Corruption is more of an obstacle to economic development than legal rent-seeking. If true, does this help policy-makers in low-income countries?

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1 Corruption is more of an obstacle to economic development than legal rent-seeking. If true, does this help policy-makers in low-income countries? '...corruption is common in both the developing and the industrial worlds. But should it be an object of concern?' (Rose-Ackerman, 1997: 32) The essential difference between the developing and industrial worlds is that while corruption has been a relatively small concern in the industrial world, it has not remained so in the developing. In fact corruption has become a major focus of policy in developing countries, particularly since ever more aid is tied to 'good governance' criteria. While there is much evidence suggesting that corruption has negative links with economic growth and development, it is not entirely clear whether the solutions proposed by certain international organisations are squarely aimed at the underlying causes of corruption. It could well be argued that corruption, as a universally demonized concept, is simply utilised as a tool to label governments inefficient; the solutions to which are the same liberalization policies of old, disguised with increasingly numerous but essentially meaningless corruption-tackling add-ons. The ambiguous nature of corruption has fuelled such suspicions, and there has been a tendency towards attributing it to any number of wider social and institutional problems. Rent-seeking - with which corruption is often associated - has also been the target of much neo-classical disdain; especially with regards to its hampering of the free market, and thus crushing effects on growth. However the question of whether or not rent-seeking behaviour in general is beneficial or detrimental to growth would take more time and space to explore than is allowed here and in any case is not the purpose of this essay. Rather, having attempted to define corruption as a type of rent-seeking, and exploring the effects it has on lowincome countries, this essay will look at whether corruption is more harmful for growth than legal rent-seeking, before turning to the question of whether such knowledge is helpful or indeed useful to policy makers. Rent-seeking and corruption, which is worse? It has long been the tradition among economists to view rents as resulting from 'government restrictions upon economic activity', that create competition, both legal and illegal for which people and companies compete (Kruger, 1974: 291). This being one of the earlier writings on the subject of rent-seeking, Kruger goes on to argue that government restrictions on the market produce inequalities causing resources to be wasted on competition for the more favourable positions, rather than on productive activities. Thus follows the conclusion that government intervention in markets

2 causes inefficiencies, especially when compared with a free market (Kruger, 1974). Aside from the fact that Kruger attempts to model an incredibly complex activity very simply - hence producing very simplistic conclusions - there are other problems with this standpoint. Firstly it ignores the possibility of positive rents; rents that not only do no harm, but actually promote growth. Secondly it fails to differentiate between legal and illegal rent-seeking, most probably due to the fact that since all rent-seeking is detrimental to the economy, it matters not to distinguish between them. However as a basis for looking at this topic, Kruger provides the assumption that while in '...most cases, people do not perceive themselves to be rent seekers...' in all cases where there is a possibility for gain, people will spend time and energy competing for such advantage (Kruger, 1974). While most writers now recognise at least the differentiation between legal and illegal rentseeking, some would go further still. Of those who argue for a wider definition of rents, Khan has put forward one of the most comprehensive categorisations. He identifies 6 types of rents: Monopoly rents where governments create a single rent in an area for which companies compete; natural resource rents which control the distribution or use of a resource; transfer rents involving the conversion of public property into private property; Schumpeterian rents rewarding investment in innovation; rents for learning rewarding those that invest in adaptation of new technologies; and monitoring and management rents those that reward efficient management (Khan & Jomo, 2000: chapter 1). Khan argues that recognising a wider framework of rents allows not only a greater appreciation for the various effects of different rents, but also enables a more comprehensive and useful tool for policy makers to determine the types of rents they want to encourage and how to do so. With rent-seeking the debate over its utility is still very much alive. With corruption this is much less the case. Corruption holds almost entirely negative connotations and is widely considered to be bad for growth. Apart from a brief spell in the mid- 1960s where it was hypothesised that corruption could be beneficial allowing for the direct payment of bureaucrats and skipping of red-tape in inefficient systems, most writing on the subject has been attempts to assess the damage done by corruption. Considering the ambiguity of the word, in terms of the exact actions it pertains to, it is impressive the reputation it has built. While in the past it has been used to describe bureaucratic inefficiency, or broadly labelled as a type of illegal rent seeking, it is now generally '...defined as the use of public office for private gain' (Rock & Bonnett, 2004: 999). There is of course an implication that corruption is in some way defined as illegal activities, but Svensson's definition encompasses the idea that corruption also acts as an indicator; 'Corruption is an outcome a reflection of a country's legal, economic, cultural and political institutions. Corruption can be a response to either beneficial or harmful rules' (Svensson, 2005: 20). Thus the extent and effects of corruption within a country could be analysed in order to determine what institutional and political changes would need to take place in order to minimize the

3 levels of corruption present. This of course assumes that there are no benefits to corruption. Certainly the data on corruption would mostly support the view that it is deleterious to growth and development. Using the Business International (BI) indices on corruption, Mauro finds a strong negative correlation between corruption and investment rate, concluding that corruption is bad for growth. He also finds that investment rate is negatively correlated with bureaucratic inefficiencies, concluding that better institutions lead to better growth (Mauro, 1995). However as numerous subsequent writings point out, correlation does not necessarily indicate causality; it is almost impossible to tell whether poor institutions breed corruption, or corruption leads to the creation of poor institutions. Svensson, in an update and evaluation of Mauro's data, found no significant correlation. Svensson suggests that this is due to the coarse nature of much of the data making cross-country comparison untenable (Svensson, 2005: 38-39). Intuitively, it could be expected that the data on corruption would be unreliable at best. Rose-Ackerman concurs: 'Reliable data on the magnitude of corruption across countries does not exist and probably cannot exist in principle' (Rose-Ackerman, 1997: 31). The BI upon which Mauro's conclusions were based, relies upon the subjective rating of business people as to the corruption levels within a country, and thus is subject to their personal biases. The obvious problem with asking the people within the country themselves is their high motivations to lie about the true nature of the problem. Empirical data on corruption is equally hard to accurately obtain since it there are few universal quantitative measures of corruption. Finally despite all the evidence to suggest that corruption is negatively associated with growth and development, there are cases in which countries have grown at impressive rates despite high levels of corruption. This largely refers to certain East Asian economies that have thrived irrespective of corruption. Rock & Bonnett propose that other factors need to be assessed in order to understand this phenomenon, namely country size and government time horizon. Firstly they find that '...corruption is likely to be much more damaging to investment and growth in small as opposed to large developing countries', which they suggest is due to larger countries having access to larger labour markets and being able to exert greater influence over foreign investment (Rock & Bonnett, 2004). Second they use Olson's concept of stationary and roving bandits as a framework to assess the time horizon of governments. In short, leaders that view their position as stable and long-term will make moves to produce more stable and profitable institutions in the country, as economic growth will produce greater benefits for themselves. Leaders that are unsure of their tenure or are in positions that experience a high turnover are likely to maximize their gains in the short term, producing more severe consequences for the country's economy as a whole. Thus they find that '...corruption tends to be growth-enhancing in the large East Asian newly industrializing countries where governments with long time horizons have centralized corruption networks with their big

4 business partners' (Rock & Bonnett, 2004: 1010). The centralization of corruption and importance of government or monopoly control over such behaviour is also highlighted by Shliefer and Vishny. They point out that where a government has control over corruption and the bribe system, bribes can be maximised, while damage to business can be minimised and thus the overall effect may not be negative. However in a system where each official acts independently, the aggregate profits from bribes is lower, business can be severely hampered and growth is open to much greater harm (Shliefer & Vishny, 1993: ). More and more, the role of government and institutions within a society can be seen to influence whether the effects of corruption are negative or not. However, this is not just an issue for corruption the success of rent-seeking also depends on government competency and bureaucratic efficiency. Khan also emphasises the need for developing states to be capable of disciplining the new markets and emerging capitalists (Khan, 2002). If successful governments are able to steer development, corrupt or not, in the productive and growth enhancing directions, then rent-seeking also needs to be managed effectively in order to ensure it is not damaging. Svensson's definition of rent-seeking implies that it has inherent social costs, defining it as '...the socially costly pursuit of rents, often created by government interventions in the economy' (Svensson, 2005: 21). Khan & Jomo argue that such definitions focus only on the inputs into rent-seeking and fail to mitigate these costs with the gains wrought from the outputs of rent-seeking. They see rent-seeking as a process '...closely related to processes of institutional change through which economic rights are altered', and thus part of the growth and development of a country (Khan & Jomo, 2000: 70). What then prevents corruption being such an aid in this procedure? Shliefer and Vishny identify the role of secrecy in corruption as the major factor in making corruption that much more damaging. The essential difference between corruption and rent seeking in terms of the illegality of corruption is that this necessarily means costs must be incurred in order to keep corruption hidden. These costs can amount to more than just the costs of bribes for silence or having to operate in a more risky environment. As Shliefer and Vishny illustrate the '...demands of secrecy can shift a country's investments away from the highest value projects, such as health and education, into potentially useless projects, such as defense and infrastructure, if the latter offer better opportunities for secret corruption' (Shliefer & Vishny, 1993: 616). It also prevents change within the system as the introduction of new players and new participants into the elite would necessarily involve much greater danger of exposure to those already in power. Apart from that, current elites are unlikely to be willing to give up or share such lucrative positions meaning that it is far easier for political leadership stagnation to occur in corrupt systems (Shliefer & Vishny, 1993: ). This again prevents dynamic change entering a system and thus stifles development. It therefore becomes apparent that it is this element of secrecy, not present in legal rent seeking, that

5 makes corruption a greater obstacle to economic development. Does this help policy-making? In concluding, as the question suggests, that corruption is more of an obstacle to economic development than legal rent-seeking, it is now necessary to look at what the implications of such a judgement are for low-income and developing countries. The obvious prescription is that corruption should in be minimised or converted as much as possible into legal rent-seeking, this having a less harmful implications. However, as far as usable advice for policy makers goes, such a statement is equal to saying it would probably be good for low-income countries if they were to try and develop; it gives advice for the ends without providing indications as to the means. Numerous remedies for corruption have been suggested. Mauro suggests that improvements in bureaucratic institutions would lead to reductions in corruption, concluding a causal relationship between the two. While later authors have disputed these findings, Mauro does note that '...one has to recognize that institutions and economic variables evolve jointly: not only do institutions affect economic performance, but also economic variables may affect institutions' (Mauro, 1995: 682). The theme of the effects of institutions on growth, corruption and rent-seeking features continuously throughout the literature on this topic. It it thus not unreasonable to suggest that the utility of the statement, "corruption is more of an obstacle to economic development than legal rentseeking", lies not in what can be done directly about corruption but in the analysis of the various problems within institutions of low-income countries. Both Rose-Ackerman and Svensson point to the symptomatic nature of corruption, accentuating the role of corruption in analyses of the institutions that allow it to continue (Rose-Ackerman, 1997:33 ; Svensson, 2005: 20). In fact Rose- Ackerman goes on to emphasise the dangers of focusing exclusively on combating corruption without taking account of the wider implications that are indicated by the presence of corruption itself. She concludes that '...the aim is not to achieve a complete rectitude but rather a fundamental increase in the honesty and the efficiency, fairness, and political legitimacy of government'. This would certainly lead to a decrease in corruption within government. However capable government is not only necessary to combat corruption. Khan argues that '...the construction of capitalism, although it may be necessary for the longterm prosperity of poor countries, is itself an ugly and conflictual process' (Khan, 2002: 165). Thus, many low-income countries find themselves running the thin line between supporting a new and productive capitalist class and yet maintaining political stability in light of the unfairness that such support entails. Here too Khan emphasises the importance of a government with the capability and strength to discipline emerging capitalists without being captured or allowing these new forces to become too influential and unproductive. However in terms of recommendations it is interesting to

6 note that '...political instability is often greater in more open developing societies where information about the effects of government policies is more freely available and the possibilities of expressing dissent are greater' (Khan, 2002: 183). In more open societies there is a greater expectation of transparency and honesty in government, in contrast to more authoritarian systems where the lack of these elements is less surprising and met with less conflict; there also being less opportunity to oppose the government in such systems. In democracies especially this can be very damaging: 'Military takeovers are frequently justified as a response to the corruption of democratic rulers' (Rose-Ackerman, 1997: 45). Indeed, there is much to suggest that there may be certain benefits to authoritarian governance in creating useful rents and maintaining political stability. Khan is vocal on this point, remarking that there is no evidence to suggest that corruption must first be eliminated nor democracy established for development to take place, and that in reality it is only those that have successfully developed that are able to sustain democracies for any length of time (Khan, 2002). In light of this it would seem that the real focus must not be on tackling corruption or encouraging legal rent seeking per se, but on strengthening government in order to allow it to implement policies that will further growth. There are rents - and rent-seeking behaviour beneficial to a state - that should be encouraged, but this requires government strong enough to regulate such behaviour. If one takes the view that development towards a capitalist society requires a certain level of both rent-seeking and corruption, and also that this is only damaging if the government and its institutions do not have the capacity to deal with this, then the danger of encouraging rentseeking behaviour lies only in the possibility of those that benefit from rent-seeking gaining the power to stagnate the system. So long as the economy remains dynamic and growing, neither rentseeking nor corruption are a problem. The knowledge that corruption is worse means that, in order to maintain and improve growth, policy-makers must target corruption first. Policies advocating the elimination of government intervention, rents and the like, without first addressing corruption and building the institutional capacity to deal with that problem, are unlikely to succeed in promoting growth. Conclusion Thus, the knowledge that corruption is a greater obstacle to economic development than legal rent seeking is helpful to policy-makers in low-income countries in two respects: Firstly, the knowledge that corruption within a country acts as an indicator of the health of government and institutions in said country suggests that these areas need addressing in order to promote growth. Similarly, if legal rent seeking is not proving productive in terms of growth, it again suggests that the government does not have adequate control over the various players within rent-seeking; Secondly, this

7 knowledge indicates the priorities policy-makers should assign to dealing with these problems. If corruption is more of an obstacle than rent seeking, eliminating rent seeking first will be essentially futile.

8 Bibliography Khan, Mushtaq H., (2002) "Corruption and Governance in Early Capitalism: World Bank Strategies and Their Limitations" in Pincus & Winters (eds) Reinventing the World Bank, Ithaca: Cornell University Press, pp Khan, Mushtaq H. & Jomo K. Sundaram (2000) Rents, Rent-Seeking and Economic Development: Theory and Evidence in Asia, Cambridge: Cambridge University Press. Krueger, Anne O., (1974) The Political Economy of the Rent-Seeking Society The American Economic Review, vol. 64, no. 3, pp Mauro, Paolo (1995) Corruption and Growth The Quarterly Journal of Economics, vol. 110, no. 3, pp Rock, Michael T., & Heidi Bonnett (2004) The Comparative Politics of Corruption: Accounting for the East Asian Paradox in Empirical Studies of Corruption, Growth and Investment World Development, vol. 32, no. 6, pp Rose-Ackerman, Susan (1997) The Political Economy of Corruption in Elliot, K., (ed) Corruption and the Global Economy, Washington: Institute for International Economics, pp Shleifer, Andrei & Robert W. Vishny (1993) Corruption The Quarterly Journal of Economics, vol. 108, no. 3, pp Svesson, Jakob (2005) Eight Questions about Corruption The Journal of Economic Perspectives, vol. 19, no. 3, pp