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From elbow grease to pure sleaze

January 25, 2003

What's the common link between the hike in public expenditure in areas like the Golden Quadrilateral project during the last few years, and India's fairly high defence expenditure? Or between our relatively low openness to global trade and, say, the declining tax-GDP ratio, or even the far greater share of indirect taxes in total collections? Corruption, that's what.

Yes, believe it or not, as a series of well-researched papers based on extensive cross-country studies just brought out by the IMF (International Monetary Fund) show, corruption is not just some benign occurrence that helps get you favoured treatment, it seriously distorts and restricts, economic growth.

On the face of it, for most of who don't eat and breathe economic theory, this sounds ridiculous. After all, if I pay Rs 100 as a bribe to a doctor in a public hospital to give me an injection worth Rs 1,000 for free, no one's really getting hurt, right? I've got an injection for Rs 900 less, and the doctor's got Rs 100 more than he would normally earn, that's all.

As for the Rs 1,000 that the government spent on the injection, it isn't really a waste, because I needed the injection anyway. (According to a recent ORG-MARG survey for Transparency International, of the Rs 27,000 crore (Rs 270 billion) Indians spent on bribes this year, roughly Rs 7,500 crore (Rs 75 billion) was spent on bribes in the health sector.) Similarly, if I bribe a bureaucrat to give me a license, my work gets done faster, so where's the loss?

Apart from the fact that corruption distorts relative prices, when corruption gets solidly entrenched, the economists explain, the corruption-tax is no longer necessarily linked to tangible favours -- it becomes like hafta, something you pay just to keep someone at bay.

In a sample of 176 Ugandan firms in 1997, for instance, it was found that the average bribe paid was equal to 28 per cent of the value of machinery imported, but none of the firms who paid the bribe got any preferential treatment. So, really, it was like just imposing a 28 per cent additional tax on them. And since no one wants to invest in areas where taxes are high, clearly corruption dissuades investments.

In fact, according to Vito Tanzi who used to head the fiscal affairs department at the IMF, corruption in Argentina reduces the return on money invested in firms by 1 to 2.5 per cent for large firms, and between 3 and 3.6 per cent for small-sized firms -- if you have to pay a bribe of Rs 1 crore (Rs 10 million), it is easier to pay it if your company has a larger turnover.

Tanzi also cites a study of the rate of return on 1,163 World Bank-funded projects in 61 developing countries -- this found that poor quality of economic policy (and this includes corruption), lowered the returns on investments by as much as 10 per cent.

All told, a one unit hike in corruption..

  • Lowers GDP growth by 1.4 per cent,
  • Lowers public spending on education by 0.2 per cent of GDP,
  • Raises child mortality by 1.1 to 2.7 deaths per 1,000 live births,
  • Reduces the flow of foreign direct investment by 11 per cent (this is equivalent to the effect of a 3.6 percent hike in the marginal tax rates), and
  • Lowers tax-GDP ratio by 2.7 per cent and total revenue-GDP by 1.5 per cent.

Curiously, or  perhaps not so curiously, a one per cent hike in corruption levels increases military spending by 0.32 per cent of GDP, as governments up their purchase of equipment on which there are big payoffs. By the same logic, Tanzi has run regression analyses which show that higher corruption is associated with higher public investment.

So how do you lower corruption? Doing what Manmohan Singh did in 1991, that is simply doing away with a host of discretionary controls in the hands of politicians and bureaucrats, which is a big blow to corruption.

Opening up the economy is another way to reduce corruption. If free imports are allowed of acrylic fibre, for instance, there is little point in bribing a politician to get a license to produce acrylic fibre.

According to a study by Carlos Leite and Jens Weidmann, if Venezuela's trade policies had been as liberal as Chile's between 1970-90, its corruption ranking would have gone down by 0.35 standard deviations, and its GDP growth would have gone up one per cent.

Hiking wages of civil servants is another option that most policy makers recommend. But, for all this to work, what's most important, is the rule of law. Hiking wages of civil servants may lower their needs for extra money, but unless they're scared of losing their jobs, there's no reason to expect them to stop taking bribes.

If, after opening up its economy to Chile's level, Venezuela had also strengthened its legal institutions to the same level, according to Leite and Weidmann's analysis, its corruption ranking would have gone down by 1 standard deviation, and its GDP growth would have gone up by 1.8 per cent.

Corruption is no longer just elbow grease, it's stifling sleaze.

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