In 2013, Brazilian police investigating a regular money-laundering case uncovered something considerably more serious: a bribery and bid-rigging conspiracy involving state-controlled oil giant Petrobras. The investigation, dubbed Operation Car Wash, revealed that some of Brazil’s major construction and engineering firms had paid billions of dollars in bribes to gain lucrative contracts from Petrobras over a period of years. Hundreds of government employees and politicians were embroiled in the affair.
Of course, unscrupulous business practices aren’t unique to emerging market economies like Brazil. Politicians in Japan accepted bribes to authorize contracts to buy US military planes in one spectacular episode in the 1970s. This incident was one of the driving forces behind the enactment of legislation prohibiting US corporations from paying bribes abroad. However, corruption, or the use of public office for personal benefit, distorts government actions and, as a result, has a negative impact on economic growth and the quality of people’s lives.
Corruption, depending on its scope, can have a significant negative impact on government finances, since governments earn less tax revenue and overpay for products and services or investment projects. However, the cost of corruption is bigger than the amount of money lost: spending priorities that are distorted harm the government’s ability to foster long-term, equitable growth. They divert public funds away from investments in education, health care, and functional infrastructure, which can boost economic performance and elevate living standards for everybody.
What are the ways that corruption stifles revenue? For one reason, it may jeopardize governments’ capacity to collect taxes in a fair and effective manner. In exchange for payments, corrupt legislators may establish tax exemptions or other loopholes, limiting revenue potential and the more complicated and opaque the tax system is, the easier it is for officials to abuse their discretion in administering it and demand bribes or kickbacks in exchange for a favorable conclusion. For example, municipal personnel allegedly received bribes in a 1996 case reported by the New York Times to make it look like overdue taxes had been paid. More broadly, tax law distortions and tax official corruption erode public faith in the government, reducing citizens’ willingness to pay taxes.
Corrupting the system can result in enormous financial gains. According to our findings, revenues are greater in countries seen to be less corrupt; the least corrupt governments collect 4% more in taxes than those with the highest levels of corruption at the same level of economic development. Over the last two decades, some nations have made progress, and if all countries reduced corruption in the same way, they could gain $1 trillion in lost tax revenues, or 1.25 percent of world GDP.
While corruption can occur anywhere, it is most common in a few hotspots. Natural resources, particularly oil and mining, are one example. The large revenues connected with natural resource extraction provide great incentives for bribes or even state capture, in which corrupt activities influence public policies and legislation in order to secure control over a country’s natural wealth. Indeed, resource-rich countries are more prone to corruption due to weaker institutions and a lack of accountability in the management of their natural resources.
Corruption is also common in government-owned businesses, where management may be influenced by civil personnel and elected officials. As a result, in countries with higher levels of corruption, state-owned firms in critical areas such as energy, utilities, and transportation are less profitable and efficient. Several high-profile corruption investigations involving such enterprises, notably Petrobras in Brazil, Elf Aquitaine in France (before it was privatized), and Eskom and Transnet in South Africa, highlight the possibility of misappropriation of public funds. Furthermore, research reveals that one of the key reasons private corporations are more productive than state-owned businesses is because of corruption. Surprisingly, in nations where corruption is less prevalent, the kind of ownership has a far smaller impact on explaining differences in firm performance (Baum and others, forthcoming).
Government purchases of products and services are another heated topic, partially because to the massive sums of money involved; on average, public procurement accounts for 13% of GDP among members of the Organisation for Economic Cooperation and Development, which represents 36 advanced economies. Because large projects typically have unique aspects that make it difficult to evaluate costs and easier to conceal bribes and exaggerate expenses, procurement tied to public investment is particularly vulnerable.
As a result, great corruption is often connected with complex and expensive undertakings like building and defense equipment. Bribes on teachers’ and health-care professionals’ salaries are more difficult to come by. As a result, when corruption is rampant, spending on education and health is likely to be lower, making worker productivity and living standards less likely to improve. The portion of the budget dedicated to education and health in low-income countries is one-third lower in more corrupt countries.
It should come as no surprise, then, that test scores are lower in countries with higher levels of corruption. Kids in more corrupt countries may spend the same amount of time in class as students in other nations, but the quality of instruction is lower. It’s not simply about reducing education funding. Bribes or connections are used to influence access to teaching posts in public schools in several nations. In several developing economies, teacher absenteeism is a common form of minor corruption, and a research in Brazil revealed evidence that where federal education subsidies to local governments are largely lost to corruption, dropout rates are higher and test scores are lower.
Reduced corruption is a difficult task, but it can yield significant rewards. Countries that drastically eliminate corruption are rewarded with increased tax income. This was the case in Georgia, where a new administration launched an intensive push in 2003 to eradicate high levels of corruption. As a result, tax revenue increased from 12% to 25% of GDP in five years, despite lower tax rates.
Georgia’s achievement represented a shift in tax compliance attitudes: the percentage of people who believe it is never acceptable to cheat has risen from approximately 50% to over 80%. People were more inclined to pay taxes as a result of improvements in services, such as decreased crime rates and fewer power outages, and renewed faith in government. Higher revenue also allowed for the payment of wage and pension arrears, boosting public trust in the government even more.
What is the most effective means of combating corruption? As in Georgia, major political shifts occasionally give opportunity for bold reforms and swift improvement. However, in most circumstances, development will be sluggish. Success necessitates political will, perseverance, and a long-term commitment to upgrading institutions. We investigated a vast number of countries to better understand the institutional qualities that are key in supporting honesty and accountability. Our research provided the following policy recommendations:
When countries reform numerous mutually supporting institutions to combat corruption, their prospects of success increase. They should begin with higher-risk areas, such as procurement, revenue administration, and natural resource management, as well as strong internal controls. As a vital pillar of a fiscal governance system, a professional and ethical civil service is also required. By creating a clear tone at the top, the leaders of agencies, ministries, and public companies can encourage ethical behavior.
Governments must keep up with rapidly changing technologies and the potential for malfeasance. Our research indicated that when governments invest in information and communication technologies and promote openness, there are less opportunities for bribes to be offered. Electronic procurement systems, for example, have shown to be effective instruments for improving transparency and reducing corruption in Chile and Korea.
Transparency and a free press are two factors that contribute to increased accountability. Colombia, Costa Rica, and Paraguay are among the countries that use an online platform to track the physical and financial progress of investment projects. A free press boosts the benefits of fiscal openness in reducing corruption, according to our cross-country analysis. Data must be extensively distributed and explained in addition to being released. The publishing of audit results influenced the reelection prospects of officials suspected of misusing public funds in Brazil, with the effect being stronger in places having local radio stations.
International collaboration is critical in addition to efforts to develop domestic institutions within countries. More than 40 countries have made it illegal for businesses to pay bribes in order to acquire business overseas. Countries might also step up their efforts to combat money laundering and minimize transnational opportunities for dirty money to be hidden in shady financial centers.
Corruption can be difficult to combat, but it is vital in order to restore public trust in government. Over time, the struggle against corruption can result in enormous economic and social gains. It all begins with domestic political will, ongoing institutional development to promote honesty and accountability, and global cooperation.