Economics of corruption
Economics of corruption deals with the misuse of public power for private benefit and its economic impact on society. This discipline aims to study the causes and consequences of corruption and how it affects the economic functioning of the state.
Economies that are afflicted by a high level of corruption are not capable of prospering as fully as those with a low level of corruption. Corrupted economies cannot function properly since the natural laws of the economy are distorted. As a consequence, corruption, for instance, leads to an inefficient allocation of resources, poor education, and healthcare or the presence of a shadow economy - which includes illegal activities and unreported income from legal goods and services that should be taxed but are not.
One of the challenges of studying corruption lies is its definition. This might appear as a minor detail, but how we define corruption affects the way we model it and how we measure it. Although there are many definitions of what corruption is, most of them overlap over the central issue - "the misuse of public office power for personal gain in an illegal manner". Certain illegal activities such as fraud, money laundering, drug trade, and black market operations, do not necessarily amount to corruption if they do not involve the use of public power. Another viable definition is as follows: corruption is an “arrangement” that involves “a private exchange between two parties, which has an influence on the allocation of resources either immediately or in the future, and involves the use or abuse of public or collective responsibility for private ends.”
The pervasiveness of corruption is a probabilistic measure and refers to the likelihood that an entering firm will encounter corruption in its dealings with government officials or politicians in the host country. A high level of pervasiveness indicates that firms are more likely to encounter corruption when undertaking normal business activities.
The study distinguishes two types of corruption: 1. Extortion: The demand of an official for a bribe under threat of harmful actions, or put him in such conditions under which he is forced to give a bribe in order to prevent harmful consequences for his law enforcement interest. 2. Collusion: When an authorized person takes a bribe for something they should not do, with both parties interested in the outcome.
The real damage from such corruption is often difficult to measure and can be many times more than officially reported figures.
Research on corruption faces a significant empirical obstacle – measurement. Corruption, by its nature, is illicit and secretive. Large portion of corruption is never discovered or prosecuted. Despite this challenge, researchers have made progress in addressing the level of corruption by attempting to measure the perception of corruption, rather than corruption itself.
As such, one way to objectively measure corruption is by counting the number of criminal indictments for corruption. However, this can be ineffective because the ratio of indictments to actual corruption may be highly variable. Often corruption goes unpunished and is thus not counted in this measure. Subjective measures, typically curated via survey data, may be a useful tool to measure corruption. Comparisons between countries may be more comprehensive and consistent, though a fair amount of bias is present in this data as well due to the nature of the subject it measures.
The International Country Risk Guide is a survey of firms on the likelihood they will be asked to make illegal or extralegal payments. The Corruption Perceptions Index is a detailed survey incorporating data from many nations and groups. Finally, the World Bank produces an annual "control of corruption" index that uses similar sources to the International Country Risk Guide and Corruption Perception Index.
History of the discipline
In 1968, Nobel laureate economist Gunnar Myrdal found corruption 'almost a taboo as research topic'. Indeed, it has mostly been a matter of political science, public administration, criminal law and sociology. However, the scenario changed since the 1970s. Since Rose-Ackerman's article "The Economics of Corruption", published in the Journal of Public Economics in 1975, more than 3,000 articles have been written with 'corruption' in the title, at least 500 of which directly focus on different aspects relating to corruption using an economic framework. Some books have also been published on the subject.One of the impulses for economists to turn their attention to this subject was corruption's increasingly evident connection to economic performance. This impulse, among other, came in the 1990s from the transforming former socialist economies of countries that used to be part of the Soviet Union. The sudden changes in their command structures led to chaotic economic, political and social changes. This absence of the rule of law and surveillance led to rent-seeking, corruption and outright thievery. Nevertheless, a healthy regulatory environment, transparent government institutions and protection of property and investor rights were important for improving efficiency in newly created market economies. While some countries managed to quickly orient themselves and adjust to the formation of a new economy, others took much longer.
Much of the research on corruption has also been conducted at the IMF and the World Bank. This was prompted by global economic integration and globalization, which increased pressure on countries to be more transparent and accountable.
Another factor in the growth of interest in the topic was the spread of democratic values in the late 1980s and 1990s. Although democratic states are not necessarily protected from corruption, they contribute to the formation of a vigilant civil society.
Only in the 1990s was the awareness of the costs of corruption widespread and first indicators measuring the level of corruption were constructed used in empirical studies.
Early research mainly focused on shortcomings in economic policies and public institutions that allowed rent-seeking by public officials. In the early stages, some publications have pointed out positive effects of corruption. The argument about the benefits of corruption in the economic literature is usually attributed to Nathaniel Leff, who believed that if government intervention in the economy has the "wrong" goals or uses the wrong methods, then corruption, which allows to circumvent or somehow neutralize this interference, is useful. For example, if firms bribe tax inspectors and reduce their tax payments in a country whose government spends all taxes on its own needs and takes them offshore. The problem with this logic is that "improper" regulation arises endogenously, precisely in order to increase corrupt payments. Since the time of Leff, the economic policy of regulation in the world has improved, so the strength of this argument is lost.
Corruption in the public and private sectors: the case of transition economies
One central question in the economics of corruption asks whether corruption is confined solely to the public sector, or whether it can equally stem from the private sector. What gives rise to this debate is the very definition of ‘corruption’. On the one hand, some economists understand corruption as the practice of exploiting public offices for personal gain. This opinion is shared by scholars Jain and Aidt. On the other hand, several international organizations understand corruption as the practice of exploiting power for personal gain: however, the power can stem from both the public and private sectors. For instance, The UN office on Drugs and Crimes stresses that corruption ‘can occur in both the public and private domains’, and the Global Program Against Corruption perceives corruption as the ‘an abuse of public power for private gain that hampers the public interest’.As such, there seems to be a consensus that the purpose of corruption is to maximize personal gain, however, a discussion is possible regarding whether this purpose is achieved in the public and/or private sectors. It could be argued that defining corruption as the practice of exploiting public power is a misleading approach. While the mainstream economists suggest that corruption can be tackled by reducing the state's economic role, evidence from transnational economies suggests otherwise. For instance, in post-Soviet Eastern Europe and Russia privatization efforts attempted to diminish state involvement in economic affairs, however, the outcome of this approach was the increased corruption due to the newly developed avenues for illicit practices among state officials.
As such, one critique of privatization is that it gives rise to corruption. The level of corruption in a given country can be measured by the Corruption Perception Index which measured the degree to which public power is perceived to be exploited for private gain. CPI ranges from 0 to 100, where an index of 0 signifies a highly corrupt state, and an index of 100 signifies a corruption-free state. Furthermore, the diagrams suggest a positive correlation between CPI and the Human Development Index. As such, HDI is associated with low levels of perceived corruption. Given that a number of transition economies classifies as ‘developing’ economies with relatively low HDI ranks, it can be argued that the and low CPIs. In Russia, privatization occurred through the ‘Loans-for-Share’ scheme which allowed state-owned companies to be leased through auctions to private individuals. Given that the auctions were rigged, a number of arbitrary restrictions were placed in order to limit competition. For instance, Surgutneftegaz conducted its auction in a remote Siberian location and is claimed to have orchestrated the closure of the local airport. Consequently, this scheme enabled a select group of well-connected oligarchs to accumulate vast wealth and economic influence by acquiring these state assets at discounted prices. This created an environment of corruption that permeated Russia's economic and political landscape. As such, throughout the 1990s, the so-called ‘Semibankirschina’, comprising the seven most influential oligarchs, effectively orchestrated economic and political activities in their own vested interests.
These examples illustrate that corruption is not solely confined to the public sector. Therefore, corruption cannot be countered solely by eliminating or diminishing the public sector.