Corruption in developing countries

Olken, Benjamin A. and Rohini Pande.
Annual Review of Economics (2012) 4:479–509.
Sharkhuu Munkhbat
Economics of Development
Cooperation
May 11, 2013
CORRUPTION IN DEVELOPING
COUNTRIES

I. Introduction
II. Estimating Magnitude of Corruption
III.Efficiency Costs of Corruption
IV.Determinants of Corruption
V. Some Caveats: Short and Long-run Effects
VI. Conclusions
2
Table of Contents

Increasing interest of the international policy community
in corruption:
• the OECD Anti-Bribery Convention,
• the UN convention against corruption,
• the World Bank Group Engagement on Governance and
Anticorruption and
• the Foreign Corrupt Practices Action of US Department of
Three main questions:
3
I. Introduction
• the OECD Anti-Bribery Convention,
• the UN convention against corruption,
• the World Bank Group Engagement on Governance and
Anticorruption
• the Foreign Corrupt Practices Action of US Department of Justice
and Security and Exchange Commission.
1. How prevalent is corruption?
2. What are the efficiency consequences of corruption?
3. What factors determines the level of corruption?

4
1.The estimated levels of corruption are remarkably
heterogeneous, so there remains little consensus about the
magnitude of corruption.
3.Corrupt behavior can be modeled in line with a few general
economic principles:
• corrupt officials respond to monitoring and punishments
• standard market forces influence the level of bribes.
I. Introduction
2.Corrupt behavior has significant adverse consequences for
efficiency and equity outcomes.
There are three important findings:

5
1. Perceptions:
The advantage: good coverage
• much easier to ask someone’s perceptions of corruption
than to actually measure corruption directly.
The challenge: may not measure corruption accurately
• perceptions of corruption fell even though actual
corruption rose
Road project: Villagers’ perceptions do not reflect actual corruption.
• increasing the actual missing expenditures by 10%,
• increases the probability a villager reports corruption by just 0.8%
II. Estimating the Magnitude
of Corruption
Methods to estimate the magnitude of corruption:

6
2. Survey: It is the most direct way of measuring corruption.
Mocan (2008) find that income and education of the individual
have positive impacts on the likelihood of being asked for a
bribe in developing countries.
of Corruption
Svensson (2003) surveyed firms in Uganda and examined how much
they paid in bribes.
On average, firms in the survey report bribe payments of about 88
USD per worker, or about 8 percent of their total costs.

7
3. Direct Observation: Best way to measure corruption.
However, corrupt officials rarely will let corrupt behavior be
observed.
.
McMillan and Zoido (2004) analyzed detailed records in Peru, with
signed contracts and videotapes of accepting the bribes.
After videotapes became public, on average, politicians received
bribes ranging from 3,000 - 50,000 USD per month, depending on
whether the politician was in the opposition party or not.
of Corruption

8
4. Graft Estimation by Subtraction: Two measures for the
same quantity, one measure before corruption takes place and
one measure after corruption takes place.
The estimate of corruption is the difference between the two
measures.
Olken (2007) implemented a related methods in road project in
Indonesia.
He estimated that “missing expenditures”—the difference between
what the village claimed the road cost and what the engineers
estimated it actually cost—averaged about 24 percent of the total
cost of the road.
of Corruption

9
5. Market Inference: The theory of market equilibrium can be
used in combination with data on market activity.
The study Fisman (2001) estimated firm’s stock price movement
when Indonesian president Soeharto fell ill given the strength of its
political connections.
On net, for the most connected firms he estimates that about 23
percent of their value was due to Soeharto’s connections.
of Corruption

10
1. A strong negative relationship between income and
corruption: richer countries may appear less corrupt.
3. Virtually all of these “hard” estimates of corruption may
suffer from selection bias.
of Corruption
2. Among countries at similar income levels, and even within
countries, there is marked heterogeneity in corruption levels.
How much corruption is there: main findings from estimates

1. Impact on firms:
11
III. Efficiency Costs of Corruption
1. If bribes are charged for other types of government activities,
this could increase the effective marginal tax rate faced by
firms.
2. For a given effective marginal tax rate, corruption are more
distortionary than tax rate and can decrease business activity of
firms.
The regression of firm growth on the bribe and tax rate:
• A one percentage point increase in bribes reduces annual firm growth
by three percentage points, while a one percentage point increase in
taxes reduces annual firm growth by one percentage point.
• Negative impacts of bribes on firm activity are three times higher than
the corresponding impacts of taxation.

12
Distortions: Corruption
could create additional
efficiency costs through
distortions.
Corrupt officials need to go
through a variety of more
convoluted procedures to
extract rents.
Price effects: If corruption
increases the cost of
government goods and
services, this could have an
effect similar to raising the
price of these goods and
services.
Corruption can have efficiency consequences through
impacts on government provisions of goods and services.
2. Impact on Government:

13
The need to keep corrupt
activity secret could also
introduce distortions, as
procurement officials may
substitute the types of goods
that make hiding corruption
easier.
Since corruption is secret,
the government may not
anticipate the amounts lost
to corruption.
Example: Building thinner
roads than official engineering
guidelines
2. Impact on Government:
Two types of distortions

3. Impact on Correcting Externalities:
14
If corruption decreases the government’s ability to correct an
externality, it may lead to inefficiency.
Someone can bribe a police officer instead of paying an official
fine.
Overweight trucks are a classic example of an externality.
Olken and Barron (2009) found that almost all trucks were
substantially over the weight limits and paid a bribe, instead to buy
an official ticket. ($0.5-$1 per payment)

4. Impact on Individuals:
15
Corruption can affect individuals directly.
Hunt (2007) shows that corruption can be an additional cost on
the victims of misfortune—particularly crime victims.
The study also shows that in many situations crime victims
bribe more than other users who are not victims.

I. The Incentives Bureaucrats Face
16
IV. Determinants of Corruption
The bureaucrat will be corrupt if p(w-v)<(1-p)(b-d)
w: wage from government
v: outside option
p: probability of detection
Several options for reducing corruption:
• Increasing the wage for staying on job
• Decreasing the outside option by increasing punishments
• Increasing the probability of detection through monitoring
b: bribe
d: dishonesty cost
Nobody will be corrupt if p(w-v)>(1-p)(b-d)
If detected: fired, v
If undetected: w+b-d

A. Factors affect the Bureaucrat’s Decision
17
1. Compensation: There is little evidence on impact of
compensation.
• higher public wages are associated with lower corruption.
• a doubling of government relative to manufacturing wages is
associated with only 0.5 point reduction in corruption index.
2. Monitoring and Punishments: Increasing monitoring
would reduce corruption.
Olken (2007), in the study of roads in Indonesia, found substantial
effects of the government audits, reducing corruption by 8
percentage points.

A. Factors affect the Bureaucrat’s Decision
18
3. Selection: The selection of who chooses to become a
bureaucrat is potentially important.
• Ferraz and Finan (2010, b) find that higher salaries attract better
political candidates, though the effects show relatively modest.
• a 20 percent increase in wages only leads to a 0.2 increase in the
average years of schooling and a 0.05 increase in the number of
terms of experience
4. Incentives in the health and education sector are
conditioned on either worker absenteeism or directly on health
or education outcomes.
For example, performance-based pay can reduce absenteeism and in
the case of school teachers improve test scores of students.

B. The Market for Bribes:
Strategic interactions between corrupt officials
19
If each agent does not fully internalize the effect of their bribes
on other agents’ bribe revenues, the total amount of bribes
would be higher.
Olken and Barron (2009) show that the average price paid by truck
drivers at checkpoints increases when the number of checkpoints
declines.
If bureaucrats are competing against one another, strategic
interactions could lead to lower bribes and more output.
Olken and Barron (2009), traveling the road should have been free,
so lower bribes would lead to greater road travel and greater social
efficiency.

II. Transparency: Three channels
20
1. Enabling information about government actions, citizens
can better monitor government officials and political
accountability can be increased.
Djankov et al (2010) examined the relationship between disclosure
rules for information about parliament members and a numbers of
measures of quality of government and corruption.
They found that public disclosure of information is associated with
lower perceived corruption and better government.

21
Reinikka and Svensson (2005) study how an information campaign
to monitor local officials can reduce corruption and increase
educational outputs.
They find that an increase in information resulted in an increase in
spending reaching the schools and ultimately an increase in school
enrollment and student learning.
2. Providing citizens with information on what they are
entitled to.

22
3. Allowing citizens to signal interest in a particular
outcome.
Peisakhin and Pinto (2010) examined whether freedom-of-
information laws can improve access to basic public goods that are
otherwise attainable only through bribery.
The results suggest that requesting information under the freedom
of information law is a reasonable, though imperfect, substitute for
bribing an official.

III. Technology and Communication
23
1. Technology can also have a substantial impact on corruption
by facilitating communication, which can enable better
monitoring.
Yang (2008) shows that pre-shipment imports inspection
programs increased import duty collection by 15 to 30
percentage points in the first five years after implementation.

24
2. Technology has played an important role in the design and
administration of the tax system.
One key idea of tax enforcement is double-reporting, where
the tax department compares two independent reports about
tax performance
Kleven et al (2010) find that that the tax evasion rate is very small
for income subject to double-reporting and much higher for self-
reported income.
In a manual system actually doing the matching from all the double-
reported information would be very challenging, but once the
system is automated it is much easier.

25
3. Technology holds promise is in procurement. Most of
governments, including developing countries, have been using
online procurement systems.
In context of road projects in India, Lewis-Faupel et al (2011) find
that electronic procurement leads to higher quality of roads and less
corruption.
Online procurement systems can potentially reduce corruption
by increasing access to information and by making the
procurement system more transparent.

The long and short run effects:
26
V. Some Caveats
• The long-run effects of an anti-corruption policy could be
smaller than the short-run effects.
• It could take time corrupt officials to learn how to
manipulate a new system.
• The long run effects could be greater than the short-run
effects.
• An anti-corruption policy could be more effective over time
if it encourages more low-corrupt officials to select into the
civil service.

VII. Conclusions
27
VII. Conclusions
• From the international perspective, there have been major efforts at
reducing corruption and promoting transparency.
• Micro-empirical analysis on corruption has dramatically increased.
• Corrupt officials respond to incentives and the threat of
punishment, even in corrupt environments.
• Strategic interactions between corrupt officials affect the level of
corruption.
• Information disclosures may incentivize politicians to perform
better and improve the incentives for high talent individuals to enter
politics.
• In some situations the long-term impacts of anti-corruption policies
exceed the short-run effects.
• Researchers have identified several innovative ways of measuring
corruption and economic theory offers significant guidance on how
to design anti-corruption policies.

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