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Business Corruption: Incidence, Mechanisms, and Consequences

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Business Corruption: Incidence, Mechanisms, and Consequences Business corruption: Incidence, mechanisms, and consequences Tina Søreide Chr. Michelsen Institute (CMI) Thesis submitted for the degree of dr. oecon at the Norwegian School of Economics and Business Administration (NHH) Bergen, Norway 9 February 2006 Acknowledgments A PhD study is an individual activity and responsibility. During this study, however, I have benefited from constructive feedback and support. I have met a large number of interesting people, and I have been working in a friendly and stimulating atmosphere at Chr. Michelsen Institute (CMI). Kjetil Bjorvatn has guided me through the process. Repeatedly I was impressed by his combination of critical comments and humor. I am very grateful for his understanding, as well as his comprehensive and rapid response. I also got the benefit of working with two excellent supervisors, Kalle Moene and Susan Rose-Ackerman. Their opinions and corrections have been important, and I have truly appreciated their friendly attitude. My stay as a visiting scholar at Yale University during the spring of 2003 was inspiring, and I wish to thank Susan for inviting me. The PhD study, the stay in New Haven included, has been financed by the Norwegian Research Council, and I am very grateful for their support. The Confederation of Norwegian Enterprise (NHO) gave me substantial backing and encouragement during my empirical studies. I wish to thank them a lot. I will also express gratitude to the survey interviewees and respondents who supported my project with their time and their confidence. The study would not have been started without encouragement from Odd-Helge Fjeldstad, Hildegunn Kyvik Nordås, Arve Ofstad, and support from the CMI administration. I am grateful for the many useful and motivating comments from all colleagues at CMI, the group of economists in particular. In addition, I would like to thank the librarians for valuable assistance. I regret that I could not spend more time at NHH. This is an inspiring environment, and I appreciated discussions with staff and students at the Department of Economics. Finally, a deep thank to my husband, Olav, for all forms of support, and for many useful discussions. Thanks also to my children Eirik, Camilla and Julia, they are happy to have realized that PhD studies are voluntary undertakings. Finally thanks to my parents and parents in law for kind support. Tina Søreide TABLE OF CONTENTS INTRODUCTION………………………………………………………………………………. 1 1 The phenomenon of corruption and economic theory 2 Business corruption 3 This thesis: incidence, mechanisms, and consequences 4 Policy implications of the research CHAPTER 1 IS IT WRONG TO RANK?.................................................................................... 13 1 INFORMATION ABOUT CORRUPTION 2 LIMITS OF THE CPI 2.1 Construction and interpretations 2.2 Crimes or legal activities 2.3 Perceptions and the actual extent of corruption 2.4 Implications of publicity 3 PROPOSALS 3.1 Reduce precision in the presentation of the CPI 3.2 Increase the CPI’s value as an anti-corruption tool 4 CONCLUSION CHAPTER 2 CORRUPTION IN INTERNATIONAL BUSINESS TRANSACTIONS: A SURVEY…... 31 1 INTRODUCTION 2 THE SURVEY 3 EXPERIENCE OF CORRUPTION 3.1 The embassy perspective 3.2 The firms’ experience 4 WHICH FIRMS ARE INVOLVED IN BRIBERY? 4.1 Size 4.2 Sector 4.3 Competitive pressure 4.4 The length of experience from international markets 4.5 The type of experience from international markets 4.6 Home country norms and activities abroad 5 RESPONSES TO CORRUPTION 5.1 Strategic choices 5.2 Tolerance of corruption 5.3 Local business practices and the use of agents and advisers 5.4 Motivation behind bribery 6 CORRUPTION AND TENDER PROCEDURES 6.1 Influence on tenders 6.2 Pre-determination of contracts 6.3 Do tender rules prevent corruption? 6.4 The rules of communication 6.5 Political pressure 7 INTERNAL CONTROL AND MEASURES 7.1 Codes of conduct, control-routines and campaigns 7.2 Company culture and the responsibility in case of a scandal 8 CONCLUSION CHAPTER 3 BEATEN BY BRIBERY: WHY NOT BLOW THE WHISTLE?.................................. 67 1 INTRODUCTION 2 WHY NOT REACT? 2.1 Market incentives 2.2 Local judicial institutions 2.3 Political corruption 3 CONCLUSION CHAPTER 4 BUSINESS CORRUPTION, UNCERTAINTY AND RISK AVERSION ……………… 91 1 INTRODUCTION 2 THE PERSPECTIVE OF FIRMS 3 UNCERTAINTY AND BRIBERY 3.1 Assumptions 3.2 Comparative statics 3.3 Overestimating the level of corruption 4 THE SIGNIFICANCE OF RISK AVERSION 4.1 Results on risk aversion and rent-seeking 4.2 The relevance to business corruption 4.3 Risk aversion and the propensity to offer bribes 4.4 Discussion 5 CONCLUSION CHAPTER 5 CORRUPTION AND PRIVATIZATION ………………………………………. 121 1 INTRODUCTION 2 THE MODEL 3 CONCLUDING REMARKS APPENDIX BUSINESS SURVEY QUESTIONNAIRE ……………………………….. 137 EMBASSY SURVEY QUESTIONNAIRE ……………………………..... 147 Introduction The phenomenon of corruption and economic theory Corruption is often defined as the misuse of entrusted authority for personal benefit. The authority is usually public or political. A decision has been made that deviates from the official aim of the institution that holds authority. Through corruption some people have obtained benefits they would not get hold of otherwise. These people represent the two sides of corruption. One has offered a bribe, and the other has abused his or her office. Both parties to the transaction will benefit, though the way the spoils are shared between them will depend on their respective negotiating powers.1 The functions of public and political institutions are affected when the practice of making such agreements is common. The consequences in a country can be considerable. Several authors have found a correlation between economic growth and perceived extents of corruption in statistical studies that include a large number of countries.2 Corruption has indeed motivated to research, and several of its welfare consequences have been examined in an economic perspective. Today it is bizarre that some of the early contributions defended corruption in terms of promoting economic growth. Huntington (1968) described corruption as the way of approaching "an over- centralized bureaucracy" (Huntington, 1968:386), an opinion he shared with Leff (1964). This interpretation has largely fallen out of favor in economic theory, as elsewhere. Myrdal (1968) was one of the first to challenge the ‘grease money’ model by showing how bribery creates incentives for civil servants to put pressure on potential bribers, and actually causes bureaucratic delays.3 A broader critique was provided by Rose-Ackerman (1978) who described corruption as an obstacle to welfare from several different perspectives, including that of firms. The conclusions have been supported, specified and elaborated in a number of studies, including those by Lui (1985), Hillman and Katz (1987), Besley and McLaren (1993); several authors have explained the persistence of the problem (Andvig and Moene, 1990; Banerjee, 1997; Tanzi, 1995); and we got case studies of the phenomenon that played important roles in communicating the nature of the problem, see for example Wade (1982) and Klitgaard (1988). During the 1980s and up until earlier 1990s, the main development in this field of economic theory was concerned with the broader rent-seeking perspective. This trend started with the early works of Tullock (1967), Krueger (1974) and Bhagwati (1982). The welfare implications of various forms of rent-seeking were determined, as were 1 See Rose-Ackerman (1999), Bardhan (1997) and Aidt (2003) broader explanation and categorization of different circumstances of corruption. 2 See Mauro (1995), Mo (2001), Gyimah-Prempong (2002), Pellegrini and Gerlagh (2004), Kaufmann, Kray and Mastruzzi (2006). 3 This theory was empirically supported by Kaufmann and Wei (1999). 1 the propensity of various actors to take part in rent-seeking. However, very few authors made a distinction between legal and illegal forms of rent-seeking, and much of this literature lacks the perspective that is necessary to understand corruption.4 Lambsdorff (2002) explains why the welfare consequences from corruption differ from those of legal rent-seeking. He points particularly at the analytical significance of personal benefits obtained by the one who receives a bribe; legal rent-seeking will often occur as an annoyance to the decision-maker in question. The focus on corruption in economic research increased significantly after Mauro’s (1995) influential paper determining a correlation between corruption and poor economic growth, and the World Bank's focus on this problem. The consequences of corruption have now been shown to materialize in very different ways.5 I will not present a complete overview of this literature. However, an important feature of corruption turns out to be its ability to produce less direct welfare consequences. For instance, corruption may encourage civil servants to seek positions that offer the best opportunity to obtain bribes, in that way influence the function of public institutions.6 It may result in deliberated delays and obstacles in the reform of business regulations in order to obtain personal benefits for civil servants, such as those relating to the issue of licenses and permits, or the persistence of inefficient business-regulations that easily could be reformed. The resulting transaction cost imposed on firms is in itself a barrier to trade and investments, and has been shown to have serious consequences for the development of trade and industry, especially
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