CORRUPTION IN THE CIS-7 COUNTRIES
Jean-Jacques Dethier, WB
The paper was prepared for the Lucerne Conference of the CIS-7 Initiative, 20th-22nd January 2003.
The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not be attributed in any manner to the World Bank, to its affiliated organizations or to members of its Board of Executive Directors and the countries they represent. The boundaries, colors, denominations, and other information shown on any map in this volume do not imply on the part of the World Bank Group any judgment on the legal status of any territory or the endorsement or acceptance of such boundaries.
The author is Senior Economist, Office of the Senior Vice President and Chief Economist, The World Bank. Comments from Joel Hellman, Jakob von Weizsacker, Helga Muller, Samuel Otoo, Andy Anderson, Dennis de Tray, Cheryl Gray and participants in the October 17, 2002 workshop are gratefully acknowledged.
2 Table of Contents
1. INTRODUCTION ...... 5 Transition in the CIS-7 Countries...... 7
2. SYMPTOMS AND MAIN DETERMINANTS OF POOR GOVERNANCE ...... 8 Symptoms...... 8 Key Governance Issues...... 10 Political Regime...... 10 Capture...... 12 Weak Administrative Structures...... 13 Nation-building...... 13 Regional Differences ...... 15 Central Asia ...... 15 Caucasus ...... 16 Moldova ...... 17 High Level Corruption...... 18 3. THE CONSEQUENCES OF CORRUPTION ...... 20 Impact on the Investment Climate...... 20 Harassment of Small Entrepreneurs...... 22 Buying Government Jobs...... 25 Corruption among Public Authorities ...... 25 Impact on Living Standards...... 27 Corruption in the Provision of Education, Healthcare and Social Services...... 29 Corruption in Education...... 29 Corruption in Healthcare ...... 30 Corruption in Social Assistance ...... 32 Corruption during Privatization: The Example of Agricultural Land ...... 33
4. WHERE DO WE GO FROM HERE? ...... 37 ANNEX 1. Why corruption is harmful to growth and poverty reduction...... 39 References...... 42
CORRUPTION IN THE CIS-7 COUNTRIES
This paper discusses corruption and its impact on growth and poverty reduction in the “CIS-7” which consists of the seven low-income countries of the Commonwealth of Independent States, namely Armenia, Azerbaijan, Georgia, Kyrgyz Republic, Moldova, Tajikistan and Uzbekistan. Because of the importance of corruption as a major constraint on the development of those countries, the paper details the various manifestations of corruption. It largely eschews the discussion of other symptoms of poor governance—such as administrative obstacles to do business, poor public administration and public expenditure management, weaknesses in the legal and judicial system—some of which are discussed in various papers prepared for this conference.
Section 1 introduces the issues by discussing governance and corruption in general. Section 2 describes the symptoms of poor governance in those seven countries using available indicators, then discusses the main issues that are responsible for these symptoms:, resistance to reform and policy distortions due to vested interests, weak state capacity and nationalism. It also discusses differences between regions (Caucasus, Central Asia, Moldova) and manifestations of high level corruption. This is followed by an analysis of the consequences of corruption, its impact on the investment climate and on living standards, in Section 3. Finally, section 4 presents brief conclusions.
4 1. INTRODUCTION
The focus on corruption and governance by the international community is relatively recent (they were completely absent from the “Washington consensus” ten years ago) but these issues are now central to the policy debate. A turning point in facing up to the corruption challenge took place at the World Bank/IMF Annual Meetings in 1996 when James Wolfensohn placed the corruption issue center stage as a worldwide challenge for development. Since then, these issues have been studied more in depth, and a lot of expertise and knowledge has been built in those areas. One important implication has been the recognition that democratic accountability, voice and transparency matter greatly for development. Development activities function much more effectively if people have the ability to shape their own life which implies that there has to be effective participation in and oversight of publicly financed activity—which, in turn, depends on information, accountability, and the quality of local organizations (see e.g. Stern 2002). In the last two or three years, the overall framework of analysis has been broadened. Different manifestations of governance and corruption have been “unbundled” into clearly defined components which have been shown to matter differently in different settings (see Kaufmann et al. 1999 and 2002; Hellman et al. 2000; World Bank 2000a).
Corruption is the abuse of public office for private gain. It covers a wide range of violations of norms including theft or misappropriation of public assets or funds; patronage in civil service recruitment or dispensation of state benefits; influence peddling and bribes. It is highly context- specific and country-specific since economic relations are embedded in specific social and cultural contexts which foster to various degrees the respect of formal norms and beneficial collective action mechanisms. Corruption includes practices that both violate or circumvent formal rules, including laws, and that involve exchanges of cash or favors. The extent and prevalence of corruption in a particular country depends largely on four factors: political and economic incentives (opportunities) for rent-seeking; the effectiveness of transparency (information and monitoring) and accountability mechanisms in the political/administrative structures of the state; the level of discretionary authority of state agents; and the effectiveness of law enforcement by police, prosecutors and justice. These factors, in turn, depend to a large
5 extent on political institutions and on economic policies (because policies which give officials a lot of discretion create more incentives for corruption)—in short, on the quality of governance.1
The literature makes a major distinction between “grand corruption” and “petty corruption.” Petty corruption (also called administrative corruption) includes mainly, but not exclusively, bribes. Rose-Ackerman (1999) distinguishes between bribes that clear markets in excess demand (when there is rationing); bribes as incentive bonuses for public officials; bribes lowering costs; and bribes permitting criminal activity (police protection, intimidation and organized crime). The prevalence of petty corruption should be viewed as a symptom of serious dysfunctions in a society. In the countries of the former Soviet Union, during the socialist period, “blat” and petty bribery were common but social connections and social standing were more important than cash (Ledeneva 1998). With the transition (and the need to earn currency), bribery and the scope of arbitrary discretion of officials increased significantly compared with the socialist period. As explained in section 3, the corruption of public institutions and public authorities in all sectors (education, health, social programs) had the effect of slowing down growth, deepening the social exclusion of low income persons, further limiting their economic opportunities and impeding their efforts to improve their standard of living. Corruption also contributed to cynicism toward political leaders and the political system, and contributed to the disengagement of the population from civil society and political life.
Grand corruption (also called high level corruption) is not a symptom but a key determinant of institutional and policy outcomes. Though it is similar in its manifestations to petty corruption (bribes, stealing public funds or receiving commissions on public contracts; dispensation of administrative jobs, etc), it is distinct from the latter because of the effects it has on policy- making and on state decisions. A small group of people exert an influence over policymaking and decisions made by the government. This group plays an important role in shaping
1 The term “governance” refers to the institutions that regulate the exercise of authority and control in society. This includes the political system (for example, how officials are elected or selected), the legal system, and governmental decision-making processes including information, monitoring, auditing and enforcement systems. These institutions are important because of the incentives they provide to individuals and enterprises. In some contexts, they provide positive incentives; allow private economic activity to be productive and allow both markets and the government to function properly—while in other contexts, they encourage rent-seeking, predatory behavior and unproductive activities such as corruption and theft (Dethier 1999a)
6 institutions and the “rules of the game“—and therefore in shaping the investment climate. This can be extremely damaging for growth because the policies influenced by these special interest groups generally do not improve the welfare of the majority, and because the investment climate shapes the environment for entrepreneurship and, ultimately, investment, job creation and productivity increases by small and large enterprises. This powerful minority can be made of politicians and/or public officials in a context of lack of accountability and checks-and-balances, or it can be a group outside of the public sector which has a disproportionate influence on state institutions and policies. There is no neat separation between investment climate ‘makers’ (politicians and government decision-makers) and investment climate ‘takers’ (the business sector). In the CIS-7, both politicians and officials and vested interests in the private sector— including foreign investors—play a key role in shaping the investment climate.
Transition in the CIS-7 Countries
Corruption in the CIS-7 countries has been facilitated by: (a) major weaknesses in the state apparatus and an institutional vacuum (i.e. the virtual absence of institutions which could effectively check the abuse of public office) at the time of independence; (b) the redistribution of state assets and wealth to private citizens—which created major opportunities for rent-seeking; and (c) the need to create new institutions and rewrite laws, decrees and policies (World Bank 2000).
One of the most important point to emphasize about the situation of the CIS-7 is that most of the corruption problems faced by these countries have arisen not because of reforms but, for the most part, because of the absence or incomplete implementation of market-friendly reforms. Thus, the economy is in limbo (neither planned nor market economy) which, in addition to a non-market incentive structure and corruption, produced powerful social constituencies and other facts on the ground that were utterly inimical to reform. The shock of independence of those countries was massive and traumatic. Independence meant the loss to most of these countries of significant fiscal and quasi-fiscal subsidies. Economic interdependence in Soviet times meant that a large number of enterprises failed when they were suddenly cut off from suppliers and customers in what became foreign countries, with different currencies and convoluted rules of
7 foreign exchange. The transition from a command to a market economy in the CIS countries has been much more difficult than initially envisaged, particularly for Moldova, Armenia, Georgia, the Kyrgyz Republic and Tajikistan, that are relatively poor in natural resources. In a very short period of time, the newly independent countries of the CIS have experienced a massive decline in living standards; large scale unemployment and a radical shift in the distribution of assets. Poverty increased very significantly in all seven countries. Poverty rates vary across countries (and between regions within each country), with highest absolute poverty rates (below $2.15 a day) in Tajikistan, Kyrgyz Republic and Moldova.2 Income inequality has also increased sharply, with Gini coefficients doubling. Politically, independence has often resulted in still more arbitrary rule. When the Soviet Union was dissolved, it was replaced by more border guards, more customs posts, more “tax collectors,” more “state inspectors”—in short, more opportunities for rent-seeking.
2. SYMPTOMS AND MAIN DETERMINANTS OF POOR GOVERNANCE
Symptoms
As a group of former Soviet nations, the CIS-7 countries have in common difficult beginnings, as explained above, and the fact that they all score poorly on international governance indicators.
Table 1: CIS-7 Countries -- Governance & Growth Governance Indicators (1) Avg Growth Rate (2) Voice & Political Govt Regulatory Rule of Control of (A) (B) Accountability Stability Effectiveness Quality Law Corruption 1991-2001 (3) 1990-2000
Armenia -0.22 -0.84 -1.03 -0.53 -0.35 -0.80 -1.3 -3.2 Azerbaijan -0.70 -0.70 -0.95 -0.14 -0.78 -1.05 1.6 -3.9 Georgia -0.07 -1.00 -0.72 -0.75 -0.43 -0.69 -6.3 -7.0 Kyrgyz Republic -0.57 -0.32 -0.61 -0.63 -0.72 -0.85 -2.7 -2.6 Moldova 0.12 -0.29 -1.10 -1.11 -0.42 -0.83 -7.7 -8.2 Tajikistan -0.69 -1.77 -1.31 -1.46 -1.25 -1.08 -7.2 -8.0 Uzbekistan -1.18 -1.17 -0.86 -1.17 -0.71 -0.66 0.1 0.4
Notes: (1) The data on the Governance Indiactors is for 2000/01; the values of each index range from -2.5 to +2.5, with higher values reflecting better governance outcomes (2) Growth rates are long-run averages of annual growth rates (3) Except Azerbaijan, where Growth Rate (A) relates to the period 1994-01 Source: Governance Indicators: Kauffman, Kraay & Zoida-Lobaton (2002); Growth Rate (A): The World Bank, World Development Indicators, various issues; Growth Rate (B): IMF-The World Bank, Poverty Reduction, Growth and Debt Sustainability in Low-Income CIS Countries, Table 1, p. 8
2 Milanovic (1998) and World Bank (2000)
8 All seven countries exhibit major deficiencies in terms of control of corruption; accountability; political instability; government effectiveness; burdensome regulations; and rule of law. They have the highest corruption perception indicators of all countries in the World (World Bank, 2000a, p.6)
· Both high level corruption (graft by high level officials and a tendency of elite to engage in state capture) and petty corruption (additional payments that individuals and businesses have to pay to get things done) are prevalent, as explained below. · The citizens have generally not been able to participate fully in the selection of governments and the media are not independent. · The likelihood of sudden, possibly violent, change in government appears to be significant despite the high degree of political continuity that at least some of the CIS-7 countries have experienced during the past decade. · The quality of public service provision, the quality of the bureaucracy, the competence of civil servants, the independence of the civil service from political pressures, and the credibility of the government’s commitment to policies is weak. Thus, these governments are not able to produce and implement good policies consistently. · There are many market-unfriendly policies such as harassment of business, price controls and excessive licensing and other regulations that impede the development of the private sector · The rule of law is weak. The effectiveness and predictability of the judiciary is low. Contracts are only weakly enforceable, and the incidence of both violent and non-violent crime is high. These societies have not been able to develop an environment in which fair and predictable rules form the basis for economic and social interactions.
Across the group of CIS-7 countries, there are of course vast national differences—as indicated by the range of values in the indicators in Table 1—which are the result of differences in initial conditions; in political systems; and in reform strategies. These differences, however, will not be examined at length in this paper. They are discussed extensively in the 2000 World Bank report, “Anticorruption in Transition.”--one of the first systematic efforts exploring how different
9 configurations of political systems, different levels of state capacity, and different degrees of ethnic and national conflict affect the nature of governance.
Key Governance Issues
The governance problems in the CIS-7 countries captured by the indicators above are symptomatic of four major problems: · Political regimes characterized by authoritarianism in some cases and/or highly unstable competition between factions/parties in other cases · Capture of the state by local elites and resistance to market-friendly reforms by vested interests, more generally · Weak state capacity—as a result of the disintegration of Soviet power where administrative capabilities were concentrated in the center—which has contributed to a breakdown in economic and social services · Difficulties in nation-building resulting from the impact of regional and national conflicts; geo-political factors and the uncertainty over national boundaries; and the lack of consensus on the new role of the state.
These four issues represent the main governance problems faced by the CIS-7 countries and the issues which differentiate them from other countries in the region. Corruption is a powerful symptom of these underlying governance problems.
Political Regime
The post-Soviet era has involved major political changes to replace the hegemony of the communist party. At the beginning of the transition, there was no well-defined process for choosing leaders and demarcating their powers. There was a vacuum in terms of political institutions and no checks and balances existed. There were no political parties with a significant reputation; the press and media had no tradition of independent reporting and the judicial system was unprepared to challenge political leaders’ abuses of power when necessary (Aslund, Boone and Johnson 1996). There are, of course, significant regional variations and some of these are discussed below. In Central Asia, the former elite simply reinforced its position after the collapse of the Soviet Union—in contrast to Russia where there was a battle for power between various factions of the old elite and reformers. In the Caucasus countries (Georgia, Armenia and
10 Azerbaijan), the outbreak of conflicts and/or incidence of political violence were major elements explaining delays in reform. The wars stopped ongoing reform efforts in the early 1990s, and had a profound and often lasting impact on subsequent political and governance developments. Armenia is a case in point All the CIS-7 have experienced some degree of political instability. This may be significant since political instability, if it occurs jointly with a government captured by interest groups and no clarity on which group is winning, does not create the right incentives for those groups to invest in long-term process of building institutions and creating and controlling norms. When political power is dispersed, interest groups may not even benefit from the stability that would be brought about by normalizing political and social relations. Interest groups tend to increase ‘social closure’ (restrict access of outsiders to political power). As a result, public political participation can be blocked to a large extent. Dispersion of power and consequently social closure are among the main causes of institutional distortions observed in CIS-7 countries.
Ultimately, the best approach to fight corruption is to limit the opportunities for rent-seeking behavior. The creation of new political institutions could have provided an opportunity to “lock in” economic reforms and reduce the scope for rent-seeking which was growing at an alarming rate in all the former Soviet Union republics. In theory, one would expect the development of private enterprises and market relations to create a demand for institutions to defend and protect the market-based system: that is the rights of private property and the enforcement of private contracts. However, many political institutions that were created in most of the CIS-7 countries were not effectively under democratic control. At the start of the reforms in the CIS-7, the former elites — essentially public-enterprise managers, government officials and Communist Party leaders — were the most organized political group, had a clear advantage over other groups and were very effective in extracting rents.3 Thus it was naïve in retrospect— considering the tradition of authoritarianism, secrecy and lack of accountability of leaders and officials, repression and lack of freedom and pervasive state intervention which existed in the Soviet
3 The main economic mechanisms used for rent extraction were large credit issues, trade regulations and price (and exchange rate) regulations which thus perpetuated a regime of distortionary policies and, of course, various forms of privatization. See Aslund, Boone and Johnson (1996)
11 Union — to expect that demand for institutions would create its own supply and that markets would "work" by themselves.
Ten years after independence, all of the CIS-7 countries have made some progress toward democracy — with Uzbekistan showing the least progress. Yet all still lack g in some essential features of democratic systems.4 Some are strong Presidential regimes while others (Moldova and the Kyrgyz Republic) have a more competitive parliamentarian-type system subject to significant pressures from interest groups. In the other countries, autocratic rulers may have been less subject to pressure but have followed opportunistic policies when their survival has been at stake. Finally, in countries that have experienced armed conflict (Armenia, Azerbaijan, Georgia, Moldova and Tajikistan), past wars have used up resources and delayed the political transition.
The nature of the political regime that developed in the CIS-7 is a major explanatory factor of poor governance. Democratization is expected to gradually change the incentives for rent- seeking. As political leaders become more accountable for their policies in the light of free media and popular opinion, incentives to maintain distortionary policies diminish. But in most of the CIS-7 countries, the old elite has been resisting reforms, thwarting the development of more political freedom and preventing more openness, more accountability and democratization.
Capture
In the countries of the former Soviet Union, the simultaneity of economic and political reforms—which makes the transition in these countries so historically unique—opened the way for powerful interest groups to influence state institutions and economic policy. The state—to various degrees in the different CIS-7 countries—has been captured by particular interest groups. In reference to the industrial organization literature, the word “capture” is used to refer to undue influence of businesses to obtain tax or regulatory advantages (EBRD 1999; Levine 1998). The concept has been applied to transition economies in World Bank (2000, 2002). High level corruption, and illicit relationships between business and high government officials have profoundly influenced policy formation in CIS-7 countries. In countries such as Azerbaijan,
4 Uzbekistan is categorized by Freedom House (2001) as a consolidated autocracy, while the political regime of the six other countries is categorized as “transitional democracies” (i.e., having made partial progress toward democracy but lagging in some essential features of democratic systems).
12 Kyrgyzstan, and Moldova state capture may not only be a symptom but a key determinant of institutional and policy outcomes. In other CIS-7 countries, the influence of the private sector on the state tends to be more subtle, yet it has also played an important role in shaping institutions and the rules of the game. A powerful minority outside of the public sector may tend to have a disproportionate influence in shaping state institutions. Thus, in all CIS-7 countries, the formation of the basic institutions of the market economy has been influenced by a small number of private individuals who have “captured” the state and this fact has been fundamental in shaping the nature of governance and the pervasiveness of corruption in those countries.
Weak Administrative Structures
In virtually all CIS-7 countries, there is no tradition of administrative management; a shortage of trained civil servants; and a weak capacity to design and implement policies because policy, in the former Soviet Union, was made at the center, in Moscow and little autonomy was given to the executive in the Soviet republics. These inherited weaknesses have caused serious shortcomings in policy implementation and budgeting. There are often no effective mechanisms to force recognition at the political level of the resource limits that exist and to force political choices in establishing expenditure priorities. Budgets do not take into account the real capacity of the government to raise revenue and do not fully reflect the new role of the government in a market economy. There are few mechanisms and little institutional capacity in government agencies to elaborate and implement realistic sectoral priorities. Bureaucrats retain a significant degree of discretion in policy and in the allocation of budgetary funds; and there is no built-in accountability system in the administration (e.g., there is generally no commitment control system so that it is not possible to trace those who overspend and to hold them accountable). Budgeting in the CIS-7 is a typical “tragedy of the commons” (i.e., although collectively political groups have an interest in using funds rationally, individually, they have an interest in taking as much as they can get) and the delivery of services such as education, health and social assistance is often unresponsive to the needs of the population and plagued by corruption (Examples are given in section 3).
Nation-building
Some governance problems have their origin in nationalism in particular in the Caucasus and in Moldova where it led to open conflict. National self-determination may result from legitimate
13 aspirations but, as mentioned by Kotkin (2002), it can also be a convenient cover for unscrupulous politicians and their apologists, and a recipe for economic difficulties.5 In the Caucasus, in Moldova and in Central Asia, national/ethnic issues are of an extraordinary complexity (partly as a result of the population movements forced by Stalin) and deep-seated nationalism was one of the many causes of the Soviet Union's demise. The creation of seven new nation-states is of great historical significance but it is too early to tell whether the countries that have been created are easier to govern than the arrangements that existed under the Soviet Union. The multinational nature of these seven newly independent states accounts for the profound post-1991 weaknesses of the nations and the nationalisms in almost all the successor states to the Soviet Union (Kotkin 2000). And equally important is the circumstance that when the Communist Party, which alone held the federal union together, underwent "reform" and disintegrated, the Soviet Union’s sub-federal administrative units became perfect vehicles for elite self-preservation and self-aggrandizement.
What the European Union has been struggling to transcend, the newly independent states of the dismembered Soviet Union have taken upon themselves. The fact that a country is a small political jurisdiction has several costs (Alesina and Spolaore 1997; Dethier 2000). First, the country does not benefit from having a large market. Second, the per capita cost of public goods such as defense decreases with the number of people who finance it so they are more expensive in small countries. Whether the majority of the CIS-7 population benefits from public goods such as law enforcement and the administration of justice is an open issue. Third, being small does not easily allow for efficient fiscal policies and macroeconomic management. For example, it has been empirically shown that large countries tend to rely more on efficient forms of taxation (such as income taxes) than on less efficient ones - custom taxes - even controlling for differences in levels of income. This being said, there are significant costs in being a large country. First, beyond a certain size, for any given political system, there can be significant coordination problems as the Soviet Union showed. Second, especially in multinational countries (in which
5 To give but one example, in the analysis of King (2000), the civil war in Moldova in the summer of 1992 was partly caused by "rogue" elements in Russia who colluded with the remnant Soviet army on behalf of the Transnistrian "cause." Above all, the war entailed a local initiative to "defend" Soviet-era industry, which was gravely threatened by the market but could--if propped up with continued state subsidies--become a source of embezzlement, while remaining a solid political base.
14 the population is demographically less homogeneous) there is more political difficulty in aggregating preferences. The average cultural or preference distance between individuals is likely to be positively correlated with the size of a country. In large countries, there is a tradeoff between the cost of having a large heterogeneous population with diverse preferences and the benefit of having a large political jurisdiction, which allows economies of scale. In a sense the CIS-7 states have inherited the problem of diverse preferences within a heterogeneous population from the Soviet Union without its economies of scale.
Regional Differences
Central Asia
In Kyrgystan, Tajikistan and Uzbekistan, governance problems are closely related to the weak state capacity and to undemocratic and/or unstable political regimes. Central Asia's native elites to a greater or lesser extent continue the Soviet tradition of repression and state control. Also, there are many examples of large-scale misappropriation of state assets (often misrepresented as “democratization” and “market reforms” by external observers). Only Kyrgyzstan implemented liberalization but the impact of these policies has remained fragile because it was trumped by a poor institutional inheritance and a difficult geopolitical environment. Kotkin (2002) claims that liberalization policies dangerously reduced Kyrgyzstan's state capacity, rendering the authorities unable to interdict armed Islamists. A reversal of policy soon put Kyrgyzstan more in line with its autocratic neighbors, but it remains less dictatorial or closed than the other countries in the region. If Kyrgystan is reasonably democratic by world standards, closer to the other end of the spectrum, by world standards also, Uzbekistan is a consolidated autocracy. Central Asia's political regimes vary considerably but they all have in common a very unsure process of political succession which could ultimately prove to be very costly. Central Asia's dual Turkic and Persian heritage, its common heritage with Russia and large Russian minority populations, and the influence of Islam (and the potential "Islamist threat" which, according to Olcott (2001), emanates from Afghanistan but is rooted in local injustice and repression) have created a complex geopolitical situation, and a rationale for authoritarianism, especially in Uzbekistan, the most populous country (with 25 million people) and Turkmenistan. The aftermath of “September 11” and the struggle for the development of Caspian oil and gas are unlikely to create a more détente-oriented context.
15 Caucasus
The three independent nations of the Caucasus have been deeply scarred by violent conflicts during and after independence. 6 The effects of war on development have been devastating, if only because of the displacement of large civilian populations and the organized looting of their assets. In all three states, government efforts to mobilize funds and soldiers for armed conflict have resulted in specific alliances between regional politicians, political entrepreneurs, and managers of industrial concerns (and possibly criminals involved in smuggling) which sometimes continue to be influential. The conflicts played a critical role in determining who controlled national power in all three states, and the prospect of renewed conflict and/or further secessionist movements remains a great influence on government behavior which may have a decisive effect on various reform programs (Bhatty 2002).
Armenia, though an early reformer, has had an intermittent reform process, intermittent because of the Nagorno-Karabakh conflict (and related assassinations in 1999) which dominates economic and political life. In the provocative language of Kotkin (2002), “[this conflict] has led not to Armenia's annexation of Karabakh but to Karabakh's annexation of Armenia, in the form of militarized paranoid politics.” Since 1994, the Armenian Government has carried out a comprehensive reform program. GDP fell by 60 percent during 1991-93 but has grown since at a rate of 5.5 percent per year. There was very strong economic growth in 2000-02, for the first time driven by export expansion. Poverty was high but is now declining, and extreme poverty is subsiding. The population living in poverty declined from 55 percent in 1998/99 to 47 percent in 2001 and, for extreme poverty, from 27 percent to 19 percent. Despite this considerable progress, sustainability of Armenia’s economic recovery remains of concern. The NK conflict has had very serious continuing economic implications including a weakened government willingness and ability to tackle vested interests opposed to reform; very negative effects on the perceptions of foreign investors; high transport costs (almost 100 percent higher than if borders
6 From 1991 to 1994, Armenia and Azerbaijan fought a war for control of the predominantly Armenian-populated Azerbaijani oblast of Nagorno-Karabakh, a war which left between ten and twenty thousand dead and saddled Azerbaijan with 740,000 displaced persons and perhaps 200,000 refugees (Azerbaijans who had lived in Armenia); Georgia fought and lost 2 wars with secessionist groups in the territories of Abkhazia and South Ossetia, leaving it with close to 300,000 displaced persons and refugees, many of them concentrated in urban centers (Bhatty 2002)
16 were open) and energy costs (almost 30 percent higher than if borders were open); and high defense expenditures (around 25 percent of budgetary expenditures).
Georgia—a once relatively prosperous Soviet republic comprising dozens of (mostly assimilated) nationalities—is plagued by unresolved armed conflicts in North Ossetia and Abkhazia (where Chechen fighters first fought as mercenaries), while the capital of Tbilisi is overrun by war refugees and violence from criminal gangs. Following the devastating economic collapse of the early post-independence years, Georgia experienced an economic recovery and has experienced growth and price stability since 1996. However, Georgia’s per-capita income is still less than 40 percent of what it was at independence. While the incidence of poverty is relatively low (23 percent of the population) it is estimated that 60 percent of the population is at risk of falling into poverty. Moreover, the poor have suffered the most from inadequate access to social services and from crippling basic infrastructure.
Azerbaijan has the prospect of oil induced prosperity with proven oil reserves of 7 billion barrels. In the early years of independence, the country faced a multitude of challenges. The conflict over Nagorno-Karabakh, IDP and refugee flows, the loss of economic potential of the occupied territories on the one hand, and the legacy of Soviet economic mismanagement and the unstable political situation on the other hand, caused a sharp economic decline. A new economic policy, starting in mid 1990s with the signing of the oil production sharing agreements and progressing towards comprehensive economic reform, continuing increase in foreign direct investment, reining in of inflation, financial stabilization, and privatization, led to a robust economic recovery. The economic recovery has been largely driven by the rapid development of the oil sector. More recently, though, strong growth was registered across the board, including in agriculture. Political power is highly concentrated and centered in the Presidency. The prospects for a smooth transition from the current regime are highly uncertain at best.
Moldova
Moldova, the poorest state of Europe, is territorially partitioned (though not along ethnic lines). Following a brief civil war in the early 1990s, "Transnistria," an internationally unrecognized statelet, broke away from the republic. A decade after independence, the GDP of Moldova stands
17 at one-third of its 1989 level, the worst economic decline among former Soviet republics. With a population of about 4.3 million (at the 1989 census), upwards of 750,000 people, about one-third of the workforce, has left for Europe, Romania and Russia, for jobs, education and income. Economic reform has not progressed well. Both Moldova and Transnistria are plagued by organized crime and corruption by state administrators. Moldova has a pluralistic landscape of political parties, and holds democratic elections. But the Soviet-era executive-branch administration remains strong and was strengthened further after the elections in 2001 that were won by the Communist party that pledged to revive socialism and deepen links with Russia (to whom Moldova owes $700 million for natural gas). While reasonably democratic, Moldova remains disorganized, poor, and without a strong and independent legal system.
High Level Corruption
A common element in all the CIS-7 countries is the collusion and alliance between government officials and rich and powerful entrepreneurs. The nature of this new elite is significantly different from the corruption-tinged nomenklatura of former Communist regimes, although in many cases they are the same persons. It comprises serving members of government (many of whom are former Communist Party bureaucrats), military or security officials, as well as managers of state-supported agencies and institutions. They have all profited from privatization processes, which they often have had a role in managing. And they have formed strong networks with market economy entrepreneurs, sometimes including organized crime figures, in the early years of the transition. These networks were established to take advantage of the power vacuum that existed in many countries following the first shock of the collapse of Party control. But the former power brokers have slowly reasserted themselves, taking advantage of the failures of economic management and public disenchantment with the market economy and capitalism (Freedom House 2001).
A key factor that distinguishes the new ruling elites from the corrupt overlords of the Communist system is their ability to exploit the opportunities provided by the increasing globalization of the international economy. Because of capture, the ease with which financial transactions can be conducted, as well as the important flows of illicit commerce across the region’s sometimes porous borders, a transnational elite has been fostered that is confident of its ability to elude detection or punishment at home. The cross-border activities of organized crime
18 groups sometimes are said to have been eclipsed by the rising prominence of government players whose insider knowledge of the old Soviet trading networks allows them to exploit loopholes in tax and customs regulations. The regional trade in energy can serve as an example of how such insider transactions are affecting the economic development of the CIS-7 countries. Armenia has lost more than $200 million from embezzlement and fraud in its energy sector since 1992, according to a parliamentary commission report that implicated several high officials (Freedom House 2001). In Azerbaijan, 16 senior political figures, including the speaker of parliament and two former ministers of foreign economic relations, were accused of embezzling oil trade revenues. Weak judicial and regulatory systems grew even weaker. Some countries, such as Georgia, have contemplated in effect giving up the battle by legalizing many of the existing practices of the black market economy.
At the same time, a disturbing tendency to use corruption charges as a way to score political points has been growing (Handelman 2001). Authoritarian governments have used anti- corruption commissions and anti-corruption strategies – Georgia even initiated them several times - to to expand their powers while at the same time further undermining the credibility of the anti-corruption agenda. In the absence of consistent government enforcement of anticorruption laws, the media and the press have been key tools in many countries for mobilizing action. In Georgia, newspapers have been the leading force in unmasking corruption, often at great personal risk. In Kyrgyzstan, a prominent television reporter was charged with embezzlement though she claimed the charges were connected to her plans to prepare television specials on opposition politicians.
The prevalence of corruption has made it extremely difficult for honest entrepreneurs to respond to the opportunities of the market economy. Section 3 gives examples of kickbacks, bribes and other forms of corruption through which public officials harass the private sector. Corruption has also cut short the progress toward further democratic reform. The prospering transnational elite now holds the same impregnable control over key institutions of governance and law enforcement that party leaders once held (in some cases, of course, they are the same people), and they are unlikely to share power or welcome transparency and accountability.
19 3. THE CONSEQUENCES OF CORRUPTION
Corruption and poor governance in the CIS-7 countries have several negative impacts. First, a poor investment climate and the harassment of entrepreneurs by the State slows down investment and growth. Second, the practice of buying government jobs, police corruption, etc. makes the administrative system dysfunctional. Third, corruption in the provision of education, health and social assistance contributes to poverty and retards human development. Fourth, the lack of transparency and numerous frauds in the privatization of state assets reinforces inequality and perpetuates the power of the elites. The theoretical and empirical literature linking corruption to poor economic growth and income inequality is summarized in Annex 1.
This section presents evidence on corruption taken from the 1999 and 2002 BEEPS survey, from surveys of households, enterprises and officials (in Georgia and Kyrgyzstan); from participatory assessments prepared for the 2000/01 World Development Report on poverty (in Kyrgyzstan and Uzbekistan); from qualitative poverty studies prepared by consultants for the World Bank (Armenia; Georgia and Moldova) and from World Bank analytic work. This evidence demonstrates that, even though the context and the parameters of corruption are different in each country, there are many commonalities between the seven countries. 7 Strategies for fighting corruption require a lot of “contextual” investigation and analysis of incentives and constraints to understand what shapes corrupt practices in each particular country (Reinikka and Svensson 2002) but patterns of corruption tend to be similar across countries (Kaufmann et al. 1999).
Impact on the Investment Climate
Corruption and harassment by public officials are profoundly damaging to the investment climate, adding to operating costs, imposing barriers to entry by firms into the sector and creating uncertainty once the firm is established. This applies to both large and small firms—but it is especially important for smaller firms and farms, with their weaker capacity to finance the costs of dealing with regulation and to use “political contacts” and other means to resist harassment.
7 Most of the examples are taken from James Anderson, Jean-Jacques Dethier, Nora Dudwick, Kathleen Kuehnast and Maria Shkaratan, “The impact of corruption on the poor in transition countries,“ mimeographed, 1999.
20 The 1999 and 2002 BEEPS surveys (carried out in all transition economies) provide useful information on the evolution of the investment climate in the CIS-7 countries.8 For the CIS-7 countries as a group, the data indicate a relatively poor business environment in 1999 and a still difficult but very significantly improved business climate in 2002. See EBRD 2002. This improvement is due in part to generally better macroeconomic performance in the region, but also to a reduction in corruption and a gradual strengthening of the capacity to enforce the rules of the market place.
In most of the CIS-7 countries, though, corruption still ranks as a major obstacle to doing
Figure 1. Bribe Tax Figure 2. Time Tax
4.5 20 4 18 16 3.5 14 3 12 1999 2.5 1999 % 10 2002 % 2 2002 8 6 1.5 4 1 2 0.5 0
0 BiH Czech Latvia Poland Russia Croatia Albania Estonia Belarus FYROM Ukraine
BiH Georgia Armenia Bulgaria Hungary Slovenia Slovakia Moldova Romania Lithuania
Czech Latvia Tajikistan Estonia Croatia FYROM Poland Russia Belarus Ukraine Albania Georgia Azerbaijan Slovenia Armenia Hungary Slovakia BulgariaMoldova Uzbekistan Yugoslavia Romania Kyrgyzstan Lithuania Tajikistan Kazakhstan Azerbaijan Uzbekistan Yugoslavia Kazakhstan Kyrgyzstan Country Country business. Figures 1 and 2 show the quantitative measure of two critical dimensions of corruption and bureaucratic ‘red tape’. The measures are (i) the share of sales paid in unofficial payments (“bribe tax”) and (ii) the proportion of management time spent with government officials (“time tax”). The time and bribe tax were low in Armenia and Uzbekistan in 2002, although in both countries this was not the case in 1999. The highest bribe taxes were recorded by the Kyrgyz Republic, Azerbaijan, Georgia and Tajikistan. Notably, in contrast to the trend in the other countries, the bribe tax in the Kyrgyz Republic apparently went up in 2002 compared to 1999.
8 For the 2002 BEEPS results we rely on the Transition Report, 2002, chapter 2 and theuseful summary provided by Vandycke (2002).
21 Harassment of Small Entrepreneurs
Table 2: SMEs in Uzbekistan
Small and medium scale Indicator 1999 2000 2001 enterprises, and self-employed SME Share of GDP (A) 29.1% 31.0% 33.8% Non SME Share of GDP 70.9% 69.0% 66.2% entrepreneurs have a crucial role GDP index (1990 = 100) (B) 94.4 98.0 102.4 to play during the transition. For GDP growth (%) (B) 4.3 3.8 4.5 SME GDP index 27.5 30.4 34.6 instance, table 2 shows the Non SME GDP index 66.9 67.6 67.8 importance of this sector in SME GDP Growth 10.58% 13.94% Non SME GDP Growth 1.02% 0.26% 9 Uzbekistan . Corruption has a SME Contribution to Total 3.08% 4.32% disproportionate effect on small GDP growth Non SME Contribution to Total 0.72% 0.18% businesses, the engine of GDP growth employment growth and income Total Growth 3.80% 4.50% generation for the poor. Bribery A: Source: Government of Uzbekistan in transition economies can constitute an extremely regressive tax. In Georgia, while large firms report an average bribe tax of 2.8 percent of annual revenues, the average bribes for small firms are nearly double at 5.4 percent. There is also a major difference in the frequency of bribe payments. While 16 percent of large firms report paying bribes frequently, the proportion of small firms rises to 37 percent. For small firms, in particular, the combination of the bribe tax and the time tax has had a severe impact on the development of new private sector companies, targeting the most dynamic sector in the economy (EBRD Transition Report 1999, p. 24). Corruption constitutes a strong disincentive for entrepreneurs. Bribes seriously cut into the earnings of the poor.10 Abuses by municipal authorities take many forms, such as “taxing” the informal sector—like migrants from Moldova.11
9 Although these encouraging numbers may at least in part be explained by those self-employed who use subsistence agriculture as a short term coping strategy when they are really unemployed. 10 For example, a poor Kyrgyz man who had his own little business carrying baggage for traders from the bus station to the local market, had to pay the administrators of the bus station a bribe to allow him to carry the baggage out of the bus station, and an equal sum to the local police. He reported that it takes at least one to two trips a day to pay for the bribe that allows him to make the rest of his small income. See “Networks, Access and the Poor in the Kyrgyz Republic.” Report prepared for the World Bank. Interview #2, Bishkek. March 1999.
11 One of the legacies of the Soviet period is the “propiska” or local registration, which gives an individual the right to live in a certain region, city, or area. Although the Russian constitution had eliminated the propiska, which once limited populations in capitals and other large cities throughout the former Soviet Union, it remains in practice. Particularly in Moscow, many people risk high fines, harassment, physical abuse or jail in attempts to evade this
22 It is beyond the scope of this paper to discuss the issue of private sector development— discussed in Vandycke (2002). Our goal here is merely to present some survey findings on the harassment of small entrepreneurs and individuals/households. Surveys carried out by the World Bank in Georgia and the Kyrgyz Republic have measured the propensity of people to pay bribes according to level of income, and the percentage of income paid in bribes according to level of income.12 Of course, the degree of bribery captures only one aspect of corruption: it does not capture, for instance, the services that are foregone because someone can not pay a bribe or the overall effect on sectors of the economy that otherwise would provide jobs and income generation. 13 In the Georgia survey, the richest 15 percent were more than three times as likely to have paid bribes than the poorest 26 percent (6 percent for the poorest against 20.7 percent for the richest and 14 percent for the middle strata). While rich households are more likely to have paid bribes than poor households, the impact relative to their income is similar, implying that when the poor do pay bribes, the effect relative to income is larger. The poorest pay 0.5 percent of their income in bribes in Georgia against 1 percent for the richest and 1.2 percent for the middle income group.
Bribery is encountered more often by households that engage in micro-enterprises. Households that engage in small scale business activities are much more likely to have paid bribes than households that rely on formal wage employment, pensions or public assistance. While such “micro-enterprise” households can be found among all income groups, those in the lower income group tend to pay larger fractions of their income in bribes than those in the higher income group. Households with informal income are nearly three times as likely to have paid bribes in the two months before the survey, and pay nearly five times as much as a percent of their requirement. This is especially true for the poor since they are the least likely to be able to bribe their way through the system. For example, in Moscow, many labor migrants active in the informal sector avoid paying the 80,000 rubles required for a 45-day work visa, risking a 300,000 ruble fine, or beating by police. See Hermine G. De Soto and Nora Dudwick. “Poverty in Moldova: The social dimensions of transition. June 1996- May 1997.” The World Bank.
12 The Kyrgyz survey results have not been released yet but should be available soon. Similar surveys have been carried out in Kazakhstan and in Latvia.
13 Important survey based information on these issues in various developing countries is presented in IFC, “Paths out of poverty,” and in the volume edited by Guy Pfefferman and Gary Fields on Small and Medium Enterprises and poverty reduction (Kluwer, forthcoming). See also John McMillan and Christoph Woodruff, “The central role of entrepreneurs in transition economies,” Journal of Economic Perspectives, 2002.
23 income. That bribery is more prevalent among households engaged in micro-enterprise is no surprise. Such households engage in social interactions of both households and of enterprises. Micro-entrepreneurs are still less likely to have bribed than formal sector counterparts. But the main message is clear: micro-enterprise, a natural and very effective defense against poverty, is hampered by corruption. From the Georgia survey, one also finds that “unofficial employment” is important for explaining whether someone bribed, and for the percentage of income.
In recent years, Uzbek men prefer not to go to Osh province in the neighboring Kyrgyz Republic to sell their agricultural produce in the large local market because—when they cross the Kyrgyz border—many of them are detained by the local police and customs officers who surreptitiously place drugs into their belongings, and then detain them for possession. In order to avoid prosecution, the Uzbeks have to bribe the police and customs officers by leaving some portion of their goods or earnings.14
One of the most frequent complaints from small entrepreneurs in both the formal and informal sectors concerns constant harassment from tax authorities, usually carried out with the aim of obtaining bribes. In many countries, entrepreneurs felt that regulations were deliberately obscure and impractical to aid officials in extracting bribes from them. They said that inspectors would appear as often as once a week to check compliance and request bribes in exchange for ignoring various “violations.” For example, a small vendor of pastries at a market in Georgia reported paying the tax inspector 50 lari, and the director of the market 120 lari. Today, this business no longer exists.15 Similarly, small entrepreneurs in Armenia reported that even after they registered their business and filled out all the required forms, they were repeatedly visited by tax inspectors, who checked their premises, equipment and raw materials, demanding money not to report them for a host of ostensible violations. Sanitation inspectors and fire inspectors also use their position to extract frequent payments. In Uzbekistan, the Sanitation Department requires that even small trades obtain a “certificate of quality” for imported goods they sell. An Uzbek entrepreneur selling imported goods explained that he could not obtain such certificates from his
14 Expert Centre for Social Research, Tashkent. “Consultations with the Poor: Uzbekistan.” Report prepared for the World Bank. 1999. 15 Nora Dudwick. “A qualitative assessment of the living standards of the Armenian population.” Armenia Poverty Assessment Working Paper No. 3. The World Bank. 1995.
24 suppliers, and the Department had therefore confiscated 15,700 soms worth of goods. He had been unable to get his goods returned, and said that the Sanitation Department inspectors could completely destroy his inventory if they wished.16.17
Buying Government Jobs
In the personalized economy of the Soviet period, social networks were critical determinants of access to material and non-material resources. The acquisition of jobs that had supplementary income from tips or bribes was particularly facilitated through such informal networks. This practice is said to continue and may even have considerably expanded (Bhatty 2002). Prices for office reportedly range from several thousand dollars for an appointment as district head in a remote agricultural province to tens of thousands of dollars for a lucrative customs post and even significantly more for positions that give control of important state assets, notably oil, gas or generated power. If necessary, ambitious candidates are reported to assemble networks of “investors” to raise the necessary funds for appointments; in any event, once appointed the official must make back his or her investment and will also wish to recoup a profit for himself and his backers. The consequences of failure can range from years wasted in an unprofitable post and the loss of political and economic support to considerably more severe penalties from disgruntled “investors”. While the “tax” imposed is distinctly regressive – the poorest and weakest typically wind up paying a larger share of their incomes to corrupt officials than do the wealthy and powerful those who extract funds primarily from the poor (local police officers, district tax inspectors, and the like) are often not particularly wealthy themselves, and may sometimes keep only a small percentage of the funds they raise.
Corruption among Public Authorities
The Kyrgyz persons interviewed for the World Bank’s 2000 World Development Report explained that the corruption that affects their everyday life is not major corruption that
16 Elizabeth Gomart. “Report on small private business in the Autonomous Republic of Karakalpakhstan and Khorezm Oblast, Republic of Uzbekistan.” May-July 1997. A report for the World Bank. 17 Not only does corruption of the Sanitary Department hurt the poor in terms of earnings; inattention to its mandate of protecting the population from contaminated foodstuffs is also harmful. Kyrgyz informants in both rural areas and the capital city of Bishkek, for example, were very upset about the violation of hygienic standards at their local markets, and reported numerous cases of food poisoning. They were also concerned that poor quality imported foods being sold without any sort of check or control were putting their health, even their lives, at risk. See Counterpart Consortium, Kyrgyzstan. “Kyrgyz Republic: Consultations for the Poor.” A report for the World Bank. 1999.
25 characterizes the activities of politicians or mafia-type organizations, it is the petty corruption of local officials or employees of state agencies who abuse the power of their positions.18 These abuses of power are ubiquitous among police, customs and tax authorities, sanitary and fire inspectors, administrators of municipal enterprises, etc. received frequent mention in studies of all CIS-7 countries. Corruption by public authorities primarily occurs in the form of requiring under-the-table payments or bribes as a means of avoiding or reducing fines or taxes owed the state, or circumventing laws and regulations. The poor are particularly vulnerable to the corruption activities of public authorities because they lack money, and more importantly, they lack the needed connections to help facilitate transactions. Consequently, the poor often must give bribes to receive services.
During the Soviet period, police were all-powerful in terms of preserving order and controlling ordinary citizens as well as crime. But with the weakening of state control, the ability and often the interest in the police in controlling crime have also weakened, and their ability to profit from their position has expanded. The police were consistently identified in the “Consultations with the Poor” studies from the Kyrgyz Republic and Uzbekistan as among the most blatant perpetrators of corrupt activities. In Moldova, most of the respondents who had reported crimes to the police felt that the police lacked any interest in assisting them. Many were afraid to contact the police in incidences of theft or rape, since the police often ended up accusing the victims.
The connection between the police and criminal organizations is a serious obstacle for small entrepreneurs, who find they have no recourse against rackets. This was a frequent complaint of small traders. A Georgian entrepreneur who borrowed $500 to open a clothing store did not expect that she would have to pay $100 to local racketeers, and another amount, which she refused to specify, to the local police to “guard” her shop. These monthly fees, added to her other expenses and commercial competition, soon bankrupted her, and she had to sell her household possessions to pay off a debt of $5,000. Georgian entrepreneurs pointed out that it was essential to have a protector (krysha, literally “roof” in Russian), to have good relations with important
18 Kyrgyz Republic: Consultations with the Poor, The World Bank, March 1999.
26 figures in the police force, and further, to publicize the fact of this relationship to protect oneself against unforeseen “accidents.” 19
Impact on Living Standards
Corruption significantly hurts low income people, both directly and indirectly. It has a direct impact on their income through four channels. First, corruption reduces the earnings from non- wage labor and hinders the advancement of small start-up businesses.20 Second, it reduces their access to assets (such as privatized land) or credit. Third, transfers are lower either because they leak to the rich (they are not well targeted to the poor) or because the rich have captured the state so that public funds go to other purposes than social spending. Fourth, poor people rely heavily on the state for health care, education and social assistance, and—as described below—various forms of corruption are common in these sectors. Corruption also has an indirect economic impact in the sense that it contributes to perpetuating poverty by reducing growth, both through unproductive public investments and indirectly through lower social spending. The main channel through which this takes place is by aggravating (increasing) income inequality. Finally, corruption also affects poverty because it undermines the credibility of state institutions and makes them ineffective.21
The increase in poverty in CIS-7 countries has been driven by the massive collapse in GDP in the early 1990s but other factors, including political factors, have played a significant role. The subsequent recovery of growth has not been sufficient to bring poverty back down. On the contrary, poverty is proving to be remarkably persistent¾even in “reform countries” like the Kyrgyz Republic. The substantial increase in inequality has also contributed to the increase in
19 Nora Dudwick. “Georgia: A qualitative study of impoverishment and coping strategies.” Technical Paper 4. Georgia: Poverty and Income Distribution. Vol. II. May 27, 1999. 20 The EBRD Transition Report 1999 (p.24) states “Bribery in the transition economies constitutes an extremely regressive tax. While large firms report an average bribe tax of 2.8 percent of annual revenues, the average bribes for small firms are nearly double at 5.4 percent. There is also a major difference in the frequency of bribe payments. While 16 percent of large firms report paying bribes frequently, the proportion of small firms rises to 37 percent.” And further “For small firms, in particular, the combination of the bribe tax and the time tax has had a severe impact on the development of new private sector companies, targeting the most dynamic sector in the economy.”
21 The perception of corruption is as important as corruption itself. The expectation that a given group (e.g. officials, or police, etc) will be corrupt becomes self-fulfilling and thus perpetuates corruption, and leads to a lower “corruption equilibrium”. The equilibrium is also frequency-dependent, i.e. an expected gain from corruption depends on the number of other people expected to be corrupt (Bardhan).
27 poverty ¾in some countries to levels rivaling those of the most unequal societies in Latin America. These economic factors have led to major changes in the relative income positions and social status of many social and professional groups. One important outcomes has been the increasing social distance between “winners” and “losers” of the reforms.
Before the transition, the social protection system provided most of the population with a subsistence minimum and a sense of financial stability. Social status and reference groups as "status" benchmarks were often more important than affluence. Thus, although social exclusion existed before the transition, it never meant extreme poverty or sense of severe financial instability. This has greatly changed during the transition as monetary relations and income inequality increased. In the Caucasus, Central Asia and Moldova, traditional ties and networks and other forms of “social capital” were disrupted because of the economic hardships linked to the transition (and, in the Caucasus and Tajikistan, the emergence of fault lines between different ethnic groups due to the wars/conflicts). For developing market economies, there is cross- country evidence that—as income drop and poverty increases—violence, crime and domestic violence increase. The same could be true for corruption. Normally the poor react to such crises by increasing family or community assistance. This is the so-called “community effect” (Prennushi, Ferreira and Ravallion 1999). But, in the countries of the former Soviet Union, it was observed that informal networks do not function effectively as substitutes when the state fails. Informal networks disappear and are not replaced by other mechanisms (Kuehnast and Dudwick 2002). The poor lack the resources to cultivate and maintain “connections” with those in power. With the monetization of the economy, informal networks of the poor are becoming smaller because they lack the money required for reciprocity, gifts, etc. required to cultivate and maintain useful social contacts. The networks that the poor can maintain are made up of people like themselves, who also lack resources and ties to those in power.
28 Corruption in the Provision of Education, Healthcare and Social Services
Corruption in Education
It takes several forms. Students and their families are required to pay bribes to ensure admission into elite schools, to receive good marks, and to secure entry into the more desired departments or institutions of higher learning. The end result is that students from poor families receive less attention in school and cannot compete effectively for university. It was not uncommon during the socialist era to present teachers with little gifts, and in some cases to pay bribes to improve grades and exam scores. Students who can afford bribes are treated better at school, while in most of the surveyed countries, students from poor families attending schools that are still formally free, complain that they receive worse treatment than do their wealthier peers. Teaching staff exploit students in other ways as well. In Georgia, informants in Batumi alleged that the wife of the school’s vice principal ran a sewing business, and students were required to order uniforms from her at the cost of 40-60 lari ($10-$15, a significant amount for a poor family).
With the abrupt decline in real wages, teachers in most post-socialist countries now earn paltry salaries, which most attempt to supplement with second jobs. Education assessments22 and poverty studies in several countries reveal that some teachers threatened to fail a student, as a way of pressuring them to pay for extra tutoring. In Georgia, this took place with primary school students, and sometimes took the form of after-school classes with several such children at once. In Armenia, Georgia and the countries of Central Asia, parents and students felt that teachers deliberately withheld information in class in order to create the demand, among university bound students.
This process has even further ramifications. Because so many teachers supplement now meager incomes by tutoring students, it is in their interest to make sure that the university demands examinations in the topics they teach. Tutoring has become so lucrative that members of particular disciplines have lobbied examination commissions to include their subjects in the examinations. Well-known university members, particularly those who had served on
22 Helen Shahriari. “Georgia. Education social assessment.” The World Bank. 1999
29 examination commissions and knew how to coach their students, could earn significant incomes.23
Even the best students may experience difficulties in enrolling if they don’t pay. In Tajikistan, a recent study notes that according to the great majority of informants, even the best students may have difficulty enrolling if they fail to pay a professor to “facilitate admission.” Payments continue after enrollment, as students find out that refusal to pay a professor before examination periods may have negative consequences.24
While many state universities (as in Armenia e.g.) reserve ostensibly free positions for high- scoring applicants, most have also introduced “paying” sections for students who do not score as well but who are able and willing to pay. In many cases, however, students still have to use connections and pay bribes to enter the state universities. Despite the widespread unemployment among the educated, young people and more educated parents still see education as important for their children, and understand that competence in the new market skills (computer science, business and management, law, foreign languages, and so on) will help them find decent employment. In Georgia, bribes to enter the “prestigious” departments (those that guaranteed a locative profession), such as law, could amount to $15,000. Entry also carries other benefits closed to poor families – in Armenia, only attendance at the state university (rather than at the less expensive private universities) allowed boys to defer military service. Hence, parents were willing to pay.
Corruption in Healthcare
Corruption in the healthcare sector inordinately affects the poor, particularly the elderly poor, for whom payments to doctors, nursing care, hospitalization, and medication potentially constitute a large percentage of their income. The free medical care of the Soviet period may have been overstated because there were costs associated with care, but these were minimal costs by comparison to the fees required today. It is also important to note that the practice of gift giving to doctors and nurses to ensure good care, once manageable on stable incomes, has become institutionalized, and also more expensive. If gifts once consisted of chocolates and cognac, with
23 Nora Dudwick. “A qualitative assessment of the living standards of the Armenian population.” A report for the World Bank. 1995.
30 manageable cash amounts for surgery and childbirth, the same procedures now cost up to hundreds of dollars.
Poor people are less likely to seek health services, a fact partially explained by the necessity to pay bribes. In Georgia, for example, the poor were less likely to have contact with policlinic and health services. The proportion who contacted policlinic and health services among the poorest 26 percent was 29 but it was 40 for the middle 59 percent and 47 for the richest 15 percent. Those who had paid any bribe at all, were more likely to have had contact with policlinic health services, an effect extremely strong at the higher income levels. Interestingly, of those who had contact with policlinic/health services, the poor were less likely to report that bribes are needed. This is consistent with anecdotal stories that the indigent are not required to pay bribes, due to either egalitarianism on the part of health professionals or to a policy of price discrimination. People generally pay bribes in the health sector because they expect that by doing so they will ensure better care. But how do they actually view the quality of care? In Georgia, those in the lower and middle income groups who paid bribes gave roughly the same quality assessments as those who had not paid bribes. At the higher end of the income continuum, those who paid bribes actually gave much poorer marks for quality than those who did not. Looked at another way, those who think bribes are required more frequently think quality is lower. Moreover, the poor generally have less faith in the honesty and integrity of state hospitals.
Moreover, with the de facto “privatization” health care, poor people have to pay under-the-table not only for outpatient treatment, but also when they are hospitalized, since they must also pay nurses and other personnel for basic care. In Moldova (and other FSU countries), a two-tier medical system is emerging, one which consists of low quality care for the very poor and an adequate public and even better private care for those who can pay the official fees, supplemented with unofficial payments in the form of bribes or gifts.25
24 Tokhir Mirzoev, “Corruption in Tajikistan as seen by the private sector.” Dushanbe, Tajikstan. September 1999. 25 Hermine G. De Soto and Nora Dudwick. Poverty in Moldova: The social dimensions of transition. June 1996- May 1997. A report for the World Bank, 1997.
31 In Armenia, Georgia, and other FSU countries, informants admitted that due to high unofficial costs, they often avoided doctors for acute illnesses or injuries. As a result, acute illnesses have become chronic, chronic illnesses have become life-threatening, and injuries have turned into disabilities. Informants also reported that doctors deceived them to make money by presenting them with frightening misdiagnoses.26 When in hospital, informants reported they often paid, not for special treatment, but just to avoid being completely neglected and mistreated.
Corruption in the health care system makes the poor particularly vulnerable, since it is often illness or injury that prevents an adult breadwinner from working, or that drains the family budget. As the result of the high costs of medical treatment in most of the post-socialist states, people are forced to make difficult decisions about whether or not they can afford to have their family members seen by someone in the medical community.
Corruption in Social Assistance
Social benefits generally constitute a major source of support for the very poor, the disabled, the elderly, and other potentially vulnerable groups. Corruption has also penetrated assistance to the most vulnerable. When humanitarian aid was channeled through these departments, recipients in many countries voiced suspicion that employees themselves disposed of a portion of the goods. When in-kind goods are distributed instead of cash, informants complained that although they were supposed to receive the market value of these items (usually foodstuffs), the ostensible value is usually above local market prices. Anger at this practice led members of a local association of disabled persons in the Kyrgyz Republic to picket the regional office of the state administration to demand that in-kind payment of pensions and benefits be prohibited; unfortunately, their action proved unsuccessful.27
26 A Georgian woman described how a gynecologist diagnosed her friend as pregnant, in order to earn the $60 fee to perform an abortion. This woman later learned that the sonogram had indicated she was not in fact pregnant. See Nora Dudwick. “Georgia: A qualitative study of impoverishment and coping strategies.” Technical Paper 4. Georgia: Poverty and Income Distribution. Vol. II. May 27, 1999. 27 Counterpart Consortium, Kyrgyzstan. “Kyrgyz Republic: Consultations for the Poor.” Report for the World Bank. 1999.
32 In some cases, recipients were forced to pay department employees in order to receive their meager assistance or pensions.28 Poor people often have to pay medical commissions to be certified “disabled” and eligible for disability payments. Many recipients feel that social assistance offices deliberately cheat them by withholding information about their rights and entitlements. An elderly pensioner in Georgia, for example, was forced to seek out legal advice to learn that he was indeed eligible to receive both a salary and his pension. Other Georgians claimed to have been blackmailed by the local housing authorities, which illegally refused to give them the required certificates required by the social assistance office before they had paid off their utility debts. Elsewhere in Georgia, informants said they had to pay twice the amount of their monthly pensions in order to begin receiving their pension. A particularly poignant example of corruption, also from Georgia, although similar cases were reported elsewhere, concerns diversion of humanitarian aid provided to children living in institutions. As an expatriate aid worker explained, although employees distributed food and clothing destined for the institutionalized children to relatives and friends in the village, the entire village in which the institution was located was so poor, that they were in effect, sharing rather than simply stealing the aid.29
Corruption during Privatization: The Example of Agricultural Land
In most CIS-7 countries, agriculture is the largest economic sector and a potential “engine of growth” for on-farm and off-farm employment and income. In many former Soviet Union countries, the state has divested itself of industrial assets, housing, and collective agricultural enterprises. In this process, many people were able to purchase the apartments they occupied for relatively low prices. The privatization of industrial enterprises, by contrast, was generally carried out in a nontransparent fashion. This extensive corruption (which is documented in several reports) affects the population indirectly rather than directly. But, in agriculture, corruption linked to privatization of land and agricultural machinery, buildings, etc. has directly affected the population, and the poorest in particular.
28 An elderly informant in a Kyrgyz village reported that post office employees forced pensioners to buy old newspapers; if they refused, the price of the newspapers was subtracted in any case from their pensions. See Counterpart Consortium, Kyrgyzstan. Op.cit.
33 Studies from various CIS-7 countries document the extent to which collective and state farm managers as well as technical specialists, have managed to acquire the best and largest shares of land, agricultural equipment, and livestock. Farm directors and managers accomplished this by a combination of factors: exploiting legal ambiguities and/or the population’s ignorance about the law; overt intimidation of or misrepresentation to collective farm employees; and refusal to accept documents or simply to abide by the law.
Armenia experienced the first and most radical restructuring of agriculture in the former Soviet Union. The nationalist party, new to power and serious about land reform, devised a complex scheme that was to take account of land quality and location, and to be distributed to families according to the number of family members. While there are few accounts of complete exclusion from privatization, respondents from studies claim that collective farm leaders acquired extra land by registering them under the names of relatives or friends. A farm survey carried out by the Bank found that poor families consistently ended up with less land, poorer quality land, and plots located farther from each other than did non-poor families.30 This finding corresponds to informants’ claims that the non-poor used their better “connections” to undermine the fairness of the process, sometimes paying bribes reportedly as high as $1,000 (in the fertile Ararat region)31 to obtain their land. In some villages, respondents claimed that the collective farm directly had acquired far more than his share of cattle, sometimes up to 50 or 100 head of cattle.
In Moldova—which has a much richer agricultural potential—there were many more allegations of corruption and fraud during the process of land privatization. As in Armenia, farm management exploited legal ambiguities and general confusion to withhold or distort information about eligibility. In some cases they claimed to have lost documents.32 Alternatively, management seized, destroyed or ignored applications. Management exploited the legal
29 Nora Dudwick. “Georgia: A qualitative study of impoverishment and coping strategies.” Technical Paper 4. Georgia: Poverty and Income Distribution. Vol. II. May 27, 1999. 30 Sharon Holt. “Armenia Poverty Assessment Paper No. 3. Using land as a system of social protection: An analysis of rural poverty in Armenia in the aftermath of land privatization.” The World Bank. 1995. 31 Elizabeth Gomart. “Social assessment of the poorest of the poor in Armenia. November-December 1997. A report for the World Bank. 32 For example, a female farm worker who had taken maternity leave in 1990 was told in 1993 that her labor certificate had disappeared, and that she could no longer be considered a member of the collective. See Nora Dudwick, “Land reform in Moldova.” The World Bank. 1997.
34 ambiguities concerning the rulings about the entitlement of social services employees to land. In several villages which had decided to give them plots, after elections in which the Agrarian Party (which largely represented the interests of collective farm managers) came to power, the Land Committee annulled this decision, essentially excluding social services employees from land ownership.
A frequent practice used to maintain the collective farms was for officials and farm management to deliberately misinform, even intimidate, people who wanted to withdraw from the collectives. A mayor interviewed for the Moldova study openly acknowledged that he had tried to discourage pensioners and female collective farm workers from claiming their land shares by informing them that their land would be confiscated if they did not farm it (the law does not make this provision). On one farm, the manager had effectively prevented pensioners from withdrawing from the collective by telling him (incorrectly) that they would lose their pensions if they withdrew. In other villages, the collective farm managers prevented people from leaving by threatening to prevent them from renting agricultural equipment; others refused to distribute the other assets (mainly agricultural machinery) who withdrew their land shares from the farm. As a stop-gap measure, one collective farm refused to allow people to withdraw until May, when it was too late to sow the crop.33
The impact of such practices has been two-fold. In some cases, collective farm workers have been intimidated or frightened into remaining on the collective farm, and accepting unfavorable working conditions, including salaries paid many months late, and often in-kind (based on pricing the in-kind goods significantly above market prices). When collective farm workers have, nevertheless, pulled out of collective farms, they have frequently done so on poorer land, with less access to necessary equipment or credit. As a result, many farmers had left parts of their land fallow and their farms were only providing for subsistence.
Restructuring agricultural enterprises has been a complicated process in Central Asia. In Tajikistan, the law, as of 1995, provided several mechanisms for distribution of private plots, as well as for renting and leasing in return for providing the farm with a share of the harvest, with written contracts. In several cases, studies found that wealthier families—or those with control of
37 Nora Dudwick, “Land reform in Moldova.” The World Bank. 1997.
35 resources (such as a shop director)—received much larger plots, and were allowed to keep a larger share of the harvest. The practice was more difficult for female-headed families, which the farm management illegally excluded from the land allocation. An interviewed private farmer in Uzbekistan reported that the local hokim (equivalent to a mayor) had offered him land because of his status as a respected religious figure. He noted that not all villagers received land, but that the hokim was more likely to provide opportunities to people of his own level. Moreover, because of the private farmer’s personal standing, he would be likelier to have access to irrigation and other inputs.34
Although farmers interviewed in eastern Georgia had received the amount of land to which they were entitled, they claimed that people who worked for law enforcement agencies, directors of schools and commercial enterprises, and “big businessmen” received the best land, orchards, vineyards, and fallow fields, while they received unirrigated, saline, and less fertile land, located 10-12 km from their homes. In Javakheti, farmers claimed that the collective farm leadership cheated them, and that some people obtained larger plots by paying bribes. In Marneuli, farm workers had signed a document agreeing to rent their land, but soon learned that the 300 hectares in question had become the property of the collective farm director.35
Corruption in the privatization of agricultural assets, particularly land, has thus affected the rural population in several ways. It has slowed down the process and made it more difficult. In some cases, farm workers with little understanding of their rights, or susceptible to intimidation, have entirely forfeited their rights to land and property, to become hired workers on the larger farms of wealthier neighbors, often the ones who have appropriated their land. In many cases, farm workers have succeeded in obtaining some land, but found that because of corrupt practices, their land is less productive and further away from their homes. In such cases, the very powerlessness which made them vulnerable to such treatment also means they have less access to credit and affordable inputs, which are often determined not just by money but by connections.
34 An Uzbek saying goes “The rich help the rich, and God helps the rich.“ See E. Gomart. “Report on small private business in the Autonomous Republic of Karakalpakhstan and Khorezm Oblast, Republic of Uzbekistan.” May-July 1997. Report for the World Bank. 35 Nora Dudwick. “A qualitative study of impoverishment and coping strategies. Technical Paper No. 4.” In Georgia: Poverty and Income Distribution. Volume II: Technical Papers. The World Bank. 1999.
36 4. WHERE DO WE GO FROM HERE?
This paper—based on evidence from surveys and analytic reports from NGOs and international organizations—has shown that corruption, both high level and administrative corruption, is still extensive in the CIS-7 and aggravates existing deficiencies in several governance areas: harassment of private entrepreneurs; weaknesses in public administration; lack of transparency and accountability; weak legal and judicial system; low participation of citizens in public affairs; and poor and unequal access to services.
This paper has indicated that institutional reform has lagged behind in all seven countries, even though GDP has begun to recover starting, in most cases, in the second half of the 1990s. The economic recovery could probably have started sooner—and proceed much more rapidly—had governments pursued structural policies more forcefully and consistently. 36 The central issue which has retarded economic reforms has been the political economy of reform, which relates to the difficulty of overriding powerful interest groups that benefit from the status quo. This has blocked reforms and prevented the CIS-7 countries from developing a consensus required for taking difficult political positions. 37 One of the key issue to be addressed in the future is thus how to counter these vested interests which have captured the state and block reforms. Other major issues which have contributed to delays in economic reforms are institutional in nature. Progress in four major areas is necessary: creating institutional restraints on power (i.e., checks and balances); increasing political accountability; strengthening participation of the population in the decisions that affect their lives (e.g. in education, health, etc) and improving the management of the public sector and professionalizing the administration. Improvements in these areas would reduce corruption, reduce capture and improve governance.
36 The policy agenda, according to IMF/World Bank (2002), includes (a)eliminating inefficient budget management procedures; (b) rationalization of government spending needs with a better focus on priority areas; (c) focus of health care spending on basic care; (d) focus of education spending on primary and secondary schooling; (e) reform of the pension system in most CIS-7 countries to improve its sustainability; (f) serious spending distortions exist within each social sector; and last but not least, (g) credible debt reduction strategies.
37 According to IMF/World Bank (2002), policy priorities include (a) eliminating inefficient budget management procedures; (b) rationalization of government spending needs with a better focus on priority areas; (c) focus of health care spending on basic care; (d) focus of education spending on primary and secondary schooling; (e) reform of the pension system in most CIS-7 countries to improve its sustainability; (f) serious spending distortions exist within each social sector; and last but not least, (g) credible debt reduction strategies. All these priorities are politically difficult to implement and require building a national consensus.
37
Finally, the development of a more attractive and competitive business climate is an area which requires urgent attention because of its crucial role in affecting investment, job creation and productivity. To improve the investment climate, the nexus between the private and public sectors will need to be reshaped. A more competitive and transparent set of institutions of influence (such as legal lobbies and the ongoing poverty reduction strategy processes) will need to be institutionalized. The potential of competitive business associations (traders, SMEs or exporters) needs to be tapped to mitigate monopolistic forces and strengthen anti-monopoly policies. Transparency of and access to information need to be extended.
38 ANNEX 1. Why corruption is harmful to growth and poverty reduction.
There is an extensive literature providing cross-country evidence that governance explains a large part of productivity differences between countries and is the primary, fundamental determinant of the long run economic performance of countries. See e.g. Hall and Jones (1999). This cross-country evidence indicates that good governance, as defined for instance by the indices described in Kaufmann, Kraay and Zoido-Lobatón (2002) is positively correlated with GDP growth (For a summary, see Dethier 1999a).
Corruption, in virtually all cross-country studies, is shown to be negatively associated with growth and poverty reduction (For references, see for example Mauro 1995, Bardhan 1997, Kaufmann 1998, Rose-Ackerman 1999, Treisman 2000). However, the empirical validity of the statement that corruption is bad for growth and equity has sometimes been questioned because some countries (such as Indonesia, Thailand, China etc) have exhibited high growth and relatively rapid poverty reduction simultaneously with high levels of corruption. 38 However, there are few cases in history of countries with weak governance experiencing high growth and rapid poverty reduction. On the contrary, when weak governance prevails, rent-seeking bureaucrats can increase the regulatory burden on private activity and delay procedures so that the effective (not just nominal) red tape and bribery may be positively correlated across firms.
Kaufmann and Shang-Jin Wei (1999),39 using worldwide firm-level surveys, have examined the relationship between bribe payment, management time wasted with bureaucrats, and cost of capital. The “efficient grease” theory probably does not hold. Firm-level surveys find that firms that pay more bribes are also likely to spend more, not less, management time with bureaucrats negotiating regulations 40, and face higher, not lower, cost of capital. Thus, it is far from clear that corruption is good for growth in the long run.
38 Efficiency arguments have been used to argue that corruption actually improves efficiency and helps growth in an environment of cumbersome and pervasive regulations (Bardhan 1997). First of all, when there are many pre- existing distortions in the economy, additional distortions in the form of bribes may actually improve welfare. Second, corruption can be seen as “speed money” and bribes may actually be helpful to reduce the red tape.
39 “Does Grease Money Speed Up the Wheels of Commerce?“ National Bureau of Economic Research, Working Paper 7093, April 1999, by D. Kaufmann and S. J. Wei 40 However, when we look at the results the other way round, namely that those companies that have to spend more management time with bureaucrats are more likely to bribe more, they need to contradict the “efficient grease” story.
39 Good governance matters not only for efficiency, but also for equity, inter alia to ensure the inclusion of everyone in society. If the institutions of governance that ensure a modicum of equity in society (such as non-discrimination in labor or credit markets, acceptable taxation and redistribution systems, etc) are weak, they are likely to have a negative impact on economic development by influencing the distribution of income and wealth. In CIS-7 countries, poor governance—as measured by the indicators shown in the table 1 of this paper—is associated with high income inequality and poverty.
Why have other countries—both within and outside the CIS—performed better than the CIS-7 in terms of limiting the negative impact of corruption on inequality and poverty? Macroeconomic changes (collapse in demand, etc) leading to changes in the returns to education or other assets cannot solely explain the increase in income inequality and poverty. Institutional change and its consequence has played an equally critical role in determining outcomes. Governance is linked to poverty through growth and income distribution. Governance variables such as protection of property rights and contracts, etc are significantly related to growth. Growth, in turn, affects income inequality and the poverty rate through several key variables: the sectoral pattern of growth (often biased against the rural sector even though agriculture is clearly a “pro-poor” sector in most developing countries); geographic pattern of growth; imperfections in markets; factor bias in technology; government policies, in particular on taxation and social welfare. In transition countries, all these factors were significant.41 Cross-country econometric studies, using large samples of countries, providing empirical evidence on the two-way link between governance, growth and poverty via the channel of inequality. Gupta, Davoodi and Alonso- Terme (1998) find a statistically significant and quantitatively sizeable positive association between corruption and poverty. A decline in the growth rate of corruption of 0.8 percentage point reduces income growth of the bottom 20 percent of the population by 7.8 percentage points.42 The empirical evidence which exists for the CIS-7 (Milanovic 1998; World Bank 2000)
41 The impact of these variables is discussed at length in the cross-country studies of De Melo, Denizer and Gelb (1996) and De Melo, Denizer, Gelb and Tenev (1997). The role of political institutions is discussed in Dethier, Ghanem and Zoli (1999).
42 Other empirical papers discussing this issue include Kaufmann et al. (1999), Knack and Anderson (1999) and Chong and Calderon (1998). The latter examine the statistical relationship between poverty/inequality and institutional efficiency. An institution is considered efficient when the benefit of creating and maintaining it
40 indicates that income from all major income categories (labor earnings, capital income, transfers) declined for the poor and increased for the rich resulting, in the aggregate, in increasing inequality. Poor governance has aggravated this inequality because jobs, assets (productive land, privatized enterprises etc) and transfers went to a group of well-connected people who then used their position to create institutions through which they could extract more rents. This was aggravated by a lack of accountability mechanisms in the public sector and by the fact that popular participation in decision-making has often been discouraged or outright opposed.
outweighs the transaction costs of doing so. Chong and Calderon use as proxies of institutional efficiency indicators provided by ICRG and BERI (both private agencies rating countries for political risk factors). Inequality and poverty measures used are, respectively, Gini coefficient or income share of the lowest decile, both from the Deininger/Squire data set. Their empirical findings suggest that, at low levels of per-capita income, increases in institutional efficiency are linked to greater inequality in the income distribution, while for richer countries, increases in institutional efficiency generate a more egalitarian income distribution. This inverted U-shaped relationship is consistent with the views of some political scientists who argue that a small degree of corruption (or, generally, institutional inefficiency) — and therefore probably a worsening of income distribution — is good for growth because it is the “oil that lubricates the machine”. Knack and Anderson (1999), using the same dataset, do not report this “U-shaped” relationship. They find that good governance improves incomes for all groups, not only for those who have the most property in need of protection. If anything, the incomes of the poor increase more rapidly than those of the rich when the “quality” of governance is higher. They conclude that the enormous gains from institutional reform in terms of material welfare appear to benefit the poor as much as —or more than—they benefit other classes. Kaufmann et al. (1999) also find that “a strong causal relationship from improved governance to better development outcomes” using data from the 1990s and instrumental variable techniques.
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