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Ushakov
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Denis
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BUS 211
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Governance and Business Strategy

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Word Count: 1635 words

Assess the effects that corruption may have on economic development. How do you reconcile the anecdotal evidence with theoretical ideas? Introduction The World Bank defines corruption as: abuse of public office for private gains 1. Corruption is seen to be an integral part of human society and demonstrates itself through a variety of ways bribing politicians, using kickbacks or tipping a waiter in a restaurant to get a better table are all examples of corruption. Corruption is generally seen as an important factor that hinders the economic development of an economy. Overwhelming amount of literature, through presenting empirical and anecdotal evidence, argues that corruption reduces the efficiency, economic growth, domestic and foreign direct investment (FDI), disadvantages the poor, reshapes the government spending to an unsustainable way and is generally harmful for the economy. A small proportion of literature on corruption, however, presents rigorous arguments in favor of corruption- presenting evidence that corruption may actually speed up the wheels of commerce Wei (1998) and hence stimulate economic growth. My essay is based on the assumption (which most of the authors on corruption agree on) that generally corruption is harmful for the economy, however one should distinguish the effects of corruption on a developed and developing economy. The main argument of my essay is that there is a major distinction between effects of corruption on developed and developing economies in the short and long terms. Corruption will cause major economic inefficiency in a developed economy, however may bring some positive effects in the short term to the developing economies. Efficiency, Economic Growth and Corruption Corruption can be like grease speeding up the wheels of commerce Wei (1998) this is formal summarizing statement along the lines of Leff (1964), Huntington (1968) and Lui (1985), who argued in favor of positive effects of corruption on a countrys economy. Corruption can be seen as good in various ways, according to these authors. Leffs (1964) general idea is that corruption facilitates beneficial trades that would otherwise not have taken place. In doing so, it promotes efficiency by allowing individuals in the private sector to correct or circumvent pre-existing government failures of various sorts. This becomes possible through emergence of speed money, which reduces the delay in moving files, getting documents, licenses etc. Levy (2007) supports these ideas by providing anecdotal evidence based on his experience coming from post-soviet Georgia. He argues that corruption allowed the Georgian economy to produce far more output and to allocate what was produced far more efficiently than would otherwise have been feasible. This evidence at the same time supports my thesis. Georgia, is a developing country. It was able to benefit from corruption in the short term in the period between the end of 1980s and the beginning of the President Saakashvilis economic reforms in 2003. The World Bank paper on the success of Georgian reforms (2012) presents evidence how Georgian government has been successfully fighting corruption in public services, since then, in order to increase economic efficiency in this part of the economy and achieve greater economic growth overall. Therefore I argue that in the long term, the government came to a conclusion that the economic growth is not possible without the radical reforms, aimed at eradicating corruption, building strong institutions and ensuring an adequate system of checks and balances. Corruption can increase efficiency and promote economic growth, but only during the early stages of economic development - as the countrys economy grow to a certain extent corruption inevitably becomes a barrier for further economic development, which needs to be removed.

1 Helping Countries Combat Corruption: The Role of the World Bank. 2012. Helping Countries Combat Corruption: The

Role of the World Bank. [ONLINE] Available at: http://www1.worldbank.org/publicsector/anticorrupt/corruptn/cor02.htm. [Accessed 27 February 2012].

Based on this anecdotal evidence and theoretical ideas of Shleifer and Vishny (1993,1998), Wei (1999), Aidt (2009) and others I argue that in the long term corruption cannot be seen as a wheels of commerce in both the developing and developed countries. Corruption has several important negative effects on the economic efficiency and growth it reduces competition, innovation, results in misallocation of resources etc. in short according to this view corruption sands the wheels of development and makes economic and political transitions difficult. The empirical and anecdotal evidence from various countries and sources proves this argument. Both actual corruption the WBES index (2000) and perceived corruption the Transparency International index are negatively related to economic growth and wealth per capita, Fisman and Svensson (2007) in their survey show that an increase in the bribery rate of 1 percentage point is associated with a reduction in firm growth by 3 percentage points. It is hard to present the genuine anecdotal evidence of corruption because of the lack of information, due to its illegal nature, therefore only a small number of such evidence gets uncovered. Siemens (Germany) in 2008 bribed Argentinian government to win government ID contract clearly this reconciles with theoretical ideas of the above authors, because such actions undertaken by Siemens have resulted in misallocation of resources and reduced competition, because possibly Siemens did not have the best possible bid in terms of cost and quality2. Russian President Medvedev acknowledges that 20% of the 5 trillion rubles ($162 billion) spent annually on procurement are handed out in kickbacks and other forms of corruption3. This evidence is reconciled with the theoretical ideas of Wei (1999) who argues that corruption skews the composition of public expenditure away from needed health and education funds, because these expenditures, relative to other public projects, are less easy for officials to extract rents from. Indeed experts say the over 80% of the corrupt contracts are related to military, secret services, highly technical (but not innovative) procurements which are more difficult to be monitored or valued by the public. As a consequence of that, infrastructure investments are biased against projects that aid the poorer parts of population towards ones that benefit the richer ones causing further inequalities in society. According to IMFs World Economic Outlook Report (2011) Russia is still considered to be a developing country despite its economic and political power. It is therefore in a similar position to Georgia, which Levy (2007) outlined in the long term it will need to fight its overwhelming corruption schemes in order to stay a competitive economy. In the short term, however Russia can follow the path of some East Asian economies. Talking about them Wei (1999) concludes: while the region seems corrupt, it is able to attract lots of foreign investment and generate growth. This point will be developed in the following section. Foreign Direct Investment and Corruption Corruption and FDI are closely related to each other. There are two opposite theoretical ideas on this relationship, however. Egger and Winner (2006) conclude: using a data set of 73 developed and less developed countries, we find that corruption is a stimulus for FDI, which confirms the position of Leff (1964) that corruption can be beneficial in circumventing regulatory and administrative restrictions. On the other hand Wei (2000) provides empirical evidence that corruption in host countries discourages foreign investment and Hines (1995) documents that US FDI mostly goes to less corrupt economies. Corruption acts like an additional cost to the foreign investor, which he or she bears during the whole time of holding business interests in the country. To invest in a Russian company, a foreigner must
Eight Former Senior Executives and Agents of Siemens Charged in Alleged $100 Million Foreign Bribe Scheme. 2012. Welcome to the United States Department of Justice. [ONLINE] Available at: http://www.justice.gov/opa/pr/2011/December/11-crm-1626.html. [Accessed 27 February 2012].
2

3 Russian Press - Behind the Headlines, November 22 | What Russian papers say | RIA Novosti. 2012. Russian Press - Behind the Headlines,

November 22 | What Russian papers say | RIA Novosti. [ONLINE] Available at: http://en.rian.ru/papers/20111122/168935857.html. [Accessed 27 February 2012].

bribe every agency involved in foreign investment, including the foreign investment office, the relevant industrial ministry, the finance ministry, the executive branch of local government, the legislative branch, the central bank, the state property bureau, and so on. The obvious result is that foreigners do not invest in Russia Shleifer and Vishny (1993). Other authors present similar evidence on the countries they do research on. By reconciling the above with my argument I conclude that corruption is not a problem for developing countries in the short term, because these economies can attract FDI using tax incentives for foreign multinationals to locate their production in these countries, e.g. China offering 2 years of tax holiday and three subsequent years of half of the normal tax rate. 4 By doing so, it achieves positive short-term effects of corruption (e.g. speed money), without compromising the FDI levels. However, in the long term, in order to become a developed economy China or another developing country will need to abandon its corruption practices at some stage of economic development, due to the fact that foreign investors still prefer to go to less corrupt countries, other things being equal. According to some empirical evidence (Wei 1999) if India could reduce its corruption level to the Singapore level, its effect on attracting foreign investment would be the same as reducing its marginal corporate tax rate by 22 percentage points.

Conclusion In this essay I have reconciled the anecdotal and empirical evidence of corruption from various parts in the world with the theoretical ideas provided by authors those who argue in favor of the efficient greasing hypothesis and against it. Using this information I have been able to prove my hypothesis of the different effects of corruption in the short and long term on developing and developed economies. I conclude that corruption can have positive effect on the developing countries in the short term, however in the long term, at some point of economic and political development governments will have to eradicate corruption to achieve further economic growth and achieve high FDI levels.

Word Count: 1635 words

4 The Peoples Republic of ChinaTax Facts and Figures 2010. Price Waterhouse Coopers. [ONLINE] Available at:

http://www.pwccn.com/webmedia/doc/633988857734651860_cn_tax_facts_figures_2010.pdf. [Accessed 27 February 2012].

Bibliography 1. Aidt, Toke Skovsgaard, Corruption, Institutions, and Economic Development (Summer 2009). Oxford Review of Economic Policy, Vol. 25, Issue 2, pp. 271-291, 2009. Available at SSRN: http://ssrn.com/abstract=1433985 or http://dx.doi.org/grp012 2. Bardham P. (1997). Competition and Development: A Review of Issues. Journal of Economic Literature, Vol. 35 (September), pp. 1320-1346 3. Egger, Peter and Winner, Hannes. How Corruption Influences Foreign Direct Investment: A Panel Data Study. Economic Development and Cultural Change, Vol. 54, No. 2 (January 2006), pp. 459-486 4. Eight Former Senior Executives and Agents of Siemens Charged in Alleged $100 Million Foreign Bribe Scheme. 2012. Welcome to the United States Department of Justice. [ONLINE] Available at: http://www.justice.gov/opa/pr/2011/December/11-crm-1626.html. [Accessed 27 February 2012]. 5. Fisman, R. and Svensson, J. (2007) Are Corruption and Taxation Really Harmful to Growth? Firm Level Evidence, Journal of Development Economics 83 (2007):6375. 6. Helping Countries Combat Corruption: The Role of the World Bank. 2012. Helping Countries Combat Corruption: The Role of the World Bank. [ONLINE] Available at: http://www1.worldbank.org/publicsector/anticorrupt/corruptn/cor02.htm. [Accessed 27 February 2012]. 7. Hines, J. 1995. Forbidden payment: foreign bribery and American business after 1977. NBER working paper 5266. 8. International Monetary Fund. World Economic Outlook (WEO) (April 2011) 9. Leff, N.H. (1964). Economic Development through Bureaucratic Corruption. American Behavioral Scientist, 8(3):8-14. 10. Levy, Daniel, Price adjustment under the table: Evidence on efficiency-enhancing corruption (January 2007). MPRA Paper No. 1648, posted 07. November 2007 / 01:54. Available online at: http://mpra.ub.uni-muenchen.de/1648/ 11. Russian Press - Behind the Headlines, November 22 | What Russian papers say | RIA Novosti. 2012. Russian Press - Behind the Headlines, November 22 | What Russian papers say | RIA Novosti. [ONLINE] Available at: http://en.rian.ru/papers/20111122/168935857.html. [Accessed 27 February 2012]. 12. Shleifer, Andrei and Vishny, Robert Corruption. The Quarterly Journal of Economics, Vol. 108, No. 3 (Aug., 1993), pp. 599-617 13. Shleifer, Andrei, State Versus Private Ownership (July 1998). NBER Working Paper Series, Vol. w6665, pp. -, 1998. Available at SSRN: http://ssrn.com/abstract=226357 14. The World Bank, 2012. Fighting Corruption in Public Services: Chronicling Georgia's Reforms (Directions in Development). Edition. World Bank Publications. 15. Wei, S.-J., How Taxing Is Corruption on International Investors?, Review of Economics and

Statistics, 82(1):1-11, February 2000 16. Wei, Shang-Jin, Corruption in Economic Development: Beneficial Grease, Minor Annoyance, or Major Obstacle? (February 1999). World Bank Policy Research Working Paper No. 2048. Available at SSRN: http://ssrn.com/abstract=604923