The economics of corruption

The National Accountability Bureau announced last week that its estimate of  “corruption” in Pakistan was Rs7 billion per day — and the following day, revised the figure to Rs12 billion. Even the lower figure is about 12 per cent of the GDP. One would like to see the NAB’s method of estimation and the precise definition of corruption used before subjecting its figures to scrutiny. The question of the robustness of NAB’s figure notwithstanding, widespread prevalence of bribery has been reported by Transparency International on the basis of surveys of citizens in contact with various government departments. Let us examine its economic consequences.

Bribery can be defined as an economic gratification paid by an individual (or organisation) to acquire an economic, social or political favour from an official in a public or private sector organisation, in violation of the formal rules and procedures of that organisation. The phenomenon of systemic bribery, suggests the emergence of a secondary market for enabling services ranging from stealing electricity, police protection for criminals, getting government contracts at inflated prices, and regular tax evasion. Such a secondary market emerges only when the enforcement of formal rules is weak and the norms of honesty and justice have eroded.

Systemic bribery hinders investment and sustained economic growth because: a) Investors face increased uncertainty, b) Bribery increases the cost of investment and is therefore another disincentive for potential investors, c) As a significant proportion of private sector resources directed at new projects flow to corrupt government officials rather than productive investment, there is a lower GDP growth for given levels of investment and d) An increase in the cost per unit of goods and services produced in a bribery infested economy would lead to lack of competitiveness in the international market and hence adversely affect exports.

If the magnitude of aggregate bribery in the macroeconomy is large, then it will accentuate the inequality in the distribution of disposable incomes in three ways: a) Low-income groups have to pay a higher percentage of their incomes for accessing public services compared to the upper income groups, b) Bribery related leakages of government tax revenue and revenues from services such as electricity, water and gas will ceteris paribus increase the fiscal deficit with the usual recourse to increased indirect taxation which is inherently regressive. Almost 70 per cent of tax revenue is drawn from indirect taxation. Evidence from Pakistan shows that the tax burden as a percentage of income was highest at 6.8 per cent for the lowest income group and was lowest at minus 4.3 per cent for the highest income group. Thus, the burden of bribery is borne predominantly by the poor. Finally, c) High levels of bribery means that for given levels of development expenditure there would be fewer and poorer quality goods and services in the public sector.

Clearly, bribery restricts economic growth and at the same time accentuates income inequality. Yet, it is only one of the myriad rents that are built into the institutional structure of the economy and constitute a fundamental constraint to sustained growth and social justice. Rents are unearned incomes. Rent is defined as a rate of return on an asset (including skills) which is greater than the opportunity cost of that asset. Thus, for example, rent is the difference between the money value of the income and perks that a government official gets compared with what she/he would have received for her/his skills in a competitive market. Similarly, the price that a consumer pays for a domestically manufactured car (under conditions of high protective import duties) is much higher than the price he would have paid under competitive conditions.

The institutional structure of Pakistan’s economy is designed to generate rents for the elite at the expense of the middle classes and the poor. It is this structural characteristic of the economy and not just bribery that prevents sustained high economic growth and equity.

Published in The Express Tribune, December 17^th, 2012.