Chapter

Chapter 10 Protecting Public Infrastructure from Vulnerabilities to Corruption: A Risk-Based Approach

Editor(s):
Gerd Schwartz, Manal Fouad, Torben Hansen, and Genevieve Verdier
Published Date:
September 2020
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Author(s)
Sailendra Pattanayak and Concha Verdugo-Yepes

The authors thank Nestor Sawadogo and Sureni Weerathunga (research assistant) for assistance with data analysis.

Introduction

Public investment is prone to corruption particularly when public officials and other actors process information and make decisions at various stages of the infrastructure management cycle for private gain. Several public investment projects have been mired in high-profile corruption scandals. For example, a scandal in Brazil that uncovered illegal payments by companies in return for construction contracts with Petrobras, the majority state-owned company, led to a reduction of 2 percent of GDP in Petrobras investments and a 5 percent reduction in gross fixed capital formation in addition to the embezzlement of about R$6.2 billion (0.13 percent of GDP) during 2004–12 (Costa and Dweck 2019). In Italy, development of the high-speed rail network has been dogged by corruption allegations and an average cost overrun of 216 percent for 13 railway construction projects in 2017, including a 917 percent cost overrun for the Milan–Florence railway line alone (Locatelli and others 2017). A corruption scandal involving private actors and politicians in South Africa has allegedly led to the embezzlement of US$7 billion (2 percent of GDP in 2017) in government funds (Transparency International 2019).

The level of discretion enjoyed by public officials is generally higher for capital expenditure than recurrent expenditure (Mauro 1998). Based on perception data, high-profile scandals, and theoretical considerations, investment in infrastructure is subject to high risks of corruption (Golden and Picci 2005; Kenny 2007). This is because infrastructure development tends to involve projects that are large, long-term, and complex—all fertile corruption grounds. Complex projects are also characterized by high degrees of information asymmetry, which makes it harder to detect misconduct in terms of inflated prices, inferior quality, or sluggish delivery (Golden and Picci 2005; Kenny 2006, 2007). Vulnerability to corruption is accentuated in countries with weak institutional capacity for public investment planning, execution and evaluation, and lack of transparency in procurement practices, as shown in the case of the Republic of Congo (IMF 2019). There is a positive correlation between different indicators of control of corruption and weaknesses in public investment management institutions (Figure 10.1).

PIMA Results versus Corruption Indicators

Source: IMF estimates based on PIMA databases (2015–18), the Control of Corruption Index from the World Bank Worldwide Governance Indicators (2010–18), and the Maplecroft Index (2016–19).

Note: PIMA = Public Investment Management Assessment.

The direct costs of corruption include loss of public funds through misalloca-tions or higher expenses and lower quality of infrastructure. Those who pay bribes aim to recover their money by inflating prices, billing for work not performed, failing to meet infrastructure contract standards, reducing the quality of work or using inferior materials. This results in much higher costs and lower quality of public infrastructure (for example, Lovei and McKechnie 2000; Deiniger and Mpuga 2005; and Hollands 2007).

Assessing the scale and cost of corruption along the public infrastructure cycle is challenging because corrupt behavior is secretive and usually does not leave a paper trail. At the same time, existing literature points to large incidences of corruption at some key stages of public investment. For example, estimates of 20–30 percent of project value lost through corruption are widespread (Stansbury 2005; Søreide and Williams 2014; Wells 2015). The Organisation for Economic Co-operation and Development (OECD) estimates that bribery in government procurement in OECD countries increases contract costs by 10–20 percent, suggesting that at least US$400 billion is lost to bribery every year (OECD 2009; see also OECD 2015a). The 2016 Rand Europe report for the European Parliament concluded that the costs of corruption in public procurement vary considerably between member states and average about €5 billion every year (Hafner and others 2016).1

This chapter discusses the types of corruption that generally occur along the public investment cycle and how they result in higher costs and lower quality of public infrastructure, introduces a risk-based approach to identify and analyze corruption risks in the context of specific institutional vulnerabilities, and proposes strategies to tackle corruption risks in infrastructure governance.2

Types of Corruption in the Public Infrastructure Investment Cycle

Corruption can be defined as the “abuse of public office for private gain.” This same definition is used in the IMF’s Guidance Note on Governance (IMF 2018a) and is relied on by the World Bank.3 A specific distinction exists between political corruption and administrative corruption. In the first, the public party involved in the corruption act is an elected official or a senior public servant. In the second, the public party is a less-senior member of the public service. Corruption cases could involve multiple private actors and a public actor.

Corruption can take many forms, ranging from small bribes to kickbacks, fraud, collusion, embezzlement, extortion, influence peddling, and unlawful interest or beneficial ownership (Table 10.1). These activities constitute criminal offences in most jurisdictions although the precise definition of the offense may differ. Each form of corruption differs in its impact at various stages of the investment project cycle and relative to types of projects (Bowen, Edwards, and Cattell 2012; Brown and Loosemore 2015; Transparency International 2016).

Table 10.1.Forms of Corruption during the Infrastructure Cycle and Their Fiscal Implications
Form of CorruptionExamples during Infrastructure CycleFiscal Implication
Bribery refers to giving, promising, soliciting, accepting, or offering a benefit to entice a government official to act in an unethical or illegal manner. Enticements can be in the form of rewards, loans, gifts, donations, special treatment, or services.Bribes paid by firms to win contracts, approve contract amendments and extensions, and influence auditors; facilitation payments made to speed up an actionIncrease in the cost of infrastructure as the payers of the bribe try to recover it in various ways (inflating the price of bids, overinvoicing, supplying low-quality material, and so on)
A kickback is payment by a successful bidder to a third party who facilitated obtaining the bid by making a secret payment for a biased decision.Based on an arrangement before bidding, the winning bid overstates the price to finance kickbacksIncreases the cost of infrastructure as the payers of kickbacks try to recover it in various ways
Fraud refers to illicit documentary practices or an act of deception with an intention to cheat, with the aim of gaining an illegal or unfair advantage (for example, contract award or financial benefit).Subverting bid qualification requirements; diverting project assets; setting up front or shell companies1 to create the illusion of competition or to conceal ownershipLower quality or higher cost of infrastructure; leakage of public resources without any tangible infrastructure development
Collusion is an undisclosed arrangement among parties involved—in the private or public sector or both—who conspire with the intention of gaining illegitimate rewards or financial gain.Bid rigging, when consenting bidders settle on the results of a bid process beforehand; price fixing, when a group of tenderers collude to fix prices; cartelization, when firms agree to fix the prices of goods they controlHigher contract prices and therefore higher costs for implementing an infrastructure project
Embezzlement occurs when an official misappropriates assets, goods, or funds that were entrusted to him or her and uses them for personal gain.The most common form is officials who steal from the state budget or extrabudgetary or slush funds and siphon off project funds or materialsLoss of public resources or need for additional allocation to cover lost funds or materials
Extortion happens when a person in a powerful position, directly or through intermediaries, asks and receives any undue pecuniary or other advantage.An incumbent political party asking an oil company that participates in public investment for a contribution to finance its election campaignDiversion of public resources when coercive power is used to distort project planning for private gain
Influence peddling and abuse of authority occurs when a person misuses his or her status or authority over the decision-making process in return for financial favors or other benefits.A powerful or high-level public official monopolizes key decisions or unlawfully interferes with decision-making at various stages to influence the outcome and so generate private gainWrong selection of infrastructure or excessively high prices paid for infrastructure project design and implementation
Unlawful interest or beneficial ownership occurs when a person in public office acts contrary to his or her duty and in breach of public trust. It may also involve a conflict of interest that affects his or her judgement. This includes favoring friends or relatives for public contracts.A public official secretly owns (or is a director of) a company and wrongly decides in its favor because of a conflict of interest that affects his impartiality; public funds diverted to companies, individuals, or groups in which the public official has unlawful interestMisallocation and diversion of public resources when infrastructure investment allocation and execution are unduly driven by personal rather than public interest
Sources: Adapted from Choi and Thum 1998; Paterson and Chaudhuri 2007; Stansbury and Stansbury 2008; Fan, Lin, and Treisman 2010; Financial Action Task Force 2012; OECD 2016a, 2016b; Chan and Owusu 2017; Sobjak 2018; Agence Française Anti-Corruption 2019; and IMF staff.

Front or shell companies refer to limited liability companies or corporations that have no corporal existence regarding jurisdiction and no commercial activities, nor are they made up of any real employees. They are normally established within secrecy for shielding the actual beneficial proprietor from disclosures, taxes, or both.

Sources: Adapted from Choi and Thum 1998; Paterson and Chaudhuri 2007; Stansbury and Stansbury 2008; Fan, Lin, and Treisman 2010; Financial Action Task Force 2012; OECD 2016a, 2016b; Chan and Owusu 2017; Sobjak 2018; Agence Française Anti-Corruption 2019; and IMF staff.

Front or shell companies refer to limited liability companies or corporations that have no corporal existence regarding jurisdiction and no commercial activities, nor are they made up of any real employees. They are normally established within secrecy for shielding the actual beneficial proprietor from disclosures, taxes, or both.

Corruption Risks at Different Stages of the Public Infrastructure Cycle

This chapter uses an analytical framework that highlights potential risks of corruption at various phases in the public infrastructure cycle and how institutional weaknesses exacerbate vulnerabilities to these risks.

Corruption can occur at any phase of the investment cycle, inflicting different costs and implying different mitigation strategies (Kenny 2006, 2009; Benitez, Estache, and Søreide 2010). Potential risks to corruption arise in five key phases of the public infrastructure cycle (Figure 10.2): (1) infrastructure project identification and preparation, including project planning, costing, and appraisal, (2) project selection and financing, (3) project procurement, (4) project implementation and contract management, and (5) the maintenance of infrastructure assets. These phases in public investment management provide opportunities for government officials, project funders, consultants, contractors, subcontractors, suppliers, joint venture partners, agents, and other actors to take decisions or manipulate information in such a way as to derive undue benefits. Table 10.2 lists specific corruption risks in each of these phases.

Key Phases along the Infrastructure Cycle Posing Corruption Risks

Source: Adapted from OECD 2015b.

Table 10.2.Specific Corruption Risks in Key Phases of the Infrastructure Cycle
PhaseSpecific Corruption Risks
Project Identification and PreparationPolitical influence or lobbying by private firms that introduces bias favoring projects that suit political or private interests; promotion of projects in return for party funds; political influence to favor large projects and new construction over maintenance; underestimated costs and overestimated benefits to get projects approved without adequate economic justification; lack of independent checks on the feasibility of projects; and inadequate project formulation opening the scope of litigation during project execution.
Project Selection and FinancingCostly project designs that increase fees and profits of consultants and contractors who may share the gain with public officials; designs that favor a specific contractor during procurement; incomplete designs that leave room for later adjustments that can be manipulated; high cost estimates to provide a cushion for the diversion of funds during project execution; political influence or abuse of authority vested with a senior official to get projects into the budget without appraisal; off-budget financing of infrastructure projects; bilateral funding tied to “sole source” procurement of the project; and pledging future streams of revenue or in-kind payments to secure project financing.
ProcurementBribery to obtain infrastructure project contracts and recovering the cost of bribery during contract execution; collusion among bidders to allocate contracts or raise prices, potentially with assistance from public procurement officials; influence, interference, or manipulation of tender evaluations by public officials to favor specific firms for contract awards; and launching the tender process and signing contracts for projects that are not in the budget, aiming for their regularization later on.
Project ImplementationCollusion between the project contractor and supervising engineer that results in the use of lower-quality materials and substandard work or an increase in the contract price, covers losses caused by the fault of the contractor, or recovers money spent on bribes or kickbacks; and false accounting or duplicate invoicing for unlawful payments to contractors.
Asset MaintenanceCollusion or agreement by the supervising engineer to accept poor-quality work during maintenance, leading to rapid deterioration of the infrastructure asset; lack of allocated funds for maintenance, as new construction takes precedence over maintenance; and the absence of an updated inventory of assets.
Source: IMF staff.
Source: IMF staff.

The subsequent analysis is based on IMF staff calculations using data from the Public Investment Management Assessment (PIMA) database (2015–18), the Public Expenditure and Financial Accountability (PEFA) assessments database (2008–18), the Control of Corruption Index from the World Bank Worldwide Governance Indicators (average during 2010–18), and the Maplecroft Index (average during 2016–19).4

Infrastructure Project Identification and Preparation

The infrastructure project identification and preparation phase involves infrastructure planning and project costing and appraisal. Significant opportunities for corruption arise during this phase, particularly when institutions related to identifying, appraising, and prioritizing public infrastructure investment are weak. A positive correlation is found between different indicators of control of corruption and project appraisal (Box 10.1). National and sectoral planning has a positive correlation with the Control of Corruption Index and not with the Maplecroft Index, which may be because whereas many countries have formal national or sectoral plans, they are often fragmented, not properly costed, and do not systematically inform public investment decisions (see IMF 2018b; and Chapter 12 of this book). However, as pointed out in the literature, some of the worst forms of grand corruption and state capture happen at this stage of the project cycle (Wells 2015).

Failures in project preparation, which may be caused by corruption, can also create opportunities for corruption later in the infrastructure cycle. For example, inadequate project preparation increases the risk of arbitration and litigation during the project execution stage. It may also lead to subsequent project implementation delays that may require changes to suppliers’ contract or project specifications that can be manipulated for private gain. The cases of Peru and the Republic of Congo illustrate such risks when the formulation and appraisal of infrastructure projects are weak (Box 10.2).

Corruption in the project identification and preparation phase can impact the various forms of investment:

  • Bribes to win contracts are often tied to project costs (Locatelli and others 2017), so there is a strong incentive to promote large new projects over small projects such as maintenance and rehabilitation.
  • Sectors such as construction, transport, and the extractive industries are typically more vulnerable to rent seeking and corruption (OECD 2014).
  • Several studies have shown that countries with high corruption tend to invest less in education and health systems and favor prestigious infrastructure projects that may have low economic and social benefits (Vargas and Sommer 2014).
  • The influence of politicians or other stakeholders with vested interests can lead to project appraisals that are manipulated or skewed to justify projects with low rates of return or that are unviable, the so-called white elephants.5

Project Appraisal and Planning Relationship with Corruption Indicators

Project Appraisal and Planning Relationship with Corruption Indicators

Source: IMF estimates based on PIMA databases (2015–18), the Control of Corruption Index from the World Bank Worldwide Governance Indicators (2010–18), and the Maplecroft Index (2016–19).

Note: In the case of project appraisal, the correlations with corruption indicators are both positive using PIMA indicators. With control of corruption, the PIMA indicator for project selection shows that r = 0.53. With the Maplecroft Index, the PIMA indicator for project selection shows that r = 0.15. In the case of national and sectoral planning, the correlation using PIMA indicators is positive only for the Control of Corruption Index (r = 0.44) but not for the Maplecroft Index (r = –0.14). PIMA = Public Investment Management Assessment.

Peru and the Republic of Congo: Project Preparation and Appraisal

Peru

In Peru, deficient specifications for technical studies—including the lack of independent checks on the feasibility of projects—reduced the attractiveness of the public tender, lessening competition and leading to implementation problems. Inadequate project formulation also led to lengthy arbitration and litigation during the project execution stage, increasing the opportunities for corruption. Implementation of the September 2018 legislative decree on the budget system (DL 1440) should strengthen project selection and budgeting. In addition, the authorities are taking steps to make the external audit more effective. The Contraloria General (Comptroller General) is starting more proactive monitoring to prevent corruption across all levels of government as effective internal controls are absent. To be effective, however, it will require significant improvements to the capacity of external auditors and a prioritization of their tasks based on a risk assessment.

Republic of Congo

In the Republic of Congo, during the infrastructure planning phase, projects are not systematically subject to a rigorous technical, economic, and financial appraisal, which raises concerns about their overall efficiency (Republic of Congo 2018; Melina, Selim, and Verdugo-Yepes 2019) and corruption risks. To the extent that such appraisals are done, they do not undergo independent external review and are not published. Anecdotal evidence suggests that construction contracts are often allocated to members of the governing coalition, particularly if these contracts involve projects that provide high-value consumption goods to the Congolese elite (Bertelsmann Transformation Index 2018).

Sources: Hernandez 2012; Solis 2017; Andina 2018; Republic of Congo 2018; and El Peruano 2019.

Infrastructure Project Selection and Financing

This phase involves infrastructure project selection, detailed design, accurate costing, and selecting the type of funding for the project (including allocation through the budget). The parties to project financing transactions include the project owner who is seeking funding for the project, prospective funders, officials and engineers in charge of detailed design, and consultants advising those parties; for example, in relation to the viability of the project. There is a positive correlation between different indicators of control of corruption and project selection (Box 10.3).

Corruption in this phase can take various forms, with different consequences (see Box 10.4):

  • Bribery or kickbacks could push projects funded by a donor who selects the construction company as a condition of funding (without tender),6 or when projects or public-private partnerships are prioritized by companies that have tendered for the contracts concerned.
  • Project appraisals may be manipulated by the deliberate overestimation of benefits and underestimation of costs, so that projects with low economic returns are selected in return for financial favors or other benefits to the official in charge of selection.
  • The detailed design of a project may be manipulated. This includes overdesign—increasing the project size or specifications—to prepare high cost estimates that provide a cushion for later diversion of funds and incomplete design that leaves room for changes during project execution. For example, site and soil investigations and environmental impact assessments may be excluded from the initial design, requiring expensive adjustments at later stages.7
  • Influence peddling by high-ranking officials may occur in the selection and funding of projects to achieve personal gain.
  • The projects could be financed off budget to circumvent scrutiny procedures (see Box 10.4) or could be implemented through state-owned enterprises, which may have looser selection criteria or be subject to less oversight.

Project Selection Relationship with Corruption Indicators

Control of Corruption Index and Maplecroft Index: Project Selection

Source: IMF estimates based on PIMA databases (2015–18), the Control of Corruption Index from the World Bank Worldwide Governance Indicators (2010–18), and the Maplecroft Index (2016–19).

Note: In the case of project selection, the correlations with corruption indicators are both positive using PIMA indicators. With control of corruption, the PIMA indicator for project selection shows that r = 0.70. With the Maplecroft Index, the PIMA indicator for project selection shows that r = 0.25. PIMA = Public Investment Management Assessment.

Of-Budget Financing, Infuence Peddling, and Manipulating Project Cost-Benefit

Republic of Congo

The Republic of Congo’s weak capacity to reconcile the government’s share of oil revenue under various production-sharing agreements and actual revenue received by the Treasury translated into substantial off-budget oil revenue which was used largely to finance infrastructure projects, including a power station (Extractive Industries Transparency Initiative 2015). Because these transactions bypassed the budget process for appraisal and selection and the requirements of the public procurement code, there are concerns about their integrity. As noted in Republic of Congo (2018), this rapid scaling up of public investment has occurred in a nontransparent, inefficient environment amid strong perceptions of corruption.

Kenya

In Kenya, Burgess and others (2009) found strong evidence that road expansion in any given year is closely related to the home regions of the prime minister and minister for public works and to those of other ethnic groups represented in the Cabinet. One outcome of this phenomenon is deterioration of the road network in areas that lack political connections (Wales and Wild 2012).

Kenya

In India, Enron’s Dabhol Power Corporation signed a deal to produce electricity at a price seven times higher than other providers. This occurred despite warnings from the World Bank that the project was too expensive. It was later alleged that local politicians had been bribed (Kenny and Søreide 2008).

Kenya

In Uganda, Booth and Golooba-Mutebi (2009) concluded that “the evidence indicates that, under the pre-2008 arrangements, the roads divisions of the Ministry of Works operated as a well-oiled machine for generating corrupt earnings from kickbacks.” They then showed how this operated as a complex system of political patronage. Public officials raised money in different ways, including accepting bribes for awarding contracts and signing completion certificates.

Kenya

In a review of 258 megatransport projects worldwide, Flyvbjerg (2007) found costs seriously underestimated at the time of the decision to build. He argued that this could not be solely attributed to a lack of experience or to the existence of “optimism bias” among planners and promoters, but in many cases, deception is deliberate and can be traced to political and organization pressures, agency problems, and distorted incentives (see also Flyvbjerg, Garbuio, and Lovallo 2009).

Sources: Extractive Industries Transparency Initiative 2015; Republic of Congo 2018; Wells 2015.

Infrastructure Procurement

Procurement of public infrastructure is among the government activities most vulnerable to corruption (OECD 2016b). Corruption risks in this phase increase when the central procurement authority is weak and tendering is neither competitive nor transparent. Countries with a higher perception of corruption tend to have a tendering process that is less open and competitive (Box 10.5). In addition to the volume of transactions and the financial interests at stake, corruption risks are exacerbated by processes that are overly complex, and where there is a close interaction and possible collusion between public officials, businesses, and other stakeholders. The OECD’s (2014) “Foreign Bribery Report” provides additional evidence that public procurement is vulnerable to corruption. It shows that more than half of foreign bribery cases occurred to obtain a public procurement contract. Corruption in this phase can take various forms and have different consequences:

  • To facilitate rent seeking and corruption, the tendering process may not be open and competitive, leading to a higher cost of procurement and lower quality of infrastructure provision. Box 10.6 discusses the example of Spain, illustrating how lack of transparency in tenders led to corrupt practices, and Korea, where the authorities have introduced measures to ensure procurement is more transparent and competitive.
  • Corruption may occur in the awarding of a public procurement contract or a public-private partnership when, for private gain, public officials share inside information with a potential bidder, manipulate the tender evaluation, provide false reasons for a direct award, or allow modifications to the bid parameters in a nontransparent manner that favors the winning bidder.
  • Bidders may collude through other mechanisms (for example, bid suppression or bid rotation)8 to give the appearance of competition. Such collusion and bid-rigging practices are believed to be widespread in many parts of the world, including in some advanced economies. Evidence is difficult to obtain, but the work of the Office of Fair Trading in the United Kingdom and the Charbonneau Commission in Québec, Canada, provide useful insights on this process (Box 10.6).

Infrastructure Procurement Practices and Corruption Indicators

Infrastructure Procurement Practices and Corruption Indicators

Source: IMF estimates based on PIMA databases (2015–18) and PEFA databases (2008–18), the Control of Corruption Index from the World Bank Worldwide Governance Indicators (2010–18), and the Maplecroft Index (2016–19).

Note: In the case of procurement with corruption, indicators are positive using PIMA and PEFA indicators. For procurement (PIMA scores in effectiveness), the correlation with control of corruption is r = 0.70. With the Maplecroft Index, PIMA scores show that r = 0.36. In the case of PEFA scores, the indicator more closely related to procurement shows that r = 0.12 with control of corruption. With the Maplecroft Index, the PEFA indicator for procurement shows that r = 0.18. PEFA = Public Expenditure and Financial Accountability; PIMA = Public Investment Management Assessment.

Infrastructure Procurement: Issues and Reforms in Selected Countries

Kenya

In Spain, the government’s poorly programmed infrastructure investment during 1995–2016 was accompanied by lack of transparency during the tendering. Recent cases reveal that bid rigging, biased scoring rules in contract assignment, and especially renegotiations after contracts came into force played major roles in facilitating corrupt deals. The government acted to bring more transparency to infrastructure investments and to reduce corruption (Spanish “Comision Nacional de los Mercados y la Competencia; CNMC 2018, 2019). This included measures to sanction bid rigging. For example, the National Commission of Markets and Competition of Spain sanctioned 15 building companies (that had created cartels to distort competition in public tenders) and 14 managers for unlawfully dividing public tenders for electrification and electromechanical systems on conventional and high-speed rail lines. For the first time, the National Commission of Markets and Competition activated the procedure for the prohibition of contracting with the government.

Kenya

In Korea, the implementation of a national procurement system (KONEPs or GePS, in Korean), a one-stop shop for public procurement, has brought notable improvement in the transparency and integrity of the public procurement administration. In 2002, the Public Procurement Service, the central procurement agency of Korea, introduced a fully integrated, end-to-end e-procurement system. This covers the entire procurement cycle electronically (including for one-time registration, tendering, contracts, inspection, and payment), and related documents are exchanged online. All public organizations are mandated to publish tenders through the system, which provides information in real time. In the Fingerprint Recognition e-Bidding system, introduced by the Public Procurement Service in 2010, each user can tender for only one company, by using a biometric security token. Fingerprint information is stored only in the concerned supplier’s file, to prevent any controversy over the government’s storage of personal biometric information. In 2012, more than 62.7 percent of Korea’s total public procurement (US$106 billion) was conducted through the system. Participation in public tenders has increased and transparency improved considerably, eliminating corruption by preventing and detecting illegal practices and collusive acts. This has led to public sector savings of US$1.4 billion (OECD 2016a, 2016b). In addition, the time to process a bid has been reduced from 30 hours to 2 hours (OECD 2016a, 2016b).

Kenya

In Québec, Canada, the Commission of Inquiry on the Awarding and Management of Public Contracts in the Construction Industry (the “Charbonneau Commission”) was created in 2011 to examine collusion or corruption in the award or management of public contracts in Québec’s construction industry. The report, released in 2015, found that schemes of collusion and corruption were widespread (Charbonneau Commission 2015).

Kenya

In the United Kingdom, the Office of Fair Trading (2009) found that firms colluded in setting artificially high prices in bidding for public infrastructure construction work. Firms would decide which contracts they wanted, and rivals would bid purposefully high prices. This is a practice known as “cover pricing.” In 2009, the Office of Fair Trading issued its decision, which saw fines totaling £129.2 million imposed on 103 construction firms that were found to have engaged in bid-rigging activities across 199 tenders from 2000 to 2006. In 11 of these bids, the winning bidder faced no genuine competition as all other bids were cover bids. The Office of Fair Trading also found six instances in which successful bidders had paid an agreed-upon sum of money to the unsuccessful bidder.

Source: OECD 2016b.

Infrastructure Project Implementation

This phase involves project execution and contract management. Corruption risks in project implementation increase when there is weak supervision, monitoring, and enforcement of the related contract. Weak internal controls and oversight arrangements, including internal and external audits, also increase the chances of corrupt behavior by rent-seeking actors. Equally, the presence of corrupt officials may deter governments from introducing and facilitating effective audit procedures.9Box 10.7 shows that weak external audit follow-up and ineffective internal audits are associated with a high level of corruption.

Deng and others (2003) reported that the most costly and serious corruption cases may occur after a contract is awarded, during the project implementation stage. Although implementation delays are easy to detect, assessing implementation quality is less straightforward, because the effects may be visible only after many years. Corruption during the procurement phase typically also affects this phase. For example, companies that paid bribes in the procurement process may seek to recover the bribes by inflating the prices of goods and services, submitting invoices for work not performed, and failing to meet contract terms and standards.

During the project implementation phase, corruption can take various forms, with different consequences:

  • There may be deficient supervision from public officials or collusion between contractors and supervising officials.10 Enforcement of the quality standards and performance standards in a contract may be compromised as a result.
  • Substantial changes in contract conditions may be introduced to allow more time or higher prices for the bidder for private gain (shared between the contractor and corrupt public officials).
  • Product substitution or work that fails to meet contract specifications may result from collusion or weak supervision.
  • The absence of effective internal control systems creates opportunity for fraudulent practices such as false accounting, cost misallocation, cost migration between contracts, and false or duplicate invoicing for goods and services not supplied. Box 10.8 illustrates how weak internal controls led to massive corruption in public investment by Petrobras, Brazil’s national oil company.

Internal and External Audit Effectiveness and Corruption Indicators

Internal and External Audit Effectiveness and Corruption Indicators

Source: IMF estimates based on PEFA databases (2008–18), the Control of Corruption Index from the World Bank Worldwide Governance Indicators (2010–18), and the Maplecroft Index (2016–19).

Note: In the case of the internal audit relationship with corruption indicators, the correlation with the Control of Corruption Index is 22.8, and the correlation with the Maplecroft Index is 16.1. In the case of external audit, the relationship is stronger with r = 36.7 for control of corruption and r = 22.8 for Maplecroft index. PEFA = Public Expenditure and Financial Accountability.

Brazil: Lack of Internal Controls in State Firms Undertaking Public Investment

Serious vulnerabilities in the internal control framework of Brazil’s national oil company, Petrobras, and weaknesses in its governance structure and operational accountability set the stage for a corruption payment scheme within the company from 2004 to 2012, resulting in about US$2.5 billion of losses in public resources. A group of companies colluded to get contracts with Petrobras, overcharge, and divert some of the funds, partly to illegally finance political parties. A fragmented external oversight system, involving multiple government agencies (the regulatory body, audit institutions, and the supervising ministry), was not able to detect the irregularities. Petrobras subsequently developed control mechanisms and introduced measures to improve its anti corruption standards and increase transparency in reaction to corruption scandals uncovered by the “Car Wash” investigation task force in 2014. It has approved a corruption prevention program (Programa Petrobras de Prevengao da Corrupgao, or PPPC) that focuses on the prevention, detection, and punishment of acts of fraud and corruption. As a result of the investigations, the Anti-Corruption Law 12.846/2013 and its regulation Decree 8.420/2015 were also enacted, allowing for strengthened external oversight by audit institutions and other external regulatory and supervisory agencies.

Sources: Engel and others 2018; Petrobras 2019.

The literature also demonstrates costs that may arise from inadequate monitoring of project implementation. For example, based on independent engineers’ estimates, increased monitoring of road projects in Indonesian villages led to an approximately 8 percent reduction in unexplained material costs (Olken 2007).

Infrastructure Asset Maintenance

Infrastructure assets, which are typically of high value, open opportunities for corruption during operation and maintenance, particularly where a sound framework for maintenance management and strong internal control systems are lacking. Such a framework would include an up-to-date register of all public infrastructure assets and regular checks to verify their condition and report damage and lack of proper maintenance.

Australia: Corruption in Maintenance of Rail Tracks

The Independent Commission Against Corruption of Australia investigated state railway operator RailCorp in 2008 and found that employees had improperly allocated contracts worth almost $A19 million to companies owned by themselves, friends, or family in return for corrupt payments totaling more than $A2.5 million. Timesheet manipulation was also widespread in parts of RailCorp and had been for decades. Nicknamed “job and knock,” it was most common in services to maintain and repair rail track such as welding. The practice was so pervasive that it was impossible for RailCorp to estimate actual labor requirements for infrastructure maintenance and infrastructure projects. There was evidence that supervisors’ tolerance of job and knock allowed it to continue and encouraged new staff to adopt it. A focus on outcomes was used to justify bending rules to get things done so that as long as rail track was being repaired or maintained, management and staff were willing to ignore proper tender procedures and record-keeping requirements.

Source: Independent Commission Against Corruption 2008.

During the maintenance phase, corruption can take forms such as bribery, fraud, collusion, and embezzlement, and have different consequences:

  • In the absence of standards and clear guidelines for infrastructure asset maintenance, the estimates and budget allocations for maintenance could be falsified; moreover, it may be difficult to assess later whether assets have been adequately maintained.
  • Officials may collude with a third party to submit false or inflated invoices for asset repair and maintenance costs or may purchase resources above actual needs to dispose of the surplus for personal gain (see the example of Australia in Box 10.9).
  • Officials may change the status of an asset from current to obsolete without justification or provide for unjustified early retirement or disposal of an asset to aid a third party or for personal gain.
  • Officials may deliberately undervalue assets that are to be disposed to aid a third party or for personal gain.
  • Maintenance projects may be neglected in favor of inappropriate and extensive new investment projects in which the scope for rent-seeking is much higher.

Addressing Corruption Risks in the Public Infrastructure Cycle

Measures to mitigate corruption risks along the infrastructure cycle need to be considered in six areas:

  • A proactive approach to corruption risk management. This approach would include clear anti corruption policies, with a focus on continual improvement; strengthening the due diligence and vetting process for contractors and other third parties; communicating and consistently reevaluating ethics and compliance standards for public officials and private actors involved in public infrastructure; and carrying out random anti corruption reviews of infrastructure projects during implementation.
  • Clear delineation of authority for decision-making without conflict of interest. This may require institutional reforms to assign clear roles and responsibilities, regulate or limit authority for decision-making, and identify and manage conflicts of interest transparently to avoid abuses of office.
  • Transparent frameworks and criteria for making infrastructure decisions. This includes clear regulatory frameworks and methodologies for processing information to produce key outputs and reports that feed into decision-making on infrastructure and reduce the discretion available to public officials to influence decisions for private gain, including digitalizing the processing of information wherever possible (to reduce the scope for human intervention).
  • Effective arrangements to enforce accountability for decisions taken, backed by sustained anti corruption and anti–money-laundering interventions. Improving accountability entails efforts to improve both the detection and the sanctioning of corrupt acts, including an alert system to signal corruption risks and suspicious behaviors by relevant actors.
  • A robust and effective framework for transparent reporting and disclosure of relevant information at all key decision points.11 This reporting should be timely and complemented by a credible whistleblower12 system (in both the public and the private sectors).13
  • Integrity of transactions of private firms and actors involved in public infrastructure. Private sector companies and executives should comply with internationally accepted internal control and accounting practices in their transactions with public agencies and officials for public infrastructure development and maintenance. Studies, however, show that infrastructure construction companies have paid inflated contract costs using sham invoices, recorded these items as legitimate expenses for goods or services, and then consolidated them in their records.14

Table 10.3 summarizes key institutional reforms in infrastructure governance to deal with vulnerabilities to corruption, and it proposes some illustrative indicators and “red flags” to alert policymakers and citizens to potential risks and to help them detect corruption. These measures should be backed by (1) strong anti corruption institutions and credible penal actions against corrupt actors (whether in the public or private sector) when corrupt transactions are detected, (2) the development of an anti corruption compliance framework in the private sector, and (3) anti–money-laundering measures (see Box 10.10).

Table 10.3.Measures and Indicators to Prevent and Detect Corruption in Public Infrastructure
Stage in Public Infrastructure CyclePreventing Corruption: Institutional Reform MeasuresDetecting Corruption: Illustrative Indicators/Red Flags
Infrastructure Project Identification and Preparation
  • Integrated infrastructure planning framework
  • Comprehensive database to forecast the need for new infrastructure projects and maintenance
  • Clear national, regional, or sectoral objectives for infrastructure
  • Inclusion of lifetime costs of the project and asset preservation costs in project appraisal
  • Independent external scrutiny of project appraisal, especially for major projects
  • Publishing information on originally estimated and updated total cost of projects
  • Project planning limited to only one alternative
  • Absence of economic evaluation/cost-benefit analysis of project
  • Misrepresentation of costs or benefits to skew the results of economic analysis
  • High percentage of growth of public investment compared with growth of infrastructure maintenance expenditure
Infrastructure Project Selection and Financing
  • Clear criteria for project prioritization, selection, and funding
  • Project costs estimated accurately before funding
  • Project detailed design reflects the ground reality to prevent unnecessary alterations during implementation
  • Public and community participation in project design and selection
  • Credible social, economic, and environmental feasibility studies
  • Planning and implementing land acquisition and resettlement polices before implementation
  • Checks and balances to prevent elected officials from choosing projects to benefit firms that contributed to their political campaigns
  • Project selection decision taken without feasibility study and project appraisal
  • Projects funded off-budget
  • Extrabudgetary funds with earmarked revenue as vehicles for public investment
  • Failure to budget realistically
  • Donor funding secured for project by pledging collateralized future revenue
  • Bids much higher or lower than the estimated project costs
  • Cost per unit significantly higher than for similar projects
Infrastructure Procurement
  • Identifying and reviewing bids for any unusual patterns
  • Due diligence testing to assure the integrity of bidding companies
  • E-procurement for bid advertising, acceptance, and reward
  • Open data and open contracting to provide transparency
  • Probity advisors and auditors to oversee procurement processes
  • Noncompetitive procedures not used without proper justification
  • Project design and specifications not restrictive or tailored to favor a contractor or firm
  • Random external review of bid specifications
  • Publishing contract and contract variation information
  • Establishing complaint mechanisms for reporting procurement fraud and addressing such complaints
  • Large difference between contract values and their estimates
  • Sole-source contracts or contracts with a single bidder, without prequalification, or both
  • Prequalification standards exclude otherwise qualified contractors
  • Use of noncompetitive procedures
  • Splitting up tenders
  • Reduced timespan for bid submission
  • Unclear definition of bid amount
  • Selection criteria not clearly defined
  • Repeat awards to the same contractor
  • Public officials or their families acquiring a financial interest or employment in a contracting firm
Infrastructure Project Implementation
  • Complete records of all decisions and criteria used for work variation orders
  • Independent external supervisor vets contract variations
  • Strong accounting practices and regular bank reconciliation of project related financial transactions
  • Treasury single account to consolidate public funds in the banking system
  • Strong internal controls and audit capacity to limit risks during project execution
  • Third-party oversight of large infrastructure projects
  • Community oversight groups to oversee project implementation
  • Projects with high cost overruns
  • Substantial change in contract conditions during implementation
  • Failure to maintain records on work progress or work variations
  • Contract files either incomplete or missing required documents
  • Failure to monitor contractors’ performance
  • Only one person responsible for multiple functions of contract management
  • Works or services certified without physical inspections
Infrastructure Asset Maintenance
  • Central register of infrastructure assets
  • Regular update of inventories and registries on maintenance
  • Regular surveys and physical verifications of assets
  • High percentage of “poor” condition infrastructure assets
  • Maintenance expenditure low compared with capital stock

Anticorruption Framework and Private Sector Integrity Compliance for Infrastructure

The anti corruption framework for corruption in infrastructure should be applicable to all stages of the public infrastructure cycle. Among other measures, this framework should include (1) enacting an anti corruption law, (2) establishing a national anticorruption agency and vesting it with powers to investigate and sanction corrupt practices, (3) understanding money-laundering risks from corruption and establishing anti– money-laundering measures, (4) identifying and managing conflict of interest situations, (5) providing standards of conduct for the private sector and consultants, (6) regulating and limiting the use of confidential information by public officials, and (7) providing protection for employees who report wrongdoing or breaches of integrity in the public and private sectors.

Sources: Sieber 2012; Financial Action Task Force 2013; OECD 2016a, 2016b; Malgrain, Picca, and Gunka 2018; Agence Française Anti-Corruption 2019; US Department of Justice 2019; and IMF staff.Note: OECD = Organisation for Economic Co-operation and Development.

Conclusions

Public infrastructure development is subject to high risks of corruption as it tends to involve projects that are large, long term, and complex—all fertile grounds for corruption. Countries with weak institutional capacity for public investment management are more vulnerable. Corruption in public infrastructure can take many forms, from small bribes to kickbacks, fraud, collusion, embezzlement, extortion, influence peddling, and unlawful interest or beneficial ownership. Corruption can occur at any phase of the investment cycle, inflicting different costs and implying different mitigation strategies.

The strategy to mitigate corruption risks along the infrastructure cycle should include a proactive approach to risk management in the public and private sectors, clear delineation of authority for public investment decision-making without conflict of interest, transparent frameworks and criteria for making infrastructure decisions, effective arrangements to enforce accountability for decisions taken, a robust framework for transparent disclosure of relevant information at all key stages, and integrity of transactions of private firms and actors involved in public infrastructure.

Specific indicators and “red flags” (as proposed in this chapter) could be used to improve the detection and sanctioning of corrupt acts, alert policymakers and citizens to potential corruption risks and systemic weak points or vulnerabilities, and so take actions to mitigate these risks. Identifying the risks of corruption and taking effective measures to tackle them are vital to a country’s development and ensuring value for money in the use of public resources.

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1

Fazekas and Koscis (2015) constructed an objective measure of corruption in public procurement, making use of a range of public procurement red fags to create a composite measure called the Corruption Risk Index.

2

We do not discuss ex post legal penal measures, which are beyond the scope of this chapter.

3

There are various other—but somewhat similar—definitions of corruption. According to public office–centered definitions, corruption in government is generally defined as the abuse or misuse of public office or authority for private gain that occurs when public officials interact with private sector actors.

4

The PIMA is the IMF’s key tool for assessing infrastructure governance along the full investment cycle (see Chapter 5 of this book). The PIMA sample used in this chapter includes assessments of 62 countries (52 field assessments and 10 desk-based assessments) and the results use a standardized methodology. The PEFA sample covers 111 countries. The Control of Corruption Index provides a relative measure of perceived corruption that ranges from –2.5 (high corruption) to 2.5 (low corruption). The Maplecroft Index assesses risk by modeling the strength of anti corruption legislation, the efficacy and independence of anti corruption bodies, and the prevalence of corruption from a business perspective; the index ranges from 0 (high risk to corruption) to 9 (less risk to corruption). For further discussion on the Control of Corruption and Maplecroft indexes, see IMF (2017a, 2017b).

5

A white elephant is a project that fails to meet public demand and whose costs of construction, operation, and maintenance are not justified by its ultimate economic and social return.

6

For example, during 2014–17, most of the road investment projects in Congo financed within the strategic partnership with China used a restricted call for tender (IMF 2019, 102).

7

Although adjustments may occur because of unexpected events or circumstances, even when a project is adequately designed, starting of without a complete plan opens the door to postcontract negotiations and opportunistic behavior.

8

Bid suppression occurs when some of the conspirators agree not to submit bids, allowing another conspirator to win the contract. Bid rotation refers to the practice of competing firms “taking turns” at winning the contract. Bid rotation is in effect a form of market allocation in which competitors enter into an agreement to get a fair share of the industry profits.

9

For example, finance ministries sometimes set up internal audit units but starve them of information and influence.

10

Collusion between supervising engineers and contractors is almost always a requirement for corruption during project implementation, as the supervising engineer controls most of the avenues through which corruption occurs.

11

Key decision points are project identification, selection, financing, procurement, and implementation. For transparent reporting and disclosure, the relevant information should include the cost of the project or the contract, the actors involved in the decision-making, criteria for the decision, the potential conflicts of interest and how they have been addressed, and the relevant public agencies and private firms or actors in charge of processing information for decision-making or project implementation.

12

A whistleblower is any person who exposes or reports an activity that is deemed illegal or unethical.

13

In several countries, whistleblowers are protected by law. For example, Italy has adopted a new law (No 179/2017 of November 30, 2017) that aims to strengthen protection for whistleblowers in the public sector and adds new protections for those in the private sector. France also recently enacted the Sapin II Act on transparency for tackling corruption, which regulates whistleblowing programs aimed at ensuring protection of whistleblowers.

14

For example, the companies Halliburton and Kinross Gold (Canada-based gold mining company) agreed to pay more than US$29.2 million and US$950,000, respectively, as penalty for their failure to implement adequate accounting controls (US Securities and Exchange Commission 2017, 2018).

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