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ECONOMIC GROWTH AND THE ASIAN PARADOX: A STUDY ON THE DIFFERENTIAL
EFFECT OF CORRUPTION IN INDIA
Morgan E. Mounts
A Thesis Submitted to the
University of North Carolina Wilmington in Partial Fulfillment
of the Requirements for the Degree of
Master of Business Administration
Cameron School of Business
University of North Carolina Wilmington
2010
Approved by
Advisory Committee
Virginie Vial
Nathalie Lalande
Emanuelle Mebratu
L. Vince Howe
Chair
Accepted by
DN: cn=Robert D. Roer, o=UNCW,
ou=Dean of the Graduate School &
Research, [email protected],
c=US
Date: 2010.10.28 10:45:13 -04'00'
___________________________
Dean, Graduate School
ACKNOWLEDGMENTS
I would like to thank my family, friends, and the faculty and staff at UNCW and
Euromed-Marseille for their support during this long process. I would especially like to
recognize my best friend and IMBA colleague Debra Garretson. Debra has provided valuable
insight along with unwavering support and constant encouragement. Without her help, my thesis
would not have been possible.
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ABSTRACT
At a time when countries around the globe are facing the consequences of a financial
crisis caused by corrupt practices and poor governance, is there still a place for development
fueled by corruption? East Asia in particular, has experienced growth in relation to corruption.
However, not all countries in Asia have enjoyed the same experience as the ‘Asian Tigers’.
India, in particular has a unique relationship between corruption and economic development.
This paper examines the differential effect of corruption in India using a framework based on the
literature of the Asian Paradox. Supporting the view that corruption may fuel growth if certain
factors are present, I conclude that the combination of country size, the political economy and
the structure of corruption networks in India have restricted the level to which their economy has
been able to grow.
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TABLE OF CONTENTS
ACKNOWLEDGMENTS .............................................................................................................. ii
ABSTRACT................................................................................................................................... iii
TABLE OF CONTENTS............................................................................................................... iv
LIST OF TABLES ...........................................................................................................................v
LIST OF FIGURES ....................................................................................................................... vi
INTRODUCTION ...........................................................................................................................1
LITERATURE REVIEW ................................................................................................................4
Theoretical review of corruption .........................................................................................4
Macro causes of corruption..................................................................................................8
Effects of corruption ..........................................................................................................15
The Asian Paradox .............................................................................................................17
Summary ............................................................................................................................23
A STUDY ON THE DIFFERENTIAL EFFECT OF CORRUPTION IN INDIA ........................24
Introduction ........................................................................................................................24
Methodology ......................................................................................................................26
Country Size.......................................................................................................................27
Domestic politics/Industrial Organization of Corruption ..................................................29
Corruption networks .......................................................................................................30
DISCUSSION ................................................................................................................................32
REFERENCES ..............................................................................................................................34
APPENDIX ....................................................................................................................................38
iv
LIST OF TABLES
Table
Page
1. Causes of Corruption ..................................................................................................................9
2. Historical average annual GDP growth percentages per capita .................................................18
v
LIST OF FIGURES
Figure
Page
1. Transparency International’s Corruption Perception Index 2009 ................................................2
2. Comparison of average GDP growth per capita to corruption rankings ....................................21
3. Comparison of indicators of business environment in South and East Asia .............................25
vi
INTRODUCTION
At a time when countries around the globe are facing the consequences of a financial
crisis caused by corrupt practices and poor governance, is there still a place for development
fueled by corruption? The neo-liberal view of corruption claims that it causes over regulation and
that it can be eradicated by open markets and free trade. Organizations, like the World Bank
support this view, often basing their assistance on the presence of good governance within a
country.
Corruption is a serious problem that can slow economic development, deter foreign direct
investment, reduce tax income, reduce efficiency in business transactions and public services,
and reduce the amount of funding available to important public programs. In this study
corruption is defined as “the use of public office for private gain” (Bardhan, 1997, p. 1321). A
worldwide movement to reduce corruption has emerged that includes participation from NGO’s,
private firms and advocacy groups.
According to Svensson (2005),“the most devastating forms of corruption include the
diversion and outright theft of funds for public programs and the damage caused by firms and
individuals that pay bribes to avoid health and safety regulations intended to benefit the public”
(Svensson, 2005, p.19). These damages particularly hurt developing economies that already lack
proper funding for public programs.
The map in Figure 1 depicts levels of corruption perceptions across the Globe; with the
most corrupt countries colored in dark blue. A majority of the highly corrupt countries are
developing or transition economies with low levels of income. Also, many of the nations have
recently been governed by socialist regimes and (besides Indonesia) have closed economies
(Svensson, 2005, p.24).
Figure 1: Global Perceived Levels of Corruption
Source: Transparency International (2009 a)
Corruption can appear in many forms, including bribery, fraud, extortion, kickbacks and
embezzlement; depending on the context and situation. Corruption can be caused by a number of
factors. Laws, cultures and customs, weak governments, too much bureaucracy
Asia is a unique case in which some sections, East Asia in particular, has experienced
exponential growth paired with high corruption levels. However, not all countries in Asia have
enjoyed the same experience as “East Asian Tigers”. In particular developing nations, such as
India, with a weak de-centralized government have experienced the most negative impacts.
Why has India not experienced the same economic growth as other Asian countries with
high levels of corruption? India’s economic growth has suffered due to the corruption caused by
a combination of a weak government with a high level of bureaucracy and a culture of bribery.
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The differential effect of corruption, caused by the factors mentioned above, is an important area
for future research (Svensson, 2005, p. 40). Currently the research literature lacks studies that
focus solely on corruption in India.
As such the purpose of this study will be to analyze the differential effect of corruption in
India. To begin we will review the literature on the theories, causes, and effects of corruption. In
the review an emphasis is placed on empirical studies of corruption in the context of the Asian
Paradox. Next a country study on India is conducted using a framework based on factors of
corruption mentioned in the literature review. Last, there will be a discussion of findings and
conclusions.
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LITERATURE REVIEW
The literature review will address three areas related to the effects of corruption on
economic growth. In the first section there will be a discussion on research related to the
theoretical study of corruption. The second section reviews empirical evidence on the causes and
effects of corruption at the macro level. Last, the third section will focus on empirical research
studies about corruption in Asia and the Asian Paradox.
Theoretical Review of Corruption
Before the empirical data regarding the economic effects of corruption can be evaluated,
one must have a thorough understanding of the theoretical concepts of corruption. Basic issues
such as defining corruption, identifying the causes of corruption, evaluating corrupt agency
relationships and analyzing the effects of institutions, culture and political economy; all
influence how researchers approach empirical research.
What is Corruption?
A popular definition for corruption, found throughout the literature, is ‘the misuse of
public office for private gain’ (Mishra, 2005, Svensson, 2005, Bardhan, 1997). The term misuse
often implies that an illegal action has occurred. But not all corrupt acts are illegal; some may
simply be dishonest or improper. While this definition is useful in the context of public
corruption, one must also recognize that corruption flows from the private sector as well. Global
firms often posses power equal to that of a public official and they can abuse that power as such.
Mishra (2005) provides a simple definition of corruption as “behavior that deviates from formal
duties because of private gains” (p. 4). This definition is more suitable to the study of private
corruption.
It is important to note that bribery, a form of corruption, is often confused with rent
seeking. Svensson (2005) explains that “rent seeking is the socially costly pursuit of rents, often
created by governmental interventions in the economy, while bribes are technically a transfer”
(p.21).
Corruption can appear in many forms, including bribery, fraud, extortion, kickbacks and
embezzlement; depending on the context and situation. According to Shah (2007), types of
corruption typically fit into one of four categories.
1. Petty, administrative, or bureaucratic corruption. Many corrupt acts are isolated
transactions by individual public officials who abuse their office by demanding bribes
and kickbacks, diverting public funds, or awarding favors in return for personal
considerations. Such acts are often referred to as petty corruption, even though, in the
aggregate, a substantial amount of public resources may be involved.
2. Grand corruption. The theft or misuse of vast amounts of public resources by state
officials—usually members of, or people associated with, the political or administrative
elite—constitutes grand corruption.
3. State or regulatory capture and influence peddling. State capture is the collusion by
private actors with public officials or politicians for their mutual, private benefit. In this
form of corruption, the private sector “captures” the state legislative, executive, and
judicial apparatus for its own purposes. State capture coexists with the conventional (and
opposite) view of corruption, in which public officials extort or otherwise exploit the
private sector for private ends.
4. Patronage, paternalism, clientelism, and being a “team player.” Corruption occurs
when officials use their official position to provide assistance to clients or colleagues
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with the same geographic, ethnic, or cultural origin so that they receive preferential
treatment in their dealings with the public sector, including public sector employment
(pp.235-236).
Although the type of corruption may vary, it continuously stems from a common relationship:
that of the principal and the agent. Various conflicts of interest and a general imbalance of
information contribute to the inherent problems of agency relationships, which we will discuss in
the next section.
Agency Relationships
Corruption can always be traced back to the structure of a relationship between two
parties. This agency structure is a central theme in the study of corruption. Mishra (2005)
explains, “an agency relationship arises when two individuals enter a non-market (contractual)
relationship and where one individual (commonly termed as the principal) relies on another
individual (commonly referred to as the agent) to carry out certain actions on his behalf” (p.5).
An agency relationship could be something as simple as one relying on a passport official to
issue a passport timely or something more complicated like citizens relying on their government
to use public funding for its intended purpose.
The problem with agency relationships is that they are ideal situations for corruption to
occur. Bardhan (1997) states that the combination of economic and political corruption usually
“refers to the use of public office for private gains, where an official (the agent) entrusted with
carrying out a task by the public (the principal) engages in some sort of malfeasance for private
enrichment which is difficult to monitor for the principal” (p. 1321). Difficulty in monitoring,
unenforceable contracts and the difference in objectives between the principal and agent are the
main sources of problems in agency relationships.
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For corruption to truly begin, two agency relationships are needed. First, the relationship
between the principal and the agent and second an additional, more public, agency relationship.
Mishra (2005), list examples of “relationships between government and tax payers, regulator and
firm, police authority and potential criminals, government provider of services and potential
recipients” as examples of public agency relationships (p.5).
The public sector has many different types of agents that provide services like regulation
and law enforcement. They are often not under the direct supervision of the principal (the
government), but they almost always interact directly with a third party (the public). Because
the government lacks sufficient information on the actions of the public, they must act as a
principal and use an additional agent to gather information and enforce rules. The government
uses various methods to entice the agent to act honestly but due to a conflict of interests, a third
party will also attempt to entice the agent to act dishonestly.
“Corruption arises when some third person, who can benefit by the agent’s actions, seeks
to influence the agent’s decisions by offering him a monetary payment which is not passed on to
the principal” (Mishra, 2005, p.6). This three-way agency relationship fits well when describing,
for example, the relationship between a regulatory authority, inspector and a private firm. For
political corruption, the framework becomes more complicated and would need to be extended to
analyze the blurry line between political and economic corruption (Mishra, 2005, p.7 & Bardhan,
1997, p.1321).
The traditional view of distortion is when a third party bribes an agent to manipulate data
or a report in favor of the firm or individual. But distortion can come from both sides;
sometimes the firm or individual may have to bribe the inspector not to submit a false report.
When a firm must bribe and inspector even though they have broken no laws, this is called
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extortion (Mishra, 2005, p.9). The difference in the two situations is bribery to cover up wrong
doings (positive bribery) and bribery to not distort the truth. Both types of corruption lead to
“distortion of incentives” (Mishra). For example, if a firm can pay a bribe to a pollution inspector
to avoid a fine then they will be enticed to continue to pollute. Or, if a firm has to pay a fine to
the pollution inspector even though they follow the rules and meet pollution standards they might
be more prone to just start polluting since they have to pay a fine either way.
The agency model is micro-theoretic, but there are other macro perspectives that
concentrate on the more extensive socio-economic structure (Mishra, 2005, p.7). These macro
theories include “the nature and the role of formal state institutions, the divide between economic
and political sphere and the development of market and other institutions” (p.7).
When economic markets do not exist or do not function properly individuals and firms
may “attempt to escape the invisible hand of the market and to redirect policy proposals for their
own advantage” (Jain, 2001, p.87). As told by Mishra (2005), when “profit considerations find a
market in the public sphere” it reflects the traditions instilled in a society long before capitalism
took hold. Although this view may explain why corruption remains in a society who has recently
broken free from the constraints of a closed market or the burden of colonialism, it does not give
reason to why corruption persists hundreds of years later. The answer to this question can be
better explained in the macro-framework.
Macro Causes of Corruption
As mentioned in the previous section, corruption begins with an agency relationship
based on asymmetrical information and competing objectives. But the structure of institutions,
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political economy, and culture all create an environment for corruption to develop and grow
within the agency relationship.
Gurgur and Shah (2005), gathered data from the Transparency International Index and
performed a statistical regression analysis to rank the causes of corruption. Their results are
depicted in Table 1. A significant finding was that changing just one standard deviation from a
“command-and-control culture to a service oriented culture may decrease corruption by over 17
percent” (p.20).
Table 1
Causes of Corruption Based on Regression Analysis of Industrial and Non-Industrial Countries
Cause of corruption
Lack of Service Orientation in
Rank of
Effect of one standard deviation change
importance
on corruption (% change around mean)
1
17.27
Weak democratic Institutions
2
-15.54
Degree of closed economy
3
10.37
Colonial Past
4
8.23
the public sector
Laxity of bureaucratic controls 5
-2.00
Centralized decision making
-4.20
6
Source: Gurgur and Shah (2005), p. 19
Gurgur and Shah (2005), also empirically analyzed, based on the Transparency
International Index, the causes of corruption in developing countries. They name the key factors
of corruption as “lack of service orientation in the public sector, weak democratic institutions
and a closed economy” (p.25). Because most developing countries have a colonial past, previous
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colonial control not make a significant impact like in the overall country analysis. The authors
also found that developing countries have more fundamental deficiencies such as lack of
democracy and weak rule of law, which must be dealt with before the structure of the economy
and decentralization can become defining factors of corruption (p.20).
Industrial Organization of Corruption Networks
In a seminal article by Shleifer and Vishny (1993), the agency theory is accepted as a
known issue and they, in turn, focus on the industrial organization structure of corruption
networks and distortionary effects of corruption versus taxation. One major finding of the study
was “weak governments that do not control their agencies experience very high corruption
levels” (p.599). Bardhan (1997) also covers this theory in his overview of corruption explaining,
“the extent of centralization in the rent-collection machinery is very important in deciding the
economic consequences of corruption. Weak and fragmented governments (even those with
authoritarian rulers) are very harmful” (p.1324).
Shleifer and Vishny (1993), explore corruption in the context of three different industrial
organization models. First, they present a simple model of corruption where a firm or individual
only requires one government good and the supply of that good is completely controlled by one
official. This monopoly model is useful in understanding the organization of corruption networks
in traditional Communist governments, monarchies and mafia-controlled regions (p. 605). In
these places knowing whom to bribe and the price of the bribe is common knowledge. In this
strict and highly controlled environment, the bribe payer feels confident that he will receive the
good requested at the agreed upon price, every time. If the government official does not
complete the transfer of goods as promised, there are strict consequences imposed by the
bureaucracy. To illustrate the situation Bardhan (1997), gives an example of Russia’s former
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Communist Party who “centralized the collection of bribes and effectively monitored (with the
help of the KGB) deviations from agreed-upon patterns of corruption” (p.1325). Set patterns of
corruption and a monitoring system provide assurance to the briber that he will receive goods as
promised and will not be required to pay further bribes. Although any form of corruption can be
detrimental to economic growth, Bardhan (1997) claims “in general centralized corruption has
less adverse consequences for efficiency than decentralized bribe taking, because in the former
case the bribee will internalize some of the distortionary effects of corruption (assuming similar
powers at all levels to determine the overall rents in the system)” (p.1324).
In the second industrial organization model of corruption, “a private agent needs several
complementary government goods to conduct business” (Shleifer & Vishny, 1993 p.604). The
agent may need several different permits and licenses to start a business and the rights to these
permits may be held by a multitude of government agents. Market structure becomes extremely
important in this situation because the government agents could choose to “collude, sell different
goods independently, or even compete in the provision of complementary government goods”
(p.605). Selling goods independently can raise the cost of bribes per unit, while competing for
the sale of the same goods may keep the bribe price down.
The third model uses the example of independent monopolists in India, some African
nations and post-Communist Russia who often sell complementary government goods in
complete disregard for the actions of other government agents. When this occurs, sellers “set
their own bribes independently in an attempt to maximize their own revenue, rather than the
combined revenue of all the bribe collectors” (Shleifer & Vishny, 1993, p.605). Bardhan (1997),
call this a “multiple veto power system…which makes centralized collection of bribes in
exchange of guaranteed favors very difficult” (p.1324). The ‘roving bandit’ theory is another
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name used to describe the independent monopolist situation. Roving bandits attempt to attain the
largest amount of bribes that they can at one time and lack regard for the sustainability of these
action in the future (Bardhan, p.1325). As a result, independent monopolists cause the “per unit
bribe to be higher and the supply of goods lower” in comparison to the collusion of jointmonopolists (Bardhan, p.1325).
In the third model Shleifer and Vishny (1993) provide an example of competition for the
supply of government goods. When two or more government agencies can supply the same good
it gives the private firm or individual bargaining power. The authors give the example of
obtaining a U.S. passport and conclude, “because collusion between several agents is difficult,
bribe competition between the providers will drive the level of bribes down to zero” (p.607). The
opposite is true in the case of unified monopolists; they work together to maximize bribe revenue
for the group.
To conclude, there are three scenarios for the industrial organization of corruption
networks. First, a corrupt but unified administration demands bribes in exchange for providing
services one can rely on, while at the same time maximizing the total monetary value of bribes.
Second, monopoly suppliers act independently which drives down the monetary value of bribes
while increasing the frequency. Last, when there is a competitive market for governmentsupplied goods or even the threat of future competition, the level of bribes will be driven down to
zero.
Institutional structure
The structure of institutions and level of centralization are connected to the organization
of corruption networks and may answer the question to why corruption is so different in each
12
society. The development of the market, presence of competition, role of economic policies and
bureaucratic culture all contribute to the development of an institution.
There are two perspectives on the establishment of institutions. Svensson (2005) explains
that institutions develop as a response to economic factors. The human capital theory
compliments this view by adding that income and education also contribute to institutional
development (p.25). On the contrary, other theories argue, “institutions are persistent and
inherited” (p.26). This theory claims culture, colonization and religious beliefs all mold the way
institutions are formed and the economic response comes afterward.
Countries that are heavily controlled by the government typically have more corruption
because as bureaucratic inefficiency increases, more opportunities for government involvement
are available. Some suggest that because of overbearing government regulations, firms are forced
to participate in corruption and offer bribes so that they can complete business transactions in a
timely manner.
However a question presents it’s self: which comes first, corruption to overcome
restricting regulations and bureaucracy or corruption in the form of bureaucratic red tape?
According to Bardhan (1997), “it is usually presumed that a given set of distortions are mitigated
or circumvented by the effects of corruption; but quite often these distortions and corruption are
caused or at least preserved or aggravated by the same common factors” (p.1323). Ultimately
corruption cannot be tied just to the outside circumstances, it often a part of the institutional
structure as well. The question of which comes first, corruption or bureaucratic red tape cannot
be answered satisfactorily based on the current empirical evidence.
Increasing government wages is one suggested method of reducing corruption associated
with bureaucrat created red tap. If civil servants receive competitive salaries, based on merit and
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performance, they may be less likely to demand bribes; especially if the level of the bribes is
insignificant compared to their salary. Increased salaries may not be the solution for fragmented
institutions; Shah (2007) argues the empirical evidence for increasing civil servants pay shows
that it is not effective in countries with a weak government. Because citizens often pay bribes to
receive a job in the civil service, raising salaries will only increase the bribe paid (p.246).
Svensson (2005) agrees that in many poor emerging economies, where corruption is
institutionalized, they may not have the enforcement abilities to ensure that civil servants do not
continue to accept bribes after salary increases (p.33).
The role of civil society in reducing corruption has become a popular research topic.
Gurgur and Shah (2005), note that empirical evidence shows a high level of political and civil
rights can reduce corruption and improve governance (p.10). Committed involvement from civil
society promotes transparency in the actions of the government and it forces elected officials to
hold themselves accountable. See Sondhi (2000) for an overview on the role of civil society in
combating corruption in India.
Colonialism
In countries that were former colonies, the structure of institutions was usually designed
for the benefit of the colonizer and not the natives (Svensson, 2005, p.26). Shleifer and Vishny
“stress the identity of the colonizer and specifically the legal system transplanted from the
colonizer to the colonies. In their view, French and socialist legal origin countries (as opposed to
former English colonies) regulate more, and regulation leads to corruption” (as quoted in
Svensson, 2005, p.26). See Garretson (2009) for a review of the economic and cultural affects of
colonialism on India.
Cultural dimensions
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A culture that separates government officials from the rest of society is created when
corruption is not regulated and the value of bribes received is more than the fine for punishment
if caught. Developing countries like India, Pakistan and Indonesia, who were once ruled under a
colonial system, often have a “command and control oriented bureaucracy” that allows civil
servants to essentially be immune to public scrutiny (Gurgur and Shah, 2005, p.11). These
countries often have complicated caste systems and social hierarchies that do not require the
public sector to justify its existence to the lower castes. Gurgur and Shah (2005) explain, “people
generally view the public sector as a position to control rent sources and to exploit state authority
for personal gain” (p.11). Essentially in these nations, it is the cultural norm for citizens to accept
corruption in the government as a given and with the opinion that they are not important enough
to do anything to change it.
Effects of Corruption
Corruption not only affects the efficiency of institutions but also the economic growth of
a nation. In a review of the statistical evidence, Wei (1999) posits high corruption levels are
associated with poor economic performance. He identifies several channels through which
economic development is effected, they include: “reduced domestic investment, reduced foreign
direct investment, overblown government expenditures, distorted composition of government
expenditure away from education, health and the maintenance of infrastructure, towards less
efficient but more manipulatable public projects” (p.2).
In an influential article by Bardhan (1997), corruption is said to reduce the incentive to
invest because of the costs associated with bribes, it reduces the level of innovation in a country
and it diverts public resources away from important projects meant to enhance productivity
15
(p.1328). In these examples corruption is like a secret tax that you cannot claim on your tax
return. If an entrepreneur has to pay a bribe to start a business that is not successful, the firm
cannot claim the bribe as a loss of income. Unlike taxes, bribe money does not get redistributed
to support public services. On the contrary, not only does corruption take away important
funding from public projects, it also reduces the tax base by collecting secret bribes.
Some empirical evidence supports the theory that corruption hampers economic growth.
After reviewing cross-country data from Business International, Paolo Mauro “finds a significant
negative association between the corruption index and the investment rate or the rate of growth.
A one-standard deviation improvement in the corruption index is estimated to be associated with
an increase in the investment rate by about three percent of GDP” (Bardhan, 1997, p.1328). This
negative correlation even holds true in countries where it is believed that speed money is needed
to do business.
In direct opposition with the findings above, others hypothesize that corruption may
actually improve efficiency in less developed countries that suffer from a rigid administration.
This view looks at corruption as ‘speed money’ or ‘grease’. Bardhan (1997) explains, “in the
second-best world when there are pre-existing policy induced distortions, additional distortions
in the form of black-marketeering, smuggling, etc., may actually improve welfare even when
some resources have to be spent in such activities” (p.1322). Economists who agree with this
argument explain simply that sometimes corruption is needed to grease the wheels of an overregulated market. They see corruption as a way to negotiate an efficient outcome in an imperfect
situation. This hypothesis assumes that the buyer has full access to the price information of the
seller.
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When the bribe payer is not aware of certain information such as “the cost levels and
bribing capacity of his competitors” it can complicate the transaction and cause information
asymmetry and inefficiency (Bardhan, 1997, p.1322). Inefficiency may result if a government
official is influenced by other considerations than just the monetary amount of the bribe.
Examples of other considerations include, “favoritism towards a particular client, or when
bribers can get away with supplying a low-quality good at a high price and when bribery is used
to limit competition from other firms” (Bardhan, pp.1322-1323). Another factor to consider is
that government officials may introduce additional administrative delays so that they can draw
more bribes.
The ‘speed money’ or ‘efficient grease’ hypothesis, as labeled by Kaufman and Wei
(1999), relies on one critical assumption that, “red tape/regulatory burden (tax, licenses, delay,
and so on) can be taken as exogenous, independent of the incentive for officials to take bribes”
(p.1). Unfortunately, corruption is often an endogenous part of the “built in corrupt practices of a
patron client political system” (Bardhan, 1997). If corrupt bureaucrats are given the chance they
will often require bribes, based on the firm’s ability to pay. In the example of endogenous
corruption, bribes are not paid to overcome a rigid administration but because of additional red
tape created by bureaucrats.
The Asian Paradox
As discussed in the previous section, the effect of corruption on economic performance is
a much-debated topic in academia. After a review of the literature, there seems to be two
schools of thought on the subject. The first claims that corruption is always detrimental to
economic performance. The second argues that in some instances corruption, although it may be
17
the best worst solution, may actually have a positive effect on the economy. A special example
in which corruption does not seem to inhibit economic growth appears in studies of Asian
countries.
As a continent, Asia’s economy has grown faster than any other region in the world.
Much attention has been given to the miraculous economic growth of ten countries in the eastern
section of Asia. Sarel (1996) reports the top four performers, known as the “Tigers”, are Hong
Kong, South Korea, Singapore and Taiwan (pp.1-2). These four countries have sustained greater
than six percent annual growth rates, of output per person, for over thirty years (Sarel, 1996, p.2).
Compared to the rest of the world, where in 1990 people were 72 percent richer than in 1960, the
average Korean was at least 638 percent richer (Sarel, 1996, p.2)! China, Indonesia, Japan,
Malaysia and Thailand all sustained growth between three and five percent since 1960, followed
by the Philippines with growth of two percent a year (Sarel, 1996, p.2).
Table 2 confirms Sarel’s claims with data obtained from The World Bank’s World
Development Indicators and Global Development Finance database. Please note data for Taiwan
is not available from the World Bank; the estimation from Sarel (1996) is used instead.
Table 2
Historical Average Annual GDP Growth Percentages per Capita
Country
GDP growth per capita (1961-1990)
Hong Kong
7%
South Korea
7%
Singapore
7%
Taiwan
estimated at 6%, Sarel (1996)
China
5%
18
Indonesia
4%
Japan
5%
Malaysia
4%
Thailand
5%
Philippines
1%
Source: The World Bank
The level of corruption in East Asia, as reported in the Transparency International’s 2008
Corruption Perception Index (CPI) (See Appendix), is high compared to the rest of the world.
The CPI rates corruption on a scale from one to ten, one being the most corrupt and the ten the
least. Any country scoring below a five has a serious corruption problem in the public sector.
In 2008, Singapore, Hong Kong and Japan rated well with scores of 9.2, 8.1 and 7.3
respectively. Taiwan, South Korea and Malaysia performed fair with scores of 5.7, 5.6 and 5.1.
China scored a 3.6, an improvement from previous years, but still disturbingly low for one of the
fastest growing countries in the world. Thailand, Indonesia and the Philippines rated even worse
with scores of 3.5, 2.6 and 2.3.
As told by Vial and Hanoteau (2010), the Asian paradox is often described as a situation
where “cronyism and corruption are prevalent, but do not necessarily hamper business” (p.693).
Or, according to Wedeman (2002), it is “the achievement of very high growth rates in real
income per capita over relatively long time periods in the face of quite high levels of corruption”
(p.34). The Asian paradox is an attempt to explain why some countries in the region have had
such rapid economic growth; it does not necessarily credit the growth to corruption, but rather
claims that it does not hinder it either.
19
Rock and Bonnett (2004) claim the effect of corruption depends on the combination of:
country size, politics of corruption, industrial organization of corruption, amount of state power,
and long term strategy of corrupt officials. In an innovative study, which focused on the East
Asian Paradox, the authors performed a series of cross-country regression tests, using data sets
from four different sources. The four data sets were key because the average level of corruption
over a short time period (five years) is often very different than the average over a long period
(30 years) (p.1005). They found that after considering the above factors, “corruption tends to
slow growth in small countries in most of the developing world, but increase it in a subset of
large East Asian economies characterized by relatively stable and strong government with close
corrupt ties to big business” (p.1000).
Rock and Bonnett (2004) explain that unlike other parts of the world, there is no common
industrial organization of corruption networks in Asia (p.1003). As such, they divide the region
into three categories. Hong Kong, Singapore and Malaysia are represented as SINGHKMAL in
Figure 2. These three newly industrializing countries (NICs) have high economic growth paired
with relatively low corruption. The other East Asian NICs: China, Indonesia, Korea, Thailand
and Japan, labeled as LEANICS, have enjoyed high growth and investment coupled with high
levels of corruption. This economic environment is what is referred to as the Asian Paradox. Last
are South Asia and the Philippines; labeled as SASIAP. In these countries, high levels of
corruption appear to have impaired economic growth.
Figure 2: Comparison of Average GDP Growth Per Capita to Corruption Rankings
20
Source: Rock and Bonnett (2004, p. 1001).
Note: MENA=Middle East and North Africa LAC=Latin America and the Caribbean and SSA=
sub-Saharan Africa.
Rock and Bonnett (2004) explain that Hong Kong, Singapore and Malaysia have
experienced high economic growth because they are small, self-governing countries that have
committed to operating without corruption (p.1003). While elsewhere in East Asia, high growth
and high corruption “reflects monopoly control of corruption networks by strong over centralized
states” (p.1003). Last, the poor economic performance associated with high levels of corruption
in South Asia and the Philippines is due to decentralized corruption networks laden with
independent monopolists with short-term time horizons who compete for control of the networks
(p.1011). Hence, in the presence of a powerful government that sees corruption as a long-term
strategy, countries may in fact, prosper with the help of bribe and rent payments.
In a study in collaboration with the World Bank, Wei (1999) argues, “that the evidence
shows that there is no support for the Asian exceptionalism hypothesis…among East Asian host
21
countries, foreign investors still prefer to go to less corrupt countries other things being equal”
(p.16). The most influential factor that the author suggests should be accounted for is the
availability of cheap labor in East Asian countries. Wei (1999) suggests that if this factor were
controlled, it would show that investors are against corruption in East Asian countries as well.
This theory supports the view that growth in the region is due to an accumulation of one of the
four basic factors used to produce goods and services in the economy, labor, rather than total
factor productivity.
Many studies review the effects of corruption on the overall economy. But few studies
have used micro-level evidence to evaluate the consequences of corruption at the firm or plant
level. Vial and Hanoteau (2010), conducted a unique study that uses micro-level data from the
Indonesian manufacturing industry to “asses the impact of plant-level corruption on output and
productivity growth” (p.693). The authors argue “endogenous corruption may have positive
effects on plant performance if predatory officials embrace a long-term strategy” (p.694). In
essence, if corrupt officials wish to have a long career, complimented by income from bribes that
is sustainable over time; they must be careful to demand bribes at levels firms can afford.
After testing their empirical model, Vial and Hanoteau (2010), “find that corruption,
measured as bribes and indirect tax payments, has a positive and statistically significant effect on
individual plant growth” (p.693). Given that this positive relationship persisted in Indonesia from
1975-1995 (the entire period that was measured) the evidence “suggests improvements in the
efficacy of the bribes system and a strengthening of the long-term contract between firms and the
government” (p.693). The authors stress that although firms can individually benefit from
corruption at the micro-level; overall, corruption is still detrimental to the productivity of the
entire economy and should be treated as such.
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Summary
The research literature indicates that the effect of corruption on economic growth is
determined by a number of factors that vary within regions. The research articles that were
evaluated in this section provide support for and against the existence of an Asian Paradox at the
macro and micro level. The literature is mostly limited to studies on the high performing Asian
Tigers and it rarely assesses the structure of corruption networks in historically low growth
countries such as India.
An important concept that appears throughout the literature review is that corruption can
have very different effects from country to country. Svensson (2005) calls this concept the
“differential effect of corruption” and notes that it is a key area in need of more country specific
research. For example, after India’s economy finally opened to the rest of the world it began to
grow quickly and now it is growing at the same rate as the Asian Tigers. At the same time, India
scored a 3.4 on the 2009 Corruption Perceptions Index. This raises the question, could India
grow even faster if corruption were lower? Some studies have attempted to address this question
but more research that evaluates “what context and type of corruption matters” is likely to be
more helpful the varying effects of corruption by nations (Svensson, 2005, p.40).
23
A STUDY ON THE DIFFERENTIAL EFFECT OF CORRUPTION IN INDIA
Introduction
India was under British colonial rule until 1947. Under colonial rule South Asian
countries increasingly became ‘plural societies’, this term implies a “fragmentation of loyalties
and, in particular, little loyalty to the community as a whole” (Myrdal, 1968, p. 51). While
western nations tend to be loyal to their nation first and self second, in South Asia loyalties lie in
less inclusive groups such as “family, caste, ethnic, religious, class or linguistic ‘communities’”
(p.51). Loyalty to these less inclusive groups encourages a distinctive type of corruption called
nepotism. A government that is characterized by favoritism can be plagued with corrupt
bureaucrats who are more devoted to promoting economic success within their small social
group rather than the country as a whole.
Between 1950 and 1990 India’s economy was completely closed, causing growth to
remain stagnate. India was second only to the Communist bloc as the most controlled economy
in the world (Lankester, 2004, p.296). Finally in 1991, their economy was liberalized. Still, it
was not until 2006 that the economy began to grow at a rate comparable to the Asian Tigers.
Lankester (2004) claims if India had pursued better policies earlier in the century it could have
enjoyed faster economic growth and more rapid reduction in poverty (p.303).
In 2008, the World Bank ranked India’s GDP at 12th in the World. Out of 183 countries,
India is ranked at 133 for overall ease of doing business compared to Singapore is who number
one. India is ranked at a horrifying 182 for enforcement of contracts, compared to China’s
ranking of 89 (World Bank, 2009). See Figure 3 for a comparison of other business indicators in
South and East Asia.
Figure 3: Comparison of Indicators of Business Environment in South and East
Source: Devarajan & Nabi 26, p.11)
India’s economy has experienced great growth, especially in the services sector. But one
could wonder how much more India could grow without the burdens of an inefficient and corrupt
political system. In a review of data concerning the effect of a change in corruption over a
variety of indicators, Wei (1999) found “an increase in corruption reduces the quality of roads,
and increased incidence of power outages, telecommunication faults and water losses” (p.12).
Wei (1999) gives an example where if corruption in a country were raised from Singapore to
Pakistan levels, there would be fifteen percent more roads in poor condition.
The poor state of India’s infrastructure and social programs exemplifies this point. As
told by Wei (1999), “corruption tends to skew public expenditure away from health and
education, presumably because they are more difficult to manipulate for bribe purposes than are
other projects” (p.11). Although an open market, even a corrupt one, can solve many problems it
cannot mend the social ills caused by a corrupt political system.
25
To reduce corruption and promote more investment, foreign and national, India needs to
“reform the government’s role in the economy, especially in areas that (by giving officials
discretionary power) are hotbeds of corruption” (Wei, 1999,p.2). Many civil workers in India
are paid a very low salary, which may entice them to engage in corrupt practices. India should
focus on “recruiting and promoting civil servants on the basis of merit and paying them a salary
competitive with similar jobs in the private sector” (Wei, 1999, p.2). Offering more competitive
pay could reduce the temptation to steal or accept bribes.
After an analysis of a data set of foreign direct investment from the early 1990s, Wei
(1999) claims, “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”. Many Asian countries already offer tax holidays for new investors, but
reducing corruption appears to be a more cost effective way to attract investment.
Although India is famous as a location for outsourcing, it is not producing jobs at a
sufficient rate to support the growing population (Jenkins, 2006, p.149). The coveted
information technology service jobs only make up .2 per cent of employment (Jenkins, 2006,
p.149). A democracy that cannot produce enough jobs for its people becomes a danger to its self.
If India does not find a method to control the many corruption networks within the country, the
economy could face dire consequences. Jenkins (2006) even suggests there could be a political
upheaval against open market policies if the liberalized economy does not result in more jobs.
Methodology
After reviewing the data on the Asian paradox, one is left to wonder why India has not,
until recently, experienced the same high levels of economic growth as the East Asian Tigers?
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India’s economy has grown rapidly in recent years even with a Corruptions Perceptions Index
score of 3.4 (see Appendix). Could India be a new addition to the Asian Paradox? Or, if
corruption were reduced would India’s economy perform even better.
Rock and Bonnett (2004) introduce a compelling framework in which to analyze the
differential effect of political corruption in Asia. In their study, like in other research articles on
Asia, India was mentioned only briefly and placed into the South Asian category. India is a
unique country that is poised to overtake China as a major player in the world economy.
Although India has received much attention for their recent growth, there is still a lack of
research on the differential effect of corruption among countries and regions (Svensson, 2005).
This study will evaluate the differential effect of corruption in India with a framework
based on evidence presented by Rock and Bonnett (2004), Shleifer & Vishny (1993) and
Lankester (2004). The effects of the following factors will be analyzed: country size, domestic
politics, industrial organization of corruption and corruption networks.
Country Size
Country size is one variable to examine when considering differences in economic
performance among nations. Large countries often have extensive internal markets and plentiful
supplies of labor. Rock and Bonnett (2004) hypothesize that large nations with high populations
are better equipped to practice import substitution for longer time periods. As a result, these
nations are less reliant on foreign aid and are able to ignore pressure from the international
community to reduce corruption (p.1000). Investors are likely to overlook corruption in
exchange for unhampered access to a large pool of inexpensive labor (Rock & Bonnet, 2004,
p.1000).
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Conversely, small countries cannot sustain import substitution policies for long. If these
nations wish to grow they are forced to be more open to foreign aid and investment. The World
Bank and other NGOs often base their aid and investment under the caveat that developing
economies “conform to emerging international norms regarding governance and corruption”
(p.1000). Also, since these countries have small domestic markets and a limited supply of labor.
International firms have no incentive to overlook corruption like they do in large nations. This
combination of factors explains why small countries like Singapore, Malaysia and Hong Kong
all have low levels of corruption with high economic growth.
The effect of country size on large countries has different results depending on the
country. Rock and Bonnett (2004) list China, India, Brazil and Mexico as examples. Even though
all of these countries have huge supplies of cheap labor, they have experienced different rates of
economic growth. China has achieved high economic growth with high levels of corruption but
Mexico has the opposite outcome. India has experienced both effects. Until the late 1990s it had
high corruption and low growth but presently India has very high economic growth with
comparatively high levels of corruption.
The sheer size of India’s labor pool is very enticing to foreign investors and has been
credited to stimulating their economy. In fact, India will soon overtake China as the most
populous country (Haub & Sharma, 2006). A large supply of cheap labor alone cannot overcome
other inherent problems like a weak democracy that is segmented by many different corrupt
officials. This may be why India has experienced high economic growth but not as great as that
of China. This leads to the next section, which will examine the effect of domestic politics.
28
Domestic Politics/Industrial Organization of Corruption
The differential effect of corruption on investment and growth also depends on domestic
politics, or as others label it, the industrial organization of political regimes (Rock and Bonnett,
2004; Shleifer & Vishny, 1993; Lankester, 2004). The commitment to reduce corruption from
strong autonomous states like Hong Kong, Singapore and Malaysia, complimented by
investment from the west, has resulted in low corruption and high growth in these small
countries (Rock and Bonnett, 2004, p.1003). In the East Asian Paradox countries, high growth is
paired with high corruption a result of a “relatively stable and strong governments with close and
corrupt ties to big business” (Rock & Bonnett, 2004, p.1000).
In India’s case there is a weak democracy with “electoral politics driving the adoption of
suboptimal fiscal and micro-economic policies” the decentralized government is unable to
control corruption among their large population (Jenkins, 2006, p.148). Oppositely, in China “the
government’s freedom from the burdens of democracy… provides officials with the tools to
stamp out the most growth-retarding forms of corruption” (Jenkins, 2006, p148). Although neoliberals claim that an open market and democratic government will encourage growth and reduce
corruption, in India it seems that democracy actually inhibits growth.
India’s weak democracy is dominated by patron client relationships where clients
frequently extract rents in the form of favors, protection and jobs. Although some of the rents are
redistributed to the needy, overall this system is harmful to economic growth (Rock and Bonnett,
2004, p.1005.) This is because when clients have influence over public officials it reduces the
overall authority and validity of the government.
The fundamental problems discussed above could be potentially traced back to India’s
transition from colonial rule to self-governance. When a legacy of corruption is passed on to a
29
newly formed democracy the industrial organization of corruption can be significantly altered by
“exchanging monopoly control of corruption networks extant in the ancient regimes with more
decentralized corruption networks fraught with the problems associated with corruption networks
dominated by multiple independent monopolists” (Rock & Bonnett, 2004, p.1011). This shift in
organization could transform corruption from a growth enhancer to an inhibitor.
Corruption networks
In addition to the strength of the government, the organization of corruption networks is
also a factor to consider. Results depend on who controls the network: a stable group who is in
control over a long period of time or an ever changing group of politicians who try to gain as
much as possible over a short time period. According to Rock and Bonnett (2004), “when those
networks are organized by a strong centralized state, corruption is likely to be less corrosive to
investment and growth than when it is organized by numerous government officials acting as
independent monopolists” (p.1003). When a strong central government has been in power for a
long time, corruption may be more centralized and controlled. In India’s case, corruption is not
centralized and independent monopolists control most of the corruption networks (Rock &
Bonnett, 2004.)
The time horizon of monopolists in corruption networks can greatly affect the level of
bribes received and economic growth. The secret to success for the large developing countries in
East Asia is that they have a government with a monopoly control combined with a long-term
view on corruption. They have invested seriously in public goods and infrastructure, which
enables them to trade privileges for bribes that they use to assure their political power and enrich
themselves (Rock & Bonnett, 2006, p.1004). In India’s case the weak government, with many
30
corruption networks, makes it difficult to provide public services and in turn makes growth more
difficult.
A key difference in the corruption networks of India is that they are controlled by a
significant number of independent monopolists who tend to have long time horizons (Rock &
Bonnett, 2006, p.1004). These stationary bandits often make a life long career out of rent and
bribe collection. But stationary bandits are only helpful to economic growth when the
government is strong enough to control them. India is missing a key component of the Asian
paradox equation: a centralized administration who monitors and controls corruption.
After an extensive review of the literature, it is clear that there is a peculiar relationship
between economic growth and corruption in all of the Asian countries. The case of India is
interesting because they are a democratic country with a large labor pool that has experienced
tremendous economic growth, but their growth compared to strong corrupt states like communist
China is not as impressive.
Am I suggesting that India should have a more authoritative political regime? I think that
perhaps India was not ready to handle a democracy combined with the corruption level in the
country. On the other hand I do not agree that corruption alone can drive growth in an economy
such as China. I see corruption as the “best worst choice” in terms of governance. But as a
businessperson one must be realistic and hope that as a country grows economically the people
will be better able to free themselves of corruption.
31
DISCUSSION
Corruption is a serious problem that can slow economic development, deter foreign direct
investment, reduce tax income, reduce efficiency in business transactions and public services,
and reduce the amount of funding available to important public programs. This paper attempts to
highlight the importance of the study of corruption to development economics and the business
sector. Different theories of corruption were reviewed along with empirical research on the
causes and effects of corruption, specifically in Asia. In addition, a study of the differential effect
of corruption in India was conducted using a framework drawn from the literature review.
An important concept that appears throughout the literature review is that corruption can
have very different effects from country to country. Svensson (2005) calls this concept the
“differential effect of corruption” and notes that it is a key area in need of more country specific
research. For example, after India’s economy finally opened to the rest of the world it began to
grow quickly and now it is growing at the same rate as the Asian Tigers. At the same time, India
scored a 3.4 on the 2009 Corruption Perceptions Index. This raises the question, could India
grow even faster if corruption were lower? Some studies have attempted to address this question
but more research that evaluates “what context and type of corruption matters” is likely to be
more helpful in evaluating the varying effects of corruption by nation (Svensson, 2005, p.40).
The literature is mostly limited to studies on the high performing Asian Tigers and it rarely
assesses the structure of corruption networks in historically low growth countries such as India.
The study of India indicates that the country has a mix of growth enhancing and growth
retarding factors that contribute to the differential effect of corruption. The enhancing factors are
the large internal labor market and the long time horizon of corrupt officials. These officials
(stationary bandits) often make a life long career out of rent and bribe collection so it is in their
best interest to demand a sustainable level of bribes from firms. Unfortunately for India,
stationary bandits only enhance economic growth when they are part of one strong government
network that works for the enhancement of the state and not the individual. In conclusion, India
is missing a key component of the Asian paradox equation: a corruption network that is
controlled and monitored by a centralized administration that works to improve economic
development in the country.
For future research I would like to examine the effects of premature democratization on
economic growth. I wonder if there is a “best path” that a country should take from authoritative
regimes, like colonialism and communism, to democracy. Does the amount of time taken to
complete the path affect economic growth? It would be interesting to compare countries under
colonial control in Africa, to China, India and the early development of the United States.
33
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Appendix: Corruption Perceptions Index 2008 (Transparency International, 2009 b., pp.397-402)
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40
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