Business Financial Crime: Bribery and Corruption

2

Corruption

The use of public office for private gain, or in other words, use of official position, rank or status by an office bearer for his own personal benefit.

3

Corruption Levels Large bribes have been reported to have been paid to get

foreign contracts or to get privileged access to markets or to particular benefits such as tax incentives.

Le Monde of March 17, 1995, reported that the bribes paid abroad by French companies in 1994 had been estimated at FF10 billion (£1 billion) in a confidential government report.

World Business of March 4, 1996, reported that the bribes paid abroad by German companies had been estimated to exceed US$3 billion a year.

These were not the only countries in which companies had paid bribes to foreign officials. Some experts have estimated that as much as 15 percent of the total money spent for weapons acquisition may be “commissions” that fill somebody’s pockets.

4

Corruption Levels Among the economic changes that have taken place in recent

years, privatization has been most closely linked with corruption.

These problems have been observed and reported in all regions of the world, but the abuses appear to have been particularly significant in the transition economies.

In these countries some individuals have become enormously rich because of these abuses.

For example the Russian experience. In the privatization of large monopolies, such as Gazprom, many close to the corridors of power received highly valued shares at very low prices.

And the “loans-for-share” scheme made some banks shareholders of enterprises by extending loans to the firms.

These developments have made many Russian citizens highly skeptical about the virtues of a market economy.

5

Bribery

Business corruption focuses on bribery: An offer or receipt of any gift, loan, fee,

reward or other advantage to or from any person as an inducement to do something which is dishonest, illegal or a breach of trust in the conduct of the enterprise’s business.

6

Bribery- Bray, J. (2007)

7

Bribery- Bray, J. (2007)

8

Bribery - Bray, J. (2007)

9

Corruption Corruption can arise under a variety of circumstances.1. Government contracts: bribes can influence who gets

the contract, the terms of the contract, as well as terms of subcontracts when the project is implemented.

2. Government benefits: bribes can influence the allocation of monetary benefits such as credit subsidies and favoured prices and exchange rates where price controls and multiple exchange rates exist.

3. Government revenue: bribes can be used to reduce the amount of taxes, fees, dues, custom duties, and electricity and other public utility charges collected from business firms and private individuals

10

Corruption4. Time savings and regulatory avoidance: bribes

can speed up the granting of permission, licenses and permits to carry out activities that are perfectly legal. This is the so-called “grease money”

5. Influencing outcomes of legal and regulatory processes: bribes can be used to provide incentives to regulatory authorities to refrain from taking action, and to look the other way

11

Economic Rent

The concept of economic rent (or monopoly profit) occupies a central place in the subject of corruption.

Economic rent arises when a person has something unique or special in his possession.

This something special can be a luxury condominium in a posh neighbourhood, a plot of land in the central business district of the city, a natural resource like an oil well

A person who owns such a special asset can charge a more than normal price for its use and earn economic rent or monopoly profit.

12

Corruption Equation

C = R + D – A

In the above equation, C stands for corruption, R for economic rent, D for discretionary powers, and A for accountability.

The equation states that the more opportunities for economic rent (R) exist in a country, the larger will be the corruption.

Similarly, the greater the discretionary powers (D) granted to administrators, the greater will be the corruption. However, the more administrators are held accountable (A) for their actions, the less will be the corruption, and hence a minus sign in front of A.

Kiltgaard, R. (1998) International cooperation co-operation against corruption, IMF/World Bank, Finance and Development, 35(1): 3.

13

Corruption Equation The equation tells us that a fertile ground for

growth of a thoroughly corrupt system will emerge in a country if it satisfies the following three conditions:

1. It has a large number of laws, rules, regulations, and administrative orders to restrict business and economic activities and thereby creates huge opportunities for generating economic rent, and especially if these restrictive measures are complex and opaque and applied in a selective, secretive, inconsistent and non-transparent way.

14

Corruption Equation2. Administrators are granted large discretionary

powers with respect to interpreting rules, are given a lot of freedom to decide on how rules are to be applied, to whom and in what manner they are to be applied, are vested with powers to amend, alter, and rescind the rules, and even to supplement the rules by invoking new restrictive administrative measures and procedures.

3. There are no effective mechanisms and institutional arrangements in the country to hold administrators accountable for their actions.

15

Incidence Incidence of corruption varies among societies, and it

can be rare, widespread or systemic. When it is rare, it is relatively easy to detect, isolate and

punish and to prevent the disease from becoming widespread.

When corruption becomes widespread, it is more difficult to control and to deal with.

The worst scenario is when it becomes systemic. When systemic corruption takes hold of a country, the institutions, rules and peoples’ behaviour and attitudes become adapted to the corrupt way of doing things, and corruption becomes a way of life.

Systemic corruption is very difficult to overcome and it can have a devastating effect on the economy.

16

Supply side question The supply side, represents the ones who give bribes,

they are not necessarily innocent victims who are forced by corrupt officials to make payoffs to go about their own legitimate business.

Both parties (giver and taker) in a bribery deal can gain from the transaction, they often conspire to defraud the public.

A bribery deal can be initiated from the supply side, and big local business firms, and large multinational corporations from industrialised countries in particular, can make proposals which officials in poor countries will find hard to resist.

17

Corruption

“… a consensus has now been reached that corruption is universal. It exists in all countries, both developed and developing, in the public and private sectors, as well as in non-profit and charitable organizations.” (Myint, 2000)

18

Causes of corruption

A key principle is that corruption can occur where rents exist, typically as a result of government regulation and public officials have discretion in allocating them.

The classic example of a government restriction resulting in rents and rent seeking behaviour is that of an import quota and the associated licenses that civil servants give to those entrepreneurs willing to pay bribes

19

Causes of corruption Since the ultimate source of rent seeking behaviour is the

availability of rents, corruption is likely to occur where restrictions and government intervention lead to the presence of such excessive profits.

Examples include trade restrictions (such as tariffs and import quotas), favoritist industrial policies (such as subsidies and tax deductions), price controls, multiple exchange rate practices and foreign exchange allocation schemes, and government - controlled provision of credit.

Some rents may arise in the absence of government intervention, as in the case of natural resources, such as oil, whose supply is limited by nature and whose extraction cost is far lower than its market price.

Since abnormal profits are available to those who extract oil, officials who allocate extraction rights are likely to be offered bribes.

Finally, one would expect that corruption is more likely to take place when civil servants are paid very low wages and often must resort to collecting bribes in order to feed their families.

20

Causes of corruptionEmpirical studies have supported certain hypotheses Namely, that there is less corruption where there are

fewer trade restrictions Where governments do not engage in favoritist industrial

policies Where natural resources are more abundant There is somewhat less corruption where civil servants

are paid better, compared with similarly qualified workers in the private sector (Van Rijckeghem, C and Weder, B 1997, “Corruption and the Rate of Temptation: Do Low Wages in the Civil Service Cause Corruption?” IMF Working Paper 97/73 (Washington: International Monetary Fund).

21

Consequences of corruption From economic theory, one would expect corruption to reduce

economic growth by lowering incentives to invest (for both domestic and foreign entrepreneurs).

In cases where entrepreneurs are asked for bribes before enterprises can be started, or corrupt officials later request shares in the proceeds of their investments, corruption acts as a tax, though one of a pernicious nature.

Corruption could also be expected to reduce growth by lowering the quality of public infrastructure and services and decreasing tax revenue

Causing talented people to engage in rent - seeking rather than productive activities, and distorting the composition of government expenditure.

However, it has been suggested that government employees who are allowed to exact bribes might work harder and that corruption might help entrepreneurs get around bureaucratic impediments.

22

Consequences of corruption

One specific channel through which corruption may harm economic performance is by distorting the composition of government expenditure.

Corrupt politicians may be expected to spend more public resources on those items on which it is easier to exact large bribes and keep them secret

For example, items produced in markets where the degree of competition is low and items whose value is difficult to monitor.

Corrupt politicians might therefore be more inclined to spend on fighter aircraft and large - scale construction projects than on textbooks and teachers’ salaries, even though the latter may promote economic growth to a greater extent than the former.

This has been supported by empirical research suggesting that policies to reduce corruption would have large payoffs for society

23

Is Corruption a Constraint to Growth?

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Neither verypervasive nor doesit have impact on

growth

Pervasive but doesnot seriously

impact growth

Top 1 or Top 3

Developing Country

Developed Country

Source: Symposium Survey, Hong Kong 2006. Total sample: 184 respondents of which 82 were from developing and 102 from developed countries.% Respondents

24

Consequences of corruption

If the costs of corruption are so high, why don’t governments get rid of it?

A possible answer is that once a corrupt system is in place, and a majority of people operate within that system, individuals have no incentive to try to change it or to refrain from taking part in it, even if everybody would be better off if corruption were to be eliminated.

25

Which forms of corruption areworse? Under a well-organized system of corruption,

entrepreneurs know whom they need to bribe and how much to offer them, and are confident that they will obtain the necessary permits for their firms.

It has also been argued that well-organized corruption is less harmful because, under such a system, a corrupt bureaucrat will take a clearly defined share of a firm’s profits, which gives him an interest in the success of the firm

26

Which forms of corruption areworse? In contrast, under chaotic corruption,

entrepreneurs may need to bribe several officials, with no guarantee either that they will not face further demands for bribes or that the permits they seek will actually be delivered.

If multiple agents request bribes from the same entrepreneur without coordinating bribe levels among themselves, they are likely to make excessive demands, with the result that entrepreneurial activity comes to a halt.

27

International Business Ethics

When business is conducted across borders, the ethics program takes on added layers of complexity.

Especially problematic when multinationals operate in host countries that have: Different standards of business practice Economically impoverished Inadequate legal infrastructure Governments are corrupt, and

The question arises in the context of different practices in the central operations and policies of multinationals.

28

Ethical Relativism or Global Values? Three main responses to the question:

The ethical relativism believes that there are no universal or international rights and wrongs, it all depends on a particular culture’s values and beliefs - when in Rome, do as the Romans do.

The ethical absolutism believes that when in Rome, one should do what one would do at home, regardless of what the Romans do. This view of ethics gives primacy to one’s own cultural values.

In contrast, the ethical universalism believes that there are fundamental principles of right and wrong which transcend cultural boundaries and multinationals must adhere to these fundamental principles or global values.

29

Government Regulation:

New global developments on the

criminalization of bribery Bribery and corruption top the list of the most

frequent ethical problems encountered by international managers.

The World Bank estimates that about $80 billion annually goes to corrupt government officials.

30

Corruption – A Global Threat

Cost of corruption exceeds by far the damage caused by

any other single crime

World Bank – More than 1 trillion US$ is paid in bribes a year

Asian Development Bank – Cost of corruption = up to 17% of GDP

The harm exceeds the proceeds – US$ 1 bribes = US$ 1.7 damage

31

References

Bray, J. (2007) Facing up to Corruption: A Practical Business Guide, Control Risks Group

Bryane, M (2004) Some Reflections on Donor Sponsored Anti-Corruption, Conference presentation, http://users.ox.ac.uk/~scat1663/Publications/Presentations/anticorruption%20speech.htm retrieved 27 Nov 2007

Dowling, P and Welch, D. (2004), International Human Resource Management: Managing People in a Multinational, Thomson.

32

References: cont. Mauro, P. (1998) Corruption: Causes, Consequences

and Agenda for Research, IMF/World Bank Finance and Development, March.

Myint, U. (2000) Corruption: Causes, Consequences and Cures, Asia-Pacific Development Journal,7(2).

Swamy, A., Knack, S., Lee, Y. and Azfar, O. (2000) Gender and Corruption, Working paper, Williams College.

Tanzi, V. (1998) Corruption Around the World, IMF Staff Papers, 45(4).

Tavits, M. (2005) Causes of Corruption: Testing Competing Hypotheses, Working paper, Nuffield College.