The Business of Corruption

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The oldest profession in the world they say is prostitution, but the most pervasive one might be corruption. It afflicts all countries in the world, even those that are fairly wealthy and have a solid reputation for honest government. In poor places where hardly any entrepreneurship exists, entrepreneurial rent-seeking pervades.

In countries that have experienced the fastest growth in the last century (East Asia) and in those that have experienced the slowest (Sub-Saharan Africa), corruption has reared its ugly head. It is one of the most detested forms of seeking a living, yet leaders who have been renowned for it have remained quite popular with their people (Marcos, Suharto, Estrada, and Fujimori).

It has been called a cancer that eats away at the fabric of society by the religious and the secular alike. I have likened it to the multi-headed hydra in Greek mythology, irrepressible. Many talk about the culture of corruption. One oft cited text by J. S. Nye describes it as

[b]ehavior 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.

Corruption may be motivated by altruism towards one’s kin (as in the case of nepotism) or it could also be based on self-interested impersonal exchange (as in regulations for sale). Some studies distinguish between bribery to make a public official act in a way that he or she would otherwise not (to disregard a traffic violation) and gift-giving to perform a legitimate function (to speed up the release of a permit).

Corruption and rent-seeking are often used interchangeably. A rent is an income derived from something that exceeds its normal or alternative use. Rent-seeking is any activity engaged in to secure them. Patron-client networks are often clustered around such rents. The relationship is symbiotic. A patron will appoint a person in his clique to a sensitive post, where the appointee can earn rents. In consideration for this, the patron expects a fair share of the proceeds to be transferred to his or her kitty.

The moralistic tone of earlier studies has been superseded by a utilitarian one which still looks disapprovingly at rents but from a social welfare standpoint viewing them as value-reducing. But as Khan and Evans have pointed out, rents may also be positive or value-enhancing as in the case of rents from innovation and non-substitutable natural resources. In developing countries, innovation rents may come from copycat technology and transferring productive labour from rice fields to factories. It now includes deploying skilled manpower overseas to remit better than normal wages back home.

In East Asia, webs of patron-client networks were set up among a triad composed of bureaucrats, capitalists and politicians to foster value-creating activities. As Khan showed, even when transfer payments were made by businesses to protect their rents, the overall effect could still be positive. The effective carrot and stick approach applied by patrons of state-run or state-sanctioned firms can make them perform quite efficiently in the marketplace to maintain their rights over these rents.

In the prosperous West, such transfers have been made legal through a system of lobbying and campaign finance. In the US for instance, political action committees or PACs are run by lobbyists, either big corporations or trade unions. While they are prohibited from making direct contributions from their treasury, they are allowed to finance their own campaign ads (as part of “free speech”) that favour their candidates during elections.

In South and Southeast Asia, patron-client networks have not been as efficient or as effective in creating value-enhancing rents as in Northeast Asia. This stems from different initial conditions. Higher inequality, a weaker bureaucracy and ethnic diversity have dampened the developmental state aspirations of these nations. The four ASEAN tigers (the original ASEAN-5 minus the Philippines) have consistently produced rapid growth, not as stellar as in East Asia, but impressive nonetheless.

Adherents of the Washington Consensus, in seeking to explain the growth of these countries before and after the Asian financial crisis, have pointed to their market and outward-looking orientation. A closer inspection, however, shows that industrial policy, interventions in the market for goods, services and finance, and patron-client networks played a crucial role in distinguishing this region from the rest of the pack. What was it about these states that allowed them to foster growth despite the all-pervasive nature of corruption that prevailed?

Weber talks of the regularity and predictable nature of legal and administrative agencies behind advanced forms of capitalism. Perhaps the answer to the question is that these states fostered a system of corruption that operated with consistency and predictability, turning it into a tax that businesses could factor into their plans. This is perhaps why investors have expressed a preference for grand (controlled) corruption over petty (uncontrolled) corruption.

Shleifer and Vishny (S&V) use the work of the nineteenth century French economist Cournot in complementary monopolies to look at corruption from an industrial organisational perspective. From this angle, regulatory agencies have a monopoly in offering licenses and permits. The ‘prices’ for these public goods are either set independently by each agency or coordinated centrally. There is a benefit derived in doing so when the licenses and permits complement one another.

Think of an investor who approaches several agencies to set up and operate a business. If each agency operated independently, each one would maximise its rents without regard for what other agencies are doing. This could be a deal breaker for the investor who withdraws his interest in the venture altogether. That reduces the revenues of all agencies. A centrally coordinated bureaucracy would lower the individual price of each agency encouraging the investment to go ahead, thereby raising revenues for all of them and generating added value to the economy.

MacIntyre uses the S&V model to highlight the difference between pre-1967 Indonesia under Soekarno and post-1967 under Soeharto. The former ran a bureaucracy that was uncoordinated and corrupt and resulted in slow growth. The latter ran one that was centrally coordinated, still corrupt, but produced steady, solid growth. MacIntyre wonders whether the same model could be used to analyse differences between Indonesia under Soeharto and the Philippines under Marcos.

Hutchcroft talks about the centralising tendencies of the authoritarian state under Marcos whose failings came in seeking to foster value-enhancing rents. As Adrian Cristobal succinctly put it, Marcos wanted to mimic the Japanese zaibatsu, but chose the wrong samurai. Danding Cojuangco, the pre-eminent crony of Marcos was more interested in ‘skimming off the top’ than fostering economic productivity with the rents he was given access to (the coconut industry).

In contrast, tycoons under Soeharto engaged in a tit-for-tat arrangement, committing hundreds of millions of dollars to state projects and arranging international financing with the implicit understanding that they would receive special favours from other deals later on. The inability of the Philippines to engage in what Hutchcroft calls ‘purposive rent allocation’ is made evident by this comparison.

The political descendants of these leaders, Gloria Macapagal Arroyo and Susilo Bambang Yodhoyono have travelled along similar paths. Both launched anti-corruption drives at the start of their presidencies, which have then deteriorated. At the end of her second term, GMA encountered severe problems with her subalterns to “moderate their greed” as she put it, while SBY has had a greater measure of success in suppressing it although recent events have tarnished him. Both fostered quite a good pace of growth.

Under the rubric of his anti-corruption twin slogans (daang matuwid/kung walang corrupt, walang mahirap), President Noynoy Aquino wants to stamp out corruption from the Philippines. What the theoretical and comparative historical analysis tells us is that there might be an optimal level of corruption (see Figure 1). Too much of it becomes counter-productive in that unpredictability prevails and everyone loses (society, the state and the economy). Too little of it and as we have seen in his first year and a half, nothing gets done, the economy sputters and investor confidence dissipates.

Figure 1: Maximizing the Total Value Added from Rents. The total value curve is the difference between the value-added through rents minus the lost value due to rent-seeking. There could be an optimal value associated with rents. High losses due to rent-seeking transfers could lead to low net value created. Too little of it could lead to very little value-adding activity to the economy. Somewhere in the middle is the optimum value or ‘price’ of a transfer to rent-seekers who add value to an economy.

Although he has signed up to the full augmented version of the Washington Consensus, P-Noy must take his cue from our more prosperous neighbours in the region. He needs to realise that taking an absolutist approach towards corruption will prove too costly and ineffective (budget-wise it is out of our spending range) and would be too disruptive to value-enhancing patron-client networks (developmental spending in infrastructure projects has deteriorated).

Balancing on the one hand the damage caused by corruption (what economists call agency costs with the costs of preventing and punishing corruption on the other (what they call monitoring and information costs) would be the first step (see Figure 2). Eliminating the more destructive value-reducing forms of rent-seeking while encouraging the positive value-enhancing ones would be the second.

Figure 2: Minimizing the Total Transaction Cost of Corruption. This means reducing the sum of the damage cost due to corruption and the cost of preventing it (monitoring and information). At low levels of corruption, the cost of prevention is high, but the damage cost is low. At high levels of corruption, the cost of prevention is low, but the damage cost is high. Somewhere in the middle is the optimum point where the total cost is lowest.

When the South Koreans grew more prosperous, they began to frown upon standard practices of companies providing kickbacks to the ruling party in exchange for rents supplied by the state. They sought to jail more recent leaders for practices that were prevalent during and instrumental to their development. The Philippines has only achieved a tiny fraction of their prosperity, yet its urban, educated middle class is demanding the same level of probity. Perhaps it is a token of just how big the social divide is in the country rather than of a sudden moral awakening.

Doy Santos aka The Cusp

Doy Santos is an international development consultant who shuttles between Australia and the Philippines. He maintains a blog called The Cusp: A discussion of new thinking, new schools of thought and fresh ideas on public policy (www.thecusponline.org) and tweets as @thecusponline. He holds a Master in Development Economics from the University of the Philippines and an MS in Public Policy from Carnegie Mellon University.