The Destructive Costs Of Greasing Palms

Corruption, like poverty, has always been with us. As long as there have been ambitious royal courtiers, greedy government officials, and minor bureaucrats on the make, the abuse or theft of public goods for private gain has occurred. In recent years, corruption has spread way beyond the poor countries of Africa and Latin America. Indeed, it has affected so many developing and developed nations that a moral revulsion against it has swept politicians out of office in countries from Brazil to Italy to Japan.

There's no question that the moral rot that corruption engenders is harmful. But corruption also carries myriad economic costs. The petty bribery practiced by minor bureaucrats who demand "speed" money or "grease" to approve licenses inflates business costs. Mafia control of markets, sanctioned by paid-off police and politicians, raises prices to consumers. Tax officials who take bribes and then allow income to go underreported deprive national treasuries of significant revenues. And high government officials who use foreign aid to purchase pricey, unneeded equipment--and get a kickback from the seller--divert resources that could be spent usefully.

More and more, international-aid officials, business executives, and political leaders are recognizing the costs of corruption and the need to address the problem. Indeed, a new nonprofit group, Transparency International, is dedicated to reducing corruption. Economists believe that there are two ways to do so. First, political and economic competition within countries must be encouraged. Second, institutional reforms, such as raising the pay of civil servants, must be adopted.

LOOKING OUT FOR NO.1. The worst consequences occur in developing countries. The direct costs of money stolen or wasted may not be great, but the indirect costs are enormous because corruption distorts incentives. In extreme cases, corruption becomes the only way to make an income or conduct a business. "The real cost of corruption lies in the demoralization, cynicism, and enervation of entrepreneurial activity throughout the Third World," says Robert Klitgaard, an economist at the University of Natal in Durban, South Africa, and author of Controlling Corruption.

Ironically, some of the countries where corruption seems to have grown most rapidly in recent years are those, such as China and Russia, where economic competition is rising. That's because initially, at least, economic growth presents new opportunities for people to grab something for themselves. But both countries have a long way to go in developing demonopolized, highly competitive economies. And neither country--not China with its communist leadership, nor Russia, with its nascent political parties--can boast of political competition.

FREE-FOR-ALL. For both countries, corruption is costly. According to Hong Kong's Independent Commission Against Corruption, outright bribes as well as gifts or payments to establish guanxi, or "connections," in China average 3% to 5% of operating costs, or $3 billion to $5 billion, assuming most of this year's $100 billion in foreign investment went into operations.

An internal report of the Chinese government, reported in the Hong Kong press last month, found that over the past decade, Chinese 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 overseas outfits in return for payoffs.

In recent years, corrupt local officials in many parts of rural China have diverted state funds intended for grain payments into speculative ventures. Meanwhile, in developed areas, particularly in and around Shenzhen and Zhuhai, funds intended for infrastructure and other projects have gone into speculative real estate deals whose main attraction was their potential for bribes and "grease" payments.

In the former Soviet Union, where corruption was once the domain of the communist leadership, the end of party rule unleashed a competitive free-for-all in corrupt practices. In the rinki, or markets, in major Russian cities, for instance, organized criminals typically set prices and threaten anyone who undersells them with violence. Last summer, experiments were tried at food markets in St. Petersburg and Moscow, with policemen, former KGB officers, and cossacks offering protection against the mob enforcers. The result: Prices to shoppers at the Danilovski market in Moscow were 15% to 20% lower than usual.

Foreigners doing business in Moscow find that bribery is de rigueur. The latest scam, according to one Western lawyer, is to direct a foreign business that wants to locate and register an office in Moscow to a "commercial structure" that does the paperwork for a fee--which is pocketed by city officials who operate the phony enterprise.

WEB OF PAYOFFS. Systematic measures of the cost of corruption around the globe may soon be developed. Researchers at the World Bank plan a project to assess the costs to business of complying with government regulations in developing nations. A key objective will be to separate the costs attributable to bribes and other forms of corruption from legitimate business costs.

Developed nations are hardly immune from corruption, although they tend to suffer less virulent strains. In the U.S., for instance, there are frequent cases of local officials, police, and government inspectors being found on the take. Scandals may flare, such as the savings and loan debacle in the U.S. and political corruption in Japan, but these do not have long-term economic consequences.

The big exception among industrialized nations is Italy, where an elaborate web of relationships between the Mafia, politicians, and business executives has been exposed. Five former Prime Ministers and several former Cabinet officers are under investigation for criminal activities, hundreds of executives have been implicated for paying bribes, and the once indomitable Mafia's powers have been curbed. Franco Cazzola, professor of political science at the University of Florence and author of a recent study on corruption, observes that businesses and politicians conspired "to raise the price of [projects] which could be done for far less."

Near Enna in central Sicily, highway overpasses were built on towering concrete pillars--even though the surrounding land is flat. In nearby Calabria on the mainland, dams stand unfinished. And all over Southern Italy, superhighways to nowhere begin and end abruptly. The Luigi Einaudi research center estimates that corruption has inflated Italy's total outstanding government debt by as much as 15%, or about $200 billion.

PAYING FOR PERFORMANCE. Italy's political system is now undergoing reform, and numerous state-owned companies are being auctioned off. That should help reverse the conditions that economists Andrei Shleifer of Harvard University and Robert W. Vishny of the University of Chicago believe foster corruption: a lack of political and economic competition. Corruption flourishes when regimes exercise monopoly power, as was the case in Soviet Russia and Eastern Europe. Today, these regions are in transition, and chaotic conditions and weak governments have allowed new corruption opportunities to arise.

Over time, however, the development of a more competitive political process, as exists in most industrialized nations, should mitigate against graft and patronage. Healthy economic competition also works against corrupt practices taking hold. Privatization of businesses, followed by demonopolization, is needed.

Further, economists say, incentives to civil servants must be changed. When there is little chance of getting caught or punished, and little income from an honest day's work, taking a bribe seems reasonable. In Singapore, where corruption is relatively infrequent, notes World Bank economist Ed Campos, civil servants are "very well paid compared with people in the private sector and compared with civil servants around the world." At the same time, stiff penalties are assessed against corrupt officials. Poorer countries may choose to "pay for performance"--as Bolivia did in 1985, when customs workers received a percentage of the 60% increase in customs revenues.

Although the fight against corruption appears to be an uphill one, the conditions that encourage corruption can be reversed. Today, in Italy, bids for public-works projects are coming in at up to 40% below initial cost estimates. And the Italian government could save $4.4 billion this year alone by not bearing the cost of corruption, the Luigi Einaudi research center predicts. On moral grounds alone, of course, it's desirable to reduce the decay and rot that corruption brings to a society. But pure economic calculus makes the effort even more worthwhile.

             Corrupt activity                       Economic cost 
      Government bureaucrat accepts              3% to 10% premium
      "speed" money to issue licenses            above licensing fee
      Organized crime, with sanction             Goods sell at 15% 
      of local officials, controls and           to 20% premium
      sets prices in markets      
      Tax collectors permit under-               Income tax revenues
      reporting of income in exchange            reduced by up to       
      for a bribe                                50%
      Government officials order                 Goods and services 
      expensive capital goods, or                priced 20% to 
      overpay or overinvoice for public          100% higher than
      works, in exchange for kickbacks           necessary
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