A recent Carnegie Endowment for International Peace report, authored by Minxin Pei, claims that using a conservative estimate, kickbacks and theft account for about 10 percent of government spending and transactions.This suggests, according to the report, that corruption and bribery costs China at least $86 billion a year.
I assume that Pei’s figures do not include corruption involving the private sector.This can be pretty large.One of my Peking University students told me last year that his job (he was very apologetic in describing it) consists of making friends with the heads of computer services at the hundreds of banks in China so that the small company he works for, which creates ATM-related software, can sell their products.
Why is this friendship important?Because the only way to get one’s products purchased, according to him, is by paying off the head of computer services, and since the person receiving the bribe needs assurances that the bribe-offerer is not working for the police, he will only accept bribes from people he knows well.My student assured me that all his competitors have someone filling a similar function.
According to the Carnegie Endowment report corruption is concentrated in areas with extensive state involvement, such as infrastructure projects, real estate, government procurement and financial services.I don’t know how good Pei’s figures are but if they are reasonable, they probably understate the cost of corruption significantly since they focus on public sector corruption, and as my student’s story suggests, corruption is widespread in the private sector too.$86 billion is a high number – about 3-4% of GDP.China, by the way, was ranked 72 on the Corruption Index among the 180 countries ranked in 2007 by Transparency International.
Although corruption is always harmful to an economy, when thinking about its economic impact we should distinguish between different kinds of corruption.If corruption is stable and predictable it can nonetheless allow businessmen to continue to develop their businesses, employ workers, and create value.In that case corruption is merely a kind of tax – inefficient in that it distorts business activity, like all taxes do, and of course even less likely than normal fiscal expenditures to be put to socially beneficial uses, but it need not significantly harm economic growth prospects.This is not to say anything about the political and social impact of corruption, which of course may be highly destabilizing.
However there are at least two cases in which corruption can be much more harmful to a country’s economy.If corruption is random and unpredictable, it can raise business uncertainty enough to cause a significant drop in investment.As a Brazilian friend of mine told me, before the presidency of Collor de Melho in the late 1980s he used to know who he needed to bribe in order to get approval for projects, access to water and electricity, roads maintained, and peace from the unions.He hated to make the payments, but at least the rules were clear and he could plan his expenditures with reasonable certainty.
Under Collor, however, things became so random and government officials so rapacious that he was never sure who he had to pay next, and since once he had made a significant investment the corruption escalated (because he had already made a big enough commitment that it made sense for officials to bleed him dry), he decided to stop investing altogether and to take his money out of the country.When corruption significantly increases the uncertainty under which businessmen operate by disrupting the rules of the game, they disinvest.
The second case is when corrupt officials discount the future at very high rates (perhaps because of uncertainty about their period in office, or factional fighting, or political instability).This changes their attitude towards long-term development.A “rational” corrupt official wants to maximize his economic rent (I love this value-neutral term for corruption) over the long term, so it is in his interest that local businessmen over whom he has power are successful and their profits grow over the long term.The bigger and more profitable they are, and the longer the bribe-giving relationship, the more money the official receives.In these cases long-term growth is very compatible with official corruption, and in fact it is pretty easy to think of cases that exhibit this kind of “far-sighed” corruption.
In cases where the corrupt official has reason to question the stability of his stay in power, however, what matters is to maximize rent in the short term, not in the long term.In that case he is more interested in looting the company of whatever assets it has that can be easily liquidated, even at the risk of killing the company.These are particularly harmful cases because the bribe-offering managers also know that the risk to the company, so presumably they also become much more interested in looting assets than in building a profitable business.This kind of corruption (along with the former) was characteristic of the last few years of Nationalist rule in China.
I have no idea what the mix of corruption in China is, but I suspect that we are largely experiencing the “good” kind of corruption (blog readers please disagree if you think otherwise).It is not just the current mix that is important, however, but also how things can change.For example, if factional fighting becomes bitter and so forces officials to discount the future at higher rates (because it is harder to predict how long they will retain power), I would imagine that we would see more of the latter kinds of corruption develop.In a way the fight against corruption, if it ever becomes effective (which I doubt), might even have the perverse consequence of increasing the looting mentality because corrupt officials will be concerned about getting enough money out of the country as quickly as possible before they get noticed and caught.
Most importantly we should understand how a great deal of corruption, even of the “good” kind, can add instability by creating a self-reinforcing mechanism that amplifies decline.By this I mean that in case where there is any sort of political or economic crisis, of the threat thereof, it may force officials to change the type of corruption – as Color de Melho’s presidency in Brazil in the late 1980s did – so that it amplifies the decline.In that case the danger of corruption is that, probabilistically speaking, it fattens the tails of the distribution of potential outcomes and, as every finance geek knows, fatter tails raise financial distress costs. In fact maybe we can think of corruption is a type of financial distress cost – the economic cost of corruption rises with the probability of crisis.
Corruption is a lot more complex than it appears. The tendency is to think that if you have moral upstanding officials that you can save the $86 billion, but corruption usually happens because someone is seriously underpaid. It isn't even clear that corruption is even economically harmful in all cases. The classic example of "good corruption" is a black market in a centrally planned economy.
Focusing on the "money that you can save" by eliminating corruption is not a good idea, because you'll usually find that fighting corruption will cost you more money (in the short term) than letting it stay. The negative aspects to corruption are less the direct costs, but rather the bad effect it has on institutions and public trust.
What does happen as an economy develops is things that used to take place under the table start taking place on the table. Instead of showing up with suitcases of cash, you hire lobbyists and make campaign contributions. It isn't any cheaper, but it does allow one to keep track of which flows are socially productive and which one's aren't and to make sure things don't get out of hand.
In the case of your ATM salesman, I doubt that ending the corruption would save anything in direct costs. For bribes to end, you'd have to have the bank dramatically increase the salary of the manager (and this is one reason Western banks pay a huge amount to managers), and you'd still have to spend a huge amount of time doing sales and marketing. The benefits wouldn't be in the direct costs, but rather in the indirect costs. The manager is going to make decisions of which is the best ATM based on what is best for the bank rather than who gives him the most money. There is also the social benefit. If it is commonly believed that rich people got their money through honest means, it makes it less likely that people will wait to string them along the wall and shoot them.
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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Comments (2) for "The costs of corruption"
- 10/13/2007 3:27 PM
January, 2008