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Candidate Number | 40801

What is the Impact of Corruption on Economic Development in the Newly


Industrialised Countries of South East Asia?

Political Corruption | L204


Abstract
Corruption, a previously neglected issue, became one of the greatest preoccupations
of Western powers trying to bring stability and prosperity to global markets. This
essay seeks to establish the relationship between corruption and development. The
focus of this paper will be the South East Asian Newly Industrialised Countries
(NICs). I suggest that whilst it is difficult to ascertain the exact impact of corruption
on development, in the absence of corruption, even greater and more sustained levels
of development can flourish. I argue that despite arguments to the contrary, all
corruption is inimical to the process of sustainable development. I suggest that the
impact of corruption on development is clearly discernable though examination of the
Asian Financial Crisis of 1997. This event demonstrated that whilst development and
corruption can coexist, corruption creates unsustainable inefficiencies and inherent
weakness in the economy for the long term.
Candidate Number | 40801

Table of Contents

Introduction__________________________________________________________4

Perspectives on Corruption______________________________________________6

Corruption and Development____________________________________________7

Influencing Government______________________________________________7

Predictability_______________________________________________________8

Innovation_________________________________________________________9

Competition & Efficiency____________________________________________11

Government Policy_________________________________________________12

Methodology_________________________________________________________14

The Asian Miracle and Corruption_______________________________________15

The Paradox of Corruption and Growth_______________________________15

Tangible Costs of Corruption_________________________________________17

Intangible Costs of Corruption_______________________________________18

Uneven Impact of Corruption and Development_________________________19

The Asian Financial Crisis_____________________________________________22

Crony Capitalism__________________________________________________22

Unveiling the Impact of Corruption___________________________________24

Conclusions_________________________________________________________26

Bibliography_________________________________________________________28

Books____________________________________________________________28

Journals__________________________________________________________28

Online Sources_____________________________________________________29

Other_____________________________________________________________30

Appendices__________________________________________________________31

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Appendix I - Social Indicators are Worse Where Corruption is High________31

Appendix II - Tax Revenue is Lower in more Corrupt Countries___________32

Appendix III: The Impact of the Financial Crisis on Financial Markets_____33

Appendix IV: Economic Indicators of East Asia_________________________34

Introduction

The post Cold War, globalized era of the 1990s saw a renewed interest in corruption
and its impact. Corruption, a previously neglected issue, became one of the greatest
preoccupations of Western powers trying to bring stability and prosperity to global
markets. But is the pursuit of an anti-corruption agenda really conducive to
development? Corruption has always existed, in all societies and at all stages of
development. The dominant discourse suggests that systemic corruption is a major
impediment to sustainable economic development yet despite extensive normative
discussion on the merits of the absence of corruption, little academic discussion based
on empirical evidence demonstrates the validity of this argument.

This paper seeks to establish the relationship between corruption and development.
The focus of this discussion will be the South East Asian newly industrialised
countries (NICs). NICs are countries exhibiting considerable industrialisation having
switched from agriculture to industrial production. South East Asian economies,
including South Korea, Taiwan, Hong Kong and Singapore, achieved exponential
growth from the 1960s to the late 1990s when the Asian financial crisis took effect.
The transformation from poverty to affluence was widely heralded as the success of
capitalism over communism and a demonstration of the success of liberal, free market
principles. However, while the governments were ostensibly laissez-faire, in practice
they were quite active in their economies. It is within this context that the study of
corruption in NICs is so fascinating. Despite bureaucracy within the market and
widespread corruption, remarkable economic development prevailed. What remains
unclear is to whether this was because of or in spite of corruption. Can some corrupt
activities actually be beneficial to rapid development?

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In only focussing on economic development, just one facet of the multi-faceted issue
of development, is addressed. The reason for this focus is for reasons of brevity and
that unlike aspects such as political or social development for which improvements or
otherwise is harder to prove, economic development is more quantifiable. A holistic
approach to development may yield different results and whilst recognising the
importance of political and social aspects, economic development yields the clearest
indicators for development. Hereafter economic development is shortened to,
development although this is not meant as an all encompassing term to describe all
aspects of development.

Beginning with an analysis of the academic perspectives on corruption, this paper


investigates South East Asian NICs to establish the impact of corruption on economic
development. These countries have been chosen as they have to a great extent
completed the industrialisation process and thus the impact of corruption is more
readily and clearly identifiable. Extensive reports of corruption in these countries
make them well suited to investigation. I argue that corruption acts as a brake to
development and that in the absence of corruption, even greater and sustained levels
of development can occur. Additionally, I argue that all corruption is inimical to the
process of sustainable development and suggest the Asian Financial Crisis is proof of
this.

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Perspectives on Corruption

It is prudent to establish what we understand by the term corruption. There are


various definitions and understandings as to what exactly constitutes corruption. The
definition most frequently used by social scientists is Nyes, that corruption is:
behaviour which deviates from the normal duties of a public role because of private-
regarding (family, close private clique), pecuniary or status gains; or violates rules
against the exercise of certain types of private-regarding influence. This includes such
behaviour as bribery (use of rewards to pervert the judgment of a person in a position
of trust); nepotism (bestowal of patronage by reason of ascriptive relationship rather
than merit); and misappropriation (illegal appropriation of public resources for
private-regarding uses)1 This can be simplified to a general definition that will be
used for the purposes of this paper: the abuse of public office for private gain.

Although defining corruption in this way is convenient, it should not be considered a


rigid framework for ruling what should or should not be considered corrupt. Different
nations and cultures have differing conceptions of corruption; legally, in terms of
public interest, and in public opinion. Furthermore, certain corrupt exchanges such
as clientelism and gift giving may be engrained within the culture of the society and
so are not considered by those involved, to be corrupt. As Gardiner notes, There are
nations where official corruption has been widespread for many years with no visible
signs of public outrage.2 The reason for this may be, as the analysis on the benefits of
corruption reveals, there are instances when corrupt activities seem to be beneficial
to development.

Perspectives on the costs and benefits of corruption can divided into those that
perceive the benefits of corruption to be positive for development, and those that
regard it as inimical to the development. Although among recent literature there is
consensus that Leffs arguments lauding the benefits are flawed, an understanding of
1
Nye, J. Corruption and Political Development: A Cost Benefit Analysis, The
American Political Science Review, 61:2, 1967, p.419 (The second part of this
definition is taken from Banfield, E. Political Influence, Glencoe III: Free Press,
1961, p.315)
2
Gardiner, J. Defining Corruption, in Political Corruption: Concepts and
Contexts, Eds. Heidenheimer A. & Johnson, M. (Transaction Publishers, 2002)
p.38

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his rationale in asserting that corruption can be beneficial to development is valuable


if only to juxtapose against opposing arguments.

Corruption and Development

Influencing Government
Leff argues that corruption is an extralegal institution used by interest groups to gain
influence over the actions of the bureaucracy to an extent that would not otherwise be
possible. This he suggests can be beneficial to development if business groups that
would otherwise be at a disadvantage in articulating their interests to the government
get an opportunity to do so. If these groups are more likely to promote growth than
the government, an enhanced position in policy making could, he suggests, be
beneficial to development. He outlines instances where this may be the case; the
government and bureaucracy may simply be indifferent to the desires of entrepreneurs
wanting to initiate or carry on economic activities. 3 The reasons for this may be the
governments dislike for a competing centre of power or that they do not attribute
much value to economic activity. Leff also suggests that governments may have other
priorities rather than the pursuit of economic development such as the consolidation
of armed forces. These are priorities which can impede development. He suggests
bribery can activate the bureaucracy to get things done which otherwise would not
take place; it can induce the government to take a more favourable view of
activities that would further economic growth [and] provide the direct incentive to
mobilize bureaucracy for more energetic action on behalf of entrepreneurs. 4 If this
were true, and operated under a perfect competition model then there may be benefits
to development.

Mauro disputes these claims, noting how in this corrupt system, the sale of
government contracts or policy through bribery means that the highest bidder always
wins: The allocation of public procurement contracts through a corrupt system may

3
Leff, N. Economic Development Through Bureaucratic Corruption, in Political
Corruption: Concepts and Contexts, Eds. Heidenheimer A. & Johnson, M.
(Transaction Publishers, 2002) p.312
4
Leff, N. Economic Development Through Bureaucratic Corruption, in Political
Corruption: Concepts and Contexts, Eds. Heidenheimer A. & Johnson, M.
(Transaction Publishers, 2002) pp.312-313

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lead to a lower quality of public infrastructure and services. 5 Rather than choosing
contractors by merit and the best potential outcome, corrupt bureaucrats could harm
development by awarding contracts which result in substandard outcomes. In this
instance the impact of corruption is a clear failure to achieve government objectives;
instead producing inefficiency and waste. With bureaucrats being buyable, they are
most likely to seek out the highest rent-seeking opportunities; Corrupt government
officials may be more likely to choose to undertake types of government expenditure
that allow them to collect bribes and to maintain them a secret.6 Rather than seeking
projects which would genuinely contribute to development, bureaucrats will look to
find large projects where money can easily be siphoned off.

If corruption takes the form of a kickback, the total amount available for public
purposes is reduced. Corruption is sometimes compared in this way to a tax on
investments and business. However, Shleifer and Vishny note that because of the need
to maintain secrecy, corruption causes a greater distortion in economic activity than
taxation. For example, dishonest government officials may favour promoting
government activities, where bribery is most easily concealed. They suggest; the
demands of secrecy can shift a countrys investments away from the highest value
projects, such as health and education into potentially useless projects such as defence
and infrastructure, if the latter offer better opportunities for secret corruption. 7 Not
only are total funds available for public use diminished but they are spent on projects
which are not necessarily best for development.

Predictability
Investments in developing countries can be particularly risky due to the
unpredictability of the political and economic conditions. The extensive role of the
government in the economy means arbitrary decision making can be problematic for

5
Mauro, P. The Effects of Corruption on Growth and Public Expenditure, in
Political Corruption: Concepts and Contexts, Eds. Heidenheimer A. & Johnson,
M. (Transaction Publishers, 2002) p.343
6
Mauro, P. The Effects of Corruption on Growth and Public Expenditure, in
Political Corruption: Concepts and Contexts, Eds. Heidenheimer A. & Johnson,
M. (Transaction Publishers, 2002) p.343
7
Shleifer, A.& Vishny, R. Corruption, The Quarterly Journal of Economics,
108:3, p.616

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business for which maintaining consistency and judging long term economic trends is
important. In this situation, securing predictability for their investment, Leff suggests,
creates a more attractive environment for investment; Corruption can help economic
development by making possible a higher rate of investment than would otherwise be
the case. By bribing officials to maintain certain political conditions, the success of
an otherwise risky investment can be secured as there is a much more assured return
on investment.

However, Mauro has demonstrated through empirical evidence that high levels of
corruption are associated with lower levels of investment and GDP. In a corrupt
environment, entrepreneurs are aware that bribes are required to ensure the release of
required documentation needed to begin business and are consequently discouraged
from investing. Additionally, a percentage of returns on the new enterprise may be
claimed. It is for this reason that Mauro suggests corruption may be interpreted to
act as a taxwhich correspondingly reduces incentives to invest. 8 Empirical
evidence shows low levels of corruption correspond to greater levels of investment;
a one standard deviation improvement in corruption indices drawn from the
Business International causes investment to rise by five percent of GDP and the
annual per capita GDP growth rate to rise by half a percentage point. 9 Although
establishing what constitutes higher and lower levels of corruption is problematic,
this link, supported by the work of Keefer and Knack indicates that there is an
unambiguous link between corruption and levels of investment, GDP and thus
development.10 Businesses want secure investments but adding corrupt rent-seeking
bureaucracy may not be effective in securing the political conditions; investors would
simply prefer a non-corrupt environment in which to invest.

8
Mauro, P. The Effects of Corruption on Growth and Public Expenditure, in
Political Corruption: Concepts and Contexts, Eds. Heidenheimer A. & Johnson,
M. (Transaction Publishers, 2002) p.342
9
Mauro, P. The Effects of Corruption on Growth and Public Expenditure, in
Political Corruption: Concepts and Contexts, Eds. Heidenheimer A. & Johnson,
M. (Transaction Publishers, 2002) p.342
10
For more on this see Keefer P. & Knack S., Institutions and Economic
Performance: Cross-Country tests using Alternative Institutional Measures,
Economics and Politics, 1995, 7:3, pp. 207-227

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Innovation
In an undeveloped society, potential entrepreneurs may be discouraged from investing
and innovating due to the barriers of entry created by existing products and processes.
In this situation, Leff suggests, graft may enable an economic innovator to
introduce his innovations before he has had time to establish himself politically. Leff
suggests that because of bureaucrats existing economic interests, innovators may be
regarded with indifference or even hostility. In this environment, bribery could
provide innovators an opportunity to obtain elusive government licenses and permits.
Furthermore, facilitation payments may allow businesses to bypass unnecessarily
cumbersome delays. Leff also suggests that corruption may increase investment by
reducing the risk that a fickle government may, in the future, intervene harmfully in
an innovator's project.

Whilst entrepreneurship is generally regarded as being innovative and beneficial to


development, in the case of, innovative rent-seeking this is not the case. Baumol
argues it is not always productive; it may even have a destructive impact on
economies where parasitical activities damage the economy.11 Corruption misallocates
potentially beneficial talent to corrupt activities and distorts investment priorities.
Where the informal, black market and corruption is more financially rewarding than
the formal economy, a brain drain effect could occur. Rather than highly talented and
educated individuals aiding development they will prevent potential development
from taking place.

Corruption invariably increases transaction costs and uncertainty in an economy while


lowering efficiency by forcing entrepreneurs to divert their scarce time and money to
bribery rather than production. As has been previously discussed, those paying the
highest bribes may be those with the best insider information and funding rather than
those who would most productive and reap the best rewards for development.
Furthermore, bribery increases business risk because of the uncertainty as to whether
government officials will actually provide the services for which they have been
bribed.

11
Baumol, W. Entrepreneurship: Productive, Unproductive and Destructive,
Journal of Political Economy 98:5, 1990, p.894

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Contrary to economists who argue the benefits of entrepreneurial corruption, Murphy


suggests that, rent seeking activities, particularly public rent-seeking by
government officials, is likely to hurt innovative activities 12 He notes that in order
to start a new enterprise, innovators often require government documentation and
licenses. Without an inside contact to expedite this process, they may be forced to pay
bribes to secure the paperwork required. This in turn increases the vulnerability to
long term bribery. Because innovators are outside the established system of bribery, it
is often not in the bureaucrats interest to enter into new corrupt transactions because
in doing so they increase their chances of being caught. Instead they may prefer to
charge their existing clients to bar innovators from entering the market. It is in this
way that oligarchies can maintain their power in the developing world and prevent
innovation which could aid development.

Competition & Efficiency


Some political scientists view corruption as being a, second best, or grease the
wheels solution, particularly in the inefficient, inept, and mismanaged bureaucracies
in developing countries. Huntington suggests, "in terms of economic growth, the
only thing worse than a society with a rigid, over-centralized dishonest bureaucracy is
one with a rigid, over centralized honest bureaucracy." 13 Those willing and able to
pay the highest bribes are likely to be those able to use it most productively.

Similarly, Leff contends that introducing competition into an otherwise uncompetitive


economy can be beneficial to development; corruption brings an element of
competition with its attendant pressure for efficiency to an underdeveloped
economy.14 By allocating contracts to the highest bidder, it ensures only those able to
pay the highest bribes, and thus the most efficient (because they have to muster capital
required) survive. Riley makes similar conclusions in a study of the impact of
corruption in developing countries - that corruption simply reflects misadministration
of government in general; a way to get around inefficient and cumbersome

12
Murphy, K. Shleifer, A. & Vishny, R. Why is Rent Seeking So Costly to
Growth? The American Economic Review, 83:2, 1993, p.409
13
Huntington, S. Political Order in Changing Societies, (Yale University Press,
1968) pp.498-499
14
Leff, N. Economic Development Through Bureaucratic Corruption, in Political
Corruption: Concepts and Contexts, Eds. Heidenheimer A. & Johnson, M.
(Transaction Publishers, 2002) p.314

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government bureaucracies.15 It is suggested that bribery can be an efficient way of


negotiating otherwise over regulated, cumbersome and ineffective legal systems.

However, there is little evidence to support these arguments. In response to the


argument for corruption being a grease which lubricates the squeaky wheels of a
bureaucratic and rigid administration, Gray and Kaufmann suggest inventing
bureaucracy to facilitate rent-seeking opportunities; fuels the growth of excessive
and discretionary regulations.16 Corruption leads to economic inefficiency and waste,
because of its effect on the allocation of funds, on production, and on consumption.
Gains obtained through corruption are unlikely to be reinvested within the country but
transferred to foreign bank accounts. These transfers represent a capital leakage from
the domestic economy. Furthermore, corruption generates inefficiency in allocation,
by permitting the least efficient contractor with the highest ability to bribe to be the
recipient of government contracts. In addition, since the cost of bribes is included in
the price of the goods produced, demand tends to be reduced, the structure of
production becomes biased, and consumption falls below efficiency levels.

Corruption encourages competition in bribery, rather than in quality and in the price
of goods and services. It inhibits the development of a healthy marketplace and
distorts economic and social development (see Appendix I). Moreover, evidence
shows that if corruption is not contained, it will grow exponentially. 17 Studies show
that: once a person is identified as willing to pay bribes, other gatekeepers appear to
be alerted, so that the person is delayed and subjected to additional forms of extortion
as he or she proceeds. Conversely, those who refuse to pay at the first gate are
earmarked as non-payers and therefore not worth the time and energy for others to try
to exploit.18

15
Riley, S. Public Office Corruption in West Africa: Political Culture, Context and
Control, (unpublished), 1987, as discussed in Defining Corruption, in Political
Corruption: Concepts and Contexts, Eds. Heidenheimer A. & Johnson, M.
(Transaction Publishers, 2002) p.37
16
Gray C. & Kaufmann, D. Corruption and Development, Finance and
Development, March 1998, p.8 available at
http://www.worldbank.org/wbi/governance/pdf/gray.pdf
17
Transparency International, TI Sourcebook, 2000, p.31
18
Exactly what these surveys are is unclear, they are mentioned in TI
Sourcebook, 2000, p.32

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Government Policy
Leff suggests that corruption can alleviate problems of bad government policy and
planning; Corruption performs the valuable function of a hedge and a safeguard
against the full loses of bad economic policy. 19 Through corrupt activities it is
possible to implement the opposite policy to the government. For example in the case
of export promotion versus import substitution whilst the government is pursuing
one avenue of policy, entrepreneurs can activate a parallel yet opposite policy to
ensure that all is not lost if the government are wrong in their policy decision.

If however, the government is in fact pursuing policy most conducive to development,


this is clearly problematic; a corrupt black market undermining government policy is
counter productive to the broader processes of development. Corruption reduces
opportunities for the government to control the economy and limits potential spending
a strong informal economy can have a crippling effect. A Mauro notes: Corruption
may also bring about loss of tax revenue when it takes the form of tax evasion. 20
Corruption reduces the transparency of economic transactions by both public and
private sector firms while undercutting the governments ability to raise capital.
Corruption can create fiscal weakness which in order to compensate for decreasing
tax revenue, may force an increase in rates of taxation on a diminishing number of
taxpayers thus reducing its ability to provide essential public goods and services (see
Appendix II).

Corruption weakens the State and its ability to promote development and social
justice. It is regressive in the sense that its costs and negative economic impact tend to
fall more heavily on small enterprises and an on individuals in a weak economic
position. The World Bank suggests: Corruption is a double jeopardy for the poor and
unprotected. They pay a high share of monopoly rents and bribes, while they are often
deprived of essential government services.21 It pushes firms into the black market,
which effectively reduces the states ability to raise capital and thus leads to ever-

19
Leff, N. Economic Development Through Bureaucratic Corruption, in Political
Corruption: Concepts and Contexts, Eds. Heidenheimer A. & Johnson, M.
(Transaction Publishers, 2002) p.314
20
Mauro, P. The Effects of Corruption on Growth and Public Expenditure, in
Political Corruption: Concepts and Contexts, Eds. Heidenheimer A. & Johnson,
M. (Transaction Publishers, 2002) p.343
21
http://www.worldbank.org/html/extdr/offrep/eap/pbsp101998.htm

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higher taxation on fewer and fewer taxpayers. This in turn reduces the states ability to
provide essential public goods, including the rule of law.22

Corruption undermines development by distorting the rule of law and weakening the
institutional foundation on which economic growth depends. The harmful effects of
corruption are especially severe on the poor, who are hardest hit by economic decline,
are most reliant on the provision of public services, and are least capable of paying the
extra costs associated with bribery, fraud, and the misappropriation of economic
privileges. Thus corruption can be seen to be one of the greatest enemies of
development.23

22
These objections have been amalgamated from a number of sources but largely
Gray C. & Kaufmann, D. Corruption and Development, Finance and
Development, March 1998, p.8 available at
http://www.worldbank.org/wbi/governance/pdf/gray.pdf
23
Ideas taken from
http://www1.worldbank.org/publicsector/anticorrupt/index.cfm

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Methodology

I hypothesise that all corruption, no matter what its form is inimical to long term and
sustainable development. Measuring specific impacts from corruption is difficult due
to the vary nature of corruption unless the corruption is brought into the public
domain, the exact impact of corruption cannot be known. In order to prove the
validity of my hypothesis I intend to investigate the economic development of South
East Asia to ascertain whether or not an explanation can be given for concurrent high
levels of corruption and development.

Rather than examining specific cases of development and corruption in countries, I


seek to explain the broader phenomena of the coexistence of development and
corruption in the region. The investigation will rely on secondary evidence from
journal articles and evidence from the internet. I will understand economic
development to be increases in a countrys real per capita income that affect broad
segments of the population and in which the productivity of resources is enhanced as
new stocks of resources are generated. 24 Although Transparency International now
offers the Corruption Perceptions Indicator (CPI) to measure the extent of perceptions
of corruption, in the period of phenomenal growth, there is no such data available.
Consequently, it will be assumed that the allegations of widespread and systemic
corruption are in fact true.

24
LeBel, P. Measuring Sustainable Economic Development in Africa,
http://alpha.montclair.edu/~lebelp/MeasuringEcSustainability.pdf

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The Asian Miracle and Corruption

The Asian Miracle raises questions for the modern view that corruption is inimical to
development. Evidence clearly shows that phenomenal rates of growth have occurred
in an in environment of high, even astronomical rates of corruption. The academic
response has been divided. Some believe it vindicates Leffs proposal that corruption
can be good - business with an emphasis on connections works as well, if not better
for development than a system based on openness, accountability and competitive
bidding. Others suggest that the Asian Miracle can be explained because systemic
corruption was not actually as bad as it is made out to be. The logic for this fits
modern analysis of corruption; systemic corruption is harmful to development and so
development within this environment is impossible. By examining the causes and
costs of corruption it will become apparent to what extent these perspectives on the
impact of corruption are true.

The Paradox of Corruption and Growth


The prevalence of informal networks, weak indigenous business, and a strong state
can explain the high levels of corruption that have co-existed with economic growth.
After the Second World War, the extensive role of the state in creating, and
augmenting markets, as well as controlling investment and the role of exports was
invaluable to their initial growth and success. The legitimacy of these managed and
fragile democracies was dependent on securing economic growth. Pei suggests that
the, emphasis on growth in East Asia had a political origin: authoritarian regimes
ruled in all high-performance East Asian economies maintaining high growth rates
was and is regarded as essential for building not just industrial economies, but the
political legitimacy of the ruling elites.25 Poor performance was typically concealed
by large government loans so that what appeared to be growth was often simply
recycled state capital.

Most of the governments owned and ran banking businesses and so corrupt finance
markets provided a way for many businesses to generate capital; Through the

25
Pei, M. Asias Political Lessons, China Business Review, September 1999,
available at http://www.chinabusinessreview.com/public/9909/pei.html

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operation of the black market mechanism, relevant officials obtain ill gotten gains
from the enterprises, while the enterprises themselves are provided special privileges
26
to make money. Businesses borrowed substantial sums of capital from the state
owned banks with low interest rates. Due to the ease and availability of these loans,
businesses tended to expand simply because they could and in so doing became
increasingly inefficient and vulnerable to problems in the face financial challenges.
Companies would reward officials who provided privileges (this could take various
forms but includes procurement of government finance, expediting paperwork and
overlooking anomalies) by providing a job for them within the company upon their
retirement from government. Due to the very nature of this bad finance, debtors were
simply unable to pay off their loans, increasing their vulnerability to financial crisis.

Xu suggests that corruption was an integral part of the way in which the economies
and markets functioned; Corruption is viewed as a kind of transaction cost, through
which enterprises can enjoy special privileges offered by the government. 27 The
corrupt finance enabled businesses to grow at a much faster rate than would otherwise
be possible. As Segal notes, Companies cut in a member or a friend of the elite, so
that business still got done, but at a vastly inflated cost. 28 These inflated costs
reduced the rate at which development could have progressed as well as creating an
underlying weakness in many businesses. Rather than expansion and success based on
results, it was through an unsustainable system of corruption.

The states role in controlling business, and largely suppressing labour and civil
society groups led to their strength and independence from outside interests. A weak
civil society compounded the corruption issue. Moran suggests that, Corruption
stemmed from interconnecting historical and structural factors. The strong state was
vital here but so also were weak social forces (particularly nascent entrepreneurial
groups) and traditions of patron-client networks of family, school, regional and other
ties.29 Government regulation, restrictions on foreign capital and competition, a

26
.Tzong-Shiang Y & Xu, D. Eds. From Crisis to Recovery: East Asia Rising
Again? (World Scientific Publishing, 2001) p.17
27
Tzong-Shiang Y & Xu, D. Eds. From Crisis to Recovery: East Asia Rising
Again? (World Scientific Publishing, 2001) p.17
28
Segal, P. Corruption, Impact, 1999, 3:2, p.5
29
Moran, J. Corruption and NIC Development: A Case Study of South Korea,
Crime Law and Social Change, 29, 1998, p.163

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concentration of power in family-owned business groups with close ties to


government, and closed financial systems contributed to growth but paradoxically,
also contributed to a steady weakening of the South East Asian economies.

Finally, in contrast to the rule based capitalism prevalent in developed Western


countries, Sing suggests the most suitable label for East Asian economies is relation-
based capitalism, a system characterised by personal and implicit agreements and
governed by second-party enforcement - based on a mutual trust between the
transaction parties.30 Where the market is small, or the number of transaction partners
is limited, Sing suggests that relation-based governance may work more effectively in
a developing economy than rule-based governance due to lower transaction costs
(establishing and maintain an effective legal system required to monitor and enforce
contracts in rule-based governance is very costly). Problems arise when the economy
grows out of this relation-based system; it is no longer sustainable. The lack of
effective rule-based capitalism and the governments inability to enforce contracts
impartially created an environment in which relation-based capitalism flourished and
became the standard method of contract enforcement which in turn has degenerated
into a system of cronyism.

Tangible Costs of Corruption


The costs of corruption in South East Asia have been revealed in a number of studies.
Over the last twenty years, the Philippines are estimated to have lost $48 billion due
to corruption, surpassing its entire foreign debt of $40 billion. 31 Over the last decade
in Indonesia, assets have fallen by more than $50 billion, primarily because corrupt
officials trading state assets have deliberately undervalued their worth in exchange for
substantial kickbacks.32 Studies reveal that governments have paid between twenty
and one hundred percent more for goods than they should have otherwise have paid. 33
30
Shen, Y. The Miracle and Crisis of East Asia: Relation-Based Governance vs.
Rule-Based Governance, Perspectives, 1:2, available at
http://www.oycf.org/Perspectives/2_110299/miracle_and_crisis_of_east_asia.htm
31
Philippine Government estimate cited from Reuter Newswire, 1997, Philippine
Corruption a Nightmare, 11 January, 1997.
32
Business Week, The Destructive Costs of Greasing Palms, 6 December, 1993,
p.133
33
Nakata, T. Corruption in the Thai Bureaucracy, Who Gets What, How and Why
in its Public Expenditures, Thai Journal of Public Administration, 18, 1978,
pp.102-128 and also in Gray, C. Civil Service Compensation in Indonesia,

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Candidate Number | 40801

An extensive study of corruption in Asia concluded: Graft and corruption has


strongly affected development efforts negatively corruption leads to the favouring
of inefficient producers, the unfair and inequitable distribution of scarce public
resources, and the leakage of revenue from government coffers to private hands. 34
The impact of this on development is painfully obvious the government is less able
to spend on genuine development projects. Although the superficial impact of
corruption may appear minimal, the long term impact is inflationary and inimical to
development.

Empirically it has been shown that countries tolerating relatively high levels of
corruption are unlikely to perform as well economically as they would have done
otherwise. In a study of over seventy countries during the late 1970s and early 1980s,
Mauro suggested that corruption, is strongly negatively associated with the
investment rate, regardless of the amount of red tape. 35 Mauros model indicates that
a one standard deviation improvement in the, corruption index translates to an
increase of 2.9% of GDP in the investment rate and a 1.3% increase in the annual per
capita rate of GDP growth.36 This clearly demonstrates the weakness of Huntington
and Leffs argument that corruption could be beneficial to attract investment.

This analysis is supported by other recent studies. Using data from thirty-nine
industrial and developing countries the World Bank found that countries that were
perceived to have relatively low levels of corruption were always able to attract
significantly more investment than those perceived to be more prone to corrupt or
illicit activity. 37 This result held true for both countries where corruption was highly
syndicated and predictable, and countries where it was not. These findings are
unambiguous; corruption is costly for development in terms of squandered
government capital and in terms of lost capital from investors.

Bulletin of Indonesian Economic Studies, 15, 1979, pp.85-113


34
Cario L. and de Leon., J. Final Report for the Study of Graft and Corruption,
Red Tape and Inefficiency in Government, 1983, cited in Klitgaard, R.
Controlling Corruption, (University of California Press, 1998) p. 38
35
Mauro, P. Corruption and Growth The Quarterly Journal of Economics, 110:3,
1995, p.685
36
Mauro, P. Corruption and Growth The Quarterly Journal of Economics, 110:3,
1995, p.695
37
The analysis was conducted by Campos, J. and Pradnam, S. in conjunction with
the 1997 World Development Report, Washington DC: World Bank, pp.102-109

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Candidate Number | 40801

Intangible Costs of Corruption


The economic ramifications of corruption may never fully quantified, or more
specifically, may only be able to be relate to the costs and benefits stemming from
specific corrupt acts. The weakness of a cost benefit analysis of corruption is that it
does not take into account the systemic impact of corruption. Although in some
instances corrupt activities or transactions may yield positive results, it may also
generate negative externalities that degrade the performance of the system as a whole
and compromise the economys long-term dynamic efficiency. The Asian
Development Bank suggest, It is the intangible indirect costs of corruption that are
both hard to recognise and far exceed its direct costs.38 Referring once more to the
caveat contained in the introduction, there are immeasurable political and social costs
of corruption that have not been discussed. These too undoubtedly demonstrate that
corrupt governance has an inimical impact on development.

Corrupt actions typically generate far more costs than benefits. A study of corruption
in one African country, for example, concluded that corruption intensified ethnic
conflict, ruined the efficiency of municipal government and federal agencies, crippled
the merit system of hiring and promotion, and generated an atmosphere of distrust
which pervades all levels of administration. The Asian Development Bank similarly
recognises a number of the inimical by-products of corruption which although not
quantifiable have a clear impact for development. 39 They note how scarce resources
are squandered on uneconomical projects because of their potential to generate
lucrative payoffs at the expense of priority sectors such as education or health which
suffer disproportionately. Furthermore, when investment does produce results, they
are often of inferior quality; public safety is often endangered due to substandard
contracting and construction which can render a project completely worthless.

Due to the potentially lucrative rewards from corruption, the Asian Development
Bank suggests that legitimate entrepreneurial activity has been hindered. Individuals
who would not otherwise engage in illicit behaviour have decided there is no

38
Asian Development Bank, Anticorruption: Our Framework, Policies and
Strategies, 1997, p.17
39
Asian Development Bank, Anticorruption: Our Framework, Policies and
Strategies, 1997, p.17-20

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Candidate Number | 40801

alternative but to focus their intellectual energy away from legitimate productive, but
less rewarding pursuits to figuring out ways to get around the system.40

Uneven Impact of Corruption and Development


Although it has been established that corruption is costly, its impact upon
development has not appeared to be uniform. The Asian Development bank suggests
that; Some countries can tolerate relatively high levels of bribery and graft and
continue to maintain respectable rates of economic growth, whereas others cannot. 41
They suggest that there are numerous factors that influence the extent to which
corruption hinders development. At the most basic level, they suggest a states natural
resource base and the sources of its comparative advantage play a critical role in its
ability to attract investment those with valuable natural resources often attract more
investment that those relying on low wage, labour intensive manufacturing to attract
foreign investment..

The form of the corruption can also affect the impact on development. The Asian
Development Bank suggests if corruption is highly predictable, the impact on
development may be reduced. If corruption is containable in this way, its impact on
development is reduced. Knowing the costs of corruption in advance means it can
simply be added predictably into a budget. If corruption is concentrated at the top
government level, bureaucratic assistance may reduce transaction costs as it adds a
measure of predictability to investment decisions, making the country inherently more
attractive than others where many different officials can demand unspecified and
unanticipated payments. However, there is still the issue of potential growth and
development that is wasted; a study of an Asian country found that in none of the
cases under consideration was the money raised through corruption directly and
productively invested.42
40
Asian Development Bank, Anticorruption: Our Framework, Policies and
Strategies, 1997, p.17-20
41
Asian Development Bank, Anticorruption: Our Framework, Policies and
Strategies, 1997, p.17
42
Werlin, H. The Consequences of Corruption: The Ghanaian Experience, in M.
Ekpo, Ed. Bureaucratic Corruption in Sub-Saharan Africa: Toward a Search for
Causes and Consequences, (University Press of America, 1979) p.253. The
second citation is from Sintaek, K. Conclusions and Recommendations, in a
paper prepared for the Fourth Working Meeting on Bureaucratic Behaviour and
Development, Hong Kong, 1978, cited in Klitgaard, R. Controlling Corruption,

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Candidate Number | 40801

Finally, the extent to which money remains in the country and is invested in
productive economic activity, or flows abroad into foreign bank accounts, has an
impact upon a nations ability to tolerate relatively high levels of corruption and still
enjoy reasonable rates of economic growth. Corruption does not explain economic
development but it did coexist with rapid growth, and in some areas, provided
flexibility to economic policy which saw resources channelled to those firms best able
to utilise them.43 A 1996 World Bank study shows that countries with a high but
predictable level of corruption had a gross investment-to-GDP ratio of 19.5%. For
countries with low predictability but a still high level of corruption, the ratio was just
12.3%.44 Lambsdorffs findings demonstrated, in a cross section study of sixty-nine
economies, that corruption significantly decreases the average productivity of capital
and, consequently, GDP.45 This evidence would seem to confirm the hypothesis that
all corruption is harmful to development.

(University of California Press, 1998) p.37


43
Moran, J. Corruption and NIC Development: A Case Study of South Korea,
Crime Law and Social Change, 29, 1998, p.173
44
Segal, P. Corruption, Impact, 1999, 3:2, p.5
45
Lambsdorff, G. Corruption in Comparative Perception, in The Economics of
Corruption, Kluwer Academic Publishers. pp.81-110

21
Candidate Number | 40801

The Asian Financial Crisis

Although the analysis clearly indicates that corruption is harmful to development,


there may be instances when these repercussions are not felt until years later. Until
about mid-1997, most of the countries in East Asia had been enjoying exceptional
growth rates of between eight and nine percent which was particularly good in
comparison to the economic growth history of developed countries. In 1997 however,
this came to an end as financial crisis hit the Asian economies. One increasingly
widespread view is that so-called crony capitalismthe misallocation of financial
resources to the friends and relatives of government officials is partly responsible. 46
Corruption exerted pressure on banks and businesses to steer capital towards
preferential business deals or the direction of government capital to political friends
and allies. According to Summers; lack of transparency on the part of financial
institutions went hand-in-hand with distorted incentives, lack of supervision, and the
absence of so-called prudential regulation.47 These unsound and corrupt practices
were in part responsible for the rapid decline of the South East Asian economies.

Crony Capitalism
Lack of transparency of financial institutions, a government-business relationship
permeated with corruption, and the absence of accountability of political and
economic authorities created a system of practices which could no longer support
itself. Crony capitalism is a term that describes a particular capitalist economy
depending extremely close relationships between private business and the state
institutions of politics and government, rather than by the espoused equitable"
concepts such as the free market, open competition, and economic liberty. 48 It was
this crony capitalism that exacerbated the structural problems that caused the 1997
crisis.

46
Shang, J. Local Corruption and Global Capital Flows, Brookings Papers on
Economic Activity, 2:2000, p.304
47
Summers, L. The Global Economic Situation and What It Means for the United
States, Remarks to the National Governors Association, Milwaukee, Wisconsin,
Aug. 4, 1998 as quoted in Bello, W. Asian Financial Crisis: the Movie, available
at http://www.focusweb.org/publications/1998/Asian%20Financial%20Crisis-The
%20Movie.htm
48
http://en.wikipedia.org/wiki/Crony_capitalism

22
Candidate Number | 40801

Close relationships between business and government worsened lending problems in


many of the South East Asian economies. Financiers were often relatives of
government officials who lent large sums of money to highly speculative capital
intensive ventures. The excessive lending created an unsustainable boom which
temporarily concealed the poor quality of many of the investments. 49 Kang suggests
that; The states inability to control firms and their growth led to endemic
overcapacity. Firms rushed willy-nilly to expand at all costs, whether or not it was
economically feasible. 50 The result was that in most major sectors of the economy
there was excess capacity and overlapping and duplication of effort.

Firms were keen to expand in order to capitalise on the supply of cheap money and
paradoxically, to ensure that the government would have no choice but to continue to
supply them with money. The reason for this was corrupt business; bureaucrats
received kickbacks from supplying money and so the situation became steadily worse,
with increased borrowing. Firms borrowed whether they needed to or not. Many
firms expanded far too quickly and without adequate management expertise or
planning. The state did bail out weak companies, and it rewarded political
relationships, not economic success .51 What kept the process from spinning out of
control for a time was a delicate balance of power between political and economic
elites. While both benefited from the close ties, neither was able to dominate the other
so stability emerged. With the rapid devaluation of currencies in the wake of the
financial crisis, this equilibrium became imbalanced and the resulting impact of
corruption finally came to light.

Crony capitalism was very much part of the economic fabric in the three decades that
South East Asian countries led the world in GNP growth. Although the system was
self-sustaining to a point, the systemic nature of the corruption meant that there was a
breaking point. An examination of the countries worst hit by the Asian Financial crisis
yields some interesting results. Hong Kong, which prior to the 1970s had a serious

49
This is described in Zhang, H. Corruption, Economic Growth and
Macroeconomic Volatility, Perspectives, 2:1, available at
http://www.oycf.org/Perspectives/7_083100/Contents.htm
50
Kang, D. Bad Loans to Good Friends: Money Politics and the Developmental
State in South Korea, International Organization, 56:1, 2002, p.188
51
Kang, D. Bad Loans to Good Friends: Money Politics and the Developmental
State in South Korea, International Organization, 56:1, 2002, p.190

23
Candidate Number | 40801

corruption, had great success in reducing corruption since the establishment of the
Independent Commission Against Corruption (ICAC) which helped greatly to clean
up the administration. Similarly, Singapore which also fared well throughout the crisis
had a well established Corrupt Practices Investigation Bureau (CPIB) which acted as
an independent body to investigate and prevent corruption in the public and private
sectors. Powers to confiscate corrupt assets and extensive legislation to combat
corruption enabled these countries to consolidate the legitimacy of their economic
growth.

Unveiling the Impact of Corruption


Transparency Internationals Corruption Perceptions index indicate that Hong Kong
and Singapore rated much higher in rankings in comparison to other South East Asian
Countries who were perceived to be more corrupt and experienced a much greater
impact from the financial crisis. A score of 0 indicates a country is perceived to be
totally corrupt whilst a score of 10 indicates a country is perceived to be totally free of
corruption. Hong Kong scored 7.3 and Singapore 8.7 compared to other South East
Asian countries who fared considerably worse in the crisis - scoring between 2.7
(Indonesia) and 5.2 (Taiwan). Examining anti-corruption agencies in other South East
Asian countries reveals interesting results. Whilst Thailand, Malaysia, South Korea,
Indonesia and the Philippines all had an anti-corruption agencies, before the 1997
financial crisis they wielded no real power in the fight against corruption. 52
Legislation enacted after the crisis has begun to slowly deal with corruption giving
more power to combat corruption.

Of the ten Asian countries involved in the financial crisis, the worst reactions against
a range of criteria was felt by the four most corrupt countries; Indonesia, South Korea,
Malaysia and Thailand (See Appendix III & IV). The crisis affected virtually all the
countries of South East Asia. However, unlike Taiwan and South Korea, who before
the crisis had failed to enact effective legislation and anti-corruption, Hong Kong and
Singapore, both of whom had established anti-corruption bureaus and had legislation
For details on the legislation passed in
52

Malaysia: see http://www.bpr.gov.my/English/mainact.htm


South Korea: see http://www1.oecd.org/daf/asiacom/countries/korea.htm
Thailand: see http://www1.oecd.org/daf/asiacom/countries/thailand.htm
Philippines: see http://www1.oecd.org/daf/asiacom/pdf/Philippines.pdf

24
Candidate Number | 40801

in place well before the crisis took place, experienced the negative effects of the crisis
to a much lesser extent. But the worst impact in terms of growth rate, inflation and
unemployment has been on Thailand, South Korea, Malaysia, and Indonesia (see
Appendix IV).

Many of the alleged benefits from corruption, such as expediting and streamlining
government transactions or enhancing civil service pay, only appear as such against
the background of public sector failure. The experiences of Hong Kong and Singapore
indicate that improving public sector management, streamlining customs procedures
and paying competitive wages with the private sector, are likely to yield greater
benefits over time than tolerating relatively high levels of corruption to compensate
for these deficiencies. Hong Kong and Singapore have demonstrated that corruption
can be reduced significantly. Fighting corruption requires reducing corruptions
benefits while raising its costs.53 These findings clearly demonstrate the inimical
impact of corruption on development and the potential benefits of implementing far-
reaching and meaningful anti-corruption initiatives.

53
Lash, N. Corruption and Economic Development, Research Paper, Loyola
University Chicago, May 2003, unpublished, p.15 available at
http://sba.luc.edu/research/wpapers/03519.pdf

25
Candidate Number | 40801

Conclusions

Evidence has shown the serious underlying consequences of corruption on economic


growth, capital formation, poverty and inequality. The analysis of this investigation,
examining the alleged costs of corruption on development from both normative and
empirical dimensions has shown the impact on long term sustainability of
development. The findings of the investigation suggest that the hypothesis all
corruption, no matter what its form is inimical to long term and sustainable
development is indeed correct. In the short term, corruption may appear to have
benefits to an economy and its development, but this misappropriation of finance and
government resources is inimical to long term sustainable development; there is a
negative relationship between corruption and the long-term rate of economic growth.

The features which lent themselves to corrupt activity are consistent in the Asian
NICs; a strong state, weak indigenous businesses, and the prevalence of informal
networks have not been the cause or facilitator of growth, they have simply coexisted
with it whilst serving as a brake to development. Through corruption, it is possible for
bad firms which otherwise would have become unsustainable to survive because of
corrupt officials. Where profitability and genuine growth have occurred, this is
despite, rather than because of the corruption.

It may only be now that the long term effects of this are becoming realised - the Asian
Financial crisis can be understood within this context. Corruption, wastage, crony
capitalism, the lack of economic and political transparency and the mismanagement of
financial institutions compounded the vulnerability of Asian countries in the wake of
currency speculations. Had corruption not been a salient feature of the Asian NICs the
effect of the crisis would have been significantly diminished. The cases of Hong Kong
and Singapore, two countries with considerably lower levels of corruption and impact
from the crisis are testament to this. Whilst it would be nave to suggest that these
anti-corruption initiatives were the only or indeed the primary factor in preventing
worse problems in these economies, they demonstrate that an anti-corruption agenda
can be instrumental in limiting the long term systemic effects of corruption which, in
the long term, can be inimical to development.

26
Candidate Number | 40801

The presence of corruption has unambiguous implications for economic growth, if not
apparent in the short-term, for longer-term sustainability. Transparency Internationals
views corroborate with these findings. They suggest that Most importantly, the
heaviest cost is typically not so much in the bribes themselves, but rather in the
underlying economic distortions they trigger and in the undermining of institutions of
administration and governance.54 The effect of corruption is widespread not only in
administrative, financial and social terms but in undermining accountable and
democratic government; there can be no argument in favour of corruption as a
genuine source of development; the impact of corruption on development is
incontrovertibly damaging and destructive for all aspects of development.

54
Transparency International, TI Sourcebook, 2000, p.32

27
Candidate Number | 40801

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Gardiner, J. Defining Corruption, in Political Corruption: Concepts and Contexts,


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M. Ekpo, Ed. Bureaucratic Corruption in Sub-Saharan Africa: Toward a
Search for Causes and Consequences, (University Press of America, 1979)

28
Candidate Number | 40801

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Brookings Papers on Economic Activity, 2:2000

29
Candidate Number | 40801

Shleifer, A.& Vishny, R. Corruption, The Quarterly Journal of Economics, 108:3

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March 1998
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30
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Tape and Inefficiency in Government, 1983

31
Candidate Number | 40801

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Appendices

Appendix I - Social Indicators are Worse Where Corruption is High


(Source: http://www.imf.org/external/pubs/ft/fandd/2002/12/picthis.htm )

32
Candidate Number | 40801

Appendix II - Tax Revenue is Lower in more Corrupt Countries


(Source: http://www.imf.org/external/pubs/ft/fandd/2002/12/picthis.htm )

33
Candidate Number | 40801

Appendix III: The Impact of the Financial Crisis on Financial Markets


(Source: DataStream and The Economist)

34
Candidate Number | 40801

Appendix IV: Economic Indicators of East Asia


(Source: The Council for Economic Planning and Development, International
Economic Situation Weekly, April 15, 1999)

35