Updated: Nov 12, 2019
The Market theory of Economics is based on the assumption that there is an innate need in a person to enrich himself. Presumably, a person who wants to enrich himself shall engage in productive behavior. The more we produce, the greater the potential for the economy to grow. This is why markets flourish when there is competition. As we produce more, the society shall benefit from the growth. But, what if a person who holds a lot of power has the incentive and opportunity to enrich himself without any positive effect on production? This rent-seeking behaviour is what we call Corruption.
We are all familiar with the term corruption. It is a universal human condition. Though this is the case, there is great ambiguity on what can be defined as corruption in a society. There are as many definitions of corruption as there are many societies. In many societies, corruption is seen as trust, as a favor, a social capital. Transparency International created Corruption Perception Index (CPI) that measures corruption in 180 countries using metrics that results from 0 (most corrupt) to 100 (not corrupt). No country ever had 100 in CPI. In 2018, Denmark and New Zealand scored highest, whereas Sudan, Syria and Somalia scored lowest. Global average is 43/100, which is below the half-way mark. Corruption in Public sector is correlated with higher birth mortality, poor public services, and lower foreign investments. Corruption also provides incentive to evade or avoid taxes owed to the government.
There are various international organizations that address the economic problems brought about by corruption. The World Bank and the International Monetary Fund come to mind. These institutions usually provide funding on significant projects across the world and there is a real fear that the funds on several projects they finance might go to the pockets of the corrupt. The World Bank organized the International Corruption Hunters Alliance (ICHA) to become a platform for discussions, and initiatives to combat corruption. The World Bank and IMF also started requiring policy initiatives to the host country of the projects they want to finance to mitigate corruption. In fiscal year 2018, the World Bank debarred or otherwise sanctioned 83 firms and individuals and recognized 73 cross-debarments from other multilateral development banks.
What’s in it for us if we understand the underlying roots of Corruption? For starters, more money will flow in the Global economy that is productive. Rent-seeking behaviour is defined as “increasing one’s wealth but not creating new wealth. It is inherently unproductive. Take for instance bribery, we can look at it as a market where the service sold is the “facilitation” of a certain official to ensure that the buyer will obtain the lucrative contract with the government. Bribery is essentially a competitive market. This market causes a misallocation of resources in a way that good public services such as building of schools, loses to other projects, such as in defense or other infrastructure has larger “kickbacks”.
In Rose-Ackerman’s "The Economics of Corruption”, they considered “the organization of private markets and the structure of government programs themselves create incentives for criminal [corrupt] behavior.” This means we can attribute the corrupt behavior as a market anomaly in which we can apply incentives/disincentives to minimize. Nathaniel Leff at Columbia University argued that corruption may introduce an element of competition into what is otherwise a comfortable monopolistic industry and payment of highest bribes becomes one of the principal criteria for allocation. Looking at bribery at this level opens up interesting policy prescriptions.
We can classify corrupt behavior into different classes: bribery, money laundering, and tax evasion. These types, in my opinion, has the most potential in disrupting any society. In this thought exercise, we shall focus on public sector corruption: Bribery. Tackling the other types will take up a whole different level of analysis.
We note that multinational corporations have facilitation funds in countries where bribery is ubiquitous in the conduct of business. Bribery is often a significant risk recognized in the governance of multinational corporations. In the aforementioned study, the economists focused on bribery. What I mean with bribery here is the act of corporations bribing government officials to secure contracts. This also happens at small transactions, which is also disruptive, but for our purposes of examining corrupt behaviour, larger transactions provide a better point of view.
Why do persons, natural or otherwise, engage with bribery? That depends on the different important factors like market of the goods about to be purchased by the government, the acceptability of corrupt practices, and the institutions in place. It is also not enough to pour resources in the detection of corrupt activities. According to Rose-Ackerman, “the amount of corruption discovered will not merely be a function of the amount of resources devoted to surveillance and law enforcement.” We will then look at this in its core: Incentives.
In 2015, the biggest corruption scheme in Latin America was exposed in Brazil called “Operation Car Wash”. It's about Petrobras, the biggest state oil company in Latin America and its involvement in large bribery schemes. The scandal was centered into the involvement of Odebrecht, a large construction company operating in Latin America, and top government officials in Brazil. It even implicated a former President, Lula de Silva, which was sentenced for 12 years in prison. It also caused the fall of Dilma Rouseff. After all the dust has settled several important infrastructure projects among 7 countries in Latin America came into a halt, showing the impact of corruption when it involves large corporations. One estimate suggests that the holding of those projects caused 500,000 layoffs across Latin America.
“There are as many definitions of corruption as there are many societies. In many societies, corruption is seen as trust, as a favor, a social capital.”
There are several factors that incentives this supply of facilitation services such as the inefficiencies of the bureaucracy due to red-tape or lack of contract oversight. This is the case in Brazil where bureaucracy is inefficient, and susceptible to corruption. Improving these processes will eliminate the need for the services. For instance, governments should improve processes to make it efficient for firms to submit bids to the government. No small group of officials should have control over the whole process. Segregation of duties is crucial in this matter. Another factor we can change is to improve efficiencies is government oversight of project metrics. Providing for damage clauses on projects for delays, and other project-related issues will ensure that the contracting firms will adhere to the original contract. Any significant variations in the contract should undergo a separate bidding process. In the case of Odebrecht, the original cost of the project that underwent investigations is $6 billion dollars. By the time the scandal exploded, Odebrecht billed Petrobras $15 billion dollars. This was made possible by lack of transparency in the project metrics. Putting clauses for damages will also trigger the mechanism of audit over the life of the project. This means better oversight and transparency in conducting business with the government. Eliminating the incentives surrounding the “market” of bribery would minimise the likelihood of corruption.
Now, let’s briefly consider the money collected from bribery. The dirty money involved in these schemes need to go somewhere it cannot be traced, thus the need for money laundering which was the pivot of the whole Operation car wash. In 2015, the world was shown a set of books (2TB worth of files) that provided us intimate details on how ill-gotten wealth is funneled through the world finance system. We all remember it as the “Panama Papers”. This exposed many wealthy individuals including some political leaders like the Prime Minister of Pakistan and
Iceland. They were forced to resign amidst the exposè. We were exposed to the ways wealthy divert their wealth to avoid scrutiny. In effect, giving officials incentives to continue engaging in corrupt activities knowing they have a way to hide their money from the eyes of the law. A solid framework on Anti-Money Laundering enforcement would be a good deterrent to ensure that the money embezzled from the government can be traced efficiently, ensuring that any perpetrator will think twice before obtaining major sums of money from bribery.
In a world where we have AI’s analyzing our financial behaviour, it is unacceptable that government and private individuals can still engage with bribery and embezzlement, and still get away with it. We should be able to create frameworks where we can better execute contracts with private firms and perform oversight function efficiently. Oftentimes we see in the headlines they single out individuals involved in the schemes, but never really delve deep into the institutions, processes, and incentives that made the scheme possible in the first place. It is also easily sold to masses to simplify the solution: replace the official with someone with integrity. As Lord Acton famously expressed it, “power tends to corrupt and absolute power corrupts absolutely.”