Download What is the Impact of Corruption on Economic Development in South

Candidate Number | 40801
What is the Impact of Corruption
on Economic Development in the
Newly Industrialised Countries of
South East Asia?
Political Corruption | L2046
Candidate Number | 40801
Abstract
Corruption, a previously neglected issue, became one of the greatest preoccupations of
Western powers trying to bring stability and prosperity to global markets. This essay
seeks to establish the relationship between corruption and development. The focus of
this paper will be the South East Asian Newly Industrialised Countries (NICs). I suggest
that whilst it is difficult to ascertain the exact impact of corruption on development, in
the absence of corruption, even greater and more sustained levels of development can
flourish. I argue that despite arguments to the contrary, all corruption is inimical to the
process of sustainable development. I suggest that the impact of corruption on
development is clearly discernable though examination of the Asian Financial Crisis of
1997. This event demonstrated that whilst development and corruption can coexist,
corruption creates unsustainable inefficiencies and inherent weakness in the economy for
the long term.
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Table of Contents
Introduction _________________________________________________________ 4
Perspectives on Corruption_____________________________________________ 6
Corruption and Development ___________________________________________ 7
Influencing Government __________________________________________________ 7
Predictability ____________________________________________________________ 8
Innovation ______________________________________________________________ 9
Competition & Efficiency ________________________________________________ 11
Government Policy ______________________________________________________ 12
Methodology _______________________________________________________ 14
The Asian Miracle and Corruption _____________________________________ 15
The Paradox of Corruption and Growth _____________________________________ 15
Tangible Costs of Corruption _____________________________________________ 17
Intangible Costs of Corruption ____________________________________________ 18
Uneven Impact of Corruption and Development______________________________ 19
The Asian Financial Crisis ____________________________________________ 22
Crony Capitalism _______________________________________________________ 22
Unveiling the Impact of Corruption ________________________________________ 24
Conclusions ________________________________________________________ 26
Bibliography _______________________________________________________ 28
Books _________________________________________________________________ 28
Journals _______________________________________________________________ 28
Online Sources _________________________________________________________ 29
Other _________________________________________________________________ 30
Appendices _________________________________________________________ 31
Appendix I - Social Indicators are Worse Where Corruption is High _____________ 31
Appendix II - Tax Revenue is Lower in more Corrupt Countries ________________ 32
Appendix III: The Impact of the Financial Crisis on Financial Markets __________ 33
Appendix IV: Economic Indicators of East Asia ______________________________ 34
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Introduction
The post Cold War, globalized era of the 1990’s saw a renewed interest in corruption and
its impact. Corruption, a previously neglected issue, became one of the greatest
preoccupations of Western powers trying to bring stability and prosperity to global
markets. But is the pursuit of an anti-corruption agenda really conducive to
development? Corruption has always existed, in all societies and at all stages of
development. The dominant discourse suggests that systemic corruption is a major
impediment to sustainable economic development yet despite extensive normative
discussion on the merits of the absence of corruption, little academic discussion based on
empirical evidence demonstrates the validity of this argument.
This paper seeks to establish the relationship between corruption and development. The
focus of this discussion will be the South East Asian newly industrialised countries
(NICs). NICs are countries exhibiting considerable industrialisation having switched
from agriculture to industrial production. South East Asian economies, including South
Korea, Taiwan, Hong Kong and Singapore, achieved exponential growth from the 1960’s
to the late 1990’s when the Asian financial crisis took effect. The transformation from
poverty to affluence was widely heralded as the success of capitalism over communism
and a demonstration of the success of liberal, free market principles. However, while the
governments were ostensibly laissez-faire, in practice they were quite active in their
economies. It is within this context that the study of corruption in NICs is so fascinating.
Despite bureaucracy within the market and widespread corruption, remarkable economic
development prevailed. What remains unclear is to whether this was because of or in spite of
corruption. Can some corrupt activities actually be beneficial to rapid development?
In only focussing on economic development, just one facet of the multi-faceted issue of
development, is addressed. The reason for this focus is for reasons of brevity and that
unlike aspects such as political or social development for which improvements or
otherwise is harder to prove, economic development is more quantifiable. A holistic
approach to development may yield different results and whilst recognising the
importance of political and social aspects, economic development yields the clearest
indicators for development. Hereafter economic development is shortened to,
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‘development’ although this is not meant as an all encompassing term to describe all
aspects of development.
Beginning with an analysis of the academic perspectives on corruption, this paper
investigates South East Asian NICs to establish the impact of corruption on economic
development. These countries have been chosen as they have to a great extent completed
the industrialisation process and thus the impact of corruption is more readily and clearly
identifiable. Extensive reports of corruption in these countries make them well suited to
investigation. I argue that corruption acts as a brake to development and that in the
absence of corruption, even greater and sustained levels of development can occur.
Additionally, I argue that all corruption is inimical to the process of sustainable
development and suggest the Asian Financial Crisis is proof of this.
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Perspectives on Corruption
It is prudent to establish what we understand by the term ‘corruption’. There are various
definitions and understandings as to what exactly constitutes corruption. The definition
most frequently used by social scientists is Nye’s, that corruption is: “…behaviour which
deviates from the normal duties of a public role because of private-regarding (family,
close private clique), pecuniary or status gains; or violates rules against the exercise of
certain types of private-regarding influence. This includes such behaviour as bribery (use
of rewards to pervert the judgment of a person in a position of trust); nepotism
(bestowal of patronage by reason of ascriptive relationship rather than merit); and
misappropriation (illegal appropriation of public resources for private-regarding uses)”1
This can be simplified to a general definition that will be used for the purposes of this
paper: the abuse of public office for private gain.
Although defining corruption in this way is convenient, it should not be considered a
rigid framework for ruling what should or should not be considered corrupt. Different
nations and cultures have differing conceptions of corruption; legally, in terms of public
interest, and in public opinion. Furthermore, certain ‘corrupt’ exchanges such as
clientelism and gift giving may be engrained within the culture of the society and so are
not considered by those involved, to be corrupt. As Gardiner notes, “There are nations
where official corruption has been widespread for many years with no visible signs of
public outrage.”2 The reason for this may be, as the analysis on the benefits of corruption
reveals, there are instances when ‘corrupt’ activities seem to be beneficial to
development.
Perspectives on the costs and benefits of corruption can divided into those that perceive
the benefits of corruption to be positive for development, and those that regard it as
inimical to the development. Although among recent literature there is consensus that
Leff’s arguments lauding the benefits are flawed, an understanding of his rationale in
Nye, J. “Corruption and Political Development: A Cost Benefit Analysis”, The American Political
Science Review, 61:2, 1967, p.419 (The second part of this definition is taken from Banfield, E. Political
Influence, Glencoe III: Free Press, 1961, p.315)
2 Gardiner, J. “Defining Corruption”, in Political Corruption: Concepts and Contexts, Eds. Heidenheimer
A. & Johnson, M. (Transaction Publishers, 2002) p.38
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asserting that corruption can be beneficial to development is valuable if only to juxtapose
against opposing arguments.
Corruption and Development
Influencing Government
Leff argues that corruption is an extralegal institution used by interest groups to gain
influence over the actions of the bureaucracy to an extent that would not otherwise be
possible. This he suggests can be beneficial to development if business groups that would
otherwise be at a disadvantage in articulating their interests to the government get an
opportunity to do so. If these groups are more likely to promote growth than the
government, an enhanced position in policy making could, he suggests, be beneficial to
development. He outlines instances where this may be the case; “…the government and
bureaucracy may simply be indifferent to the desires of entrepreneurs wanting to initiate
or carry on economic activities.”3 The reasons for this may be the government’s dislike
for a competing centre of power or that they do not attribute much value to economic
activity. Leff also suggests that governments may have other priorities rather than the
pursuit of economic development such as the consolidation of armed forces. These are
priorities which can impede development. He suggests bribery can activate the
bureaucracy to get things done which otherwise would not take place; “…it can induce
the government to take a more favourable view of activities that would further economic
growth… [and] provide the direct incentive to mobilize bureaucracy for more energetic
action on behalf of entrepreneurs.”4 If this were true, and operated under a perfect
competition model then there may be benefits to development.
Mauro disputes these claims, noting how in this corrupt system, the sale of government
contracts or policy through bribery means that the highest bidder always wins: “The
allocation of public procurement contracts through a corrupt system may lead to a lower
quality of public infrastructure and services.”5 Rather than choosing contractors by merit
Leff, N. “Economic Development Through Bureaucratic Corruption”, in Political Corruption: Concepts
and Contexts, Eds. Heidenheimer A. & Johnson, M. (Transaction Publishers, 2002) p.312
4 Leff, N. “Economic Development Through Bureaucratic Corruption”, in Political Corruption: Concepts
and Contexts, Eds. Heidenheimer A. & Johnson, M. (Transaction Publishers, 2002) pp.312-313
5 Mauro, P. “The Effects of Corruption on Growth and Public Expenditure”, in Political Corruption:
Concepts and Contexts, Eds. Heidenheimer A. & Johnson, M. (Transaction Publishers, 2002) p.343
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and the best potential outcome, corrupt bureaucrats could harm development by
awarding contracts which result in substandard outcomes. In this instance the impact of
corruption is a clear failure to achieve government objectives; instead producing
inefficiency and waste. With bureaucrats being ‘buyable’, they are most likely to seek out
the highest rent-seeking opportunities; “Corrupt government officials may be more likely
to choose to undertake types of government expenditure that allow them to collect
bribes and to maintain them a secret.”6 Rather than seeking projects which would
genuinely contribute to development, bureaucrats will look to find large projects where
money can easily be siphoned off.
If corruption takes the form of a kickback, the total amount available for public purposes
is reduced. Corruption is sometimes compared in this way to a tax on investments and
business. However, Shleifer and Vishny note that because of the need to maintain
secrecy, corruption causes a greater distortion in economic activity than taxation. For
example, dishonest government officials may favour promoting government activities,
where bribery is most easily concealed. They suggest; “…the demands of secrecy can
shift a country’s investments away from the highest value projects, such as health and
education into potentially useless projects such as defence and infrastructure, if the latter
offer better opportunities for secret corruption.”7 Not only are total funds available for
public use diminished but they are spent on projects which are not necessarily best for
development.
Predictability
Investments in developing countries can be particularly risky due to the unpredictability
of the political and economic conditions. The extensive role of the government in the
economy means arbitrary decision making can be problematic for business for which
maintaining consistency and judging long term economic trends is important. In this
situation, securing predictability for their investment, Leff suggests, creates a more
attractive environment for investment; “Corruption can help economic development by
making possible a higher rate of investment than would otherwise be the case.” By
Mauro, P. “The Effects of Corruption on Growth and Public Expenditure”, in Political Corruption:
Concepts and Contexts, Eds. Heidenheimer A. & Johnson, M. (Transaction Publishers, 2002) p.343
7 Shleifer, A.& Vishny, R. “Corruption”, The Quarterly Journal of Economics, 108:3, p.616
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bribing officials to maintain certain political conditions, the success of an otherwise risky
investment can be secured as there is a much more assured return on investment.
However, Mauro has demonstrated through empirical evidence that high levels of
corruption are associated with lower levels of investment and GDP. In a corrupt
environment, entrepreneurs are aware that bribes are required to ensure the release of
required documentation needed to begin business and are consequently discouraged
from investing. Additionally, a percentage of returns on the new enterprise may be
claimed. It is for this reason that Mauro suggests “…corruption may be interpreted to act
as a tax…which correspondingly reduces incentives to invest.”8 Empirical evidence
shows low levels of corruption correspond to greater levels of investment; “…a one
standard deviation improvement in corruption indices drawn from the Business
International causes investment to rise by five percent of GDP and the annual per capita
GDP growth rate to rise by half a percentage point.”9 Although establishing what
constitutes ‘higher’ and ‘lower’ levels of corruption is problematic, this link, supported by
the work of Keefer and Knack indicates that there is an unambiguous link between
corruption and levels of investment, GDP and thus development.10 Businesses want
secure investments but adding corrupt rent-seeking bureaucracy may not be effective in
securing the political conditions; investors would simply prefer a non-corrupt
environment in which to invest.
Innovation
In an undeveloped society, potential entrepreneurs may be discouraged from investing
and innovating due to the barriers of entry created by existing products and processes. In
this situation, Leff suggests, “…graft may enable an economic innovator to introduce his
innovations before he has had time to establish himself politically.” Leff suggests that
because of bureaucrats’ existing economic interests, innovators may be regarded with
indifference or even hostility. In this environment, bribery could provide innovators an
opportunity to obtain elusive government licenses and permits. Furthermore, ‘facilitation
payments’ may allow businesses to bypass unnecessarily cumbersome delays. Leff also
Mauro, P. “The Effects of Corruption on Growth and Public Expenditure”, in Political Corruption:
Concepts and Contexts, Eds. Heidenheimer A. & Johnson, M. (Transaction Publishers, 2002) p.342
9 Mauro, P. “The Effects of Corruption on Growth and Public Expenditure”, in Political Corruption:
Concepts and Contexts, Eds. Heidenheimer A. & Johnson, M. (Transaction Publishers, 2002) p.342
10 For more on this see Keefer P. & Knack S., “Institutions and Economic Performance: Cross-Country
tests using Alternative Institutional Measures”, Economics and Politics, 1995, 7:3, pp. 207-227
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suggests that corruption may increase investment by reducing the risk that a fickle
government may, in the future, intervene harmfully in an innovator's project.
Whilst entrepreneurship is generally regarded as being innovative and beneficial to
development, in the case of, ‘innovative rent-seeking’ this is not the case. Baumol argues
it is not always productive; it may even have a destructive impact on economies where
parasitical activities damage the economy.11 Corruption misallocates potentially beneficial
talent to corrupt activities and distorts investment priorities. Where the informal, black
market and corruption is more financially rewarding than the formal economy, a brain
drain effect could occur. Rather than highly talented and educated individuals aiding
development they will prevent potential development from taking place.
Corruption invariably increases transaction costs and uncertainty in an economy while
lowering efficiency by forcing entrepreneurs to divert their scarce time and money to
bribery rather than production. As has been previously discussed, those paying the
highest bribes may be those with the best insider information and funding rather than
those who would most productive and reap the best rewards for development.
Furthermore, bribery increases business risk because of the uncertainty as to whether
government officials will actually provide the services for which they have been bribed.
Contrary to economists who argue the benefits of entrepreneurial corruption, Murphy
suggests that, “…rent seeking activities, particularly public rent-seeking by government
officials, is likely to hurt innovative activities…”12 He notes that in order to start a new
enterprise, innovators often require government documentation and licenses. Without an
inside contact to expedite this process, they may be forced to pay bribes to secure the
paperwork required. This in turn increases the vulnerability to long term bribery.
Because innovators are outside the established system of bribery, it is often not in the
bureaucrat’s interest to enter into new corrupt transactions because in doing so they
increase their chances of being caught. Instead they may prefer to charge their existing
‘clients’ to bar innovators from entering the market. It is in this way that oligarchies can
Baumol, W. “Entrepreneurship: Productive, Unproductive and Destructive”, Journal of Political
Economy 98:5, 1990, p.894
12 Murphy, K. Shleifer, A. & Vishny, R. “Why is Rent Seeking So Costly to Growth?” The American
Economic Review, 83:2, 1993, p.409
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maintain their power in the developing world and prevent innovation which could aid
development.
Competition & Efficiency
Some political scientists view corruption as being a, ‘second best, or ‘grease the wheels’
solution, particularly in the inefficient, inept, and mismanaged bureaucracies in
developing countries. Huntington suggests, "…in terms of economic growth, the only
thing worse than a society with a rigid, over-centralized dishonest bureaucracy is one
with a rigid, over centralized honest bureaucracy."13 Those willing and able to pay the
highest bribes are likely to be those able to use it most productively.
Similarly, Leff contends that introducing competition into an otherwise uncompetitive
economy can be beneficial to development; “…corruption brings an element of
competition with its attendant pressure for efficiency to an underdeveloped economy.” 14
By allocating contracts to the highest bidder, it ensures only those able to pay the highest
bribes, and thus the most efficient (because they have to muster capital required) survive.
Riley makes similar conclusions in a study of the impact of corruption in developing
countries - that corruption simply reflects misadministration of government in general; a
way to get around inefficient and cumbersome government bureaucracies.15 It is
suggested that bribery can be an efficient way of negotiating otherwise over regulated,
cumbersome and ineffective legal systems.
However, there is little evidence to support these arguments. In response to the
argument for corruption being a ‘grease’ which lubricates the ‘squeaky wheels’ of a
bureaucratic and rigid administration, Gray and Kaufmann suggest inventing bureaucracy
to facilitate rent-seeking opportunities; “…fuels the growth of excessive and
discretionary regulations.”16 Corruption leads to economic inefficiency and waste,
because of its effect on the allocation of funds, on production, and on consumption.
Gains obtained through corruption are unlikely to be reinvested within the country but
13
Huntington, S. Political Order in Changing Societies, (Yale University Press, 1968) pp.498-499
Leff, N. “Economic Development Through Bureaucratic Corruption”, in Political Corruption: Concepts
and Contexts, Eds. Heidenheimer A. & Johnson, M. (Transaction Publishers, 2002) p.314
15 Riley, S. “Public Office Corruption in West Africa: Political Culture, Context and Control”,
(unpublished), 1987, as discussed in Defining Corruption, in Political Corruption: Concepts and Contexts,
Eds. Heidenheimer A. & Johnson, M. (Transaction Publishers, 2002) p.37
16 Gray C. & Kaufmann, D. “Corruption and Development, Finance and Development”, March 1998, p.8
available at http://www.worldbank.org/wbi/governance/pdf/gray.pdf
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transferred to foreign bank accounts. These transfers represent a capital leakage from the
domestic economy. Furthermore, corruption generates inefficiency in allocation, by
permitting the least efficient contractor with the highest ability to bribe to be the
recipient of government contracts. In addition, since the cost of bribes is included in the
price of the goods produced, demand tends to be reduced, the structure of production
becomes biased, and consumption falls below efficiency levels.
Corruption encourages competition in bribery, rather than in quality and in the price of
goods and services. It inhibits the development of a healthy marketplace and distorts
economic and social development (see Appendix I). Moreover, evidence shows that if
corruption is not contained, it will grow exponentially.17 Studies show that: once a
person is identified as willing to pay bribes, other ‘gatekeepers’ appear to be alerted, so
that the person is delayed and subjected to additional forms of extortion as he or she
proceeds. Conversely, those who refuse to pay at the first ‘gate’ are earmarked as nonpayers and therefore not worth the time and energy for others to try to exploit.18
Government Policy
Leff suggests that corruption can alleviate problems of bad government policy and
planning; “Corruption performs the valuable function of a ‘hedge’ and a safeguard
against the full loses of bad economic policy.”19 Through corrupt activities it is possible
to implement the opposite policy to the government. For example in the case of export
promotion versus import substitution – whilst the government is pursuing one avenue of
policy, entrepreneurs can activate a parallel yet opposite policy to ensure that all is not
lost if the government are wrong in their policy decision.
If however, the government is in fact pursuing policy most conducive to development,
this is clearly problematic; a corrupt black market undermining government policy is
counter productive to the broader processes of development. Corruption reduces
opportunities for the government to control the economy and limits potential spending –
a strong informal economy can have a crippling effect. A Mauro notes: “Corruption may
Transparency International, TI Sourcebook, 2000, p.31
Exactly what these surveys are is unclear, they are mentioned in TI Sourcebook, 2000, p.32
19 Leff, N. “Economic Development Through Bureaucratic Corruption”, in Political Corruption: Concepts
and Contexts, Eds. Heidenheimer A. & Johnson, M. (Transaction Publishers, 2002) p.314
17
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also bring about loss of tax revenue when it takes the form of tax evasion….” 20
Corruption reduces the transparency of economic transactions by both public and
private sector firms while undercutting the government’s ability to raise capital.
Corruption can create fiscal weakness which in order to compensate for decreasing tax
revenue, may force an increase in rates of taxation on a diminishing number of taxpayers
thus reducing its ability to provide essential public goods and services (see Appendix II).
Corruption weakens the State and its ability to promote development and social justice.
It is regressive in the sense that its costs and negative economic impact tend to fall more
heavily on small enterprises and an on individuals in a weak economic position. The
World Bank suggests: “Corruption is a double jeopardy for the poor and unprotected.
They pay a high share of monopoly rents and bribes, while they are often deprived of
essential government services.”21 It pushes firms into the black market, which effectively
reduces the state’s ability to raise capital and thus leads to ever-higher taxation on fewer
and fewer taxpayers. This in turn reduces the state’s ability to provide essential public
goods, including the rule of law.22
Corruption undermines development by distorting the rule of law and weakening the
institutional foundation on which economic growth depends. The harmful effects of
corruption are especially severe on the poor, who are hardest hit by economic decline,
are most reliant on the provision of public services, and are least capable of paying the
extra costs associated with bribery, fraud, and the misappropriation of economic
privileges. Thus corruption can be seen to be’ “…one of the greatest enemies of
development.”23
Mauro, P. “The Effects of Corruption on Growth and Public Expenditure”, in Political Corruption:
Concepts and Contexts, Eds. Heidenheimer A. & Johnson, M. (Transaction Publishers, 2002) p.343
21 http://www.worldbank.org/html/extdr/offrep/eap/pbsp101998.htm
22 These objections have been amalgamated from a number of sources but largely Gray C. & Kaufmann,
D. “Corruption and Development”, Finance and Development, March 1998, p.8 available at
http://www.worldbank.org/wbi/governance/pdf/gray.pdf
23 Ideas taken from http://www1.worldbank.org/publicsector/anticorrupt/index.cfm
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Methodology
I hypothesise that all corruption, no matter what its form is inimical to long term and sustainable
development. Measuring specific impacts from corruption is difficult due to the vary nature
of corruption – unless the corruption is brought into the public domain, the exact impact
of corruption cannot be known. In order to prove the validity of my hypothesis I intend
to investigate the economic development of South East Asia to ascertain whether or not
an explanation can be given for concurrent high levels of corruption and development.
Rather than examining specific cases of development and corruption in countries, I seek
to explain the broader phenomena of the coexistence of development and corruption in
the region. The investigation will rely on secondary evidence from journal articles and
evidence from the internet. I will understand economic development to be “…increases
in a country’s real per capita income that affect broad segments of the population and in
which the productivity of resources is enhanced as new stocks of resources are
generated.”24 Although Transparency International now offers the Corruption
Perceptions Indicator (CPI) to measure the extent of perceptions of corruption, in the
period of phenomenal growth, there is no such data available. Consequently, it will be
assumed that the allegations of widespread and systemic corruption are in fact true.
LeBel, P. “Measuring Sustainable Economic Development in Africa”,
http://alpha.montclair.edu/~lebelp/MeasuringEcSustainability.pdf
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The Asian Miracle and Corruption
The Asian Miracle raises questions for the modern view that corruption is inimical to
development. Evidence clearly shows that phenomenal rates of growth have occurred in
an in environment of high, even astronomical rates of corruption. The academic
response has been divided. Some believe it vindicates Leff’s proposal that corruption can
be good - business with an emphasis on connections works as well, if not better for
development than a system based on openness, accountability and competitive bidding.
Others suggest that the Asian Miracle can be explained because systemic corruption was
not actually as bad as it is made out to be. The logic for this fits modern analysis of
corruption; systemic corruption is harmful to development and so development within
this environment is impossible. By examining the causes and costs of corruption it will
become apparent to what extent these perspectives on the impact of corruption are true.
The Paradox of Corruption and Growth
The prevalence of informal networks, weak indigenous business, and a strong state can
explain the high levels of corruption that have co-existed with economic growth. After
the Second World War, the extensive role of the state in creating, and augmenting
markets, as well as controlling investment and the role of exports was invaluable to their
initial growth and success. The legitimacy of these managed and fragile democracies was
dependent on securing economic growth. Pei suggests that the, “…emphasis on growth
in East Asia had a political origin: authoritarian regimes ruled in all high-performance
East Asian economies …maintaining high growth rates was and is regarded as essential
for building not just industrial economies, but the political legitimacy of the ruling
elites.”25 Poor performance was typically concealed by large government loans so that
what appeared to be growth was often simply recycled state capital.
Most of the governments owned and ran banking businesses and so corrupt finance
markets provided a way for many businesses to generate capital; “Through the operation
of the black market mechanism, relevant officials obtain ill gotten gains from the
enterprises, while the enterprises themselves are provided special privileges to make
Pei, M. “Asia’s Political Lessons”, China Business Review, September 1999, available at
http://www.chinabusinessreview.com/public/9909/pei.html
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money.” 26 Businesses borrowed substantial sums of capital from the state owned banks
with low interest rates. Due to the ease and availability of these loans, businesses tended
to expand simply because they could and in so doing became increasingly inefficient and
vulnerable to problems in the face financial challenges. Companies would reward officials
who provided privileges (this could take various forms but includes procurement of
government finance, expediting paperwork and overlooking anomalies) by providing a
job for them within the company upon their retirement from government. Due to the
very nature of this bad finance, debtors were simply unable to pay off their loans,
increasing their vulnerability to financial crisis.
Xu suggests that corruption was an integral part of the way in which the economies and
markets functioned; “Corruption is viewed as a kind of transaction cost, through which
enterprises can enjoy special privileges offered by the government.”27 The corrupt
finance enabled businesses to grow at a much faster rate than would otherwise be
possible. As Segal notes, “Companies cut in a member or a friend of the elite, so that
business still got done, but at a vastly inflated cost.”28 These inflated costs reduced the
rate at which development could have progressed as well as creating an underlying
weakness in many businesses. Rather than expansion and success based on results, it was
through an unsustainable system of corruption.
The states’ role in controlling business, and largely suppressing labour and civil society
groups led to their strength and independence from outside interests. A weak civil society
compounded the corruption issue. Moran suggests that, “Corruption… stemmed from
interconnecting historical and structural factors. The strong state was vital here but so
also were weak social forces (particularly nascent entrepreneurial groups) and traditions
of patron-client networks of family, school, regional and other ties.”29 Government
regulation, restrictions on foreign capital and competition, a concentration of power in
family-owned business groups with close ties to government, and closed financial
systems contributed to growth but paradoxically, also contributed to a steady weakening
of the South East Asian economies.
26.Tzong-Shiang
Y & Xu, D. Eds. From Crisis to Recovery: East Asia Rising Again? (World Scientific
Publishing, 2001) p.17
27 Tzong-Shiang Y & Xu, D. Eds. From Crisis to Recovery: East Asia Rising Again? (World Scientific
Publishing, 2001) p.17
28 Segal, P. “Corruption”, Impact, 1999, 3:2, p.5
29 Moran, J. “Corruption and NIC Development: A Case Study of South Korea”, Crime Law and Social
Change, 29, 1998, p.163
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Finally, in contrast to the ‘rule based capitalism’ prevalent in developed Western
countries, Sing suggests the most suitable label for East Asian economies is ‘relationbased capitalism,’ a system characterised by personal and implicit agreements and
governed by second-party enforcement - based on a mutual trust between the transaction
parties.30 Where the market is small, or the number of transaction partners is limited, Sing
suggests that relation-based governance may work more effectively in a developing
economy than rule-based governance due to lower transaction costs (establishing and
maintain an effective legal system required to monitor and enforce contracts in rulebased governance is very costly). Problems arise when the economy grows out of this
relation-based system; it is no longer sustainable. The lack of effective rule-based
capitalism and the governments’ inability to enforce contracts impartially created an
environment in which relation-based capitalism flourished and became the standard
method of contract enforcement which in turn has degenerated into a system of
cronyism.
Tangible Costs of Corruption
The costs of corruption in South East Asia have been revealed in a number of studies.
Over the last twenty years, the Philippines are estimated to have lost $48 billion due to
corruption, surpassing its entire foreign debt of $40 billion.31 Over the last decade in
Indonesia, assets have fallen by more than $50 billion, primarily because corrupt officials
trading state assets have deliberately undervalued their worth in exchange for substantial
kickbacks.32 Studies reveal that governments have paid between twenty and one hundred
percent more for goods than they should have otherwise have paid.33 An extensive study
of corruption in Asia concluded: “Graft and corruption has strongly affected
development efforts negatively …corruption leads to the favouring of inefficient
producers, the unfair and inequitable distribution of scarce public resources, and the
30
Shen, Y. “The Miracle and Crisis of East Asia: Relation-Based Governance vs. Rule-Based Governance”,
Perspectives, 1:2, available at
http://www.oycf.org/Perspectives/2_110299/miracle_and_crisis_of_east_asia.htm
31 Philippine Government estimate cited from Reuter Newswire, 1997, “Philippine Corruption a
Nightmare”, 11 January, 1997.
32 Business Week, The Destructive Costs of Greasing Palms, 6 December, 1993, p.133
33 Nakata, T. “Corruption in the Thai Bureaucracy, Who Gets What, How and Why in its Public
Expenditures”, Thai Journal of Public Administration, 18, 1978, pp.102-128 and also in Gray, C. “Civil
Service Compensation in Indonesia”, Bulletin of Indonesian Economic Studies, 15, 1979, pp.85-113
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leakage of revenue from government coffers to private hands.”34 The impact of this on
development is painfully obvious – the government is less able to spend on genuine
development projects. Although the superficial impact of corruption may appear
minimal, the long term impact is inflationary and inimical to development.
Empirically it has been shown that countries tolerating relatively high levels of corruption
are unlikely to perform as well economically as they would have done otherwise. In a
study of over seventy countries during the late 1970s and early 1980s, Mauro suggested
that corruption, “…is strongly negatively associated with the investment rate, regardless
of the amount of red tape.”35 Mauro’s model indicates that a one standard deviation
improvement in the, ‘corruption index’ translates to an increase of 2.9% of GDP in the
investment rate and a 1.3% increase in the annual per capita rate of GDP growth.36 This
clearly demonstrates the weakness of Huntington and Leff’s argument that corruption
could be beneficial to attract investment.
This analysis is supported by other recent studies. Using data from thirty-nine industrial
and developing countries the World Bank found that countries that were perceived to
have relatively low levels of corruption were always able to attract significantly more
investment than those perceived to be more prone to corrupt or illicit activity. 37 This
result held true for both countries where corruption was highly syndicated and
predictable, and countries where it was not. These findings are unambiguous; corruption
is costly for development in terms of squandered government capital and in terms of lost
capital from investors.
Intangible Costs of Corruption
The economic ramifications of corruption may never fully quantified, or more
specifically, may only be able to be relate to the costs and benefits stemming from
specific corrupt acts. The weakness of a cost benefit analysis of corruption is that it does
not take into account the systemic impact of corruption. Although in some instances
Cariño L. and de Leon., J. “Final Report for the Study of Graft and Corruption, Red Tape and
Inefficiency in Government”, 1983, cited in Klitgaard, R. Controlling Corruption, (University of California
Press, 1998) p. 38
35 Mauro, P. “Corruption and Growth” The Quarterly Journal of Economics, 110:3, 1995, p.685
36 Mauro, P. “Corruption and Growth” The Quarterly Journal of Economics, 110:3, 1995, p.695
37 The analysis was conducted by Campos, J. and Pradnam, S. in conjunction with the 1997 World
Development Report, Washington DC: World Bank, pp.102-109
34
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corrupt activities or transactions may yield positive results, it may also generate negative
externalities that degrade the performance of the system as a whole and compromise the
economy’s long-term dynamic efficiency. The Asian Development Bank suggest, “It is
the intangible indirect costs of corruption that are both hard to recognise and far exceed
its direct costs.”38 Referring once more to the caveat contained in the introduction, there
are immeasurable political and social costs of corruption that have not been discussed.
These too undoubtedly demonstrate that corrupt governance has an inimical impact on
development.
Corrupt actions typically generate far more costs than benefits. A study of corruption in
one African country, for example, concluded that corruption intensified ethnic conflict,
ruined the efficiency of municipal government and federal agencies, crippled the merit
system of hiring and promotion, and generated an “atmosphere of distrust which
pervades all levels of administration.” The Asian Development Bank similarly recognises
a number of the inimical by-products of corruption which although not quantifiable have
a clear impact for development. 39 They note how scarce resources are squandered on
uneconomical projects because of their potential to generate lucrative payoffs at the
expense of priority sectors such as education or health which suffer disproportionately.
Furthermore, when investment does produce results, they are often of inferior quality;
public safety is often endangered due to substandard contracting and construction which
can render a project completely worthless.
Due to the potentially lucrative rewards from corruption, the Asian Development Bank
suggests that legitimate entrepreneurial activity has been hindered. Individuals who
would not otherwise engage in illicit behaviour have decided there is no alternative but to
focus their intellectual energy away from legitimate productive, but less rewarding
pursuits to figuring out ways to ‘get around the system.’40
Uneven Impact of Corruption and Development
Although it has been established that corruption is costly, its impact upon development
has not appeared to be uniform. The Asian Development bank suggests that; “Some
Asian Development Bank, Anticorruption: Our Framework, Policies and Strategies, 1997, p.17
Asian Development Bank, Anticorruption: Our Framework, Policies and Strategies, 1997, p.17-20
40
Asian Development Bank, Anticorruption: Our Framework, Policies and Strategies, 1997, p.17-20
38
39
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Candidate Number | 40801
countries can tolerate relatively high levels of bribery and graft and continue to maintain
respectable rates of economic growth, whereas others cannot.”41 They suggest that there
are numerous factors that influence the extent to which corruption hinders development.
At the most basic level, they suggest a state’s natural resource base and the sources of its
comparative advantage play a critical role in its ability to attract investment – those with
valuable natural resources often attract more investment that those relying on low wage,
labour intensive manufacturing to attract foreign investment..
The form of the corruption can also affect the impact on development. The Asian
Development Bank suggests if corruption is highly predictable, the impact on
development may be reduced. If corruption is ‘containable’ in this way, its impact on
development is reduced. Knowing the costs of corruption in advance means it can
simply be added predictably into a budget. If corruption is concentrated at the top
government level, bureaucratic assistance may reduce transaction costs as it adds a
measure of predictability to investment decisions, making the country inherently more
attractive than others where many different officials can demand unspecified and
unanticipated payments. However, there is still the issue of potential growth and
development that is wasted; a study of an Asian country found that in none of the cases
under consideration was the money raised through corruption “directly and productively
invested.”42
Finally, the extent to which money remains in the country and is invested in productive
economic activity, or flows abroad into foreign bank accounts, has an impact upon a
nation’s ability to tolerate relatively high levels of corruption and still enjoy reasonable
rates of economic growth. Corruption does not explain economic development …but it
did coexist with rapid growth, and in some areas, provided flexibility to economic policy
which saw resources channelled to those firms best able to utilise them.”43 A 1996 World
Bank study shows that countries with a high but ‘predictable’ level of corruption had a
gross investment-to-GDP ratio of 19.5%. For countries with low predictability but a still
Asian Development Bank, Anticorruption: Our Framework, Policies and Strategies, 1997, p.17
H. “The Consequences of Corruption: The Ghanaian Experience”, in M. Ekpo, Ed. Bureaucratic
Corruption in Sub-Saharan Africa: Toward a Search for Causes and Consequences, (University Press of
America, 1979) p.253. The second citation is from Sintaek, K. “Conclusions and Recommendations”, in a
paper prepared for the Fourth Working Meeting on Bureaucratic Behaviour and Development, Hong
Kong, 1978, cited in Klitgaard, R. Controlling Corruption, (University of California Press, 1998) p.37
43 Moran, J. Corruption and NIC Development: A Case Study of South Korea, Crime Law and Social
Change, 29, 1998, p.173
41
42 Werlin,
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high level of corruption, the ratio was just 12.3%.44 Lambsdorff’s findings demonstrated,
in a cross section study of sixty-nine economies, that corruption significantly decreases
the average productivity of capital and, consequently, GDP.45 This evidence would seem
to confirm the hypothesis that all corruption is harmful to development.
Segal, P. “Corruption”, Impact, 1999, 3:2, p.5
Lambsdorff, G. “Corruption in Comparative Perception”, in The Economics of Corruption, Kluwer
Academic Publishers. pp.81-110
44
45
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The Asian Financial Crisis
Although the analysis clearly indicates that corruption is harmful to development, there
may be instances when these repercussions are not felt until years later. Until about mid1997, most of the countries in East Asia had been enjoying exceptional growth rates of
between eight and nine percent which was particularly good in comparison to the
economic growth history of developed countries. In 1997 however, this came to an end
as financial crisis hit the Asian economies. “One increasingly widespread view is that socalled crony capitalism—the misallocation of financial resources to the friends and
relatives of government officials is partly responsible.”46 Corruption exerted pressure on
banks and businesses to steer capital towards preferential business deals or the direction
of government capital to political friends and allies. According to Summers; “… lack of
transparency on the part of financial institutions went hand-in-hand with distorted
incentives, lack of supervision, and the absence of so-called prudential regulation.”47
These unsound and corrupt practices were in part responsible for the rapid decline of the
South East Asian economies.
Crony Capitalism
Lack of transparency of financial institutions, a government-business relationship
permeated with corruption, and the absence of accountability of political and economic
authorities created a system of practices which could no longer support itself. Crony
capitalism is a term that describes ‘a particular capitalist economy depending extremely
close relationships between private business and the state institutions of politics and
government, rather than by the espoused ‘equitable’" concepts such as the free market,
open competition, and economic liberty.’48 It was this crony capitalism that exacerbated
the structural problems that caused the 1997 crisis.
Shang, J. “Local Corruption and Global Capital Flows”, Brookings Papers on Economic Activity,
2:2000, p.304
47 Summers, L. “The Global Economic Situation and What It Means for the United States”, Remarks to
the National Governors Association, Milwaukee, Wisconsin, Aug. 4, 1998 as quoted in Bello, W. “Asian
Financial Crisis: the Movie”, available at
http://www.focusweb.org/publications/1998/Asian%20Financial%20Crisis-The%20Movie.htm
48 http://en.wikipedia.org/wiki/Crony_capitalism
46
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Close relationships between business and government worsened lending problems in
many of the South East Asian economies. Financiers were often relatives of government
officials who lent large sums of money to highly speculative capital intensive ventures.
The excessive lending created an unsustainable boom which temporarily concealed the
poor quality of many of the investments.49 Kang suggests that; “The state’s inability to
control firms and their growth led to endemic overcapacity. Firms rushed willy-nilly to
expand at all costs, whether or not it was economically feasible. ”50 The result was that in
most major sectors of the economy there was excess capacity and overlapping and
duplication of effort.
Firms were keen to expand in order to capitalise on the supply of cheap money and
paradoxically, to ensure that the government would have no choice but to continue to
supply them with money. The reason for this was corrupt business; bureaucrats received
kickbacks from supplying money and so the situation became steadily worse, with
increased borrowing. “Firms borrowed whether they needed to or not. Many firms
expanded far too quickly and without adequate management expertise or planning….
The state did bail out weak companies, and it rewarded political relationships, not
economic success ….”51 What kept the process from spinning out of control for a time
was a delicate balance of power between political and economic elites. While both
benefited from the close ties, neither was able to dominate the other so stability emerged.
With the rapid devaluation of currencies in the wake of the financial crisis, this
equilibrium became imbalanced and the resulting impact of corruption finally came to
light.
Crony capitalism was very much part of the economic fabric in the three decades that
South East Asian countries led the world in GNP growth. Although the system was selfsustaining to a point, the systemic nature of the corruption meant that there was a
breaking point. An examination of the countries worst hit by the Asian Financial crisis
yields some interesting results. Hong Kong, which prior to the 1970’s had a serious
corruption, had great success in reducing corruption since the establishment of the
Independent Commission Against Corruption (ICAC) which helped greatly to clean up
This is described in Zhang, H. Corruption, Economic Growth and Macroeconomic Volatility,
Perspectives, 2:1, available at http://www.oycf.org/Perspectives/7_083100/Contents.htm
50 Kang, D. “Bad Loans to Good Friends: Money Politics and the Developmental State in South Korea”,
International Organization, 56:1, 2002, p.188
51 Kang, D. “Bad Loans to Good Friends: Money Politics and the Developmental State in South Korea”,
International Organization, 56:1, 2002, p.190
49
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Candidate Number | 40801
the administration. Similarly, Singapore which also fared well throughout the crisis had a
well established Corrupt Practices Investigation Bureau (CPIB) which acted as an
independent body to investigate and prevent corruption in the public and private sectors.
Powers to confiscate corrupt assets and extensive legislation to combat corruption
enabled these countries to consolidate the legitimacy of their economic growth.
Unveiling the Impact of Corruption
Transparency International’s Corruption Perceptions index indicate that Hong Kong and
Singapore rated much higher in rankings in comparison to other South East Asian
Countries who were perceived to be more corrupt and experienced a much greater
impact from the financial crisis. A score of 0 indicates a country is perceived to be totally
corrupt whilst a score of 10 indicates a country is perceived to be totally free of
corruption. Hong Kong scored 7.3 and Singapore 8.7 compared to other South East
Asian countries who fared considerably worse in the crisis - scoring between 2.7
(Indonesia) and 5.2 (Taiwan). Examining anti-corruption agencies in other South East
Asian countries reveals interesting results. Whilst Thailand, Malaysia, South Korea,
Indonesia and the Philippines all had an anti-corruption agencies, before the 1997
financial crisis they wielded no real power in the fight against corruption.52 Legislation
enacted after the crisis has begun to slowly deal with corruption giving more power to
combat corruption.
Of the ten Asian countries involved in the financial crisis, the worst reactions against a
range of criteria was felt by the four most corrupt countries; Indonesia, South Korea,
Malaysia and Thailand (See Appendix III & IV). The crisis affected virtually all the
countries of South East Asia. However, unlike Taiwan and South Korea, who before the
crisis had failed to enact effective legislation and anti-corruption, Hong Kong and
Singapore, both of whom had established anti-corruption bureaus and had legislation in
place well before the crisis took place, experienced the negative effects of the crisis to a
much lesser extent.
But the worst impact in terms of growth rate, inflation and
For details on the legislation passed in
Malaysia: see http://www.bpr.gov.my/English/mainact.htm
South Korea: see http://www1.oecd.org/daf/asiacom/countries/korea.htm
Thailand: see http://www1.oecd.org/daf/asiacom/countries/thailand.htm
Philippines: see http://www1.oecd.org/daf/asiacom/pdf/Philippines.pdf
52
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unemployment has been on Thailand, South Korea, Malaysia, and Indonesia (see
Appendix IV).
Many of the alleged benefits from corruption, such as expediting and streamlining
government transactions or enhancing civil service pay, only appear as such against the
background of public sector failure. The experiences of Hong Kong and Singapore
indicate that improving public sector management, streamlining customs procedures and
paying competitive wages with the private sector, are likely to yield greater benefits over
time than tolerating relatively high levels of corruption to compensate for these
deficiencies. “Hong Kong and Singapore have demonstrated that corruption can be
reduced significantly. Fighting corruption requires reducing corruption’s benefits while
raising its costs.”53 These findings clearly demonstrate the inimical impact of corruption
on development and the potential benefits of implementing far-reaching and meaningful
anti-corruption initiatives.
Lash, N. “Corruption and Economic Development”, Research Paper, Loyola University Chicago, May
2003, unpublished, p.15 available at http://sba.luc.edu/research/wpapers/03519.pdf
53
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Conclusions
Evidence has shown the serious underlying consequences of corruption on economic
growth, capital formation, poverty and inequality. The analysis of this investigation,
examining the alleged costs of corruption on development from both normative and
empirical dimensions has shown the impact on long term sustainability of development.
The findings of the investigation suggest that the hypothesis all corruption, no matter what its
form is inimical to long term and sustainable development is indeed correct. In the short term,
corruption may appear to have benefits to an economy and its development, but this
misappropriation of finance and government resources is inimical to long term
sustainable development; there is a negative relationship between corruption and the
long-term rate of economic growth.
The ‘features’ which lent themselves to corrupt activity are consistent in the Asian NICs;
a strong state, weak indigenous businesses, and the prevalence of informal networks have
not been the cause or facilitator of growth, they have simply coexisted with it whilst
serving as a brake to development. Through corruption, it is possible for bad firms which
otherwise would have become unsustainable to survive because of corrupt officials.
Where profitability and genuine growth have occurred, this is despite, rather than
because of the corruption.
It may only be now that the long term effects of this are becoming realised - the Asian
Financial crisis can be understood within this context. Corruption, wastage, crony
capitalism, the lack of economic and political transparency and the mismanagement of
financial institutions compounded the vulnerability of Asian countries in the wake of
currency speculations. Had corruption not been a salient feature of the Asian NICs the
effect of the crisis would have been significantly diminished. The cases of Hong Kong
and Singapore, two countries with considerably lower levels of corruption and impact
from the crisis are testament to this. Whilst it would be naïve to suggest that these anticorruption initiatives were the only or indeed the primary factor in preventing worse
problems in these economies, they demonstrate that an anti-corruption agenda can be
instrumental in limiting the long term systemic effects of corruption which, in the long
term, can be inimical to development.
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Candidate Number | 40801
The presence of corruption has unambiguous implications for economic growth, if not
apparent in the short-term, for longer-term sustainability. Transparency International’s
views corroborate with these findings. They suggest that “Most importantly, the heaviest
cost is typically not so much in the bribes themselves, but rather in the underlying
economic distortions they trigger and in the undermining of institutions of
administration and governance.”54 The effect of corruption is widespread – not only in
administrative, financial and social terms but in undermining accountable and democratic
government; there can be no argument in favour of corruption as a genuine source of
development; the impact of corruption on development is incontrovertibly damaging and
destructive for all aspects of development.
54
Transparency International, TI Sourcebook, 2000, p.32
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Bibliography
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Moran, J. “Corruption and NIC Development: A Case Study of South Korea”,
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29
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Gray, C. & Kaufmann, D. “Corruption and Development, Finance and Development”,
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Appendices
Appendix I - Social Indicators are Worse Where Corruption is High
(Source: http://www.imf.org/external/pubs/ft/fandd/2002/12/picthis.htm )
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Appendix II - Tax Revenue is Lower in more Corrupt Countries
(Source: http://www.imf.org/external/pubs/ft/fandd/2002/12/picthis.htm )
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Appendix III: The Impact of the Financial Crisis on Financial
Markets
(Source: DataStream and The Economist)
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Appendix IV: Economic Indicators of East Asia
(Source: The Council for Economic Planning and Development, International Economic
Situation Weekly, April 15, 1999)
34