceptions, lacking the requisite information or the will to challenge the prevailing political order, went on to other pursuits’’ (p. 3). The end of communism focused interest on corruption which was evident in the postcommunist states. At the same time, standards of conduct changed for governments in developing countries, with donors becoming less forgiving and governance indicators becoming part of the policy conditionality associated with concessionary loans and other aid from the international financial institutions. Nongovernment organizations (NGOs) such as, in particular, Transparency International, placed governance and corruption at the forefront of attention. The U.S. had adopted an anticorruption policy through the Foreign Corrupt Practices Act of 1977, with the rest of the developed world following in 1997 with the adoption of the OECD convention on Combating Bribery of Foreign Officials in International Business Transactions. The IMF also contributed to reducing corruption through standards of transparency and accountability in the management of public funds and through requirements to safeguard the use of IMF-provided resources and to preempt misreporting of information. This volume is another means, through policy research, whereby the IMF focuses attention on issues of governance and corruption. Vito Tanzi (Corruption around the world: causes consequences, scope, and cures) points out that corruption, defined as the abuse of public power for private benefit (p. 25), has been endemic in human civilization. Tanzi notes that bribes should be distinguished from exchange of gifts: cultural differences can explain different sizes of gifts but the question is ‘‘at what point does a gift become a bribe?’’ (p. 25). He observes the link between corruption and the size of government: corruption grew as the size of government grew. Government regulation, taxation, procurement, and public spending for private benefit all provide foundations for corruption. State enterprises have been, in particular, dens of corruption. Abolishing the state would abolish corruption because all transactions would take place in markets, and people could exchange gifts as well, if they so wished. Nathaniel Leff had proposed in 1964 that corruption could be beneficial in overriding
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bureaucratic impediments to economic activity. Tanzi, however, emphasizes the costs of corruption. People become disillusioned with markets (to the extent that free markets are present), with democracy (where present) and with the government itself; the intentions of government regulations and policies are subverted and property rights and the rule of law are compromised, as are markets and incentives. Income distribution is also made more unequal, with the poor likely to lose the most from corruption. Tanzi lists different solutions for corruption through penalties, institutional controls (honest and effective supervisors, good auditing offices, and clear rules on ethical behavior), transparent rules, laws and processes, and exemplary behavior by leadership. However, Tanzi notes the difficulties of eliminating corruption in poor countries where salaries in state employment are low and where overemployment in the state sector is often government policy. Tanzi concludes: ‘‘corruption is closely linked to the way governments conduct their affairs in modern societies (and) the fight against corruption is, thus, ultimately linked with the reform of the state’’ (p. 54).
3. Public-sector remuneration and corruption Caroline Van Rijckeghem and Beatrice Weder (Bureaucratic corruption and the rate of temptation: Do wages in the civil service affect corruption and by how much?, reprinted from the Journal of Economic Development 2001) investigate the relation between state-sector wages and corruption. The government of Singapore has paid, for example, relatively high public-sector wages, with the objective of attracting highquality personnel to government employment. The high wages also preempt incentives for bribes, which is an application of the efficiency-wage hypothesis (the high wages deter corruption by making dismissal unattractive). High wages are not required to eliminate corruption if the bribe potential is low. Corruption may also be inhibited by deferred postretirement payments and by greater probability of detection, as wages within a bureaucratic hierarchy increase. There is also a ‘‘fair-wages view’’ that government officials have a personal preference for honesty and will choose not to be corrupt provided that wages are sufficiently high so as to be regarded as ‘‘fair’’. The empirical results reported by Van Rijckeghem and Weder indicate that large increases in wages would have been required to eliminate corruption in a sample of 31 developing and low-income OECD countries (the data cover the period 1982 – 1994). Further evidence from case studies confirms rejection of the direction of causality that government wages are low because governments feel that they do not have to pay more because of the income from corrupt activities. With the causality running from low wages to corruption, the conclusion is that inordinately high increases in public-sector wages in poorer countries appear to be required if significant reductions in corruption are to take place. Sheetal K. Chand and Karl O. Moene (Controlling fiscal corruption) set out a model that shows how bonus payments to tax administrators can reduce corruption; the bonus payments substitute for bribes. A case study from Ghana is used to show how, after a change in government in 1981, ‘‘rampant fiscal corruption was brought under control’’. Chand and Moene propose that bonus incentives should be given to higher-level bureau-
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crats, although the authors note that bonus payments for collecting taxes could inspire overzealous tax-collecting behavior. The conclusion offers a view of human nature (p. 109): ‘‘Most fiscal officers, if properly trained, have a sense of professional pride and would not condone corruption’’ and the government officials ‘‘become corrupt partly out of necessity or because of peer group pressure’’.
4. Governments and discretionary corruption It is often taken for granted that governments have an interest in eliminating corruption because corruption reduces tax revenue and distorts the intent of public spending. However, Era Dabla-Norris (A game theoretic analysis of corruption in bureaucracies) sets out a model where corruption is discretionary and ‘‘arises when the dictator chooses not to deter it’’ because of monitoring costs, low wages in the state sector or ineffective tax administration. Because of multiple equilibria in the model, identical societies can end up with high or low levels of corruption. A country can therefore be caught in a high-corruption trap. In this type of model, high corruption is due to ‘‘bad luck’’. Joshua Charap and Christian Harm (Institutionalized corruption and the kleptocratic state) continue the theme of discretionary corruption in proposing that ‘‘corrupt practices are created to satisfy a leader’s desire to foster loyalty through patronage’’. That is, corruption may be an efficient means for the ruler or the ruling elite to maintain support. Corruption is, in these cases, ‘‘systematic and deliberate’’ and is the ‘‘natural result of efficient predatory behavior in a lawless world’’. This makes corrupt bureaucratic hierarchies much like predatory hierarchies: a bandit stealing a farmer’s crop is in principle no different from a corrupt bureaucrat extracting bribes from citizens. The morality is the same, even if the activity of the government bureaucrat ‘‘for sometimes ill-defined reasons—has come to be considered legitimate.’’ Corruption, therefore, reflects the presence of a principal-agent problem between government and citizens, only if principles of democracy and individual rights have come to be accepted, so that indeed, the citizen is the de-jure ‘‘principal’’. The term ‘‘corruption’’ therefore needs to be used against the background of the institutions that prevail, with ‘‘corrupt’’ activities being possibly simply the manifestation of predatory authoritarian government.
5. Natural resources and corruption Carlos Leite and Jens Weidmann (Does mother nature corrupt?: Natural resources, corruption, and economic growth) propose that personal prizes available to be won through appropriation of a country’s natural resources provide incentives for corruption and rent seeking, with the most able persons in a society possibly engaging in the rentseeking activities. Rent seeking, in the extreme, takes the form of outright war or internal conflict aimed at securing the income from the natural resources. With inappropriate institutions, natural resources are therefore not a national asset.
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6. Is corruption beneficial or harmful? Corruption that allows disadvantageous government restrictions to be circumvented is socially beneficial. Vito Tanzi and Hamid Davoodi (Corruption, growth, and public finance), however, take exception with the ‘‘romantic’’ view that has ‘‘made corruption an almost virtuous activity and possibly good for growth in a word stifled by bad government’’. They point to data showing that high-corruption countries have had lower growth. There is a question of causality, not correlation. Reasons proposed for a link from corruption to low growth are that (1) corruption discriminates against small enterprises; (2) corruption discourages private investment; and (3) corruption directs talent or personal abilities to unproductive activities (seeking and extracting rents). Growth often stems from new smaller enterprises rather than large existing (often state) enterprises; if corruption deters development of smaller enterprises, growth is therefore also inhibited. The evidence confirms that corruption more adversely affects start-up and smaller enterprises. Where corruption is pervasive, the good political connections enjoyed by large enterprises override the good business skills and entrepreneurial spirit present in start-ups and small businesses. The large enterprises use corruption to protect themselves from the competition of new entrants, while, at the same time, petty bureaucrats prey upon small businesses. The data confirm that owners and managers of small firms spend more time dealing with government bureaucrats. The conclusion is, therefore, that small firms are advantaged by corruption while corruption may benefit large firms. Corruption also reduces investment; and direct foreign investment is shifted into joint ventures so that local partners can provide protection against corruption. Corruption also increases unproductive public investment. High corruption is also associated with lower operation and maintenance expenditures, which explains why development projects fail to continue after aid resources have been made available and aid-provided project managers have departed. High corruption is also associated with poor-quality public infrastructure. All of these effects reduce growth. Corruption is also higher in countries pursuing active industrial policies that give procurement preferences to domestic enterprises. Regarding allocation of abilities, studies find that the higher is the corruption index, the more students are attracted to studying law. This has a negative effect on growth. Corruption also adversely affects tax revenue collection. The type of taxation matters: evidence indicates, for example, rampant corruption by collectors of tariff revenue. Corruption is also prevalent in the collection of individual income taxes because of the mutual interest of the tax inspector and the taxpayer to underreport income. Higher corruption is also associated with lower revenue collected from indirect taxes (VAT, sales taxes, and turnover taxes). The introduction of VAT to replace other taxes, however, reduces corruption because of the compliance requirements and interconnections between reporting by buyers and by sellers. In high corruption countries, government tax revenue available for public finance is low but actual ‘‘taxes’’ paid by taxpayers tend to be high; corruption denies the tax revenue to the government, while the tax revenue that does reach the government is spent in unproductive ways or is privately appropriated before reaching designated public expenditure objectives. Corruption thus makes public finance quite ineffective.
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7. Corruption and the composition of public spending Paolo Mauro (Corruption and government expenditure, reprinted from the Journal of Public Economics 1998) provides evidence that corruption changes the composition of government spending through biases that provide ‘‘more lucrative opportunities’’ for personal gain through corruption. Corruption is linked to market structure; the scope for receiving bribes is greater when public procurement takes place in less competitive markets because of the higher profits available to be shared between the supplier and the government official. Corruption is also furthered by public spending on ‘‘goods whose exact value is difficult to monitor’’ and by ambiguity of valuation, both of which facilitate secrecy in bribe payments. Public spending on high-technology and military equipment is therefore susceptible to corruption: ‘‘it will be easier to collect substantial bribes on large infrastructure projects or highly sophisticated defense equipment than on textbooks or teachers’ salaries’’ (p. 236). For health spending, there are more opportunities for bribes through public spending on medical equipment than on salaries of doctors and nurses. For transfer payments, the scope for corruption increases with bureaucratic discretion in deciding who receives payments; the scope for bribes is limited when payments are based on age and is greater when payments are based on personal disability or unemployment. Mauro observes that: ‘‘it seems easier to hand out a disability pension to a healthy person than to give a teaching job to an unqualified person’’. Mauro’s empirical findings confirm that corruption is associated with a bias against public spending on education, and suggests a similar bias due to corruption against public spending on health care. Sanjeev Gupta, Hamid Davoodi, and Erwin Tiongson (Corruption and the provision of health and education services) add to the evidence linking the composition of public spending and corruption. They find that ‘‘a high level of corruption has adverse consequences for a country’s child and infant mortality rates, percent of low-birthweight babies in total births, and dropout rates in primary schools. In particular, child mortality rates in countries with high corruption are about one-third higher than in countries with low corruption; infant mortality rates and percent of low-birthweight babies are almost twice as high, and dropout rates are five times as high’’ (p. 271– 272). It follows that ‘‘improvements in indicators of health care and educational services do not necessarily require higher public spending’’ (p. 272). Rather, education and health care would be improved, without changing public spending, by reducing corruption. Vito Tanzi and Hamid Davoodi begin chapter 11 (Corruption, public spending, and growth), with an example from Italy where capital spending had been a large part of GDP but declined sharply after ‘‘a huge corruption scandal, popularly labeled tangentopoli (bribe city), brought down the political establishment that had ruled Italy for several decades’’ (p. 280). After the elimination of corruption, in Milan, ‘‘the cost of city rail links fell by 52 percent, the cost of one kilometer of subway fell by 57 percent, and the budget for the new airport terminal was reduced by 59 percent to reflect the lower construction costs’’ (p. 281). This motivates the hypothesis that corruption is tied to capital spending by government. The growth models of Harrod, Domar, and Rostow emphasize capital spending as the path to economic growth and, as the source of a ‘‘strong intellectual bias in the economics profession in favor of capital spending (p. 281), and emphasize the rule that ‘‘it is all right to borrow as long as the borrowing is for
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investment projects’’ (p. 282). There are also political gains from following this rule since ‘‘ribbon-cutting ceremonies, when new investment projects related to roads, dams, irrigation canals, power plants, ports, airports, schools, and hospitals are completed and inaugurated, are very popular with politicians’’ (p. 282). Capital spending is additionally highly politically discretionary, whereas current spending is less discretionary because of inflexibility due to public spending on entitlements and other past budgetary commitments. When subcontracting of government projects to private sector takes place, there is political discretion in determining who receives the contract, with opportunities for bribes (or ‘‘commissions’’) for political and bureaucratic decision makers. The private firm that wins the contract can include the bribe or commission in the quote for costs, with an understanding that the initial low quote can be adjusted upward in the future or that the costs can be reduced by use of low-quality materials. Tanzi and Davoodi observed that ‘‘experience with public-sector projects, especially in developing countries, is full of stories about roads that need to be repaired a short time after completion, power plants that worked at much lower capacity, and so on’’ (p. 284)—because ‘‘projects are chosen for their bribe-generating capacity and not for their productivity. The productivity of the projects becomes almost irrelevant’’ (p. 285). Corruption, thus, not only reduces the return to new investment but also reduces or eliminates the returns from past investments because of the bias against current spending on operations and maintenance. Consequently, ‘‘new projects are undertaken while the existing structure is left to deteriorate’’ (p. 286). Public spending on operations and maintenance may be intentionally reduced so that new replacement projects are required, which will provide new bribe opportunities for political and bureaucratic decision makers. The following hypotheses therefore emerge to be tested: (1) Other things being equal, high corruption is associated with high public investment (the hypothesis is not rejected). (2) Other things being equal, high corruption is associated with low government revenue (the hypothesis is not rejected). (3) Other things being equal, high corruption is associated with low operation and maintenance expenditures (whether the hypothesis is rejected depends on the proxy for unavailable direct data on operations and maintenance expenditure). (4) Other things being equal, high corruption is associated with poor quality of infrastructure (the hypothesis is not rejected). Hence, when corruption is present, ‘‘economists should be more restrained in their praise of high public-sector investment spending’’ (p. 297). Sanjeev Gupta, Luiz de Mello, and Raju Sharan (Corruption and military spending, reprinted from the European Journal of Political Economy 2001) provide further evidence that corruption affects the composition of public spending. They point out that bribes account for some 15% of military spending in low-income countries. Military spending is attractive for corrupt government officials not only because of the direct private benefits through bribes but also because military spending allows rent extraction from the population. That is, the purpose of military spending is not external defense but domestic repression. The empirical estimates cover 120 countries for the period 1985– 1998; data
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limitations are noted, in particular, because military spending is often part of other items in the government budget. The empirical results reveal that ‘‘societies that are perceived as being more corrupt have a higher share of military spending in GNP’’ (p. 314). When effects of IMF conditionality are investigated, the finding is that ‘‘military procurement tends to be lower in countries with IMF-supported programs’’ (p. 321). The empirical estimates also confirm the motives for public spending on military procurement not related to external threats; military procurement expenditures are found to be related to corruption and domestic repression. The conclusion is that less corruption and the end of repressive autocratic regimes will result in a more socially productive composition of public expenditure.
8. Government decentralization and corruption Luiz de Mello and Matias Barenstein (Fiscal decentralization and governance) note that the literature suggests greater accountability when the same level of government levies taxes and spends the revenue because of the closer link between the population being served (voters if there is democracy) and political decision makers; although, also, decentralization may allow corrupt local politicians to ‘‘capture’’ local government and the very proximity of beneficiaries of public spending to political decision makers may increase rather than reduce corruption. Where there is democracy, an advantage of decentralization is that corruption may be reduced through intergovernmental (or yardstick) competition. There are therefore countervailing influences on the relation between decentralization and corruption. Past empirical results that are noted suggest that corruption is greater in federal (decentralized) systems of government. In their own empirical estimates, the authors test the hypotheses that (1) governance improves with fiscal decentralization and (2) that the improvement is greater when more revenue is collected at lower than higher levels of government. The empirical results broadly support both hypotheses. However, the authors qualify the case for fiscal decentralization as reducing corruption with warnings about the need for local government institutions that protect against capture of local government by self-interested local politicians and local political elites. Political freedom is required to allow ‘‘citizen participation through civil society organizations in local development’’ (p. 361). Caution is also advised against imposing more responsibilities in tax administration and budget preparation, execution, and supervision than local government has the capacity to handle.
9. Taxation and corruption Dhaneshwar Ghura (Tax revenue in sub-Saharan Africa: effects of economic policies and corruption) studies 39 sub-Saharan countries in the period 1985– 1996. Corruption is measured by an index composed of (1) the extent to which government officials expect bribes when engaged in tax assessment, (2) the provision of trade licenses, and (3) the regulation of exchange controls. Beyond the direct costs of
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bribes, corrupt tax and customs officials impose social costs by ‘‘complicating procedures for taxpayers who refuse to participate in the bribery scheme, thus forcing them out of business or into the informal sector’’ (p. 379). Empirical results provide ‘‘strong evidence that an increase in the level of corruption lowers the tax revenueGDP ratio’’ (p. 383). Jean Hendriks, Michael Keen, and Abhinay Muthoo (Corruption, extortion, and evasion, reprinted from the Journal of Public economics 1999) set out a theoretical model describing an encounter between a taxpayer and a tax inspector. The tax inspector can attempt to obtain a bribe through extortion by threatening to report more income than the taxpayer has truly earned (in the model, the tax inspector costlessly observes the true income of the taxpayer). The government might also pay the tax inspector a commission based on tax revenue collected. In such situations, taxpayers can be either victims of extortion or accomplices in tax evasion. The gains from tax evasion through corruption are regressive because high-income persons have more to gain than low-income persons. The authors conclude that honest tax payment requires that tax inspectors receive a commission on taxes paid by high-income persons but not low-income persons. The need to finance such a commission increases the average tax rate. The conclusion is that a benevolent government that seeks to maximize tax revenue through honesty in tax collection can do no better than pay tax inspectors a fixed wage and set penalties proportional to the extent of misreporting with a proportional tax schedule. In looking for policies that make collusion between the taxpayer and the tax inspector unattractive, governments face a difficult task because both the taxpayer and tax inspector can, through collusive corruption, gain at the expense of the government. Much depends on the likelihood of detection and the penalty if detected and the intrinsic honesty in the system (or social norms regarding corruption and tax evasion). Commission payments provide the tax inspector with an incentive not to cooperate in underreporting the taxpayer’s level of income. However, even without this incentive, the model shows that commission payments are required for honest progressive taxation. The commission payments however promote extortion, by giving the tax inspector a credible reason for overstating the taxpayer’s income.
10. Corruption and the distribution of income Corruption affects both efficiency and income distribution. Era Dabla-Norris and Paul Wade (Production, rent seeking, and wealth distribution) propose a theoretical model to explain why the rich tend to focus on obtaining income from corrupt activities. In the choice between corrupt and productive activities (the authors describe corruption as rent seeking), individuals face a fixed cost of entry into seeking gains from corruption through government employment but not into productive activity. An additional incentive for the rich to enter the corrupt government bureaucracy is that they can thereby protect their own wealth from the corrupt appropriative activities of other government officials. The model therefore contains both supply and demand side reasons for why corrupt government is the domain of the wealthy. The poor are productive and are the prey. The model is motivated by evidence that the wealthy in
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poor countries tend to perpetuate themselves and their families in government employment and in control of government. Government officials also often have family businesses that are related to the officials’ fields of authority. There is no law enforcement in the model because the thieves themselves would be required to enforce the law. Sanjeev Gupta, Hamid Davoodi, and Rosa Alonso-Terme (Does corruption affect income distribution?, reprinted from Economics of Governance 2002) show empirically that corruption changes income distribution to the disadvantage of the poor in poor countries. Higher corruption is associated with greater income inequality and with increased poverty; also, growth of income of the poor is higher in countries that are poorly endowed with natural resources. The study complements other empirical studies that have shown how corruption adversely affects public expenditure and taxation by showing how corruption affects income distribution; that is, beyond the various inefficiencies due to corruption, inequality is increased by corruption. The tendencies for capital-intensive budgetary expenditures arise because corruption decreases labor demand. The rich, at the same time, have greater means to pay for the benefits available through corruption and have the means to pay the costs of entering government and of controlling government authority, which are the sources of the corruption, and provide the benefits from corruption.
11. Corruption in transition economies George Abed and Hamid Davoodi (Corruption, structural reforms, and economic performance in the transition economies) assembled and used a comprehensive database to investigate the evolution of corruption in 25 transition economies over the period 1994– 1998. They find that the ‘‘corruption perception index is higher in countries that lived longer under a central planning system, have lower per capita GDP, and have made slow progress in structural reforms’’ (p. 536). In the final chapter (Improving governance and fighting corruption in the Baltic and CIS countries: The role of the IMF), Thomas Wolf and Emine Guˆrgen observe how corruption was endemic and present in different forms1 and describe how the policy content of IMF-supported programs in the decade of transition sought to contribute to improving governance by ending policies and procedures such as subsidies and tax concessions that were primary sources of corruption.
1 The reported forms of corruption included: abuse of tax-free status and preferential trading rights for charitable institutions and sporting groups; refusal to give permits for foreign-owned hotels; bribes for import contract registration based on the number of pages, with short contracts rejected; individualized surcharges on the sale (or allocation) of foreign exchange; a state energy company headed by a close relative of a senior official and responsible for licensing all oil imports; the sale of a large public utility ‘‘at an absurdly low price to an investor with connections to government officials who negotiated the deal’’ (p. 541); and also ‘‘low-interest bank credits were given to dubious borrowers’’ (p. 542) with failure to repay resulting in banking crises. Corruption was also endemic in privatization procedures.
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12. An evaluation Because the edited volume consists of papers by different authors, there is at times an overlap in literature surveys. In addition, the extended descriptions of how the empirical results were obtained and the robustness and diagnostic tests that were done, while necessary, may be of more interest to econometrics practitioners than to economists whose primary interest is in the results that were obtained. Where rent seeking appears, there is sometimes limited appreciation of conceptual contributions of the literature on rent seeking. The focus of the analysis of rent seeking is the efficiency loss that a society incurs when personal abilities are attracted to unproductive quests for personal gain through influencing decisions about distribution. Corruption and bribes do not necessarily imply social loss from rent seeking. Social loss requires rents to be contestable.2 Statements about social losses from rent seeking therefore require reference to contestability; in the absence of contestability, politically determined income transfers may change distribution but there is no associated social loss. Corruption therefore does not necessarily imply rent seeking. The IMF has produced a volume of papers that academic researchers will overall find encompassing and interesting. The papers in the volume offer an excellent point of departure for an investigation of how corruption compromises the effectiveness of public finance and contributes to development failure in low-income countries.3
References Easterly, W., 2001. The Elusive Quest for Growth: Economists’ Adventures and Misadventures in the Tropics. MIT Press, Cambridge, MA. Hillman, A.L., 2002. The World Bank and the persistence of poverty in poor countries. European Journal of Political Economy 18, 783 – 795. Hillman, A.L., 2003. Public Finance and Public Policy: Responsibilities and Limitations of Government. Cambridge Univ. Press, New York.
2 The extent of social loss depends on different considerations. For a review of the literature on the social loss from rent seeking, see Hillman (2003). 3 The volume might be read in conjunction with Easterly (2001) who describes development failure from the perspective of his World Bank experiences (for a review of Easterly’s book, see Hillman, 2002).
Corruption and public finance: an IMF perspective Arye L. Hillman * Department of Economics, Bar-Ilan University, Ramat Gan 52900, Israel CEPR, London, UK CES-ifo, Munich, Germany Received 15 September 2003; accepted 16 September 2003 A review of Governance, Corruption, and Economic Performance, George T. Abed and Sanjeev Gupta, editors, International Monetary Fund, Washington D.C., 2002, pp 564, ISBN 1-58906-116-0 Soft cover Available online 28 July 2004
Abstract Public finance should be a means whereby governments in low-income countries are able to increase economic growth and end poverty. Corruption, however, reduces tax revenue and makes public expenditure policies ineffective for achieving social objectives. The papers in this volume, which is sponsored by the Fiscal Affairs Department of the International Monetary Fund (IMF), describe how corruption makes public finance ineffective in promoting economic development. D 2004 Elsevier B.V. All rights reserved. JEL classification: H11; H26; O17 Keywords: Corruption; Public finance; IMF
1. Introduction The people who can best describe corruption are those themselves engaged in corruption. After the perpetrators themselves, the next best placed to describe corruption are those who interact with the governments within which corruption takes place. Prominent among the latter are staff members of the International Financial Institutions. This book, edited by two staff members of the Fiscal Affairs Department of the International Monetary Fund (IMF) and with contributions principally by IMF staff
* Department of Economics, Bar-Ilan University, Ramat Gan 52900, Israel. E-mail address: [email protected] (A.L. Hillman). 0176-2680/$ - see front matter D 2004 Elsevier B.V. All rights reserved. doi:10.1016/j.ejpoleco.2003.09.004
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economists, demonstrates the extent to which issues associated with governance and corruption concern the International Monetary Fund. The studies in the book make clear why, when governments are corrupt, public finance is ineffective in increasing growth and reducing poverty.
2. Corruption within public finance In an introductory overview, the editors, George Abed, and Sanjeev Gupta, note the only relatively recent interest of economic researchers and also the IMF and World Bank in corruption. The attention that has come to be given to corruption is attributed to globalization through requirements of greater transparency by governments in poorer countries that have been recipients of private capital inflows. Previously, capital flows had been primarily official through governments and had been motivated by political influence sought by donors. Corruption under these circumstances was ignored: ‘‘many countries were governed by regimes that, to say the least, did not adhere to the strictures of good government, and most bilateral (and to some extent multilateral) donors and creditors often refrained from asking too many questions. The economics profession, with notable exceptions, lacking the requisite information or the will to challenge the prevailing political order, went on to other pursuits’’ (p. 3). The end of communism focused interest on corruption which was evident in the postcommunist states. At the same time, standards of conduct changed for governments in developing countries, with donors becoming less forgiving and governance indicators becoming part of the policy conditionality associated with concessionary loans and other aid from the international financial institutions. Nongovernment organizations (NGOs) such as, in particular, Transparency International, placed governance and corruption at the forefront of attention. The U.S. had adopted an anticorruption policy through the Foreign Corrupt Practices Act of 1977, with the rest of the developed world following in 1997 with the adoption of the OECD convention on Combating Bribery of Foreign Officials in International Business Transactions. The IMF also contributed to reducing corruption through standards of transparency and accountability in the management of public funds and through requirements to safeguard the use of IMF-provided resources and to preempt misreporting of information. This volume is another means, through policy research, whereby the IMF focuses attention on issues of governance and corruption. Vito Tanzi (Corruption around the world: causes consequences, scope, and cures) points out that corruption, defined as the abuse of public power for private benefit (p. 25), has been endemic in human civilization. Tanzi notes that bribes should be distinguished from exchange of gifts: cultural differences can explain different sizes of gifts but the question is ‘‘at what point does a gift become a bribe?’’ (p. 25). He observes the link between corruption and the size of government: corruption grew as the size of government grew. Government regulation, taxation, procurement, and public spending for private benefit all provide foundations for corruption. State enterprises have been, in particular, dens of corruption. Abolishing the state would abolish corruption because all transactions would take place in markets, and people could exchange gifts as well, if they so wished. Nathaniel Leff had proposed in 1964 that corruption could be beneficial in overriding
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bureaucratic impediments to economic activity. Tanzi, however, emphasizes the costs of corruption. People become disillusioned with markets (to the extent that free markets are present), with democracy (where present) and with the government itself; the intentions of government regulations and policies are subverted and property rights and the rule of law are compromised, as are markets and incentives. Income distribution is also made more unequal, with the poor likely to lose the most from corruption. Tanzi lists different solutions for corruption through penalties, institutional controls (honest and effective supervisors, good auditing offices, and clear rules on ethical behavior), transparent rules, laws and processes, and exemplary behavior by leadership. However, Tanzi notes the difficulties of eliminating corruption in poor countries where salaries in state employment are low and where overemployment in the state sector is often government policy. Tanzi concludes: ‘‘corruption is closely linked to the way governments conduct their affairs in modern societies (and) the fight against corruption is, thus, ultimately linked with the reform of the state’’ (p. 54).
3. Public-sector remuneration and corruption Caroline Van Rijckeghem and Beatrice Weder (Bureaucratic corruption and the rate of temptation: Do wages in the civil service affect corruption and by how much?, reprinted from the Journal of Economic Development 2001) investigate the relation between state-sector wages and corruption. The government of Singapore has paid, for example, relatively high public-sector wages, with the objective of attracting highquality personnel to government employment. The high wages also preempt incentives for bribes, which is an application of the efficiency-wage hypothesis (the high wages deter corruption by making dismissal unattractive). High wages are not required to eliminate corruption if the bribe potential is low. Corruption may also be inhibited by deferred postretirement payments and by greater probability of detection, as wages within a bureaucratic hierarchy increase. There is also a ‘‘fair-wages view’’ that government officials have a personal preference for honesty and will choose not to be corrupt provided that wages are sufficiently high so as to be regarded as ‘‘fair’’. The empirical results reported by Van Rijckeghem and Weder indicate that large increases in wages would have been required to eliminate corruption in a sample of 31 developing and low-income OECD countries (the data cover the period 1982 – 1994). Further evidence from case studies confirms rejection of the direction of causality that government wages are low because governments feel that they do not have to pay more because of the income from corrupt activities. With the causality running from low wages to corruption, the conclusion is that inordinately high increases in public-sector wages in poorer countries appear to be required if significant reductions in corruption are to take place. Sheetal K. Chand and Karl O. Moene (Controlling fiscal corruption) set out a model that shows how bonus payments to tax administrators can reduce corruption; the bonus payments substitute for bribes. A case study from Ghana is used to show how, after a change in government in 1981, ‘‘rampant fiscal corruption was brought under control’’. Chand and Moene propose that bonus incentives should be given to higher-level bureau-
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crats, although the authors note that bonus payments for collecting taxes could inspire overzealous tax-collecting behavior. The conclusion offers a view of human nature (p. 109): ‘‘Most fiscal officers, if properly trained, have a sense of professional pride and would not condone corruption’’ and the government officials ‘‘become corrupt partly out of necessity or because of peer group pressure’’.
4. Governments and discretionary corruption It is often taken for granted that governments have an interest in eliminating corruption because corruption reduces tax revenue and distorts the intent of public spending. However, Era Dabla-Norris (A game theoretic analysis of corruption in bureaucracies) sets out a model where corruption is discretionary and ‘‘arises when the dictator chooses not to deter it’’ because of monitoring costs, low wages in the state sector or ineffective tax administration. Because of multiple equilibria in the model, identical societies can end up with high or low levels of corruption. A country can therefore be caught in a high-corruption trap. In this type of model, high corruption is due to ‘‘bad luck’’. Joshua Charap and Christian Harm (Institutionalized corruption and the kleptocratic state) continue the theme of discretionary corruption in proposing that ‘‘corrupt practices are created to satisfy a leader’s desire to foster loyalty through patronage’’. That is, corruption may be an efficient means for the ruler or the ruling elite to maintain support. Corruption is, in these cases, ‘‘systematic and deliberate’’ and is the ‘‘natural result of efficient predatory behavior in a lawless world’’. This makes corrupt bureaucratic hierarchies much like predatory hierarchies: a bandit stealing a farmer’s crop is in principle no different from a corrupt bureaucrat extracting bribes from citizens. The morality is the same, even if the activity of the government bureaucrat ‘‘for sometimes ill-defined reasons—has come to be considered legitimate.’’ Corruption, therefore, reflects the presence of a principal-agent problem between government and citizens, only if principles of democracy and individual rights have come to be accepted, so that indeed, the citizen is the de-jure ‘‘principal’’. The term ‘‘corruption’’ therefore needs to be used against the background of the institutions that prevail, with ‘‘corrupt’’ activities being possibly simply the manifestation of predatory authoritarian government.
5. Natural resources and corruption Carlos Leite and Jens Weidmann (Does mother nature corrupt?: Natural resources, corruption, and economic growth) propose that personal prizes available to be won through appropriation of a country’s natural resources provide incentives for corruption and rent seeking, with the most able persons in a society possibly engaging in the rentseeking activities. Rent seeking, in the extreme, takes the form of outright war or internal conflict aimed at securing the income from the natural resources. With inappropriate institutions, natural resources are therefore not a national asset.
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6. Is corruption beneficial or harmful? Corruption that allows disadvantageous government restrictions to be circumvented is socially beneficial. Vito Tanzi and Hamid Davoodi (Corruption, growth, and public finance), however, take exception with the ‘‘romantic’’ view that has ‘‘made corruption an almost virtuous activity and possibly good for growth in a word stifled by bad government’’. They point to data showing that high-corruption countries have had lower growth. There is a question of causality, not correlation. Reasons proposed for a link from corruption to low growth are that (1) corruption discriminates against small enterprises; (2) corruption discourages private investment; and (3) corruption directs talent or personal abilities to unproductive activities (seeking and extracting rents). Growth often stems from new smaller enterprises rather than large existing (often state) enterprises; if corruption deters development of smaller enterprises, growth is therefore also inhibited. The evidence confirms that corruption more adversely affects start-up and smaller enterprises. Where corruption is pervasive, the good political connections enjoyed by large enterprises override the good business skills and entrepreneurial spirit present in start-ups and small businesses. The large enterprises use corruption to protect themselves from the competition of new entrants, while, at the same time, petty bureaucrats prey upon small businesses. The data confirm that owners and managers of small firms spend more time dealing with government bureaucrats. The conclusion is, therefore, that small firms are advantaged by corruption while corruption may benefit large firms. Corruption also reduces investment; and direct foreign investment is shifted into joint ventures so that local partners can provide protection against corruption. Corruption also increases unproductive public investment. High corruption is also associated with lower operation and maintenance expenditures, which explains why development projects fail to continue after aid resources have been made available and aid-provided project managers have departed. High corruption is also associated with poor-quality public infrastructure. All of these effects reduce growth. Corruption is also higher in countries pursuing active industrial policies that give procurement preferences to domestic enterprises. Regarding allocation of abilities, studies find that the higher is the corruption index, the more students are attracted to studying law. This has a negative effect on growth. Corruption also adversely affects tax revenue collection. The type of taxation matters: evidence indicates, for example, rampant corruption by collectors of tariff revenue. Corruption is also prevalent in the collection of individual income taxes because of the mutual interest of the tax inspector and the taxpayer to underreport income. Higher corruption is also associated with lower revenue collected from indirect taxes (VAT, sales taxes, and turnover taxes). The introduction of VAT to replace other taxes, however, reduces corruption because of the compliance requirements and interconnections between reporting by buyers and by sellers. In high corruption countries, government tax revenue available for public finance is low but actual ‘‘taxes’’ paid by taxpayers tend to be high; corruption denies the tax revenue to the government, while the tax revenue that does reach the government is spent in unproductive ways or is privately appropriated before reaching designated public expenditure objectives. Corruption thus makes public finance quite ineffective.
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7. Corruption and the composition of public spending Paolo Mauro (Corruption and government expenditure, reprinted from the Journal of Public Economics 1998) provides evidence that corruption changes the composition of government spending through biases that provide ‘‘more lucrative opportunities’’ for personal gain through corruption. Corruption is linked to market structure; the scope for receiving bribes is greater when public procurement takes place in less competitive markets because of the higher profits available to be shared between the supplier and the government official. Corruption is also furthered by public spending on ‘‘goods whose exact value is difficult to monitor’’ and by ambiguity of valuation, both of which facilitate secrecy in bribe payments. Public spending on high-technology and military equipment is therefore susceptible to corruption: ‘‘it will be easier to collect substantial bribes on large infrastructure projects or highly sophisticated defense equipment than on textbooks or teachers’ salaries’’ (p. 236). For health spending, there are more opportunities for bribes through public spending on medical equipment than on salaries of doctors and nurses. For transfer payments, the scope for corruption increases with bureaucratic discretion in deciding who receives payments; the scope for bribes is limited when payments are based on age and is greater when payments are based on personal disability or unemployment. Mauro observes that: ‘‘it seems easier to hand out a disability pension to a healthy person than to give a teaching job to an unqualified person’’. Mauro’s empirical findings confirm that corruption is associated with a bias against public spending on education, and suggests a similar bias due to corruption against public spending on health care. Sanjeev Gupta, Hamid Davoodi, and Erwin Tiongson (Corruption and the provision of health and education services) add to the evidence linking the composition of public spending and corruption. They find that ‘‘a high level of corruption has adverse consequences for a country’s child and infant mortality rates, percent of low-birthweight babies in total births, and dropout rates in primary schools. In particular, child mortality rates in countries with high corruption are about one-third higher than in countries with low corruption; infant mortality rates and percent of low-birthweight babies are almost twice as high, and dropout rates are five times as high’’ (p. 271– 272). It follows that ‘‘improvements in indicators of health care and educational services do not necessarily require higher public spending’’ (p. 272). Rather, education and health care would be improved, without changing public spending, by reducing corruption. Vito Tanzi and Hamid Davoodi begin chapter 11 (Corruption, public spending, and growth), with an example from Italy where capital spending had been a large part of GDP but declined sharply after ‘‘a huge corruption scandal, popularly labeled tangentopoli (bribe city), brought down the political establishment that had ruled Italy for several decades’’ (p. 280). After the elimination of corruption, in Milan, ‘‘the cost of city rail links fell by 52 percent, the cost of one kilometer of subway fell by 57 percent, and the budget for the new airport terminal was reduced by 59 percent to reflect the lower construction costs’’ (p. 281). This motivates the hypothesis that corruption is tied to capital spending by government. The growth models of Harrod, Domar, and Rostow emphasize capital spending as the path to economic growth and, as the source of a ‘‘strong intellectual bias in the economics profession in favor of capital spending (p. 281), and emphasize the rule that ‘‘it is all right to borrow as long as the borrowing is for
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investment projects’’ (p. 282). There are also political gains from following this rule since ‘‘ribbon-cutting ceremonies, when new investment projects related to roads, dams, irrigation canals, power plants, ports, airports, schools, and hospitals are completed and inaugurated, are very popular with politicians’’ (p. 282). Capital spending is additionally highly politically discretionary, whereas current spending is less discretionary because of inflexibility due to public spending on entitlements and other past budgetary commitments. When subcontracting of government projects to private sector takes place, there is political discretion in determining who receives the contract, with opportunities for bribes (or ‘‘commissions’’) for political and bureaucratic decision makers. The private firm that wins the contract can include the bribe or commission in the quote for costs, with an understanding that the initial low quote can be adjusted upward in the future or that the costs can be reduced by use of low-quality materials. Tanzi and Davoodi observed that ‘‘experience with public-sector projects, especially in developing countries, is full of stories about roads that need to be repaired a short time after completion, power plants that worked at much lower capacity, and so on’’ (p. 284)—because ‘‘projects are chosen for their bribe-generating capacity and not for their productivity. The productivity of the projects becomes almost irrelevant’’ (p. 285). Corruption, thus, not only reduces the return to new investment but also reduces or eliminates the returns from past investments because of the bias against current spending on operations and maintenance. Consequently, ‘‘new projects are undertaken while the existing structure is left to deteriorate’’ (p. 286). Public spending on operations and maintenance may be intentionally reduced so that new replacement projects are required, which will provide new bribe opportunities for political and bureaucratic decision makers. The following hypotheses therefore emerge to be tested: (1) Other things being equal, high corruption is associated with high public investment (the hypothesis is not rejected). (2) Other things being equal, high corruption is associated with low government revenue (the hypothesis is not rejected). (3) Other things being equal, high corruption is associated with low operation and maintenance expenditures (whether the hypothesis is rejected depends on the proxy for unavailable direct data on operations and maintenance expenditure). (4) Other things being equal, high corruption is associated with poor quality of infrastructure (the hypothesis is not rejected). Hence, when corruption is present, ‘‘economists should be more restrained in their praise of high public-sector investment spending’’ (p. 297). Sanjeev Gupta, Luiz de Mello, and Raju Sharan (Corruption and military spending, reprinted from the European Journal of Political Economy 2001) provide further evidence that corruption affects the composition of public spending. They point out that bribes account for some 15% of military spending in low-income countries. Military spending is attractive for corrupt government officials not only because of the direct private benefits through bribes but also because military spending allows rent extraction from the population. That is, the purpose of military spending is not external defense but domestic repression. The empirical estimates cover 120 countries for the period 1985– 1998; data
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limitations are noted, in particular, because military spending is often part of other items in the government budget. The empirical results reveal that ‘‘societies that are perceived as being more corrupt have a higher share of military spending in GNP’’ (p. 314). When effects of IMF conditionality are investigated, the finding is that ‘‘military procurement tends to be lower in countries with IMF-supported programs’’ (p. 321). The empirical estimates also confirm the motives for public spending on military procurement not related to external threats; military procurement expenditures are found to be related to corruption and domestic repression. The conclusion is that less corruption and the end of repressive autocratic regimes will result in a more socially productive composition of public expenditure.
8. Government decentralization and corruption Luiz de Mello and Matias Barenstein (Fiscal decentralization and governance) note that the literature suggests greater accountability when the same level of government levies taxes and spends the revenue because of the closer link between the population being served (voters if there is democracy) and political decision makers; although, also, decentralization may allow corrupt local politicians to ‘‘capture’’ local government and the very proximity of beneficiaries of public spending to political decision makers may increase rather than reduce corruption. Where there is democracy, an advantage of decentralization is that corruption may be reduced through intergovernmental (or yardstick) competition. There are therefore countervailing influences on the relation between decentralization and corruption. Past empirical results that are noted suggest that corruption is greater in federal (decentralized) systems of government. In their own empirical estimates, the authors test the hypotheses that (1) governance improves with fiscal decentralization and (2) that the improvement is greater when more revenue is collected at lower than higher levels of government. The empirical results broadly support both hypotheses. However, the authors qualify the case for fiscal decentralization as reducing corruption with warnings about the need for local government institutions that protect against capture of local government by self-interested local politicians and local political elites. Political freedom is required to allow ‘‘citizen participation through civil society organizations in local development’’ (p. 361). Caution is also advised against imposing more responsibilities in tax administration and budget preparation, execution, and supervision than local government has the capacity to handle.
9. Taxation and corruption Dhaneshwar Ghura (Tax revenue in sub-Saharan Africa: effects of economic policies and corruption) studies 39 sub-Saharan countries in the period 1985– 1996. Corruption is measured by an index composed of (1) the extent to which government officials expect bribes when engaged in tax assessment, (2) the provision of trade licenses, and (3) the regulation of exchange controls. Beyond the direct costs of
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bribes, corrupt tax and customs officials impose social costs by ‘‘complicating procedures for taxpayers who refuse to participate in the bribery scheme, thus forcing them out of business or into the informal sector’’ (p. 379). Empirical results provide ‘‘strong evidence that an increase in the level of corruption lowers the tax revenueGDP ratio’’ (p. 383). Jean Hendriks, Michael Keen, and Abhinay Muthoo (Corruption, extortion, and evasion, reprinted from the Journal of Public economics 1999) set out a theoretical model describing an encounter between a taxpayer and a tax inspector. The tax inspector can attempt to obtain a bribe through extortion by threatening to report more income than the taxpayer has truly earned (in the model, the tax inspector costlessly observes the true income of the taxpayer). The government might also pay the tax inspector a commission based on tax revenue collected. In such situations, taxpayers can be either victims of extortion or accomplices in tax evasion. The gains from tax evasion through corruption are regressive because high-income persons have more to gain than low-income persons. The authors conclude that honest tax payment requires that tax inspectors receive a commission on taxes paid by high-income persons but not low-income persons. The need to finance such a commission increases the average tax rate. The conclusion is that a benevolent government that seeks to maximize tax revenue through honesty in tax collection can do no better than pay tax inspectors a fixed wage and set penalties proportional to the extent of misreporting with a proportional tax schedule. In looking for policies that make collusion between the taxpayer and the tax inspector unattractive, governments face a difficult task because both the taxpayer and tax inspector can, through collusive corruption, gain at the expense of the government. Much depends on the likelihood of detection and the penalty if detected and the intrinsic honesty in the system (or social norms regarding corruption and tax evasion). Commission payments provide the tax inspector with an incentive not to cooperate in underreporting the taxpayer’s level of income. However, even without this incentive, the model shows that commission payments are required for honest progressive taxation. The commission payments however promote extortion, by giving the tax inspector a credible reason for overstating the taxpayer’s income.
10. Corruption and the distribution of income Corruption affects both efficiency and income distribution. Era Dabla-Norris and Paul Wade (Production, rent seeking, and wealth distribution) propose a theoretical model to explain why the rich tend to focus on obtaining income from corrupt activities. In the choice between corrupt and productive activities (the authors describe corruption as rent seeking), individuals face a fixed cost of entry into seeking gains from corruption through government employment but not into productive activity. An additional incentive for the rich to enter the corrupt government bureaucracy is that they can thereby protect their own wealth from the corrupt appropriative activities of other government officials. The model therefore contains both supply and demand side reasons for why corrupt government is the domain of the wealthy. The poor are productive and are the prey. The model is motivated by evidence that the wealthy in
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poor countries tend to perpetuate themselves and their families in government employment and in control of government. Government officials also often have family businesses that are related to the officials’ fields of authority. There is no law enforcement in the model because the thieves themselves would be required to enforce the law. Sanjeev Gupta, Hamid Davoodi, and Rosa Alonso-Terme (Does corruption affect income distribution?, reprinted from Economics of Governance 2002) show empirically that corruption changes income distribution to the disadvantage of the poor in poor countries. Higher corruption is associated with greater income inequality and with increased poverty; also, growth of income of the poor is higher in countries that are poorly endowed with natural resources. The study complements other empirical studies that have shown how corruption adversely affects public expenditure and taxation by showing how corruption affects income distribution; that is, beyond the various inefficiencies due to corruption, inequality is increased by corruption. The tendencies for capital-intensive budgetary expenditures arise because corruption decreases labor demand. The rich, at the same time, have greater means to pay for the benefits available through corruption and have the means to pay the costs of entering government and of controlling government authority, which are the sources of the corruption, and provide the benefits from corruption.
11. Corruption in transition economies George Abed and Hamid Davoodi (Corruption, structural reforms, and economic performance in the transition economies) assembled and used a comprehensive database to investigate the evolution of corruption in 25 transition economies over the period 1994– 1998. They find that the ‘‘corruption perception index is higher in countries that lived longer under a central planning system, have lower per capita GDP, and have made slow progress in structural reforms’’ (p. 536). In the final chapter (Improving governance and fighting corruption in the Baltic and CIS countries: The role of the IMF), Thomas Wolf and Emine Guˆrgen observe how corruption was endemic and present in different forms1 and describe how the policy content of IMF-supported programs in the decade of transition sought to contribute to improving governance by ending policies and procedures such as subsidies and tax concessions that were primary sources of corruption.
1 The reported forms of corruption included: abuse of tax-free status and preferential trading rights for charitable institutions and sporting groups; refusal to give permits for foreign-owned hotels; bribes for import contract registration based on the number of pages, with short contracts rejected; individualized surcharges on the sale (or allocation) of foreign exchange; a state energy company headed by a close relative of a senior official and responsible for licensing all oil imports; the sale of a large public utility ‘‘at an absurdly low price to an investor with connections to government officials who negotiated the deal’’ (p. 541); and also ‘‘low-interest bank credits were given to dubious borrowers’’ (p. 542) with failure to repay resulting in banking crises. Corruption was also endemic in privatization procedures.
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12. An evaluation Because the edited volume consists of papers by different authors, there is at times an overlap in literature surveys. In addition, the extended descriptions of how the empirical results were obtained and the robustness and diagnostic tests that were done, while necessary, may be of more interest to econometrics practitioners than to economists whose primary interest is in the results that were obtained. Where rent seeking appears, there is sometimes limited appreciation of conceptual contributions of the literature on rent seeking. The focus of the analysis of rent seeking is the efficiency loss that a society incurs when personal abilities are attracted to unproductive quests for personal gain through influencing decisions about distribution. Corruption and bribes do not necessarily imply social loss from rent seeking. Social loss requires rents to be contestable.2 Statements about social losses from rent seeking therefore require reference to contestability; in the absence of contestability, politically determined income transfers may change distribution but there is no associated social loss. Corruption therefore does not necessarily imply rent seeking. The IMF has produced a volume of papers that academic researchers will overall find encompassing and interesting. The papers in the volume offer an excellent point of departure for an investigation of how corruption compromises the effectiveness of public finance and contributes to development failure in low-income countries.3
References Easterly, W., 2001. The Elusive Quest for Growth: Economists’ Adventures and Misadventures in the Tropics. MIT Press, Cambridge, MA. Hillman, A.L., 2002. The World Bank and the persistence of poverty in poor countries. European Journal of Political Economy 18, 783 – 795. Hillman, A.L., 2003. Public Finance and Public Policy: Responsibilities and Limitations of Government. Cambridge Univ. Press, New York.
2 The extent of social loss depends on different considerations. For a review of the literature on the social loss from rent seeking, see Hillman (2003). 3 The volume might be read in conjunction with Easterly (2001) who describes development failure from the perspective of his World Bank experiences (for a review of Easterly’s book, see Hillman, 2002).