are easy to collect, governments will opt for increasing consumption taxes, which tend to be regressive, disproportionately affecting the lower-income groups. To give another example: in Russia the minimum pension—received by some 37 million people—fell by 70 percent in real terms between 1991 and 1996 because the government had “lost” several billion dollars in annual budget revenue through tax exemptions extended to cronies and favored companies.

Johnson, Kaufmann and Zoido-Lobatón (1998) used cross-country data to establish that the higher the level of corruption in a country, the larger the share of its economic activity that will go underground, and, hence, will be beyond the reach of the tax authorities. Not surprisingly, studies have shown that corruption also undermines foreign direct investment since it acts in ways that are indistinguishable from a tax; other things being equal, investors will always prefer to establish themselves in less corrupt countries. Wei (2000) reviewed FDI data from 14 source countries to 45 host countries, and concluded that: “an increase in the corruption level from that of Singapore to that of Mexico is equivalent to raising the tax rate by 21-24 percentage points.”

# **_Undermining private sector development_**

Corruption undermines the investment climate, discourages private-sector development and innovation and encourages various forms of inefficiency; the more widespread it is, the more damaging its effects. Budding entrepreneurs with bright plans and ideas will be intimidated by the bureaucratic obstacles, financial costs and psychological burdens of starting new business ventures (including dealing with corrupt officials to obtain permits and licenses) and will either opt for taking their ideas to some other less corrupt country, if they can afford to do so, or, more likely, may desist altogether, or opt for early departure from the market, quickly shutting down newly created companies. So, corruption is either a barrier to entry into the market or a factor in precipitating early departure; in either case, economic growth is adversely affected. The high incidence of corruption will imply an additional financial burden on businesses, imposing heavy costs on them, thereby undermining their international competitiveness. Unlike a tax, which is known and predictable and can be built into the cost structure of the enterprise in an orderly fashion, bribes are necessarily unpredictable and random and will undermine cost control, reduce profits and undermine the efficiency of those who must pay them to stay in business. Paulo Mauro (1995) used some indices of corruption and institutional efficiency to show that corruption lowers investment and, hence, economic growth. He offers the following example: “if Bangladesh were to improve the integrity and efficiency of its bureaucracy to the level of that of Uruguay (corresponding to a one-standard deviation increase in the bureaucratic efficiency index), its investment rate would rise by almost five percentage points, and its yearly GDP growth rate would rise by over half a percentage point” (p. 705).<sup>16</sup> 16 Rose-Ackerman (1997b, p. 91) gives an interesting illustration of the effects of corruption on the viability of development projects. Assume that 20 percent of the funding for a particular project is lost to corruption—this could be because of over-invoicing of costs, losses due to theft of equipment and so on; the details themselves are not essential. Assume a rate of return of 10 percent. Because of corruption, a US$100 million project could have been 20