Public funds are misdirected to projects that benefit corrupt officials rather than those serving the public good

The phenomenon broadly referred to as corruption has existed for over 2,000 years. And throughout history accusations of corruption have caused governments to fall and prominent politicians, including presidents and prime ministers, to lose their official positions.

In modern times publicity on corruption focuses on accusations of corruption by politicians and government officials and the legal outcome of tried cases. But the public is provided little information about the damaging economic consequences of corruption, a subject which seems to be mainly confined to the interests of scholars and academic journals.

Economic consequences of corruption

The most popular definition of corruption is that it is “the abuse of public power for private benefit”. Given this definition it should not be concluded that corruption cannot exist within the private sector. However, this article focuses mainly on corrupt public practices that have adverse consequences for the economy.

Most scholars in their studies conclude that corrupt public practices result in lower economic growth. And it is argued that such corruption by manipulating incentives and market forces diminishes the growth potential of economies mainly through producing inefficiencies in the allocation of resources.

More specifically, public funds are misdirected to projects that benefit corrupt officials rather than those serving the public good, like vital infrastructure or social services.

Nobel Laureat, Joseph Stiglitz has written that “corruption American style” involves, among other things, “passing laws that ensure that one gets overpaid for what one sells to the government (defence contractors and drug companies) or that one underpays for natural resources that rightfully belong to the public (oil and mining companies using public lands)”.

Furthermore, inefficient resource allocation can result from bribes and questionable regulations that prevent the entry of new firms. Competition is significantly undermined by protecting existing businesses, enabling high concentrations, and preventing the competitive forces that typically lower prices and drive innovation. These restrictions allow established companies to maintain market power and high profits, often at the expense of consumer welfare and market dynamism.

And the competence of institutions can be weakened by the government exercising irregular practices in the appointment and promotion of public servants. Numerous persons are often employed in governments, primarily because of their slavish loyalty to and relations with the ruling elite, as against people who have the capabilities to provide better service to the public. This appears to be the case in many countries where government administrations, for example, do not seem to have the competent staff to objectively evaluate, prepare and effectively implement viable infrastructure projects, despite having ample financial resources to do so. Indeed, EU bureaucrats complain about the sluggish pace of members in tapping the plentiful funds available from their institution for development projects.

Notably, corruption involving bribes in combination with institutional incompetence raises the costs and lowers the quality of public services, particularly in health and education, creating unofficial barriers and discouraging use especially by lower income families.

Money laundering, by definition, involves the hiding of ill-gotten funds by perpetrators of corruption. And governments in tax haven jurisdictions have been accused of facilitating money laundering by offering the sale of properties and passports in exchange for the funds being laundered. And such practices and transactions in turn have induced considerable investments in up-market properties that have tended to price many ordinary citizens out of being able to secure decent housing and be willing to produce offspring.

And the toleration of tax evasion, produces unfair competition in the business sector and cheats governments out of much-needed revenue. Furthermore, tax evasion and tax avoidance, especially by the rich and powerful, together with the syphoning off of public funds meant for social grants, housing and pensions, disproportionately harms the poor and widens income and wealth inequalities.

Furthermore, widespread corruption leads to an erosion of trust in public institutions, such as tax departments, resulting in a deterioration of government effectiveness.

In essence, corruption hinders efficient resource allocation, discourages innovation and entrepreneurship, widens income and wealth inequalities, and undermines the rule of law, and in the process significantly prevents economies from reaching their full potential.

Combating corruption

Even in countries where corruption is having profound adverse consequences for the economy and society, governments focus narrowly on one or two specific measures like increasing penalties on public sector employees or creating an Anti-Corruption Authority to combat corruption.

Such policies have usually proved to be unsuccessful, and fiscal experts argue that a multi-faceted approach is required to fight corruption. Moreover, Victor Tanzi, former director of the IMF’s Fiscal Affairs department, has contended that policies to combat corruption cannot be seen independently from the need to reform the role of the state. The reason being is that “a certain role of the state almost inevitably creates a fertile ground for corruption.”

And Tanzi has written that “Any realistic strategy (to tackle corruption) must start with an explicit recognition that there are those who demand acts of corruption on the part of public sector employees and there are public employees willing for a price to perform these acts.” And he adds that, “in the background there is the state, which to a large extent through its many policies and actions creates the environment and incentives that influence those who pay bribes and those who accept or demand them.” Indeed, it is the state that influences the relationship between briber and bribee.

Thus, according to Tanzi the fight against corruption should be closely connected with reform of the state, rather than any single action.

Hence, it is recommended that serious actions to reduce corruption take place on a number of fronts.

Foremost, there should be honest and visible commitment by the leadership to the fight against corruption. The leadership must show and demonstrate zero tolerance for it.

Action should be taken to reduce the demand for corruption by scaling down regulations and other policies such as tax incentives, and by making those that are retained as transparent and as non-discretionary as possible. Undeniably, too much discretion allows abuse of regulations and policy incentives.

The strict enforcement of laws and regulations combining legal, administrative and technological measures is necessary to create a system of high risk and low reward for corrupt acts. Furthermore, effective enforcement requires strong apolitical institutions, such as anti-corruption agencies, prosecutors and independent courts as well as efficient tax administration.

In addition, combatting the criminal act of tax evasion requires utilising digital technology for enforcement including using AI to detect evasion, greater clarification and international cooperation in distinguishing between tax evasion and tax avoidance, and the implementation of rigorous reporting standards. Also in this connection, voluntary tax compliance can be enhanced by simplifying tax-filing procedures, so as to reduce compliance costs for taxpayers.

Combating money laundering – frequently associated with tax evasion – should be part of a broader agenda to fight serious crime, including corruption. And in accord with an EU Directive affirming that “corruption must be a predicate offence to money laundering”, the enforcement of the law on perpetrators would be much more effective as money laundering carries a severe penalty within the anti-money laundering regulation.

Most importantly, to reduce the contribution of government employees in supplying corruption, public reforms should be undertaken, including greater merit-based appointments and promotion of personnel, raising and maintaining public sector wages at adequate levels, increasing incentives toward honest behavior including protection of whistleblowers, rotating staff in high risk positions to prevent collusion, enforcing strict codes of conduct and penalties on public servants, and digitising public services to decrease bribery.