The honest truth about kickbacks

1st October, 2011

It may be better to get 10 per cent of a booming economy than 100 per cent of a stagnating one

An old joke: a bureaucrat from Sani Abacha’s Nigeria visits a bureaucrat in Suharto’s Indonesia and is impressed that his Indonesian counterpart lives in a nice house and drives a Mercedes. “Do you see that road? Ten per cent,” the Indonesian explains.

A couple of years later the visit is reciprocated. Suharto’s man finds the Nigerian civil servant in a palace with a pair of Ferraris. “Do you see that road?” says the Nigerian, gesturing at virgin rainforest. “One hundred per cent.”

There is more to the joke than meets the eye, of course: Indonesia managed to combine severe corruption with many years of strong growth, while Nigeria stagnated over a similar period. Corruption matters, but so does the type of corruption.

And here is a conundrum. Technocrats have long offered economic policy advice to powerful people in developing countries, yet powerful people may have much more to gain by ignoring the advice and lining their own pockets. The problem is so severe it is a wonder that economies ever develop at all. But the situation is not hopeless, because contrary to the joke, it may be better to get 10 per cent of a booming economy than 100 per cent of a stagnating one.

A new working paper from Michael U. Klein of the Frankfurt School of Finance and Management argues that if elites profit from corruption and control the levers of policy, we should ask ourselves what sort of policy advice might appeal to a corrupt bureaucrat while still being sound economics?

Consider the traditional form of corruption: paying bribes in exchange for favourable treatment. This may be harder than it looks, even in a society where corruption is common: one must still find corrupt partners, establish a deal, and secretly enforce it.

Klein, who studied Nigeria in the 1980s, gives some baffling examples of behaviour that may have been designed to drive away the honest and leave only the corrupt. In one case, the boss of an engineering company arranged to meet the managing director of a large public enterprise after many requests and much waiting. When finally brought into the managing director’s office, he found his counterpart facing the wall. Four hours passed; the only sound was that of a radio playing. Then the managing director turned and a deal was struck.

The waste involved in arranging, monitoring and enforcing corrupt deals can be immense – Klein has found that transaction costs of large projects rise from 3 per cent to at least 10 per cent in “complicated” environments. Prosecutions for corruption can be tough to pull off, says Klein, because big Nigerian firms had no accounts in the late 1970s. (There was also a national tradition of fires breaking out in accounting departments.) All this is dreadfully damaging for growth.

What might work better, while still satisfying the avarice of a country’s elite? One idea would be for elites to hold direct stakes in commercial firms. But the result would still look like a mafia town: too much emphasis on squashing competition and not enough on meeting the needs of customers.

Perhaps this is why export markets have proved such an important element in the success of many Asian economies: domestic markets may be sewn up in corrupt deals, but the government can still insist on export success as a precondition for political favours. Only productive firms are allowed to join the corrupt club – with export markets a good test of genuine productivity. For a case study, consider decades of South Korean growth.

Perhaps there is a touch of fatalism about all this. Eventually one would hope for a world where corruption is very rare. While we’re waiting for that, it’s worth asking how even a corrupt economy can achieve growth.

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