What Is the Effect of Market Competition on Corruption? Some Surprising New Findings

How does market competition affect the prevalence of corruption? Some people think that increasing competition could decrease corruption (see here and here). The intuition is that increased competition lowers firms’ profits, meaning that public officials cannot extract as much money out of the firms through extortive threats (e.g., a threat to falsely report noncompliance with safety regulations unless the firm pays a bribe). As the saying goes, you can’t squeeze blood from a turnip. By contrast, the argument continues, in less competitive markets firms have higher profits, and officials, knowing this, can use threats to extract some or all of this surplus for themselves. However, others have argued that increased market competition may lead to more corruption. Those taking this position tend to emphasize collusive rather than extortive corruption (see here and here) and point out that increased market competition makes collusion—which is, of course, a risky proposition—more attractive to firms, because the firms have more to gain from a leg up on their competitors. For example, an importing firm that pays a bribe to avoid paying customs duty will receive greater benefit from this competitive advantage when competition is fierce, since it will allow the firm to reduce prices and increase its market share more extensively. A monopolistic importer, by contrast, has less of an interest in paying the bribe to avoid the import duty, since a monopolist can offset much of the duty by raising consumer prices without needing to worry about losing much market share.

So, one can construct plausible theoretical arguments in both directions. What does the empirical data say about which story is closer to the truth? There have been a handful of studies so far, but they provide contradictory or equivocal results—some studies find that more competitive markets are associated with less corruption (see here, here and here), but others have found the opposite. But these studies focus on “corruption” generally, while the theories sketched above suggest that the effect of market competition on corruption may differ depending on the type of corruption—coercive or collusive. One prominent study, by Alexeev and Song (2013), explicitly incorporates this distinction and finds—based on analysis of data from the World Bank Enterprise Surveys of manufacturing firms in different countries—that increased competition increases the prevalence of collusive corruption. While this is an important step in the right direction, the survey data used here is still not ideal: the measure of “collusive corruption” is based on the respondent firms’ answer to a question about the amount of money firms in their line of business typically need to pay to public officials each year “to get things done,” which seems both vague and potentially overinclusive.

Luckily, later on the World Bank Enterprise Surveys expanded the range of corruption measures collected as part of its Investment Climate surveys in developing countries, recently publishing the latest of these surveys (get the data here), that may shed new light on this debate. The attractive feature of this more comprehensive survey data is that, in contrast to the data used by Alxeev and Song, the new surveys ask not only about the one vague measure of corruption, but ask separately about four different kinds of informal payments: to tax officials (hereinafter tax bribe); to secure government contracts (hereinafter contract bribe); to secure an import license (hereinafter import bribe); and to secure an operating licensing (hereinafter operating bribe). The survey, both in its current and older version, further asked every firm to report the number of competitors that it faces in its market of operation, which provides a ready firm-specific measure of market competition.

A thorough analysis of the competition-corruption link using this new data will need to await future work, but as a first step, I conducted some preliminary, exploratory quantitative analysis of the Investment Climate survey data. The results were surprising, and suggest not only is asking whether “corruption” is positively or negatively correlated with market competition is too crude, but also that even the proposed collusive-coercive distinction does not adequately capture the nuances of the relationships between competition and various forms of corruption.

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Do Chinese Aid Projects in Africa Make Corruption Worse? And If So, Why?

Development aid is a potentially powerful tool for promoting economic growth among the world’s poor. However, development aid is plagued by corruption, in no small part because many of the poorest areas are also the most susceptible to corruption. In addition to that dilemma, some research suggests that the injection of outside funds into existing corrupt societies can actually exacerbate governance problems. Is this true? And does the impact of development aid on corruption (and development) depend on the source of the aid? An important new paper by Ann-Sofie Isaksson and Andreas Kotsadam suggests that the answers are yes and yes—in particular, they find that Chinese aid projects in Africa may worsen local corruption.

To investigate the question whether Chinese aid projects affect local corruption in Africa, the authors combine data from separate sources. For data on local corruption, the authors make use of the Afrobarometer surveys, with data on nearly 100,000 respondents in 29 countries, collected over a 12 year period (2000-2012) in four separate surveys. The authors focus in particular on respondents’ answer to questions about the frequency of paying bribes to avoid problems with the police or to obtain documents or permits. The authors use the geographic location of survey respondents, together with information on the geographic location of 227 Chinese-aid-supported projects in Africa, in order to identify those respondents who live geographically close to a project supported by Chinese development aid. The results are stark: African citizens who live in areas with Chinese-sponsored projects are 4 percentage points more likely to pay a bribe to police, and 2 percentage points more likely to pay a bribe for permits or documents. Given baseline reported bribery rates of about 13-14%, this means that citizens living near a Chinese aid project are about 30% more likely to report paying a bribe to the police, and about 15% more likely to report paying a bribe for a permit or document.

The most natural explanation is that Chinese aid projects tend to stimulate more corruption. There are, of course, a number of other possible explanations, which the authors address and for the most part rule out, or at least suggest are unlikely:

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Rescission of Contracts and Revocation of Licenses As Means to Combat Corruption

Article 34 of the UN Convention Against Corruption (UNCAC) generally requires that each State Party “take measures … to address the consequences of corruption.” In recognition of the fact that government contracts and licensing processes have been among the areas most prone to corruption and bribery–and of the fact that the threat of criminal punishment may not be a sufficient or even viable deterrent to such corruption–UNCAC Article 34 further declares that “States Parties may consider corruption a relevant factor in legal proceedings to annul or rescind a contract, withdraw a concession or other similar instrument or take any other remedial action.” Although that second sentence of Article 34 is not mandatory, State Parties–particularly demand-side countries with an unfortunate reputation for corruption in government contracting (such as Kenya, Guinea, Indonesia and Philippines) should adopt that principle into their national laws.

Law providing for the nullification of contracts or concessions procured through corruption would be a strong deterrent to bribe-paying by firms. Although such bribery is already illegal, in some cases criminal punishments are simply insufficient to deter corrupt practices conducted in demand-side countries. Often the threat of sanctions is low, and even though some companies have been hit with substantial sanctions, this loss has been mitigated by the profits acquired by the operation of the tainted contract or license. And a company might think twice before acceding to a bribe demand from a lower-level public official (or even a high-level official) if the company knows that, by paying the bribe, they may be putting the whole contract in jeopardy if the government later decides it wants to reneg on the deal. Moreover, if a demand-side country were to adopt a law that allows for nullification of any government contract or concession procured through corruption, it would send strong signals to that international community that this country will no longer tolerate these corrupt practices. Continue reading