Corruption: a hidden tax on growth

11 Nov 15

Public sector corruption is of mounting concern to citizens around the world. What can individuals and institutions to do address it?

In recent years, citizens’ concerns about allegations of corruption in the public sector have become more visible and widespread. From São Paulo to Johannesburg, citizens have taken to the streets against graft. In countries like Chile, Guatemala, India, Iraq, Malaysia and Ukraine, they are sending a clear and loud message to their leaders: address corruption!

Policymakers are paying attention too. Discussing corruption has long been a sensitive topic at inter-governmental organisations like the International Monetary Fund. At its Annual Meetings in Lima, Peru, the IMF hosted a refreshingly frank discussion on the subject.  The panel session provided a stimulating debate on definitions of corruption, its direct and indirect consequences, and strategies for addressing it, including the role that individuals and institutions such as the IMF can play. This blog gives a flavour of the discussion.

What is corruption?

Defining corruption may seem easy. Most people will have the sense that they know it when they see it. For example, a public official takes a bribe in exchange for providing a financial or political gain. However, experts increasingly consider corruption to be much broader. Rather than merely being a transaction between two parties, as one panellist put it, corruption can be viewed as “the privatisation of public policy”. Powerful elites in business and politics collude to control public institutions, capture the policy-making process, and monopolise government contracting and procurement. Another panellist defined corruption even more broadly as “the lack of impartiality in government”, where public money and authority are used in ways that impact negatively on human well-being.

The costs of corruption

The direct economic costs are obvious to most people. Demand for bribes by providers of services affects achievement of social outcomes. The bribe to the taxman that reduces public revenues, and lowers government’s provision of public services. A school that is not built because the allocated funds have been misappropriated. Yet, the indirect costs are likely to be economically far-reaching. As investigated in Governance, Corruption, and Economic Performance by George T. Abed and Sanjeev Gupta (editors), corruption has a negative impact on economic growth through, for example, the over-investment in rent seeking, the underinvestment in productive activities, and the perpetuation of inefficient policies, among other things. The economic costs of corruption, which by the way afflicts countries at all stages of development, are substantial. One 2005 study estimated that the global cost of bribery alone could be as high as 1.5 trillion dollars (in the order of 2 percent of the world’s current GDP). Other studies show a strong correlation between lower levels of corruption and long-term improvements in GDP per capita and in human development indices. In sum, corruption is a tax on growth and investment.

Moreover, some panellists emphasised that the costs are not only economic in nature. Corruption also contributes to the loss of public trust in government, higher levels of inequality in political influence, the deterioration of public values and, ultimately, to the diminution of citizens’ well-being or quality of life. These non-economic costs create a vicious cycle of under-performance of the public sector that is harmful to the economy in the long-term. 

Broad and multifaceted approach required 

Given how broadly corruption and its consequences are now viewed, all panellists agreed that addressing it also requires a broad and multifaceted approach. Such a holistic approach requires leadership, changing incentives and building values, which are all mutually reinforcing.

First, leaders must be willing to bring to account powerful vested interests—the big fish rather than the small fish, the tigers rather than the flies. They must also set the example by being above reproach. Lee Kuan Yew of Singapore is a prime example of a leader who successfully fought corruption through his own personal example and the political will that he engendered.

Second, strong incentives. Leadership must be complemented by a strong system of carrots and sticks—positive reinforcement and accountability. There needs to be a clear framework to combat corruption that is enforced. At the same time, governments need to ensure that public officials earn a living wage. Openness of the economy through deregulation and liberalization will also help since overly regulated economies create strong incentives to maintain corrupt practices. Poland is a good example of quick and effective liberalisation measures. Transparency of government operations and transactions is also important as a disincentive.

Three, building values of integrity. Countries need to promote a culture that values clean government. Building such a culture requires education of citizens. Formal training can help, but ultimately values must be learned through the education system, peer pressure and the day-to-day work experiences and practices of institutions.

How the IMF can help 

Given that corruption has implications for the soundness of public finances and for the stability of financial markets—issues of direct interest to the IMF—panellists emphasized that the Fund has a clear interest in helping its members to tackle corruption.

The IMF assists countries to deter corruption through better design and transparency of public financial management systems (see, for example, IMF Fiscal Transparency Code) and by supporting stable and transparent economic and regulatory environments that limit the scope for arbitrary and preferential treatment. In crisis situations where dealing with corruption is deemed to be critical for macroeconomic stability, the Fund has been more active. In some instances, it has insisted on the reform of legislative frameworks for anti-corruption and of law enforcement functions. Kenya, Indonesia and Ukraine are examples.

In most cases, corruption starts long before it becomes critical to the economy. How early should the IMF become more directly involved in helping to address it? Given the long-term impact of corruption, should discussions be integrated in the IMF’s annual consultations with its members? Here, the IMF’s First Deputy Managing Director, David Lipton, acknowledged that this is not an easy question. While member countries are more open to discussing corruption, it is still a sensitive topic and the IMF role will require some further examination and discussion. In any case, Mr Lipton emphasised, when a country shows real political will to tackle corruption, the IMF should help it to make the bold and comprehensive changes to economic policies and regulatory frameworks that are necessary to decisively limit the costs of this hidden tax.

This article was first published on iMFdirect, the International Monetary Fund's global economy forum

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