Journal Issue

Why developing countries can’t afford corruption

International Monetary Fund. External Relations Dept.
Published Date:
May 2003
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As globalization extends its reach and picks up its pace, the cost of corruption is drawing heightened scrutiny from investors, host countries, international agencies, and academics. Why the growing interest? For one thing, Wei said, the end of the Cold War has reduced the importance of geopolitical considerations in aid allocations. There is now considerably less incentive to tolerate “governance-challenged regimes,” such as those of Ferdinand Marcos’s Philippines or Mobutu Sese Seko’s Zaïre (now the Democratic Republic of the Congo).

There are business reasons, too, for taking a hard look at the costs of corruption. Given increased globalization, investors have options. They can pick and choose where to invest, and the new math of globalization encourages them to factor in such things as the high costs of bribes. Studies indicate, for example, that moving from a relatively clean government environment, like that of Singapore, to one as corrupt as, say, Indonesia under Suharto, could entail costs for foreign direct investment equivalent to a 50 percent increase in the marginal corporate tax rate.

More corrupt economies are also now seen as more prone to financial crises, because they are more likely to depend on short-term foreign loans—the type of capital most likely to flee a country in the event of a shock. Research by Wei and Gaston Gelos, another IMF economist, suggests that portfolio investment is also negatively affected by corruption and that fund managers typically favor less corrupt countries.

Advanced countries have also taken steps to discourage or at least not abet corruption. In 1999, OECD countries (and some non-OECD countries as well) signed a treaty banning bribery by their firms of foreign government officials. Out is the tax incentive for bribery under the old system, and in is the potential for criminal punishment of such behavior under the new law.

But is it bad for development?

While there has never been outright support for corruption, Wei said, a number of academics, notably Harvard University’s Samuel Huntington, have argued that corruption has its uses in economies that are otherwise clogged with licensing requirements and other bureaucratic obstacles. In those countries, he observed, corruption helped grease the wheels and actually get things done. In Huntington’s view, the only thing worse than dishonest and rigid bureaucracy is honest and rigid bureaucracy.

But this excusing of corruption, Wei said, confuses the cart with the horse. It is more likely, he said, that bureaucratic red tape is created to provide officials with opportunities to pad their incomes. Rather than condone corruption, why not address the root causes of the problem? In fact, Wei cited various pieces of empirical evidence that overwhelmingly demonstrate that corruption injects sand, not grease, into the economic development process.

How corrupt?

How are companies looking to make sound investments, or international organizations seeking to ensure responsible use of their financing, able to measure how corrupt a country is? Reliable quantitative data have long been lacking, but in recent years private organizations, both for profit and not, have developed useful yardsticks. Wei cited several indices that can make the task of measuring corruption easier. He pointed to the Political Risk Services Group, which now offers, for a fee, corruption ratings for a number of countries in its International Country Risk Guide.

Harvard University and the World Economic Forum jointly produce The Global Competitiveness Report. This report contains the results of regular surveys of 5,000-7,000 business executives around the world in which they were asked to estimate and rate the severity of corruption they might encounter in completing several business transactions (such as obtaining import or export licenses, foreign exchanges, or bank loans) in these countries. Transparency International’s ( Corruption Perceptions Index and the World Bank’s Control of Corruption Index tap a variety of other sources and offer their composite measures on the Internet.

All of these indices, Wei acknowledged, are subjective. But since perceptions often drive business decisions, they provide useful information. In fact, he said, a German study of its exporters—undertaken in the mid-1990s when bribing foreign officials was legal—gathered data on the percentage of export business that involved bribery of foreign officials. Its results were highly correlated with the perceptions-based studies now taking place.

On the international front

Are multilateral institutions like the IMF doing their share to complement domestic and investor interest in better governance? Wei cited a case in which the IMF, in response to severe governance problems, suspended financing to a member country.

Much remains to be done, Wei said, but the international community has begun to “move in the right direction on this important issue”

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