COMMENT: Corruption and economic development —Jamil Nasir - Friday, January 21, 2011

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Corruption deepens the chasm between the poor and the rich, big businesses and small enterprises, the powerful and the powerless, the big man and the small fry

An overwhelming body of empirical evidence suggests that the impact of corruption on economic growth and development is highly devastating. Corruption impedes foreign and domestic investment, and increases transaction costs. It raises uncertainty and is responsible for low incomes and underdevelopment as it sands the wheels of economic growth. Validity of the literature that sprang up in the context of the ‘Asian paradox’, i.e. miraculous growth of most East Asian countries despite the prevalence of corruption stands discredited in the light of the latest empirical studies on the subject. There are a number of channels through which the negative effects of corruption are transmitted to the economy.

Corruption misallocates talent and resources, and distorts technology choices. People, being rational human beings, join the fields of employment that possess maximum potential for rent seeking. For example, university graduates may prefer to become tehsildars or police station house officers (SHOs) rather than agriculturists and business entrepreneurs.

Public sector employment in Pakistan is a pertinent example of this misallocation of talent. Up until the last few years, a dominant majority of the graduates appearing in the civil services examination hailed from medical and engineering backgrounds — students who had burnt the midnight oil to become ‘pen pushers’ despite having good qualifications in the fields of medicine and engineering. Although other factors such as respect for the civil service in society (which is fading now), security of service tenure and passion for public service delivery should not be ruled out as motivating factors, yet the fact remains that rent-seeking by grabbing power remains one of the potential reasons for joining the public sector in Pakistan.

As regards sectoral misallocation, huge deals in arms by developing countries are pertinent examples. Scandals have surfaced from time to time in several developing countries (like the Bofors scandal in India and Agosta submarine deals in Pakistan) where allegations of receiving fat commissions were levelled against politicians and those at the helm of affairs. If the incentive for commissions had not been there, there is every possibility that the funds would have been funnelled to other sectors like physical infrastructure development, directly related to economic growth and development.

Corruption also distorts technology choices. One of the motivational factors for imports of capital-intensive technology by developing countries stems from the potential opportunities of corruption attached to such deals. It may be pointed out here that most developing countries are abundant in labour, so labour-intensive technology generally is the best fit for these countries as it creates more employment opportunities. The health sector presents another glaring example of distortion in technology choices. Big hospital infrastructures and sophisticated medical equipment are generally preferred to rural health clinics specialising in preventive care even in the poorest countries.

Corruption hampers the ability of the state to raise taxes, encouraging informal businesses. The reasons are obvious. Due to corruption in the tax machinery and complex procedures of tax collection (upon which corruption thrives), businesses avoid getting registered for tax purposes. This direct correlation between corruption and the informal economic sector is easy to understand. In countries where corruption levels are high, informal sectors of the economy are huge. Again, Pakistan is a pertinent example. According to various estimates, the informal sector constitutes 50 to 60 percent of our total GDP.

Further, corruption impacts decisions to start businesses because you need information on bribes to start and run the business in a corruption-ridden set-up. Thus potential entrants to business face uncertainty as to what bribes to pay and when to pay. In this way, corruption acts as a barrier to the entry of new firms into business. Additionally, it acts as a heavy drain on existing businesses as well. Whenever there is an upward increase in tax revenue targets, it is the existing tax-paying businesses upon which the hammer falls, as governments are unable to tax the businesses operating in the informal sector. This eventually harms economic growth. We can also say that the low tax base has a direct link with corruption.

Moreover, the impact of corruption is differential and discriminatory. It falls heavily on small businesses and disadvantaged sections of society. Corruption deepens the chasm between the poor and the rich, big businesses and small enterprises, the powerful and the powerless, the big man and the small fry. It is a well-known fact that strict enforcement of the canons of rule of law is lacking in developing countries. The elite are well connected socially as well as politically. They can buy public services/goods like utility connections, access to law enforcement agencies for redressal of their grievances and dispensation of justice, whereas the cost borne by the less powerful for such public goods in a corrupt institutional set-up is very high. Corruption is regressive for small businesses as well. One of the potential reasons for the less developed small and medium enterprises (SME) sector in Pakistan can be traced to corruption. Corruption creates, sustains and perpetuates poverty and inequality traps in society.

The question is: why is corruption so widespread in developing countries? Surely it is not due to difference in the quality of human beings. The reasons are many but the chief reason is over-regulation of the economy. Over-regulation basically stems from the fact that developing countries are low-trust societies. Unnecessary rules, procedures and multiple layers of checks and supervision are common in developing countries. Added to this, accountability mechanisms are weak.

Our understanding of the corruption issue is fallacious. If corruption is high and the state feels that it needs to tackle it to recoup its eroded legitimacy in the eyes of the public, an immediate prescription is to set up one more anti-corruption agency, which is generally as corrupt as other institutions. Rather, in some cases, the level of perceived corruption about such watchdogs is higher when compared to the institutions they are supposed to oversee.

Corruption should not be viewed merely as an administrative problem. The corruption issue has economic dimensions as well and requires economic insight for its solution. Economic reforms aimed at simplifying cumbersome laws and procedures, doing away with inefficient regulations and redesigning the incentive system for the civil services can go a long way in reducing the levels of corruption, both real and perceived, in the ‘land of the pure’.

The writer is a graduate from the Columbia University in Economic Policy Management

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