Fighting Corruption Critical for Growth and Macroeconomic Stability—IMF Paper

IMF RESEARCH

Fighting Corruption Critical for Growth and Macroeconomic Stability—IMF Paper

IMF Research | May 11, 2016

Corruption undermines growth and economic development
Economic and social costs are high
Transparency, effective institutions, and leadership key factors of success

By vigorously reducing corruption, countries can improve economic stability and boost growth and development, according to a new IMF staff paper.

Public corruption, defined as an abuse of public office for private gain, afflicts economies at all stages of development. Governments around the world face the challenge of addressing citizens’ increased concerns over high corruption as evidenced by recent scandals in many countries.

“While the direct economic costs of corruption are well known, the indirect costs may be even more substantial and debilitating, leading to low growth and greater income inequality. Corruption also has a broader corrosive impact on society. It undermines trust in government and erodes the ethical standards of private citizens,” said IMF Managing Director Christine Lagarde.

“Given the potential impact of corruption on macroeconomic stability and sustainable economic growth, the IMF has been actively engaged in helping our members design and implement anti-corruption strategies,” she added.

Corruption impedes the conduct of budgetary and monetary policy and weakens financial oversight, ultimately hurting inclusive growth, says the paper, Corruption: Costs and Mitigating Strategies, released today. The analysis presented in the paper draws on extensive literature on the topic as well as on IMF experience gained in many countries. The paper shows that the topic is “macro-critical”—that is, critical to the achievement of macroeconomic stability, which is at the core of the IMF’s mandate.

While hard to measure properly, the economic costs of corruption could be substantial. A recent estimate put the annual cost of bribery at around $1.5 to $2 trillion (roughly 2 percent of global GDP). The economic and social costs of corruption could potentially be even larger.

How corruption hampers economic growth

The paper observes that corruption affects economic development in several ways.

First, it weakens the state’s capacity to raise revenue and perform its core functions. By harming the culture of compliance, corruption increases tax evasion. For instance, when tax exemptions are viewed as arbitrary, citizens’ have less incentives to pay taxes. As a result, the state collects less revenue and is unable to provide public services, with potential negative consequences for growth.

Second, by inflating costs in the public procurement process, corruption undermines the quantity and quality of public spending. Funds can also be siphoned off through off-budget transactions. This lowers resources available for public investment and other priority spending, aggravating infrastructure gaps and impacting on growth.

Third, because of lower public revenues, countries tend to rely more on central bank financing, which creates an inflation bias in the country. At the same time, corruption further weakens financial oversight and stability of the financial system. This arises from poor lending and regulatory practices and weak banking supervision.

Finally, corruption can even raise the cost of accessing financial markets as lenders factor in corruption. The private sector is further hurt because it raises uncertainty for firms and act as a barrier to entry for new entrants. Resources are allocated to rent-seeking activities instead of productive activities.

The social and environmental costs can also be significant. Reduced allocations for social programs and the resources lost through corruption limit the build-up of human capital. At the same time, weaker, poorly enforced environmental regulations lead to more pollution and more than desired extraction of natural resources. In the extreme cases, systemic corruption can lead to political instability and conflict. It has been argued that natural resource abundance can accentuate the situation.

Mitigating strategies

While the paper recognizes that there is no common recipe for all countries, it also emphasizes that a comprehensive approach is crucial. Short-term measures with more immediate impact, must be complemented with preventive measures and strict enforcement. The paper offers policymakers practical guidance, drawing on the IMF’s perspective of helping its members design and implement economic reforms, including anti-corruption strategies. The paper identifies four building blocks:

• Transparency is a pre-requisite. Countries need to adopt international standards on fiscal and financial transparency. Because of the relative share of extractives industries in many economies, transparency in this particular sector is crucial. Governments need also to support international standards on transparent corporate ownership. A free press also plays a key role in exposing corrupt practices.

• To enhance the rule of law, a credible threat of prosecution must exist. Enforcement must also target the private sector. In certain cases, new specialized institutions must be set up where existing ones are corrupt. An effective anti-money laundering framework must be in place to minimize the laundering of proceeds of corruption.

• Excessive regulation creates rents which are allocated at the discretion of public officials and must be eliminated. De-regulation and simplification are cornerstones of efficient anti-corruption strategies. However, it is important to have an adequate institutional framework in place first when transitioning from state controlled monopolistic markets (emerging economies in Eastern Europe).

• A clear legal framework is required. However, all of the best frameworks come to nothing, unless they are implemented. And implementation is all about effective institutions. In particular, a key objective is to develop a cadre of competent public officials who are independent of both private influence and political interference—and are proud of this independence. Finally, leadership plays a critical underlying role. Leaders must set a personal example and ensure decisive action is taken when needed.