Corruption undermines developing countries' economy

The following is an excerpt from a chapter, titled "Restraining Arbitrary State Action and Corruption," of the 1997 World Bank Development Report. The report, titled "The State in a changing world", was issued in Washington yesterday. This is the first of two articles.

WASHINGTON: Restraining the potential use and abuse of state power is a challenge for any country. Harder still is doing it without depriving state agencies of the flexibility they need to do their job.

But arbitrary and capricious state action undermines more than credibility. It undermines the rule of law itself, by weakening the force of whatever rules the state has set in place. And it fosters conditions that encourage state officials to place themselves above the law and tempt the rest of society to do the same. Development, in these circumstances, hits a brick wall.

Sustainable development generally calls for formal mechanisms of restraint that hold the state and its officials accountable for their actions. To be enduring and credible, these mechanisms must be anchored in core state institutions; if these are too weak, external mechanisms such as international adjudication may substitute temporarily. The two principal formal mechanisms of restraint are a strong, independent judiciary and the separation of powers.

To prosper, economies need institutional arrangements to resolve disputes among firms, citizens, and governments; to clarify ambiguities in laws and regulations; and to enforce compliance.

Societies have devised a broad array of formal and informal mechanisms to do this, but none more important than the formal judiciary. It alone has access to the coercive authority of the state to enforce judgments. And it alone has the formal authority to rule on the legality of actions by the legislative and the executive branches. This special relation to the rest of the state puts the judiciary in a unique position to support sustainable development, by holding the other two branches accountable for their decisions and underpinning the credibility of the overall business and political environment. Yet judiciaries can play this role only when three core conditions are met: independence, the power to enforce rulings, and efficient organization.

Independence from the rest of government is the most important of these. Whatever the precise character of judicial relations with the legislature and the executive, all industrial countries -- and many developing countries -- rely on the judiciary to hold the executive accountable under the law and to interpret and enforce the terms of the constitution.

Judicial independence has been repeatedly compromised in some countries, and in no country has the judiciary been immune from political efforts to override its decisions.

The effectiveness of the judiciary also depends on its decisions being enforced. In practice that means that other branches of the government must consent to provide the resources needed for enforcement, including personnel authorized by law to serve court documents, to seize and dispose of property, and to turn the proceeds over to the winning party.

Developing relationships among the judiciary, legislature, and executive that ensure judicial independence and reliable enforcement is a gradual process. Studies show that private sector confidence in the rule of law increases with each year a stable regime remains in place.

The third component of judicial effectiveness is organizational efficiency, which is needed to avoid long delays in clearing cases. Long delays raise the transactions costs for dispute resolution and may block access for some potential users; however, the internal efficiency of the judiciary is less critical than its independence and its enforcement authority.

Even when saddled with cumbersome and costly procedures, judicial systems can strengthen credibility in countries as long as their decisions are perceived to be fair. Any state beginning from a weak institutional base should consider building this aspect of judicial performance its first priority.

Judiciaries may be capable of enforcing rules, but if the public has little faith in those rules remaining stable, the state's credibility can still be compromised. The classic constitutional mechanism for restraining constant legislative changes is the horizontal and vertical separation of powers.

The broader the separation of powers, the greater will be the number of veto points to be navigated to change any rule-based commitments. Thus the separation of powers increases confidence in the stability of rules. Multiple veto points can be a double- edged sword, however; they make it just as hard to change harmful rules as to change the beneficial ones.

Many developing countries, including some with formal separation of powers, have few effective checks and balances on the action of political leaders. In some countries legislative oversight is weak because of poor capacity and inadequate information. In others the executive dominates a compliant legislature. But like the development of a well-functioning judicial system, the formal elaboration of constitutional checks and balances, or their more effective institutionalization, is a gradual process.

Instruments of restraint are a vital foundation for sustainable development. But excessive restraint can lead to paralysis. Instruments for restraining government need to be complemented by institutional arrangements that build in flexibility for the executive branch in formulating and implementing policies and adapting to new information and changing circumstances.

Countries have tried a variety of institutional arrangements that combine flexibility with restraint. Some arrangements -- such as deliberation councils in East Asia and the Administrative Procedures Act in the United States -- delegate substantial autonomy to executive agencies to define the substance and undertake the implementation of policy.

But they also require these agencies to follow procedures that open their decisions to input and oversight by other arms of the state and by civil society and businesses. Other arrangements rely on mechanisms within the executive branch to promote flexibility within restraints, such as the devolution of managerial authority to executive agencies within set budgets and performance targets.

But even if bureaucracies are embedded in processes that provide ample opportunity for outside input and oversight, the risk remains that officials will pursue personal rather than organizational goals. Self-seeking behavior can degenerate into corruption when private interests wield their influence in illegal and secret ways, circumventing the legal and bureaucratic rules designed to keep them out. Whether public institutions succumbs to these and other sources of corruption will depend on the strength of their institutional defenses.

Today, citizens everywhere demand greater probity of government officials, and the new transparency in domestic and global markets brings corruption more quickly to the public eye. In the past few years allegations of corruption have contributed to the fall of governments throughout the world. Two former presidents of the Republic of Korea have been prosecuted and indicted. A president of Brazil was impeached on charges of corruption.

Corruption has been defined in many ways. This Reports defines it as the abuse of public power for private gain. Although corruption tends to get the most attention, it is a symptom of a more general problem of perverse underlying incentives in public service.

Corruption flourishes where distortions in the policy and regulatory regime provide scope for it and where institutions of restraint are weak. The problem of corruption lies at the intersection of the public and the private sectors. It is a two- way street. Private interests, domestic and external, wield their influence through illegal means to take advantage of opportunities for corruption and rent seeking, and public institutions succumb to these and other sources of corruption in the absence of credible restraints.

Corruption violates the public trust and corrodes social capital. A small side payment for a government service may seem a minor offense, but it is not the only cost -- corruption can have far-reaching externalities. Unchecked, the creeping accumulation of seemingly minor infractions can slowly erode political legitimacy to the point where even noncorrupt officials and members of the public see little point in playing by the rules.

Studies have shown a clear negative correlation between the level of corruption (as perceived by businesspeople) and both investment and economic growth. This is confirmed for investment levels by the results of the private sector survey conducted for this Report.

The survey identified corruption as one of the major obstacles to doing business in many countries. Yet it is not just a cost of doing business. Other surveys and anecdotal evidence suggest that the greatest victims of petty corruption are usually the poor.

Despite such evidence, many parts of the developing world retain a certain ambivalence toward corruption. A commonly heard view is that corruption merely greases the wheels of commerce, and that without it there would be no transactions and no growth. Apparent support for this argument comes from the fact that some countries that rank high in surveys of the level of corruption have also excelled in economic growth.

The predictability of corruption -- both that of the amount one has to pay and that of receiving the outcome one has paid for -- provides some insights into this apparent paradox. For a given level of corruption, countries with more predictable corruption have higher investment rates. But even in these countries corruption has an adverse impact on economic performance.

No matter how high the degree of predictability of corruption in a country, its rate of investment would be significantly higher were there less corruption.

Countries that have so far achieved high rates of economic growth despite serious corruption may find themselves paying a higher price in the future. Tolerating corruption that siphons off payments of, say, 10 percent on average may generate pressures to increase the take to 15 or 20 percent.

Corruption feeds on itself, creating a widening spiral of illegal payoffs until ultimately development is undermined and years of progress are reversed. And the very growth that permitted corruption in the past can produce a shift from productive activities to an unproductive struggle for the spoils. Over time corruption becomes entrenched, so that when governments finally do move to contain it, they meet powerful resistance.

Incentives for corrupt behavior arise whenever public officials have wide discretion and little accountability. Politicians, bureaucrats, and judges control access to valuable benefits and can impose costs on private citizens and businesses. Public officials may be tempted to use their positions for private gain by accepting bribes; for their part, private individuals may be willing to make illegal payments to get what they want from government. Thus, a necessary condition for corruption is that public officials have rewards and penalties at their disposal.

Some corruption stems from opportunities generated by the policy environment, at the bottom or the top of the hierarchy. Payoffs are frequent to lower-level officials charged with collecting tariffs, providing police protection, issuing permits, and the like. When corruption is endemic, these officials may create additional red tape and delays to induce even higher payments.

Of course, corruption also occurs at the highest levels of government, in the awarding of major contracts, privatization, the allocation of import quotas, and the regulation of natural monopolies. This helps explain why corruption is more prevalent in countries with highly distorted policies, as measured by variables such as the black market exchange rate premium.

The probability of being caught and punished (for the person paying the bribe and for the official receiving it) also affects the level of corruption. Economic analysis of the law suggests that individuals weigh the expected benefits of breaking the law against the expected costs (the probability of being caught and punished multiplied by the level of punishment).

Window A: Corruption feeds on itself, creating a widening spiral of illegal payoffs until ultimately development is undermined and years of progress are reversed.

Window B: Incentives for corrupt behavior arise whenever public officials have wide discretion and little accountability.