August 8, 2011Doug Hadden
Carlos Lipari, FreeBalance Washington
This is a blog series discussing factors that impact development in developing countries. As a For Profit Social Enterprise (FOPSE), improving country growth through good governance is the core company mandate at FreeBalance. As such, FreeBalance participates in governance, development, foreign aid, ICT for development and transparency discussions globally.
“Poor governance is among the most important causes of state failure and underdevelopment. Hence innovations and reforms in the governmental and bureaucratic apparatus are an important prerequisite for development. E-government policy initiatives have gained international validity by the donor community as a catalyst for such reforms. To be sure, the characteristics of the state model implicit in e-government applications and the economics of transition from a backward state organization to e-government are equally relevant for the success of the initiative.” (Claudio Ciborra , Diego D. Navarra)
When politicians declare that they are striving to improve governance, they are often using a diplomatic way of saying that reducing corruption is a priority.
Increased Visibility of Governance and the Costs of Corruption
Over the last couple of decades, a greater importance has been given to both governance and the corruption that arises due to bad governance. Institutions such as the IMF, and World Bank have become increasingly interested in finding ways to access the quality of the governance of a given country and on how to improve it. (FreeBalance has had here an important role, providing countries with IT solutions that have rapidly improved their public financial management). Processes like the Public Expenditure and Financial Accountability (PEFA) framework is helping to focus governments on improving governance factors.
The perception of costs and benefits of corruption has changed over the years. Such change has contributed to turn governance into the very hot topic that it is today.
For a long period of time, economic literature had presented a “romantic” view of corruption. It had argued that corruption could relax government-imposed rigidities, increase commerce and even allocate investment in a more efficient way (by giving priority to more profitable investments). This perception has changed. The general belief today is that corruption benefits mostly “rent seekers”, that “it is subject to increasing returns that perpetuate it” and creates an environment “that, in time, can lead to the collapse of political regimes” (Vito Tanzi & Hamid Reza, IMF Edition 2000-2182)
In addition to this, corruption can be perceived as an extra tax on the economy that further distorts its activity and introduces uncertainty (Shang-Jin Wei, Nov. 1997). Like almost any tax, this limits economic activity to a suboptimal level and tends to slow down economic growth.
What history has demonstrated is that corruption leads to higher transactions costs and does not necessarily provide preference to agents that deliver the highest social surplus. Because investors are risk-averse, the uncertainty related to corruption (and bad governance in general) is incompatible with low risk premiums, which affects investment opportunities, making them less attractive.
Corruption and Poverty
One of the reasons why corruption also depresses the country’s development has to do with the fact that the capital raised by means of corruption, being illegal, tends to be kept outside the country, instead of invested in the local economy. This topic is particularly sensitive in countries with more corruption concentrated at a high level because as it dries out the economy from resources that should finance private demand and investment.
When it comes to the impact of corruption on poverty, even though there is some evidence that reducing corruption actually reduces income inequity (Sanjeev Gupta et all, Economics of Governance, 3rd Edition 2002), I would agree that it is very important to understand and try to quantify the potential impact that certain anti-corruption measures will have on inequity and the social costs related to the adjustment process that is always necessary. Certain types of small corruption, when paid by the wealthiest of a given country or its foreigners, can ultimately provide a better life for many of its citizens, allowing some of these low income families to finance their children’s education and open small businesses. Changing the income structure of these families can have high social costs and this should not be ignored. Even so, one can easily agree that corruption must be reduced and that it tends to strongly limit a country’s ability to grow.
The fact that developed countries providing development assistance, along with international organizations such as the IMF or the World Bank are becoming more sensitive to this issue is just another reason why better governance is becoming crucial for the success of developing nations. Finally, this also allows us to better understand why a company such as FreeBalance has such an important role leveraging economic growth.
According to the United Nations, the middle class has a crucial role when it comes to improve local governance. In order to achieve this, though, it has to be well informed, interested, organized, and empowered, actively pursuing it.