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The Asian financial crisis stands out as an example of large-scale systemic failure that was driven, some degree, by corruption

By John D. Sullivan
Dec 18 - 24, 2000

After years of being tolerated with a mixture of apathy, cynicism, and denial, corruption is now becoming a target of serious international action. As firms around the world face slimmer profit margins due to increased competition, the international business community is becoming increasingly aware that corruption is costing them money-profits. The added cost of corruption, particularly in developing countries where it is more pervasive, has made business change the way it operates globally. The business communities in many countries are signalling to lawmakers that they are tired of corrupt dealings and that it is time for change. Business is acknowledging that corruption is an issue that must be faced, and that they, the private sector, have a role in eliminating this disease. However, business is certainly not the only victim of corruption; the citizens of developing countries who are losing valuable resources are victimised to an even greater degree. The poor share disproportionately in the negative effects of corrupt behaviour in the form of lost jobs and income. In the developing world, resources and funds that could go into infrastructure, education, and other elements integral to development end up lining someone's pocket due to the effects of corruption. Corruption scares away investment that could reach those areas and bring new prosperity.

At the same time, it has to be acknowledged that business is often the source of corruption or, at the very least, a participant in the misuse of public authority for private gain. First, recall the old axiom that the bad tends to drive out the good. Firms that refuse to participate in corrupt transactions may find themselves forced out of certain markets or countries. This is especially the case when corruption is systemic. Of course, multinational companies have the option to leave a country entirely and, in many cases this is exactly what has happened. Domestic firms, especially small businesses are much more vulnerable. However, they too can leave the market. In some cases, they can shut down their firms and leave the country — immigrate to more hospitable locations. In other cases, they can emigrate into the informal sector or the underground economy. While corruption is not the only cause for either type of emigration, it is surely a major contributor.

The world has witnessed the new focus being placed on corruption through a series of headlines publicising the ousting of political leaders. Accusations of corruption have been levelled at officials around the world, including some in the US and other developed countries. The lack of communication and opaque markets have been identified as major contributors to the Asian crisis, which grabbed the attention of even the most developed markets. Today corruption is one of the leading causes for the lack of foreign investment in Russia and Ukraine. No one is arguing that corruption doesn't occur everywhere to some degree; however, there is a fundamental difference in how it affects developed versus transitional or developing economies. In developed countries the fight against corruption is a fight for fairness and increased efficiency in markets that are already well structured. In developing and transitional countries corruption can be so pervasive that it can undermine the state and hinder development of democratic values and market systems.

Combating corruption is, of course, important in its own right since left unchecked, corruption has a corrosive effect on democracy and the general well being of a nation. In addition, combating corruption can serve as a lever or a tool for bringing about broader economic reforms and creating a level playing field on which business operates. These additional benefits can become an important part of the effort to mobilise support for anti-corruption programmes. As society begins to realise that corruption harms everyone through lost jobs and lower incomes, it becomes easier to arouse public support for anti-corruption measures.

Efforts to attack corruption have grown exponentially in just the last decade. Well-publicised cases of corruption in developing countries, in international organisations, and in the advanced industrial democracies have created a growing public demand to attack the issue vigorously.

Root causes of corruption

Corruption occurs in a variety of ways. While there is general agreement that corruption is the abuse of public office for private gain, there are still many areas where peoples in different countries have different feelings about what is and isn't a corrupt practice. For example, most would agree that bribing a Civil servant is corruption. However, hiring relatives (nepotism), giving contracts to supporters (cronyism), abusing privileged information to buy or sell stock (insider trading), and other such practices are viewed differently around the world. Following the Asian and Russian financial crises, the trend seems to be in the direction of a more inclusive definition of corruption rather than strictly limiting it to actual bribes.

One of the major breeding grounds for corruption can be found in the area of governmental applications of laws and regulations including but not limited to labour law, tax rules, customs and currency regulations, and health and safety laws. The World Bank expert, Daniel Kaufmann, has provided an illustrative list of the key areas that involve discretion and should be targets for reform.

Daniel Kaufmann's list

Issuing licenses, permits, quantitative import restrictions (quotas), passports, customs and border- crossing documentation, and banking licenses.

Implementing price controls

Blocking new firms and investors from entry to markets and providing monopoly power.

Awarding public procurement contracts.

• Granting subsidies, soft credits, tax exemptions, and inflated pensions and allowing tax evasion.

• Imposing foreign-exchange controls resulting in multiple exchange rates, the over invoicing of imports, and the flight of capital.

• Allocating real estate, grain storage facilities, and telecommunications and power infrastructure.

• Selectively enforcing socially desirable regulations such as those that apply to public health and the environment.

• Maintaining obscure or secret budgetary accounts

Inter-governmental efforts to fight corruption: Levelling the playing field

Without doubt, one of the major initiatives to attack corruption is the recent OECD "Convention on:

Combating Bribery of Foreign Public Officials in International Business Transactions." By ratifying the convention, governments are pledging to remove the tax deductibility of bribes and payments and to make it a criminal offence to pay bribes. Until the OECD governments agreed on this measure, many countries allowed their companies to deduct the costs of bribing foreign governmental officials to get contracts or other favours. The United States ended this practice with passage of the Foreign Corrupt Practices Act of 1977, but most other developed countries failed to follow the US lead. Once these countries actually adopt legislation to put the convention into practice in their countries, the "supply side" of corruption will be significantly reduced.

Corporate governance as a tool

Another related mechanism that is not only worthwhile in its own right but also helps to reduce the supply side of corruption is tough corporate governance standards. These are the practices that companies use to run their boards of directors, set policies for behaviour throughout the company, develop business strategies, and generally steer the corporation. Although there is not one form of corporate governance there are certain internationally accepted principles that underlie sound business structures. Concepts that contribute to effective corporate governance include:

• Instituting independent auditing;

• Defining the concept of "conflict of interest" and how it affects members of boards of directors and senior management;

• Strong independent boards of directors, with a strong audit committee and internal audit functions;

• Laws and regulations guaranteeing shareholder rights, especially the rights of minority shareholders;

• Established and accepted standards of financial accountability and transparency within firms;

• Commitment to honest and fair dealings with all elements of the community (employees, suppliers, customers, and neighbours). When these processes are fully implemented, it becomes much more difficult for a company to pay a bribe, practice nepotism, indulge in illegal campaign financing, or indulge in other forms of corruption.

Civil society and political will

For systemic change to occur on the demand side of corruption, the entire structure of how the legal system functions and government policies are created and implemented must be improved. It is equally important that this restructuring process involve input from affected organizations and individuals in society, including the representatives of private business and non-profit groups and academic experts on the policies being addressed.

Political will is crucial to enforcing initiatives against corruption. There is nothing easy about this process. In many cases, prominent leaders in these countries may become implicated in corruption charges only to leave their successors operating still corrupt regimes. That is why civil society organizations and the press must be in a strong position to push for reforms—real changes—when the political will flag. Education and increasing the flow of information to the general public are key instruments to obtaining widespread support for reform.

Business associations, think tanks (public policy research institutes), and other civil society organisations can be key actors in attacking the problem of corruption. First, they can demand that government sign and enforce the new OECD anti-corruption convention and subsequent legislation. Representing their members, they can strive to make sure that standards are understood and clearly enforced, and that complaints and infractions of the law are investigated. They can also inform policymakers about discrepancies in the application of anti-corruption measures and help legislators define more effective laws.

Business associations and think tanks can advocate for increased open market reforms, and as reforms begin to take hold and privatisation moves forward there become fewer opportunities for corruption. Reforms in government and the elimination of red tape will reduce the discretionary authority of government officials thereby curtailing one avenue that breeds bribery. Since state-owned firms do not necessarily have to be profitable, there is an environment ripe for crony dealings and as these firms privatise and change to profit-making companies they will have to change their internal culture. Privatised firms will no longer want to lose profits to bribery and will become another force in the fight against corruption.

Business associations that fill the role of advocating business policy before government in an open manner perform a great service to anti-corruption efforts and the cause of democratic governance. So do their counterparts in the world of think tanks. The alternative scenario in many transitional and developing countries is for firms to strike deals with government officials behind closed doors. Dealing behind closed doors is a breeding ground for corruption and prevents the creation of a level playing field where business thrives best.

In addition to political will, civil society has a major role to play in restoring a sense of ethics and ethical behaviour as a social norm. In many societies, most notably in the formerly communist societies, corruption has reached a point where it has created a national norm or standard of behaviour that corruption, especially petty corruption, is acceptable behaviour.

Indeed, public education programmes are becoming an important and accepted part of national anti-corruption programmes. Transparency International has teamed up with other NGOs in a number of countries to carry out such efforts. In addition, the World Bank has been assisting countries to develop National Integrity Programs that have specific goals for various agencies as well as Watchdog functions for civil society and the media.

Recommendations and lessons learned

One of the most important observations that can be made is that efforts to establish democracy as a form of government are extremely important in the overall effort to eradicate corruption. Democracy assistance targeted at establishing transparency in government, bolstering the free media, creating a rule of law, and holding free and fair elections directly attack some of the root causes of corruption. The reverse is equally true, many of the anti-corruption programmes described above contribute significantly to the development of Liberal democratic systems.

Equally important is the fact that economic reforms and the adoption of a market-oriented economy also are associated to a great degree with lower levels of corruption. As noted in the text above, corruption flourishes in those countries where governmental decision-makers, especially those at lower levels in the government, have a great deal of discretionary authority. However, a market-oriented economy is not simply an economy where government gets out of the way. This is one of the great myths hampering efforts to build sound economies in emerging markets. Rather, in a healthy market-oriented economy government plays a vital role in enforcing contracts, providing for a level playing field (ant-trust measures and pro-competition), enforcing property rights, and a host of measures to ensure all firms are treated equally (domestic and foreign). Establishing these functions of government while reducing discretionary decision making (usually behind closed doors) are a key part of both anti-corruption and building a sound market system. Some 70 per cent of indigenous firms reported that they had forgone investments due to over-regulation and unclear rules in the World Bank survey. Countries that are more integrated into the international economy are likely to be less corrupt as well.

Some very useful lessons have been learned through the experiences of the host of programmes addressing corruption, including those run by civil society. The following list is by no means exhaustive but does offer a useful starting point to advance the worldwide effort to eliminate corruption. The list is separated into efforts to address the demand side that is usually associated with government, and the supply side, normally found in the private sector.

Conclusions

While there are many instances of corruption to pick from in today's world, the Asian financial crisis stands out as an example of large-scale systemic failure that was driven, some degree, by corruption and its correlates: lack of transparency in government and poor or non-existent corporate governance.

The costs of such systemic corruption can be considerable as was seen in Asia. However, countries throughout the world are paying an even higher cost in the form of jobs that were never created, firms that exist in the informal economy or were never created, consumer services that don't exist, and, most of all, the corrosion of democracy. Yet, evidence is building that corruption in being taken seriously and that the "taboo" against discussing such issues is being broken.

Most importantly, there is a movement growing worldwide that is insistent on reform including business associations and think tanks, international non-profits like Transparency International, and the governments of the OECD as well as some developing country governments. These groups have the tools and they are building the political will to force reform.