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p. 4 of 10 BACK | NEXT I. Introduction II. ADB'S Response III. Definitions of Corruption IV. The Costs of Corruption V. ADB's Position on Anticorruption Issues VI. Conclusions and Recommendations VII. Appendixes

Anticorruption

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IV. The Costs of Corruption

21. Corruption has not always been perceived as having a negative impact upon development. In earlier decades, arguments were advanced that it could have beneficial effects. In countries where public sector wages are often low and in some cases may not even be enough to live on, some maintained that it was natural for civil servants to augment their salaries by other means. It was alleged that corruption could advance economic efficiency by helping restore artificial and administratively determined prices to market-clearing levels. Others maintained that corruption played a useful redistributive role, transferring resources from wealthy individuals and corporations to those of more modest means, or that it could serve as a tool of national integration by allowing ruling elites to entice or co-opt fractious political, ethnic, or religious groups. Finally, some scholars have argued that corruption is a natural stage of development. They note that it was generally widespread in many advanced countries until recently, when it was reduced (but not eliminated) through the gradual imposition of public sector reforms over the last century.

22. Robert Klitgaard, one of the most astute students of the problem of corruption in development, notes that these arguments have several common features.⁷ First, they often refer to the benefits stemming from specific illicit acts and do not consider the systemic impact of corruption. Although a given incident or transaction may have 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.

23. Second, many of the alleged benefits from corruption, such as streamlining government transactions or enhancing civil service pay, only appear as such against the background of a public sector that is failing to perform effectively. The experience of economies such as Singapore indicates that patient and persistent efforts toward improved public sector management, by streamlining customs procedures or by paying wages that are competitive with the private sector, for example, are likely to result in greater benefits over time than tolerating relatively high levels of corruption to compensate for these deficiencies.

24. Third, corruption encourages people to avoid both good regulations and bad. There is no guarantee that an importer who bribes a customs official to expedite the clearance of badly needed medication one week will not bribe the official to expedite the clearance of illegal narcotics the next.

25. The task of evaluating the practical impact of corruption upon a country’s development is a complicated one that is now being subject to increasing scholarly attention. Although there are instances when illicit acts can improve the economic rates of return, the bulk of the evidence indicates that 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.” 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.”⁸ An extensive study of corruption in another Asian country concluded:

Graft and corruption has strongly affected development efforts negatively, belying the so-called “revisionist hypothesis” prevalent in the West which considers corruption as either a necessary step in the development process or a means of speeding it up. Instead [our research] found that corruption leads to the favoring of inefficient producers, the unfair and inequitable distribution of scarce public resources, and the leakage of revenue from government coffers to private hands. Less directly, but no less perniciously, corruption leads to loss of confidence in government.⁹

26. Upon closer inspection, many of corruption’s alleged distributive, efficiency, and political benefits turn out to be illusory. Rather than enhancing a more equitable distribution of income, corruption distorts the allocation of social resources away from those who are legally entitled to them and toward the rich, the powerful, and the politically well connected. Rather than compensating civil servants for poor pay, corruption undermines the merit system and compromises service professionalism and esprit de corps. At times, it can even foster additional inefficiencies within the public sector.¹⁰ Instead of cementing political loyalties, corruption more often breeds public cynicism and resentment toward the political process and those associated with it.

27. Many studies of the cost of corruption in individual cases paint a disturbing picture of resources lost, squandered, or devoted to suboptimal uses:

1. Some estimates calculate that as much as $30 billion in aid for Africa has ended up in foreign bank accounts. This amount is twice the annual gross domestic product (GDP) of Ghana, Kenya, and Uganda combined.¹¹
2. Over the last 20 years, one East Asian country is estimated to have lost $48 billion due to corruption, surpassing its entire foreign debt of $40.6 billion.¹²
3. An internal report of another Asian government found that over the past decade, state assets have fallen by more than $50 billion, primarily because corrupt officials have deliberately undervalued them in trading off big property stakes to private interests or to international investors in return for payoffs.¹³
4. In one South Asian country, recent government reports indicate that $50 million daily is misappropriated due to mismanagement and corruption. The Prime Minister stated publicly recently that the majority of bureaucrats and the administrative machinery from top to bottom are corrupt.¹⁴
5. In one North American city, businesses were able to cut $330 million from an annual waste disposal bill of $1.5 billion by ridding the garbage industry of Mafia domination. A particular problem was the permeation of regulatory bodies by organized crime.¹⁵
6. Studies of the impact of corruption upon government procurement policies in several Asian countries reveal that these governments have paid from 20% to 100% more for goods and services than they would have otherwise.¹⁶
7. Corruption can cost many governments as much as 50% of their tax revenues. When customs officials in a Latin American country were allowed to receive a percentage of what they collected, there was a 60% increase in customs revenues within 1 year.¹⁷
8. Some estimates of the role of corruption in a European country concluded that it has inflated this country's total outstanding government debt by as much as 15% or $200 billion. In one city, anticorruption initiatives have reduced the cost of infrastructure outlays by 35-40%, allowing the city to significantly increase its outlays for the maintenance of schools, roads, street lamps, and social services.¹⁸

28. Although almost impossible to value accurately, the indirect costs of corruption can often dwarf its direct costs. Scarce resources are squandered on uneconomical projects because of their potential to generate lucrative payoffs, and priority sectors such as education or health suffer disproportionately. Legitimate entrepreneurial activity is hindered or suppressed. Public safety is endangered by substandard products and construction. Capital is redirected toward more transparent and predictable investment sites. Individuals who would not otherwise engage in illicit behavior decide they have no alternative, and intellectual energy is diverted from more productive pursuits to figuring out ways to “get around the system.” In extreme cases, the legitimacy of the public sector itself is called into question, and governments may be confronted with political instability or collapse.

29. Although corruption is costly, its impact upon development is not uniform. Some countries can tolerate relatively high levels of bribery and graft and continue to maintain respectable rates of economic growth, whereas others cannot. Several factors influence the extent to which corruption serves as a brake upon the process of development. At the most basic level, a state’s natural resource base and the sources of its comparative advantage play a critical role in its ability to attract investment.19 A second factor is the form in which corruption is practiced. In some countries, corruption is highly routinized. Payoffs are generally known in advance and concentrated at the top in a “one-stop” fashion. Such an approach may reduce transaction costs and add 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. Finally, the extent to which money remains in the country and is invested in productive economic activity, or flows abroad into foreign bank accounts, will also have an impact upon a nation’s ability to tolerate relatively high levels of corruption and still enjoy decent rates of economic growth.

30. In spite of these caveats, the most recent and innovative empirical research demonstrates that—even correcting for variables such as bureaucratic efficiency—countries that tolerate relatively high levels of corruption are unlikely to perform as well economically as they would have otherwise. In a study of over 70 countries during the late 1970s and early 1980s, IMF economist Paolo Mauro found that corruption “is strongly negatively associated with the investment rate, regardless of the amount of red tape.” Mauro’s model indicates that a one standard deviation improvement in the “corruption index” will translate into an increase of 2.9%t of GDP in the investment rate and a 1.3% increase in the annual per capita rate of GDP growth.²⁰

31. This analysis is supported by other recent studies. Using data from 39 industrial and developing countries that controlled for income, education, and policy distortion, two World Bank researchers 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. This result held true for both countries where corruption was highly syndicated and predictable, and countries where it was not.²¹ Another recent study, which utilized econometric analysis to examine the impact of corruption upon foreign direct investment in East Asia, found that perceptions of corruption had a strong and negative impact upon the flow of foreign investment. According to the study’s findings, East Asia is no different from any other region in this regard.²²

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