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zu Kiel Faculty of Economics

Corruption in the Russian Federation: Its In3luence on Political and Economical Development
The economic theory of corruption exerted on the case of the Russian Federation

by Ruben Werchan

Table of Content

Introduction 1. Economic Theory of Corruption 1.1. The Problem of DeWining Corruption 1.2. An Economic Model of Corruption 1.3. The Role of the Government 1.4. Causes and Deterrences of Corruption 2. The Case of the Russian Federation 2.1. Empirical Data on Corruption in the Russian Federation 2.2. Consequences of Corruption for the Russian Society and Economy 2.3. Reasons for the Corruption in the Russian Federation 2.4. How to Battle Corruption in the Russian Federation Conclusion

2 3 3 4 6 7 8 8 13 14 16 18

When talking about modernization, there is a hugh gap in the understanding of what is meant by that between Russian and Western European politicians. Western European politicians usually refer to a simultaneous modernization of the economy and the political system. And by modernization of the political system they mean off course democratization. The Russian political elite however is determined to realize economic modernization leading to better global competitiveness of the Russian industry, without altering the political system. The success of this approach is doubted by western politicians and scientists likewise, and so far there exists little evidence for economic development since the growth in Russian gross domestic product (GDP) is carried exclusively by oil and gas exports. One of the main problems associated with the russian political and administrative system that deters economic development is corruption. Corruption restrains investment and thereby economic growth. It also leads to a suboptimal allocation of resources that seriously jeopardizes the efWiciency of the economy. In terms of degree of democratic institutions, freedom of press, and corruption Russia can be compared to other countries in a similar stage of economic development and with similar economic output (cf. Shleifer/Treisman 2005: 152). But at the same time it stands out for a number of reasons. What makes it unique, concerning corruption, in comparison to other countries of equal development status and economic power was best described by James Leach, the then chairman of the US-Congresses Committee on Banking and Financial Services, who wrote in his opening statement to the hearing on Russian money laundering at the US house of representatives in 1999: What sets Russia apart is the pervasiveness of politically tolerated corruption in a country of such sweeping geographic size and seminal geopolitical signiWicance (Leach 1999: 199). With this statement Leach stressed what distinguishes Russia from other countries, that have seen an equal level of corruption: Russia is bigger, economically and politically more inWluential and in the end poses a signiWicant amount of nuclear weapons. Another development, that makes Russia unique is that corruption is not decreasing with economic growth but seems to be very consistent. Various studies have shown, that corruption has grown during Vladimir Putins Wirst presidency and remained at a comparably high level all the way through the presidency of Dmitry Medvedev.1 Because of its unique position, the Russian Federation is an interesting subject for scientists. This paper is aimed at bringing quantitative and qualitative analysis of Russian corruption

1 See section 2.1. for more detail.

together, identify main reasons, problems and possible solutions, and to analyze it on the background of the economic theory of corruption. For this purpose, the Wirst chapter will give an overview of the economic corruption theory, including a working deWinition, a model of corruption and some insights on the role of the state and main causes and deterrences of corruption. The papers focus will be on corruption of public servants. The second chapter will present data on corruption in the Russian Federation and analyze its causes and consequences as well as give some ideas on what is done and what should be done to battle corruption.

1. Economic Theory of Corruption

1.1. The Problem of De3ining Corruption Basically all contemporary literature on the issue of corruption opens with a description of the difWiculty, or even impossibility of deWining corruption (cf. Jain 1998: 13). The literature also complains about the fact, that the lack of a convenient and consistent deWinition of the problem makes the empirical analysis difWicult and less fruitful (McChesney 2010: 219). Nevertheless everybody tries to give a deWinition but still no consensus has been found. The main drawback of most deWinitions of corruption is the normative element they posses. Those deWinitions try to include the unlawful aspect of corruption. Illegitimacy is an important aspect in the normative analysis of corruption, but from an economic point of view, it makes little difference, wether corruption involves legal or illegal transactions (cf. Rose-Ackerman 2001: 48f.). It is important to stress this aspect, because what is illegal and what is not, depends largely on the legislation in a given country, and things that are illegal in one country may be legal in another. Nevertheless the consequences of corruption are largely the same. Generally there are two types of corruption: private sector and public sector corruption. Vito Tanzi proposed a neutral deWinition that covers both private and public sector corruption: Corruption is the intentional noncompliance with arms length relationship aimed at deriving some advantage from this behavior for oneself or for related individuals (Tanzi 1998: 564). Even though, corruption can occur and does occur in the private sector, namely in large enterprises when it comes to hiring, or subcontracts (cf. Tanzi 1998: 564), most scientiWic interest is directed to public sector corruption, since it is by fare more widespread and has therefore worse consequences for welfare.

Concerning public sector corruption, Fred S. McChesney offers a good deWinition based in the property-rights approach.2 According to him, corruption should be de1ined as a governmental actors use of resources, that nominally he does not own, but that effectively he does own, to enrich himself personally. How he can enrich himself depends on the market(s) within which corruption is bought and sold (McChesney 2010: 223). Although this deWinition captures the act of corruption the best, it lacks some precision. It is not corruption that is bought and sold, rather corruption is the act of buying and selling of a state owned resources to the mutual beneWit of the buyer and the governmental ofWicial. Arvind K. Jain stresses the point, that corruption refers to a situation where an asymmetry of power exists and is abused. public ofWicials, bureaucrats, legislators, and politicians use powers delegated to them by the public to further their own economic interests (Jain 2001: 73). When looking at corruption as an economic transaction, it describes a private agent buying something from the government, or more precise from a governmental ofWicial or employee. That something that is bought from the public servant should logically be something, the private agent could not purchase elsewhere. The one good, government is a monopoly owner of, is power. By deWinition the government is the only agent in a society that has the right to coerce the citizenry, and thus the right to assemble armies and police forces, maintain prisons and levy taxes - none of which are recognized rights of private individuals (McCheney 2010: 224). It is accordingly the monopoly of power, that gives governmental ofWicials and employees something to sell to private individuals. The following section will present an economic model of corrupt behavior of public servants and their private clients. 1.2. An Economic Model of Corruption A basic economic model of corruption was presented by Andrei Shleifer and Robert W. Vishny. In this model, the government produces a good, which is then sold to private agents by an governmental ofWicial. This ofWicial can artiWicially limit the access to this good, in practice this means a long delay or an imposition of many requirements (Shleifer/Vishny 1998: 93), thus creating a situation where he or she is the monopoly supplier of this scarce good. The price of the distribution of the good, hence the amount of the bribe, is then determined by setting marginal revenue equal to marginal cost. It has to be distinguished between the two cases of corruption with and without theft. In the case of corruption without
2 See next subsection.

theft, the governmental ofWicial turns over the price of producing the good to the government and therefore these costs determine the marginal cost of the ofWicial for providing the good. In this case, the amount the private agent has to pay for the good always lies above the government price, because the bribe is added to this price (cf. Shleifer/Vishny 1998: 93f.). In case of corruption with theft, the ofWicial does not turn over the price of producing the good to the government. Instead he actually hides the sale from the government and his marginal costs are therefore zero. In this case the bribe may actually be lower than the ofWicial governmental price (cf. Shleifer/Vishny 1998: 94f.). Examples for corruption without theft would be the provision of a passport or a permit, which only takes place, after a bribe is paid. Examples for corruption with theft would be the imposing of a Wine or the declaration of customs. The ofWicial then collects a Wine or customs that are lower then they would be without corruption, but does not report the act of Wining or the declared products to the government, and keeps the whole paid sum to him- or herself. The effect of corruption without tax on the economy is the same as a commodity tax. The only difference is, that the tax revenue would go to the government, while the bribes are kept by the bureaucrats (cf. Shleifer/Vishny 1998: 94f.). The model by Shleifer and Vishny describes the practice of rent-seeking by public servants. Rent-seeking is a problem of insufWicient property rights: If property rights were clearly delineated and perfectly secure, there could be no rent- seeking. Rent-seeking arises because of the discretionary power of the state to alter or transfer property rights through taxation and spending, regulation and eminent domain makes private property rights insecure (McChesney 2010: 226). Assigning and modifying property rights is one of the elementary functions of governments. It guarantees the functioning of the economy. Only if property rights are clearly assigned and enforced, can economic interactions take place. Property rights are then traded between private actors on markets (cf. Benson 1984: 390). Ideally the government intervention would be held to a minimum and the assignment of property rights would be led by the goal to maximize social welfare and economic efWiciency. If this would actually be the case, there would be no room for rent-seeking. If however property rights are not clearly deWined and/or not secure, government ofWicials and employes have the discretionary power to alter and reassign them for personal gain. In this case the private agent has to decide wether to rightfully buy a desired property right on the market, or bribe a public servant to have him reassign the property right to the private agent. He will do the latter, if the bribe is less than the market price (cf. Benson 1984: 390f.). 5

Weak institutions are a key condition for the government to posses discretionary power, and the public servants to be able to use this power for their personal beneWits. Especially legal institutions must be such that ofWicials are left with an incentive to exploit their discretionary power to extract or create rents (Aidt 2003: F633). Therefore, the legal system can easily be caught in a vicious cycle. If for whatever reasons a system of corruption that is beneWicial for the political elite is established, this elite will try to keep it. To achieve this, the political elite weakens the legal and judicial system by cutting its resources and appointing corrupt judges. But reduced resources and corrupt judges will make it hard for the legal system to Wight corruption, thereby giving corruption the opportunity to spread even further (cf. Jain 2001: 72). What forms public sector corruption can take and what consequences it has, will be examined in the following subsection. 1.3. The Role of the Government When focussing on how the state can use its discretionary power for personal beneWits of its ofWicials and bureaucrats, a distinction can be made between three levels of corruption. The highest level concerns public, especially economic, policy and the implementation of policies. Corruption on this level leads to the creation of policies that create opportunities for rent seeking for the governmental ofWicials and public spending[s] [are] diverted to those sectors where gains from corruption [for the governmental ofWicial] are greatest and where the discretional nature of the procedures reduces the risks involved (Portella/Vannucci 1993: 518). This kind of corruption, that leads to policy decisions that serve primarily the interest of some governmental ofWicial, has the most serious consequences for society because it leads to an inefWicient allocation of resources on a large scale, and thereby creates an incalculable welfare loss (cf. Jain 2001: 74). The second level is concerned with the legislative, and describes the extend, to which legislators can be inWluenced through corruption. Corruption takes place in form of legislators receiving payments, or favors from private agents in order to pass a legislation beneWicial to these agents. Wether these payments are legal or illegal depend on the legal framework of the given country. An often seen legal form of payments to a legislator to inWluence legislative outcomes are campaign contributions (cf. Rose-Ackerman 2001: 47). In democratic systems, legislators have to balance the gain from bribery and legislation that serves only the particular interests of those that paid the bribe, and the possible punishment of the voters, that can lead to a loss of ofWice in the next election. If legislators are believed to balance the gain from corruption and the risk of being reelected, when deciding on wether to be corrupt or not, it is obvious, that a system of election forgery encourages bribe taking of legislators. If 6

the legislator expects elections to be forged and therefor knows that his or her election does not actually depend on voters decision, he or she does not face the risk of losing the next election due to eventual corruption. Therefore a malfunctioning democracy reduces the disincentives of corruption (cf. Jain 2001: 86). The lowest level of political corruption involves bureaucrats and other public employees. This type of corruption describes bribery of public ofWicials for either providing a good, that would otherwise not be available, or to speed up the process of the provision of a good provided by the government. It also involves corruption in the judiciary, where bribes can lower either the costs or the chances of legal penalties (Jain 2001: 75). But what are the factors that foster corruption and which factors hinder it? 1.4. Causes and Deterrences of Corruption One factor, suggested to support a corrupt environment, is a comparably large public sector. The logic behind that assumption is straight forward. If it is government structures, that cause corruption, then the reduction of these structures leads to declining corruption. The instrument suggested to Wight corruption is therefore privatization (cf. Becker 1994). However this theory is not backed by empirical Windings. The scandinavian countries are just one example of countries with a strong public sector and very few corruption (cf. Lambsdorff 2006: 4). And also the suggested cure, privatization, has been shown to be less effective then the theory suggests, because it has been seen that many transition economies experienced massive corruption in the privatization programs themselves (Lambsdorff 2006: 5). A clearer correlation exists between political competition and corruption. The more competition exists within the political system, the fewer the opportunities for corruption. This holds for two reasons. First, if there exists competition between governmental ofWicials, as is usually the case in democracies, the discretionary power of the individual ofWicial is limited. The ofWicial has limited decision power because an agreement with other ofWicials is necessary to form a decision, and also deWinite promises can not be made, because chances are that at the end of a term the ofWicial is not reelected (cf. Montinola/Jackman 2002: 150). Second, if competition exists between government agencies that provide goods to private agents, the bargaining power of the client is strengthened. If two agencies offer complementary services, the private individual can choose to turn to the less corrupt agency (Montinola/Jackman 2002: 151). Therefore centralized and undemocratic systems are beneWicial for corruption. The economic cost-beneWit-analysis contributes to the solution of the corruption problem by providing insights on how corruption relates to public servants pay and the possible loss 7

from detection. The basic argument is, that the higher the salary, the chance of detection and the penalties, the lower the incentives for corruption. However, wages do not have to increase to levels, unrealizable for most developing countries. Caroline Van Rijckeghem and Beatrice Weder name factors that reduce corruption under an only modest increase in public servants wages. First of all, since the most bribes in the public sector are low, wages would only have to increase moderately. Second of all, it is not the absolute level of wages, that inWluences corruption, but the question wether wages are perceived as being fair. And last of all, if public service remuneration includes personal beneWits, such as reasonable pensions, health insurance, or opportunity for promotion, the incentives to risk being Wired because of corrupt behavior are reduced (cf. Van Rijkeghem/Weder 2002: 60f.). But also the structure of the economy inWluences the level of corruption in an country. One economic factor that has been made out to signiWicantly contribute to corruption is the availability of natural resources. If resource rents are easily appropriable by an established elite, they may trigger bribes and distort policies (Bulte/Damania 2008: 3). The reason is, that resources increase the payoff of rent-seeking behavior because the extraction and sale of natural resources produce large rents (cf. Bulte/Damania 2008: 3). Whoever owns the right to extract and sell the resources has the opportunity to earn this rent. Since initially this right usually lies with the government, it offers public servants huge discretionary opportunities to allow or deny access to the resource economy. This model was empirically conWirmed by Sambit Bhattacharyya and Roland Hodler in a study of 124 countries. They found out that natural resources feed corruption, however they do not, if the country had well developed democratic institutions at the point of the discovering of the resources (cf. Bhattacharyya/ Hodler 2010: 619), as was the case in Norway.

2. The Case of the Russian Federation

2.1. Empirical Data on Corruption in the Russian Federation There has been a lot of scientiWic attention on corruption in the Russian Federation. The main reason for this attention is, that the Russian Federation is a member of the G20 (the 20 economically most powerful countries) and ranks the country with the ninth highest gross domestic product (GDP) in the World (cf. OECD 2011: 23f.). But at the same time it is the by far most corrupt country among the G20, with rank 133 out of 176 countries in Transparency Internationals Corruption Perception Index (cf. Transparency International 2012: 4). But even though studies that asses the inWluence of corruption in Russia on economic, political, 8

and social development are numerous, studies that actually tried to quantify corruption in russia are few. The most elaborate of these studies has been carried out by the Russian non- governmental INDEM Foundation.3 The study by the INDEM Foundation was carried out in 2005 and included some data from a 2001 study. Its main Winding was that corruption was very common both in 2001 and in 2005, but the structure of the corruption market had changed between 2001 and 2005. It was characterized by a mutual readiness to bribe and take bribes in 2001, but this mutual agreement on corruption was not found in 2005. By then, a higher percentage of respondents was willing to refuse paying bribes, but at the same time the pressure from authorities to pay bribes had increased, and so had the average bribe amount. The report puts it as follows: In general we have to deal with two opposite behavior strategies: the authorities build up its pressure towards citizens and the citizens avoid corruption. If previously one could argue that corruption process may be caused by both parties, nowadays this given suggestion just con1licts with any facts available (INDEM 2005). Table 1 summarizes the main Windings of the study. The study estimates the overall volume of the every day corruption market at about three billion US-Dollar and the business corruption market at about 300 billion US-Dollar (cf. INDEM 2005). This result means, that in 2005 the total amount of bribes paid by businesses, exceeded the ofWicial federal budget revenues by more than two and a half times. This is an alarming result recalling the model from chapter one: Bribes have the same inWluence on the economy as corruption, but do not contribute to the state budget, and therefore bribes can be regarded as missed government revenues and thereby lead to a smaller state budget. That on the other hand decreases the capacity to act of the government and also leads to distributional problems. The fact that corruption is seen as a major problem by the russian citizens is reWlected in the 133rd rank in the Corruption Perception Index (CPI) of Transparency International. A survey of the most important russian opinion research institute, Levada, comes to a similar but more detailed result on perception of corruption. In their yearbook of opinion polls from 2012, they present numbers on how corruption is perceived in Russia today. The main results are that 90 percent of respondents see corruption as being worse today then a decade ago (see Table 2). The same percentage of respondents stated that they believe that governmental ofWicials and leading bureaucrats make only a small part of their actual income public (see Table 3) and
3 INDEM stands for Information Science for Democracy. It is a nongovernmental organization that was

established in 1997 with the aim to contribute to the development of democratic institutions in the Russian Federation. Its main Iield of work however has become research on corruption.

Table 1: Everyday corruption market in the Russian Federation (2001/2005)

Problem Corruption risk (in percent) 2001 Free medical service School: to enter required school and Ainish successfully Higher education: enter, transfer another one, exams etc. Pensions: paperwork calculations etc. Social payments: paperwork calculations etc. Solving problems related to the conscription procedure Employment: to get a desired job or career development Land area: to obtain territory etc. Dwelling: to obtain and/or legalize a relevant proprietary interest To get dwelling maintenance & repair work services To obtain justice in law-court to get assistance from the military To get registration, domestic or foreign passport To solve problems with road police authorities 23,5 13,2 36,0 11,3 16,2 32,6 24,6 14,9 28,9 32,2 26,2 27,4 19,7 59,3 2005 37,7 41,0 52,1 11,4 19,8 57,7 29,2 39,8 34,3 29,5 39,5 40,2 32,7 59,6 Readiness to bribe (in percent) 2001 80,4 76,2 66,7 50,0 47,4 50,0 80,0 75,0 75,6 60,5 59,4 77,3 76,0 86,0 2005 62,0 60,8 63,2 17,1 30,6 63,4 35,0 51,1 41,9 31,6 43,6 54,7 48,9 68,9 corruption market Total market share Average bribe volume (million US$) of corruption market Amount (in Rubles) 2001 602,41 70,10 449,37 0,29 6,62 12,66 56,16 20,09 123,02 22,67 274,48 29,95 65,84 368,38 2005 401,1 92,4 583,4 7,9 80,3 353,6 143,4 84,4 298,6 15,6 209,5 29,6 87,7 183,3 2001 28,7 % 3,3 % 21,4 % 0,01 % 0,3 % 0,6 % 2,7 % 1,0 % 5,9 % 1,1 % 13,1 % 1,4 % 3,1 % 17,5 % 2005 14,8 % 3,4 % 21,5 % 0,3 % 3,0 % 13,0 % 5,3 % 3,1 % 11,0 % 0,6 % 7,7 % 1,1 % 3,2 % 6,8 % 2001 1093 1238 4305 50 250 3250 963 2000 2529 292 13964 1715 664 896 2005 1423 2312 3869 2250 3467 15409 2448 3713 5548 400 9570 930 1426 920 Average No. of bribes per year per person 2001 1,098 2,213 0,820 0,669 1,065 1,010 0,950 0,655 0,848 0,771 0,681 1,787 1,107 1,089 2005 0,847 0,950 0,875 0,339 0,657 0,650 1,053 0,698 0,809 0,954 0,672 0,809 1,030 1,120

(own table. source: INDEM 2005)


Table 2: How do you think, did corruption and theft in the administration develop within the past 10 to 12 years?
It increased It staid the same It decreased No answer 41 43 9 7

Table 3: In your opinion, how much of their income do governmental ofIicials and leading bureaucrats make public with their annual declaration?
All of it The larger part of it The smaller part of it Only very few of it No answer 2 13 38 32 15

(source: Levada 2012: 144)

(source: Levada 2012: 144)

Table 4: How do Russians view the governments attitude towards corruption?

Questions\Answers In your opinion, do government ofAicials and leading bureaucrats have a foreign bank account? In your opinion, is corruption an unavoidable occurrence in a coutry where the public does not control those in power, where are no honest elections, free press, and real political competition? In your opinion, does the present-day administration in its striving for power only rely on people, faithful to it and in return closes its eyes on their crimes and allows them unlawful practices to enrich themselves? In your opinion, is the present-day campaign against corruption only carried out to draw attention away from real economic problems, and the incapability of the Putin- administration to fulAill the promises, made before the elections? In your opinion, is the present-day campaign against corruption only designed to increase the trust in Vladimir Putin and keep him free of charges of establishing a corrupt regime in Russia? In your opinion, will Vladimir Putin keep his promise, made before the elections, of reducing corruption by two to three times at minimum within the next six years? yes 70 33 rather yes 24 44 rather no 2 12 no 1 2 no answer 3 9









22 6

38 30

21 36

5 14

14 15

(own table. source: Levada 2012: 144, 145)


almost 100 percent of respondents believe, that these ofWicials and bureaucrats have accounts in foreign banks (cf. Levada 2012: 144). The survey also shows a very paradoxical view of the population on governments attitude towards corruption. While a vast majority states that in their view corruption and nepotism is common practice among government ofWicials and that the campaign against corruption is merely an effort to draw attention away from pressing problems and increase the popularity of Vladimir Putin, they also believe that Putin at least tries to Wight corruption and 25 percent even believes in his success (cf. Levada 2012: 145). Tables 4 summarize the Windings of the Levada survey. Another interesting insight on corruption in Russia was discovered by the OECD. They regressed the Transparency International CPI against per capita GDP and share of petroleum in total exports for various countries. Both regressions showed a signiWicant relationship. Both regressions also showed, that corruption in Russia is considerably high, compared to other countries with similar per capita GDP or similar shares of petroleum in exports (cf. OECD 2011: 66f.). The following Wigures from the OECD illustrate the results. They support the statement of James Leach, that Russia is more corrupt, than comparable countries.


Even though these empirical analysis are mostly concerned with corruption at the level of government employees, is does not mean, that high level corruption does not exist. The problem with high level corruption is, that it is harder to measure. But the large amount of bribes, paid by businesses, suggest that corruption at the highest levels takes place. Also Elena Denisova-Schmidt notes, that approximately 80% of all administrative positions are held by people, that have some kind of personal relationship with Vladimir Putin. That includes coworkers from the time when he worked with the KGB, political allies from his time in St. Petersburg, such as Dmitry Medvedev, members of the cooperative Ozero (the society established by Putin and his friends who owned cottages near St. Petersburg), and off course family members and close friends of Putins people (cf. Denisova-Schmidt 2012: 5). This alarming percentage is a graphical example of the predominance of nepotism, and oriented on personal beneWits behavior in the Russian political elite. The following subsection is concerned with the consequences of the corruption for the Russian economy and society. 2.2. Consequences of Corruption for the Russian Society and Economy The OECD summarizes the negative consequences Russia suffers from corruption as follows: Currently, investment is hindered by widespread corruption and a weak and inconsistent application of the rule of law. That slows down the modernisation process, and also leaves Russia with a more energy-intensive economy than otherwise. Corruption also in1lates the cost of public procurement, reducing the effectiveness of government spending and, other things being equal, worsening the 1iscal balance (OECD 2011: 20). Michael P. Barry used a computable general equilibrium (CGE) model 4 to calculate the economic costs of corruption in the Russian Federation. According to the basic model of corruption without theft, he models the burden imposed on the economy by corruption as a Wive percent tax. This is a rather modest burden compared to the amount of corruption presented in the previous subsection. Barry comes to the result, that corruption in Russia decreases GDP by approximately two billion US-Dollar and reduces consumer welfare by 2.4 billion US-Dollar (cf. Barry 2009: .397). He splits up the welfare effect into three parts to make the effect more clear. The welfare loss consists of a $2.98 billion allocation efWiciency loss and a $3.6 billion loss in Russian terms of trade. These losses are partially offset by a gain in savings and investment efWiciency, because the recipients of bribes have extra funds available

4 CGE modeling techniques attempt to summarize all economic markets (supply curves and demand curves) in a

large, integrated system of simultaneous equations. All micro markets are aggregated into a macro system, which allows for discussion of economy-wide variables, such as national price level, national output, total factor productivity, sectoral output, and sectoral trade (Barry 2009: 394).


for investment, savings, and consumption. But this positive effect can not fully compensate the negative effects of corruption (cf. Barry 2009: 397). By examining the structure of gains and losses due to corruption, the strongest impact is seen on investments. The decrease by approximately 40% in comparison to a situation without corruption (cf. Barry 2009: 398f.). In a study on bank lending and corruption, Laurent Weill found a signiWicant negative inWluence of corruption on both investment and bank lending. Corruption was found to diminish investments signiWicantly. It adds to the uncertainty of investors and banks and this uncertainty is passed on to the receiver of loans in form of increased interest rates. Thus making investment more costly and therefore less attractive (cf. Weill 2011: 241) The reason, investment is hampered by corruption is that legal institution usually protect investments and ensure the enforcement of contracts (cf. Weill 2011: 233). Corruption, an underdeveloped rule of law and unclear property rights all add to uncertainty for the investor and therefore reduce incentives to invest. Reduced investment on the other hand slows down the development of the Russian economy. Another serious consequence of corruption on public welfare is its impact on social expenditures. Yuriy Timofeyev found out, that corruption signiWicantly diminishes the efWiciency of public expenditures and thereby the ability of the state to reduce poverty (cf. Timofeyev 2011: 48). The reason is, that in most transition countries, social expenditure are the main contributors to poverty reduction. Because of corruption the tax incidence is decreased in Russia and thereby the funds for social expenditures, or in other words the sum that can be redistributed through government programs is deminished (cf. Timofeyev 2011: 45ff.). 2.3. Reasons for the Corruption in the Russian Federation In an article from 2009, then president Dmitry Medvedev named some of the reasons he believed to be responsible for corruption in Russia: Until today this corrosion has been due to the excessive government presence in many signi1icant aspects of economic and other social activities. But it is not limited to governmental excess -- business is also not without fault. Many entrepreneurs are not worried about 1inding talented inventors, introducing unique technologies, creating and marketing new products, but rather with bribing of1icials for the sake of controlling the 1lows of property redistribution (Medvedev 2009). By naming government involvement in the economy, and businesses investing in bribery rather than in research and development, he shows a profound understanding of the logics 14

and dynamics of corruption, since both factors have been made out both by theoretical and empirical economic literature on corruption.5 The key reason for corruption, presented in the Wirst chapter, is the opportunity for rent- seeking. Situations that allow for the generation of a rent facilitate the spreading and prevailing of corruption. A factor that allows for rent-seeking on a large scale in Russia is the heavy reliance on natural resources of the Russian economy. Not only is this situation given, but it is also getting worse, because the resource sectors is growing relative to the rest of the Russian economy: one key aspect of the opportunity for corruption, the availability of natural resource rents, has expanded sharply in the last dozen years (OECD 2011: 13). This might be one reason, why corruption has rather been increasing than decreasing over the past decade. Another reason for corruption has been identiWied by Veronika Belousova and her co-authors. In a study, using data from different Russian regions, they found out, that the economic more prosperous regions of the Russian Federation witnessed signiWicantly less corruption, than less prosperous regions. The reason is most likely, that these regions have better anti- corruption measures and also that economically successful individuals are less likely to engage in illegal corruption (cf. Belousova et al. 2011: 11). Because the Russian economy is considerably weak in general and especially weak in almost every sector other than the oil- and gas sector, it is reasonable to assume, that the economic underdevelopment contributes to the prevailing of corruption in Russia. Reasons for corruption in different parts of the Russian society and economy are easily explained. The main reason for the widespread corruption in the education sector for example is the low wages of teachers and professors. Russia spends the second lowest percentage of GDP of all OECD countries on education, only Turkey being worse (cf. OECD 2011: 38). Reasons for the large sums of bribes paid by businesses, by far the biggest share of the overall corruption market, as has been shown in subsection 2.1., are twofold. The OECD names complex and hard-to-comply-with regulations and the need to stay competitive with other Wirms that pay bribes, the most important factors (cf. OECD 2011: 65). One last important reason for the widespread corruption in Russia lies within the institutional structure and history of the country. Two factors have been made out in the Wirst chapter to be obstructive to the development of a corrupt environment: well deWined property rights and a strict rule of law. Neither can be found in contemporary Russia. Constanze Dobler and Harald Hagemann even claim that Russia lacks a history of property rights and the rule of law. The
5 See previous chapters and subsections.


reason is that secure property rights and the rule of law necessitate a third party enforcement mechanism able to implement the rights against private persons or the state (Dobler/Hagemann 2011: 23). In Russia however law has always been used by the government as an instrument that could be used against the citizens. Since people could not rely on the government or the law, to achieve certain goals, but had to trust personal relationships and networks. As a consequence a system of corruption, bribery, and nepotism evolved (cf. Dobler/Hagemann 2011: 23). It is therefore unlikely that corruption can be reduced, unless the Russian government breaks with the tradition of using the law as an instrument of the ruling power. This leads over to the question, of what can be done to effectively battle corruption in Russia. 2.4. How to Battle Corruption in the Russian Federation First steps in Wighting corruption in Russia have already been taken. The government started by approving international rules, such as the UN Convention against Corruption in 2006, and the OECD Convention on Combating Bribery of Foreign Public OfWicials in international Business Transactions in 2011 (cf. Denisova-Schmidt 2012: 13). Also in 2008 a National Anti- Corruption Plan has been adopted. It is aimed at reducing corruption in the legal system. The most important steps, that are to be taken according to the plan are the increasing the judicial pay, the introduction of new, more transparent, procedures for appointing judges, the establishing of new mechanisms for punishing judicial malfeasance, and also to bring courts under federal jurisdiction to reduce their dependence on regional authorities (cf. OECD 2011: 44). If carried out, most of those steps are likely to improve the situation in the judicial system, although success of the last measure is highly doubtful. Reduced independence of regional authorities, but increased dependence on federal authorities, that are also known to pressure the courts, may just be substituting one evil by another. Strictly speaking, it is economically not optimal to fully eliminate corruption. The costs would be prohibitively high because it would for example require very high wages for public servants, major changes in the legal system and very harsh penalties. Theoretically, the optimal level of corruption would be reached, when the marginal costs of further reduction equal the marginal social beneWits from that reduction (cf. Tanzi 1998: 586). That also explains, why there exists no country on earth without any corruption. But the Russian Federation is far from the point, where marginal social beneWits equal the marginal costs of reducing corruption. Therefore real efforts have to be made to reduce corruption.


Belousova et al. recommend, in accordance with their Windings, policies that are aimed at economic development. The following economic prosperity would then lead to declining corruption (cf. Belousova et al. 2011: 16). Economic growth however can only be achieved, if the investment climate in the Russian Federation is improved. The reasons for the grim investment climate, presented in the previous subsection, are weakly deWined property rights and a unreliable judiciary system and unclear legal circumstances. The main problem obstructing the solution of this problem is the lack of political will. Supposed this will existed, the problem could relatively easy be stemmed with some policy reforms. The need for the solution of this problem is beautifully illustrated in the following interview: The interviewer: Let us assume that corruption is not at present in our society. The expert: With the current laws? The interviewer: Yes. The expert: If the existing laws were fully obeyed, it would be a catastrophe. It would mean that society would stop in its development, the economy would collapse (Cheloukhine/ King 2007: 112) Dobler and Hagemann however present a rather fatalistic view concerning the possibility of improving the rule of law and the security of property rights in Russia. In their opinion, the necessity of corruption and bribery lies within the character of the Russian political system with the patriarch as the head of state (Dobler/Hagemann 2011: 27), and real political reforms are unlikely to happen in the near future, because they would unavoidably lead to a weakening of the central power. One policy measure to battle corruption, suggested by the literature, is privatization. If governmental ofWicials and bureaucrats are known to be corrupt, the idea is to limit the rent seeking opportunities for them by reducing the size of the state sector. The efWiciency of this measure is doubted by Belousova et al. which have found no correlation between the degree of privatization and actual and perceived corruption in different Russian regions (cf. Belousova et al. 2011: 14). Johann Graf Lambsdorff comes to the same conclusion, that downsizing the public sector does not help to reduce corruption, at least not during the transition period (Lambsdorff 2006: 5). One example may serve as illustration, why this policy measure is so susceptible to corruption itself, that it does not help. The Russian program loans for shares, carried out in the mid-1990s, had the aim to improve the public budget by lending shares of large state owned companies to private bidders. If the state would not repay those bidders, the shares would they with them and could been sold for proWit, what 17

was in the end exactly what happened (cf. Treisman 2010: 2.). The practice of the auction however looked as follows: On November 3, 1995, in the remote Siberian town of Surgut, an auction took place for the right to lend the cash-strapped Russian government tens of millions of dollars. Collateral for the loan was to be a 40 percent stake in the countrys 1ifth largest oil company, Surgutneftegaz. Two bidders made it into the auction room; a third had been barred because of problems with the 1irms paperwork. Had any others planned to 1ly out from Moscow to take part, they would have had trouble: the local airport mysteriously chose to close that day. When, late in the evening, the participants emerged, the winner turned out to be Surgutneftegazs own pension fund. (Treisman 2010: 1) This example is symptomatically for how privatization often looked like throughout the history of economic transition in post-soviet Russia. It illustrates, why privatization neither reduces corruption nor leads to an increase in welfare, and should therefore implemented very cautious, if at all.

It has been shown, that corruption has a number of negative effects on public welfare. These are conveniently summarized by Yuriy Timofeyev: Corruption slows down economic growth and increases the gab between the rich and the poor. It also skews the incentive structure, with adverse consequences on the poor by depriving them of income generation opportunities [...] Finally, corruption can affect the targeting of social programs to the truly needy because funds are siphoned off from poverty programs by well-connected people in the public and private sector (Timofeyev 2011: 39). All of these problems as well as the explanations of why they exist have been presented in this paper. The theoretic and empirical background offers suggestions which circumstances foster and which deter the development of a corrupt system. The analysis of the Russian case has shown, that almost all factors, beneWicial to corruption are found in Russia. It comes therefore at no surprise, that Russia is one of the most corrupt countries on earth, and most likely the most corrupt country of its economic and geo-political importance. Nevertheless there exists hope for improvement. The problem of corruption has been acknowledged the political elite and even been ofWicially one of the main goals of the 18

presidency of Dmitry Medvedev. But so far few more than declarations on the battle of corruption has been made by the government. Combining this fact with the observed development of corruption in Russia in the past decade, one has to agree with the fatalistic conclusion of Dobler and Hagemann, that a reduction of corruption will take place under the given political system. This also means, that the approach of economic modernization without political modernization, chosen by the Russian political elite, is not feasible. In the face of the pressing negative consequences of corruption for the Russian society and economy, it is doubtful how long the momentous stability is Russia will hold. First signs of a destabilization of society can already be witnessed in Russia as more and more people are openly calling for political reform. Also the survey by the Levada centre has shown a changing attitude of the public towards corruption. With respect to the welfare of the Russian public a soon change in the development of corruption in Russia is desirable, if not absolutely necessary.


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