Corruption and Investment

The author is the Coordinator of Action for Economic Reforms, a research and policy advocacy NGO focusing on macroeconomic policy and governance issues.

The perception that corruption under the Gloria Macapagal Arroyo (GMA) administration is rampant sticks.

Some serious charges exposed by the so-called Magdalo group in
connection with unabated corruption in the Armed Forces of the
Philippines and Panfilo Lacson’s startling accusations against “Jose
Pidal” are the latest dramatic examples.

The fact that even those who condemn the Magdalo group for
participating in the failed coup d’etat acknowledge the legitimacy of
its grievances suggests how deep-seated corruption is. As for the Pidal
expose, the public attitude is to shoot the messenger but not the

Even before these issues exploded, serious charges of corruption had
already besieged the GMA administration – for example, the alleged
anomalies relating to the construction of the Diosdado Macapagal
highway and the building of the new international airport.

Stories also circulate about investors giving bribes amounting to
hundreds of millions of pesos for changes in the rules, or for
defensive lobbying to ensure that rules are not reversed, or simply for
business entry. The problem though is no one is willing to do a Chavit
Singson act and file formal complaints in the proper venue.

Of course, corruption has long been a trademark of Philippine political
and economic life. Joseph Estrada fell because of the blatant
corruption under his administration. Charges of high-level corruption
tainted the Fidel Ramos administration, the more prominent being the
Amari and the Philippine Centennial deals. Corazon Aquino is saintly,
but many believe that “Kamag-anak, Inc.” took advantage of her
administration to gain privileges. Undeniably, the most brazen
corruption and cronyism occurred during the Marcos dictatorship though
some would argue that the Estrada administration’s venality was not far
behind. Before the Marcos period, corruption was a main cause of the
electoral defeats of incumbents.

In this light, people across the spectrum – progressives and
conservatives, liberals and fascists, etc. – regard corruption as the
country’s central problem. The conventional wisdom is that corruption
impairs investments and growth. Corruption increases the costs of doing
business. Corruption results in output that is inferior or substandard
(as the briber has to reallocate funds for the bribe and hence scrimp
on production).

It undermines merit-based criteria, as contracts are awarded to cronies
or favored parties (contrary to the view that the most efficient entity
has the capacity to shell out the highest bribe and hence has the best
chance to win).

Corruption, too, creates negative externalities. A number of empirical and econometric studies support the conventional view.

Widely cited is Paolo Mauro’s “Corruption and Growth” (1995) that shows
the negative association of corruption with high investments.

Nevertheless, the conventional wisdom has repeatedly been challenged.
Following Samuel Huntington (1968), some scholars have argued that
corruption is a “grease” that speeds up the process of investment
transactions. In addition, the supporters of the theory of the “second
best” are pragmatic to concede that some corrupt activities can negate
distortions in policy. For example, smuggling, in a situation of very
high tariffs, provides producers with lower-priced imported inputs and
consumers with cheaper consumption goods.

Many are likewise puzzled by the experience of high growth in East Asia
despite widespread corruption and rent seeking. How can one explain the
rapid growth over a long period in China or in Suharto’s Indonesia in
spite of the high degree of corruption in these countries?

In this light, the volume edited by J. Edgardo Campos (The Boom and
Bust of East Asia, 2001) offers penetrating insights. Mr. Campos’s
thesis, proven by regression results, is that high levels of corruption
do not deter investments and growth, as long as such corruption is
predictable. (That is, those who bribe are certain or likely to get the
government favors or contracts.)

This predictability through systematic and organized corruption
explains the phenomenon in China, Indonesia, Malaysia, Thailand, and
South Korea.

The worst situation is that of high levels of corruption together with
unpredictability in the outcomes arising from corruption. This
unfortunately is the Philippine case. To quote Campos: “Corruption
regimes that are more predictable… have less negative impact on
investment than those that are less predictable.”

Indeed, the ideal situation is to have low levels of corruption
combined with policy predictability or certainty. But the difficult
question for developing countries is how to get there.

The contributors to the Campos volume present country studies that show
how transitional institutional frameworks and governance arrangements –
definitely far from ideal in securing property rights or enforcing
contracts since they still accommodate corruption and rent seeking –
can suffice to sustain high investments
In China’s case, Shuhe Li and Peng Lian explain how the mechanisms of
local information, interregional competition, and “market-preserving
authoritarianism” contribute to the flow of investments and the
enforcement of contracts and property rights.

In the case of Indonesia during the Suharto regime, Andrew MacIntyre
argues that while the dictator gained tremendously from corruption,
Suharto was wise enough to put institutional constraints on corruption
so as not to kill the goose that lays the golden eggs.

Suharto minimized the costs through the surveillance of officials and
the identification of sectors not to be affected by corruption.
Moreover, he agreed to have some measures that tied government’s own
hands, to give a credible commitment to investors in the event of
uncertainty. An example of this was the liberalization of the capital
account, which proved to be disastrous in light of the massive capital
flight in 1997-1998.

To be sure, the lessons and experiences from the East Asian countries
in managing sustained growth in conjunction with corruption are not
transferable to the Philippines. For one thing, some neighboring
countries have (or had) authoritarian regimes that perform the role of
monopoly suppliers, thus minimizing gridlock and reducing the
possibility of veto. However, Philippine society has shown its
preference for democracy in choosing leaders, policies, and rules. The
Marcos dictatorship was a failure, for among other things, it lacked
legitimacy and hence failed to build a social and political consensus
that was a necessary condition for sustained growth.

Yet, it is fairly clear that the present setup is insufficient to
manage corruption and thus make it more predictable. Emmanuel S. de
Dios and Hadi Salehi Esfahani offer an institutionalist framework to
address this problem. Concretely, they propose the reduction of
presidential power by devolving such power to the other branches of the
National Government and to the local governments, by increasing the
bureaucracy’s autonomy, and by binding government to global commitments.

Not everyone will agree to these proposals. But what alternatives can
the Philippines offer, in light of its own experience with corruption?
Thus far, the stereotyped approach of moral and punitive means has not
worked. Perhaps it is time to acknowledge an approach that “reforms”
corruption, which an institutionalist framework can better address.

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