**Sectoral Perspectives on Corruption**

### November 2002

# Corruption and the Private Sector

Russ Webster

The views and interpretations represented in this paper belong solely to
its author and should not be attributed to USAID or to MSI.

![](media/image1.png)

**Corruption and the Private Sector**

Russ Webster

Again, the many are more incorruptible than the few; they are like the
greater quantity of water which is less easily corrupted than a little.
The individual is liable to be overcome by anger or by some other
passion, and then his judgment is necessarily perverted; but it is
hardly to be supposed that a great number of persons would all get into
a passion and go wrong at the same moment.

From Aristotle's Politics, Book III Part X, 350 B.C.

##  {#section .TOC-Level-2}

## The Issues {#the-issues .TOC-Level-2}

Let's imagine for a moment two people each running a different business.
The first is a small shop owner who makes and sells pastries, cakes and
other delectable treats to many satisfied customers, from local
townsfolk to the many tourists that visit from spring to fall each year.
He's been in business for five pretty good years, but he's starting to
worry about the future. He's noticed the health inspector is making more
visits, unannounced, and asking the usual questions that lead up to the
inevitable, subtle, and unspoken cash transaction, followed by a smile
and topped off with a *gratis* espresso and slice of his renowned
chocolate torte. Other officials were on the move too for some reason.
The tax inspector had already made twice as many visits this year than
last. And, just the other day the director from the local business
licensing office unexpectedly stopped by. After small talk,
complimentary cakes and ice cream, he mentioned that, "oh by the way,"
our shop-owner-friend should stop by the licensing office soon to
discuss some "irregularities" in the licensing papers he'd filed this
year. This of course could mean only one thing more: yet another payment
to keep his business "legal." His "unofficial payments" to government
officials this year would certainly double at this rate.

Our second businessman manages a large holding company with several
subsidiary interests in trade, telecommunications, print media, and
light manufacturing exports. Right now he's on his way to a cocktail
reception where he hopes he'll meet the Deputy Minister for Public Works
and Communications. He's already had two meetings with the deputy to
discuss the government's plan to privatize the largest TV broadcasting
network in the country. The deputy knows of his company's interest in
winning the bid, but our business manager is becoming less certain of
their success. He recently learned their major competitor was lining up
a foreign joint-venture partner with the promise of additional financing
and access to new technologies that could sweeten their position and
give them an unbeatable edge. Unfortunately his company hadn't been able
to line up such partners. He was hoping that tonight the deputy would
agree to have dinner with him next week. He'd for sure have to offer a
substantial gift to win the deputy's favor, particularly in light of his
competitor's growing advantage.

The involvement of a foreign investor did add another wrinkle that he
might be able to work to his advantage, however. Several
parliamentarians recently had introduced a draft bill to prohibit
foreign investors from operating in certain "strategic sectors."
Broadcasting was on that list, but he'd heard from his friends in
parliament that certain private interests were lobbying heavily to get
it removed. Tomorrow he'd call his cousin who works in the Prime
Minister's office to find out which members of parliament were wavering
on this issue, and then try to go meet with them. It could prove to be
an expensive year for doing business, but he'd give it his best shot.

Many factors affect corruption between the public and private sector.
[^1] In the case of our baker, he must pay bribes out of necessity. If
he didn't pay he'd faced several dangers. The paperwork might slow down
to the point he has to spend more and more time chasing bureaucrats and
less time running his business. Or, even worse, the corrupt officials
could deny him a license and force him to shutdown. Taxes present him
with another problem. If, as in many early stage open-market economies,
his taxes are high and the tax code frequently changes, then it's
probably cheaper (and quicker) to pay off the tax inspector than it is
to put the time and money into following the letter of the tax laws,
even though this is a short-run solution with dubious and unpredictable
risks attached.

So, like a good business manager, our baker weighs his options, and
chooses the most economical means of staying in business. But, what
appears to be a quicker way to get the job done now (paying the bribe)
overtime can become and expensive proposition with uncertain outcomes.
The costs and risks of corruption are economically *inefficient* and
thereby distort growth potential. The bribes he must pay are nothing but
uneconomical transaction costs: they are rent payments that add nothing
to his business. If he could instead invest those monies he could grow
his business and create more jobs, produce more and better goods for his
customers, generate higher incomes for himself and his employees, and
generally contribute to a better standard of living for his community.
Because so many businesses face the same problem the negative impacts on
the local economy can be significant.

We might try to argue that the bribes are simply another form of taxing
our baker, and if his bribery payments are less than what he'd pay in
taxes, then he's in fact better off. Well, yes...and no: yes, the *costs
may* be less but the *returns* *certainly* are less. In a developed
economy tax payments go towards the public good: infrastructure that
businesses need (water, electricity, roads), education that builds human
skill and knowledge, health services for employees, a central banking
system that stabilizes financial markets, a police force that protects
citizens, a judicial system that upholds the law, and the like. With an
adequate and reliable tax system, governments can pay a living wage to
bureaucrats and inspectors so they're under less pressure to engage in
bribery and corruption.

But this brings us to yet more issues that shape the mindset of our
baker. Public services may not be improving. In some former communist
countries they may even be worse than before. He certainly isn't
convinced that the government uses its budget wisely. So why should he
pay his taxes? The streets are in shambles. Telephone service is
erratic. Health costs are skyrocketing. He's been told that soon the
cost of electricity will almost double. He has little police protection,
if any: the police certainly aren't protecting him from the local mafia
thugs that he *also* has to pay for "protection." So, in his cynical
view bribery and corruption are a necessary evil, a fact of life and the
reality of running a business. He sees no alternative. There's no one to
complain to that will set things right.

The case of our large business manager is a bit different. He is trying
to "buy" decision outcomes that will favor his enterprise and create a
better growth opportunity *for him*. As we can see from the example,
this significantly distorts the marketplace by eliminating competition
that would produce greater value for consumers: when pressured out, the
more efficient international investor will take his business and go
somewhere else. In the short run, buying influence may produce growth
opportunities for his business, but these are uneconomical and
unsustainable in the medium to long term. Having paid once, he will
likely have to pay again and again to secure his non-competitive
position. Herein is a strong similarity to our baker: the money spent on
bribes is money taken away from productive investment: capital
productivity declines, markets distort, and the economy suffers.

A number of studies over the past decade seek to explain the dynamics or
underlying causes of corruption as well as the economic impacts.
Although researchers debate the methodological rigor and statistical
validity of specific studies, evidence is emerging of a definite
relationship between corruption and economic growth. The causal
relationship may not be clear, but we know that economies with less
corruption perform better. Most experts accept that there is a cyclical
nature to corruption and poverty, where each feeds on and contributes to
the other. However, until recently many scholars regarded corruption as
a relatively low transaction cost compared to the benefits from
increased employment and income in, for example, less-developed
countries. Using mainly macroeconomic variables, these studies argued
that bribery was an efficient means to secure productive capital
investments that contribute to economic growth; in other words, the
bribe simply helped to "grease the wheels" for the immediate
transaction. This macro view was based mainly in Coasian Theory which
states that if market transactions are costless, a rearrangement of
rights will always take place if it leads to an increase in production
value. [^2] Another way of stating this is to say that if nothing
obstructs efficient bargaining, then the parties to the negotiation will
reach the most efficient agreement, commonly called a state of Pareto
efficiency after the 19^th^ Century mathematician and economist Vilfredo
Pareto.[^3] The problem with this model is that the Coasian world of
costless bargaining, perfect information, and efficient markets is far
different than the real world where affected parties are kept out of
negotiations, information is restricted, and wealth accumulates to a few
who control access to markets and to the levers of decision-making that
establish un-economic rules of the marketplace.

New evidence, however, better illuminates the negative affects of
corruption. The World Bank and other donors have supported research that
looks at a broad range of institutional and legal variables affecting a)
the competitive position of enterprises and in turn b) the comparative
strengths of the economy. For example, Paolo Mauro argues that
corruption has a negative impact on the ratio of investments to GDP.
[^4] There is also a strong correlation between GDP and rankings on
corruption indexes. In their work on economic growth and governance,
Kaufmann and Kraay analyze the strong positive correlation between
governance per capita incomes, for example. [^5] Among the more
interesting current debates is the question of "causality," i.e., does
corruption result in low GDP or do low GDPs cause corruption? Many
scholars have been unconvinced by the evidence, concluding that this is
a "vicious cycle" of one affecting the other, and that the focus should
be on "breaking this cycle" through economic growth and governance
improvements. [^6] The Kaufmann/Kraay study, however, suggests that
there is more likely a flow of causality from good governance to
increased incomes, rather than the reverse flow, which in fact may be
somewhat negative. How then would we explain the phenomenon of China's
economic growth without democratic reforms? Well, Kaufmann et al may
explain this by looking at the negative reverse relationship between
growth and governance. Recent studies of China have looked closely at
the tenuous nature of their growth, which is being held together through
unsustainable state intervention and dubious fiscal management, and an
alarming level of corruption. In fact, it appears that areas of China
that successfully institute good governance reforms are out-performing
other areas still plagued by corruption. [^7]

Our two earlier examples illustrate the motivation for and impacts of
corruption between public officials and businesses. Many variables --
social, economic, political, cultural -- will shape the character of
corruption in a specific context, but there are common conditions that
set the stage for corruption to occur. In order to mitigate corruption,
we must understand these conditions. In this paper we'll discuss: a)
where corruption occurs, b) what creates the incentive for corruption,
c) what creates the opportunity, and d) why institutional protections
(laws, regulations, reporting and monitoring systems) are weak. We'll
also explore the incentives and disincentives of government-business
corruption and how it affects private sector growth and economic
development in general. We'll elaborate a list of circumstances (or
"vulnerabilities") in which corruption of this sort typically takes
place. (See Table 3: Vulnerabilities -- Where Does Corruption Take
Place?) I'll conclude the paper by summarizing what is being done now to
curb corruption in the public/private sphere of activity, and also by
discussing strategies (working with business and with government) that
USAID could consider or expand upon in its own work.

## "Vulnerabilities" or Where Corruption Occurs {#vulnerabilities-or-where-corruption-occurs .TOC-Level-2}

Official corruption has been with us since, well, at least since the
time of Aristotle and most certainly before. Some level of corruption is
still common in most of the world. (See Tables 1 and 2 for comparative
regional data on corruption.) Most international companies have long
accepted bribery as necessary for doing business in less developed
economies where public officials had substantial control over contracts,
licenses, and foreign investment decisions. Until recently, most Western
countries even allowed bribery payments to foreign countries as
legitimate business expenses (some still do). [^8]

  ----------------------------------- -----------------------------------
  Table 1: Some Comparisons of        
  Bribery Payments by Region and by   
  Firm Size [^9]                      

  Category                            Percentage of firms that responded
                                      they had to make "irregular
                                      payments" to get things done
                                      always, mostly or frequently.

  By Region                           

  South Asia                          65 %

  Developing East Asia                62 %

  Africa                              52 %

  MENA                                36 %

  CEE                                 33 %

  CIS                                 29 %

  LAC                                 28 %

  OECD Countries                      12 %

  Developed East Asia                 11 %

  By Firm Size, All Regions           

  Small                               40 %

  Medium                              34 %

  Large                               31 %
  ----------------------------------- -----------------------------------

Times are changing, however, and the anti-corruption movement is growing
in the business world. This movement has some roots in the Foreign
Corrupt Practices Act passed in the US in 1977 and similar laws passed
in other countries with global business interests. Today there is a host
of organizations promoting the benefits -- social, political and
economic -- of ethical business practices. And, their credibility has
been strengthened by recent studies showing not only the negative
economic impacts of corruption, but also the positive effects on markets
and economic growth that a stable investment climate and rule of law can
have. Businesses are starting to listen and adopt "good governance" or
"ethical business" programs for several reasons. Many global enterprises
have prominent places in the market; they also know that a good public
image and good public relations will help secure this position. And,
aside from their sense of social responsibility, some enlightened
business managers have a longer-term vision and know that corruption
hinders social and economic development. By doing their part to foster
growth of under-developed economies, they're creating new markets and
wealthier consumers.

  ----------------------- ----------------------- -----------------------
  Table 2: Percentage of                          
  Revenues Paid in                                
  Unofficial Payments to                          
  Public Officials, by                            
  Region [^10]                                    

  Region                  Percentage of Revenues  Percentage of Firms
                          Paid                    Responding "0% Paid"

  Africa                  Not asked               Not asked

  MENA                    Not asked               Not asked

  CEE                     5.5 %                   0.9 %

  South Asia              5.0 %                   18.8 %

  Developing East Asia    4.6 %                   22.7

  CIS                     3.4 %                   3.4 %

  LAC                     2.0 %                   58.0 %

  East Asia (not incl.    0.6 %                   86.3 %
  China)                                          

  OECD Countries          0.6 %                   83.0 %

  Average                 3.0 %                   38.7 %
  ----------------------- ----------------------- -----------------------

Let's look first at some basic concepts that will help us understand
impacts of corruption. How does corruption harm private sector
development? How does it harm the economy? If an under-paid government
worker can make a little on the side to better feed his or her family
why should we be concerned? The fundamental issue is about short-term
gain to a few vs. long-term harm to many. As we saw from the two
examples above, although the business (and the corrupt official) may
gain in the short run, the bribe payment shifts money away from
potentially productive investments in the business. These non-economic
transaction costs keep the level of enterprise development low relative
to those enterprises that are able to invest in growing their business.

To generate growth, businesses must use their capital resources
productively. When capital is drawn away into non-economic transactions,
this negatively affects enterprise growth as well as the marketplace in
general. Corruption distorts growth incentives also by forcing out
potentially better producers of goods or services. As we can see in the
second example, the bribes to policy decision-makers give one firm an
edge over the competition; it is, however, an uncertain edge that may be
good only for the time being, for this one transaction, for the parties
to the negotiation and *not* for the market. This "edge" too is not
based on market factors; in fact they are non-economic advantages
granted through rent payments to the state. That is, one firm wins the
contract or pushes out the competition not because of the value they
bring to the market, but because they can distort market-effects by
controlling political decisions and their outcomes. The competition --
who is prepared to bring new communication technologies and other
sources of financing to the deal -- loses the deal and their competitive
advantage is kept out of the marketplace. Who loses? Workers who could
have gotten a better wage working for a more competitive enterprise;
consumers who could have gotten better quality goods or services at a
better price; ultimately, the economy, which could have generated a
better standard of living for all citizens.

This is a basic description of how corruption affects enterprise growth
and economic development. But where do these corrupt transactions
typically take place? Before we look at this range of "vulnerabilities"
where corruption between business and government occurs, let's turn back
to our two examples because they illustrate two broad categories of
corruption that are useful to our understanding. Our baker faces the
problem of *administrative corruption* or what is sometimes called
"petty corruption," (although this is a term I don't advocate because it
understates the impact of a single corrupt act which is typically
repeated numerous times and collectively produces significant harm by
keeping poor people poor and holding back those who could move ahead).
He must pay bribes to public officials to keep his business running.
These could be in the form of "processing fees" to get documents, or
what we might call "blinders fees" to keep an inspector's head turned in
the other direction. These payments don't "grease the wheels" of the
plodding bureaucracy like some would think, they establish rules (albeit
unpredictable) for the game that create *incentives* for public
officials to fabricate more and more delays.

The second example illustrates another form of corruption called *state
capture*. This is the payment of bribes to try and shape the policy and
legal environment to the captor firm's advantage. A *capture economy* is
one where such payments are common variables in the state's
decision-making procedures. The negative impacts of state capture are
not insignificant, even over a short period of time. A recent study by
the World Bank showed that the overall growth rate of enterprises in a
*capture economy* is about ten percentage points lower than a
non-capture economy over a three-year period. [^11]

The dynamics of state capture can involve active solicitation from the
public sector side as well. In our example, the businessman is buying a
decision from a policy maker. In reality, decision makers frequently
abuse their position and offer up their influence to solicit support
from business in the form of cash or gifts. It would be misleading to
portray public officials as passive players that can be "engaged" or
"captured" for the right price. Public officials also seek to sell their
influence and power to the highest bidder. Public sector corruption also
perpetuates a kind of illicit hierarchy where lower level jobs are sold
off and these in turn create informal systems of kickbacks and patronage
that perpetuate corrupt practices, inefficiencies, and barriers to
meaningful public sector reform. In this way, the higher levels of
corruption which we've characterized as state capture are linked down
through the bureaucracy to administrative corruption that occurs at
lower, seemingly "less harmful," levels. The point here is that public
sector corruption creates a murky culture of abusive alliances where
power and influence flow in many directions among players in government
as well as business.

Table 3 describes the situations where corruption can most commonly
occur in the relationships between public officials and private
businesses. This comes from the work of Daniel Kaufmann, a Senior Expert
at the World Bank. Notice that most of the situations described fall
into the category of *state capture.*

+-----------------------------------------------------------------------+
| Table 3: Vulnerabilities -- Instances Where Corruption can Take       |
| Place. [^12]                                                          |
+-----------------------------------------------------------------------+
| -   Where a government agent is responsible for issuing of licenses,  |
|     permits, customs clearance and border-crossing documents, banking |
|     licenses, etc.                                                    |
|                                                                       |
| -   Where government regulators decide about price controls or taxes  |
|     on commodities (for example: to keep prices high on locally       |
|     produced commodities that have an inelastic demand; or to assign  |
|     high duties on imported goods that compete with domestic          |
|     producers).                                                       |
|                                                                       |
| -   Where policies are set that could block new firms and investors   |
|     from entering the marketplace, and thereby allow a monopoly       |
|     position of another firm.                                         |
|                                                                       |
| -   In the awarding of contracts for publicly procured goods or       |
|     services.                                                         |
|                                                                       |
| -   In making policy decisions or enacting laws that would grant to   |
|     certain classes of enterprises subsidies, soft credits, or tax    |
|     exemptions.                                                       |
|                                                                       |
| -   Where government inspectors monitor tax compliance or evasion.    |
|                                                                       |
| -   In the setting of and administration of foreign exchange control  |
|     mechanisms.                                                       |
|                                                                       |
| -   In allocating real estate/privatizing state properties.           |
|                                                                       |
| -   Where government agencies could "selectively" enforce socially    |
|     desirable regulations (e.g. location of certain types of          |
|     businesses, enforcement of equal employment regulations, etc.)    |
|                                                                       |
| -   Where monitoring mechanisms are weak and allow government         |
|     officials to maintain obscure or secret budgetary accounts.       |
+-----------------------------------------------------------------------+

We can readily see that there is wide scope for corruption between
business and government in an environment where rules and regulations
are ambiguous, and where oversight is weak. It is a natural tendency for
businesses to seek advantage over their competitors, and it is not
surprising that public officials would take advantage of weak
institutional frameworks to peddle their influence for personal gain.
Weak institutions, an uncertain rule of law, insecure property rights
and the like encourage the kind of short term focus on day-to-day
business survival that makes corruption appear more beneficial than it
in fact is. The correlation between the rule of law and the "marketplace
for corruption" is an inverse one. A strong rule of law would be
characterized by:

-   A rational set of laws governing the operations of private business,
    the protection of property rights, and the enforcement of contracts.

-   Anti-monopoly policies and procedures to enforce them.

-   A reasonable rate of taxation on private business.

-   An efficient system of patents and protection for intellectual
    property.

-   An efficient and stable set of regulations governing licensing,
    inspections and audits on business.

-   An efficient judiciary (and ADR mechanisms) for sorting out contract
    disputes.

-   Administrative procedures that guarantee public access to government
    decision makers and to their deliberations that shape policies and
    laws.

-   Laws and administrative procedures that protect "whistle blowers"
    from reprisal.

-   Laws and enforcement mechanisms that ensure accountability of
    private firms to their shareholders and capital markets.

-   Disclosure laws that compel those in public office to disclose
    private financial interests.

In addition to public laws and governmental institutions, the private
sector can also play a role in supporting the rule of law by promoting,
for example: efficient capital market systems and institutions; practice
of good corporate governance and business ethics (here is a role for
associations for example), and; quality standards for goods and services
in the marketplace. There is also an obvious role here for education and
training institutions that target entrepreneurs and business managers.

Aside from the negative impacts of corruption on private enterprise
development and economic growth (which we've argued earlier), why is a
"strong rule of law" important to individual businesses? A major problem
facing all businesses is risk. From the early stages of developing a
business plan, to the point of running a successful operation, business
managers are constantly dealing with risk. Risk is a natural force
shaping the behavior of enterprises and the character of the marketplace
in any economy. But, a strong rule of law helps to reduce risk or at
least make it easier to estimate accurately by creating institutions and
laws that are predictably -- not idiosyncratically -- enforced. Risks
therefore are higher in an economy characterized by administrative
corruption, rent-seeking officials, or a plethora of firms seeking to
capture the state. If risk can be lowered through a rule of law that
successfully mitigates corruption, investors are more likely to enter
the market in greater numbers and dollars.

Up to this point we've highlighted the public sector side of corruption
by focusing on the rule of law and how the absence of transparent,
accountable public institutions and regulations creates the opportunity
(and the incentive) for corrupt transactions. Within this view, we're
naturally led to look towards "fixing the public sector" as a solution
to the problem of corruption. No doubt the public sector has a major
role to play, and indeed much of the literature to date is focused on
the role of government, and on how ineffective public institutions and
legal frameworks breed corruption. However, recent debates and studies
are focusing more on how *corruption breeds inefficient and
unaccountable governments*. (A popular cliché is "corruption is a
two-way street.") This is a more complete picture because it highlights
the role that business plays in perpetuating corruption, and leads us to
explore strategies that involve changing the behavior of business, not
just of government. In this regard there have been several conferences,
papers, and workshops of late that explore the linkages between good
*corporate governance* and corruption.

Corporate governance describes the relationship between the managers of
a company and other stakeholders. How does this relate to corruption?
Basically, if a company is accountable about its use of capital
resources, then bribery payments should be disclosed. The threat of
"exposure" is a disincentive to corruption. But, beyond simple
accounting, ethical business practices are regarded more and more as
important aspects of corporate governance. In 1999, 29 member countries
of the OECD adopted the principles of corporate governance appearing in
Table 4. In 2000, these principles were included among the 12 core
"standards for global financial stability" which are recognized as
important benchmarks by international financial institutions. According
to the OECD,

> A good corporate governance regime helps to assure that corporations
> use their capital efficiently. Good corporate governance helps, too,
> to ensure that corporations take into account the interests of a wide
> range of constituencies, as well as of the communities within which
> they operate, and that their boards are accountable to the company and
> the shareholders. This, in turn, helps to assure that corporations
> operate for the benefit of society as a whole. It helps to maintain
> the confidence of investors -- both foreign and domestic -- and to
> attract more "patient", long-term capital. ("OECD Principles of
> Corporate Governance," 1999, pg. 7)

+-----------------------------------------------------------------------+
| Table 4: OECD Principles of Corporate Governance [^13]                |
+-----------------------------------------------------------------------+
| > *The Corporate Governance framework should:*                        |
|                                                                       |
| 1.  Protect shareholders' rights.                                     |
|                                                                       |
| 2.  Ensure the equitable treatment of all shareholders, including     |
|     minority and foreign shareholders. All shareholders should have   |
|     the opportunity to obtain effective redress for violation of      |
|     their rights.                                                     |
|                                                                       |
| 3.  Recognize the rights of stakeholders as established by law and    |
|     encourage active co-operation between corporations and            |
|     stakeholders in creating wealth, jobs, and the sustainability of  |
|     financially sound enterprises.                                    |
|                                                                       |
| 4.  Ensure that timely and accurate disclosure is made on all         |
|     material matters regarding the corporation, including the         |
|     financial situation, performance, ownership, and governance of    |
|     the company.                                                      |
|                                                                       |
| 5.  Ensure the strategic guidance of the company, the effective       |
|     monitoring of management by the board, and the board's            |
|     accountability to the company and the shareholders.               |
+-----------------------------------------------------------------------+

We can see from this how lax corporate governance and the lack of
corporate accountability facilitate corruption "vulnerabilities" between
business and the public sector. If managers aren't answerable to
shareholders and other stakeholders about how they use corporate funds
and negotiate agreements, then there's less risk of getting caught. In
fact, the incentives to be corrupt and the likelihood of succeeding at
it become greater as oversight structures become weaker. Hellman et al
discovered that in capture economies (characterized by a high degree of
state capture corruption) captor firms grew four times as fast as other
firms in the capture economy, and also had substantially greater levels
of investment. But, let's not be misled by these growth rates. In spite
of these gains to a few, the losses are greater to the private sector as
a whole when compared with non-capture economies: the average growth
rate of sales for all firms in high capture countries is only 11.1
percent, compared to 21.4 percent in low capture countries. [^14] The
long-term wealth of "gainer firms" in a capture economy is questionable
too. Their "gains" are only relative in comparison to those firms
they've been able to push out of the marketplace. The fact that they
substitute corruption for productive investments and sound business
practices undermines their long-term viability and global
competitiveness.

## Responses to Corruption in the Dealings Between Business and Government {#responses-to-corruption-in-the-dealings-between-business-and-government .TOC-Level-2}

Mitigating corruption that takes place between the public sector and
business is a huge challenge. People in developing and transitioning
economies have long accepted corruption as common practice. They don't
like it when it directly affects them, but they see no alternative to
getting business done. Effective anti-corruption programs also require
resources, so although politicians denounce corruption, they may lack
the funds to finance the institutional, legal, and human resource
changes that are necessary to get positive results.

Faced with serious budget constraints, government leaders find it very
difficult to accomplish two things necessary to mitigate corruption. The
first is to shift the incentives so that public officials aren't tempted
by bribes. This means increasing government salaries and benefits, and
putting in place performance incentives with monetary rewards. The
second area has to do with establishing a rule of law and the means to
enforce it. This means implementing new laws, strengthening public
agencies, building an effective and efficient judiciary, and creating
reasonable yet effective oversight agencies that can identify and punish
offenders, both from government as well as business. Although these
measures are costly, the negative impacts on enterprise development,
global competitiveness, and economic growth are worse.

We'll turn in a minute to some innovative work that's being done with
the private sector, but let's first highlight what needs to be done to
support anti-corruption efforts in the public sector. The list is large
but necessary if governments want to pursue a serious anti-corruption
program:

-   Immediate adoption of laws that require public hearing periods for
    proposed laws and amendments, and implementation of public sector
    reforms that open the policy-process to broad civic participation.

-   Setting of harsh criminal penalties for extortion by public
    officials.

-   Adopting laws on political financing and asset declaration.

-   Adopting laws and regulations on lobbying.

-   Adopting laws and creating effective regulatory agencies that
    protect markets from monopolization and enforce anti-trust.

-   Enacting "sunshine" laws that enable public access to government
    hearings, legislative debates, and require publicly-available
    minutes.

-   Adopting "freedom of information" legislation that allows public
    access to all official documents, and mandatory disclosure of
    individual votes in parliament/legislature.

-   Creation of a "corruption impact" agency to monitor and analyze
    potential vulnerabilities in government operations and new
    legislation.

-   Requiring publication of court decisions and case schedules.

-   Working with the media to inform and educate the public.

In addition to these legal and institutional reform efforts, governments
must set a high priority on basic training and capacity building efforts
for elected officials and all public agencies (including the judiciary)
that interact with the private sector. The best way to raise awareness
is through public education and open dialogue about corruption and how
it affects the community and the economy.

Some recent innovations seem to hold particular promise in mitigating
administrative corruption. One is "one-stop-shopping" for business
licenses and other operating permits. Naturally, the greater number of
official stamps or signatures that a business needs to operate, the
greater the number of vulnerabilities or opportunities for bribery.
Local governments are beginning to realize that they will attract more
investment if they simplify these procedures and assign one office to
interact with local businesses on all official matters. This approach
has been piloted successfully in a number of transitioning economies of
the former Soviet Bloc.

Another innovation builds on the theory that government ultimately is a
service organization, and they should gauge their success on the basis
of citizen (i.e. "customer") satisfaction. [^15] One simple monitoring
tool for tracking customer satisfaction is a "point-of-service
evaluation survey" or POSE. These are short surveys that are given to
customers (for example, a truck driver passing through border-customs)
that "score" the quality of government service provided to them. They
can then be dropped into a collection box or returned by post
(pre-stamped) anonymously. The advantage is that they are short, they
provide ongoing feedback to senior public sector managers, and they can
tell citizens who to contact if they have complaints about the services.
The other advantage is that they promote positive attitudes about the
proper role of government services. Such a system can be implemented
anywhere that government is responsible for a transaction that affects
an individual or a business. And, it could be tied to an awards system
or certification of excellence program based on customer satisfaction.
[^16]

What can be done with the business community to encourage good corporate
governance practices? At the international level there already are
several conventions and "codes of conduct" in place that are designed to
level the playing field in trade and foreign investment. Transparency
International -- a leading NGO in this field -- has cited numerous
examples of best practices in the private sector to mitigate corruption
and promote ethical businesses practices in the corporate workplace.
[^17] There are also many examples of businesses collaborating with
civic groups to speak out on issues of corruption, promote public
education, and advocate for market-led policy reforms and economic
development. Many global companies have adopted their own standards of
ethical conduct in an effort to "self-regulate." A number of institutes,
associations, and other NGOs offer services to large companies in how to
design, implement, monitor, and provide training to staff on managing a
corporate ethics program.

Can these "self-regulation" practices be successfully transferred to
enterprises working primarily in domestic markets in underdeveloped or
transitioning economies? How could they be motivated? I think it's safe
to say that global companies are motivated by their high profile and
broad market base to maintain a good public image, and to adopt
standards of conduct that will protect that image and those markets.
This is particularly important in today's "information age." If a
company is accused of corruption in one country, it's only a matter of
minutes before that news can be broadcast around the globe.

But what motivates companies operating in much smaller domestic markets
to practice good corporate governance, let alone set up mechanisms to
monitor and enforce a code of ethics? Here, the size and ownership
structure of a company may be a factor. Smaller, privately owned
companies deal mainly with the day-to-day problems of administrative
corruption; they truly are at the mercy of the government. Their
problems are affecting them and their employees, not a broader group of
shareholders, board members, or venture capitalists. They are only
accountable to themselves. Plus, they probably can't afford the cost (or
the risk) of liquidating their business and moving to another location.
For them the best course of action would be to organize themselves and
pressure the government to stop bribery and extortion. By teaming with
other local interests -- business associations, NGOs, and civic groups
-- micro, small and medium sized enterprises will speak with greater
force and authority. And, by teaming with the media, they can educate
the public about how corruption negatively affects consumers,
discourages investors, and stifles employment and income growth in the
community. In addition, businesses can propose that the government
create a public-private partnership or task force to monitor
anti-corruption efforts. Organization, political pressure, and public
awareness are key strategies to fight administrative corruption at the
local level.

Larger businesses that are traded on the local stock exchange, however,
could have an impact on state capture and administrative corruption by
adopting corporate governance principles, instituting a code of ethics,
and engaging in open dialogue with their peers, the government, and the
media about the problems of corruption. Their public commitment to
stopping corruption could help shift expectations, redefine business
norms or standards of practice, restore public confidence, and spur
government to make legal and institutional reforms that promote
competition.

But let's not be too enthusiastic or naïve. There is a problem inherent
in this approach. Some (maybe even many) of these larger businesses have
already been party to corruption, and very well may be in future. Why
would they promote a practice that they don't subscribe to? Well, the
same argument was certainly made a few decades ago about global
companies. A few "enlightened" ones, however, found a connection between
their corporate interests and the interests of the society at large in
denouncing unethical business practices. Although there is no empirical
evidence at hand, there should be a few leaders from this class of
enterprises -- those that are larger, publicly traded, and prominent in
the local economy -- willing to be our partners in promoting good
corporate governance and ethical business practices. Local businesses
with foreign interests may be good candidates; the foreign partner may
be more familiar with the importance of good governance, and, in
addition, may welcome this opportunity to improve their image in the
local society.

## Program Strategies  {#program-strategies .TOC-Level-2}

Corruption is a crosscutting issue affecting USAID's programs in
economic growth and in democracy development. We can see from the
discussion above that an effective anti-corruption effort must target
stakeholders in both sectors -- public as well as private. We can also
see that the largest challenge is a fundamental one of changing
attitudes, incentives and enforcement mechanisms to promote good
behavior and punish corrupt actions or decisions. Much of the work that
USAID is doing already has this aim. Among these programs, are the
following:

-   Promoting decentralization and fiscal accountability.

-   Creating systems and institutions that promote public participation
    in policy dialogue and policy implementation.

-   Creating more responsive and transparent public service mechanisms
    at the local level.

-   Strengthening business associations as advocates for market reform.

-   Promoting trade liberalization policies and competitiveness
    strategies.

-   Improving accountability and efficiency of capital markets.

-   Promoting and implementing transparent and efficient programs to
    procure state-services from the private sector.

-   Helping businesses in a "cluster" or sub-sector to enhance their
    competitiveness in global markets.

-   Opening up and improving legislative processes.

-   Developing independent media that is educated about corruption and
    its affects on the economy.

-   Creating public-private partnerships of businesses, civic groups,
    and local government to fight corruption and monitor results.

-   Educating the public on the social and economic costs of corruption.

-   Improving public communications capabilities of government
    officials.

-   Strengthening the role and participation of independent "think
    tanks" to analyze political and economic issues.

-   Legislating public disclosure of corporate interests held by elected
    officials.

Each of these objectives will affect corruption by helping reduce
vulnerabilities between government and business. At the same time they
are strengthening institutions and relationships among stakeholder
groups that are necessary for successful enterprise growth and economic
development. In addition, USAID should promote innovation in areas that
directly address vulnerabilities. For example:

-   Helping local governments institute "one-stop-shops" for enterprises
    to conduct official business and give business owners and citizens a
    place to provide customer feedback on services, etc.

-   Helping business associations or think tanks conduct, analyze and
    publicize corruption surveys.

-   Introducing a corruption curriculum (focused on the costs to
    enterprise growth and economic development) into public
    administration training programs and workshops.

-   Instituting point-of-service-evaluations wherever businesses and
    government agencies interact.

-   Supporting public education programs.

-   Encouraging (and providing TA for) larger businesses to adopt
    governance standards and corporate codes of conduct.

Even considering the possible range of programmatic interventions,
effectively reducing corruption and promoting real competition among
enterprises in developing economies are enormous tasks. And, success
will be determined mainly by the will and commitment of political and
business leaders. For our part, we must convince them that corruption is
holding back their entry into new markets and stifling economic growth
which in turn will be good for business. We must constantly seek out
leaders (in both public and private sector) that understand and advocate
the "level playing field" argument, that is, that open markets will best
serve social and economic objectives as well as private business
interests over the long term.

The most promising new area for cost-effective impact may be the
development and implementation of monitoring tools that expose
corruption, mainly administrative corruption. But this alone isn't
enough. Changing the higher-stakes, higher-return culture of state
capture, may be more daunting, but it's nonetheless more important to
achieving fundamental and sustainable change. In government, as in
business, standards and expectations start at the top. For these
reasons, USAID -- along with other donors -- must continue pushing for
policy change and institutional reforms at all levels of government
wherever possible, while at the same time researching, testing, and
promoting best practices that mitigate, or at a minimum expose,
corruption where vulnerabilities are highest.

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[^1]: Although not the subject of this paper, there are forms of
    business corruption, racketeering and extortion that exist outside
    the sphere of public sector involvement. Many small businesses, for
    example, are extorted for "security" or "protection payments" by
    mafia thugs. Mafia groups sometimes will pressure successful
    enterprises to buy from certain suppliers, or retail through certain
    outlets. In other cases that don't involve organized crime, loan
    officers may demand kickbacks in return for the business applicant's
    credit approval. Whatever the source, corruption takes capital away
    from productive investments that will help grow an enterprise and
    make it more competitive, which is a principal argument presented
    here. Because this paper focuses on public sector corruption, these
    other areas aren't explored here.

[^2]: Ronald Coase introduced this proposition, now known as the Coase
    Theorem, in his 1960 article "The Problem of Social Costs." Coase's
    ideas have since had a profound impact on economic and legal
    discussions.

[^3]: A "Pareto-efficient state" is where no one in the economy can be
    better off without someone else being worse off. In other words,
    this is when the economy is making optimum use of available
    resources for the greatest possible number of beneficiaries. Later
    the team of N. Kaldor and J.R. Hicks elaborated Pareto's work to
    formulate a test for comparing proposed changes ([Economic
    Journal]{.underline}, 1939). Simply stated, the Kaldor-Hicks test
    compares the net benefits of two options: if the net benefit
    (aggregate benefits minus aggregate costs) of option A outweighs the
    net benefit of option B, then A is the better choice.

[^4]: "Corruption and Growth," *Quarterly Journal of Economics*, CX/3
    (August): 681 -- 712.

[^5]: "Growth without Governance," Kaufmann, Daniel and Arat Kraay, The
    World Bank, July 2002.

[^6]: For a summary discussion of the economic impact debate, see
    "Research on Corruption: A Policy Oriented Survey" by Andvig and
    Fjeldstad, December 2000, Commissioned by NORAD.

[^7]: See the Financial Times five-part series on "China's Future," by
    James Kynge, October 28^th^ -- November 1^st^, 2002.

[^8]: The US government stopped allowing tax deductibility of foreign
    bribes in 1958.

[^9]: From "Voices of the Firms 2000: Investment Climate and Governance
    Findings of the World Business Environment Survey," Batra, Kaufmann
    and Stone. The World Bank Group, May 2002.

[^10]: Ibid, Batra et al.

[^11]: "Seize the State, Seize the Day: State Capture, Corruption and
    Influence in Transition," World Bank Policy Research Working Paper
    2444, Hellman, Jones and Kaufmann, September 2000.

[^12]: "Anticorruption Strategies: Starting Afresh? Unconventional
    Lessons from Comparative Analysis," Kaufmann, Daniel in R.
    Stapenhurst and S. Kpundeh (editors), [Curbing
    Corruption]{.underline}, The World Bank, 1999, p. 94. (Cited in
    "Corporate Governance: An Antidote to Corruption" by CIPE, 2002.

[^13]: For the complete document, go to
    <http://www.oecd.org/pdf/M00008000/M00008299.pdf>.

[^14]: Hellman, Jones and Kaufmann, page 18.

[^15]: The World Bank, for example, is developing a series of
    "governance monitoring tools" that include a range of instruments
    and procedures to evaluate governmental service performance and
    measure improvements over time. These include surveys, scorecards,
    feedback forms, and hotlines.

[^16]: "Strategies to Combat State Capture and Administrative Corruption
    in Transition Economies," Joel S. Hellman.

[^17]: See the TI Source Book 200 on "Confronting Corruption: The
    Elements of a National Integrity System," Appendix of Emerging Best
    Practices.