Comment Pieces

The Economic Impact of Corruption by Professor Joe Nellis

Posted on January 24, 2011

Extensive academic research over many years and across many countries supports the view that corruption in its many forms is an evil which negatively impacts overall economic development and hurts the poorest of those in our societies. Economic growth is affected negatively by corrupt activities such as bribery and fraud in a number of ways. For example, sizeable tax revenues are inevitably misdirected by activities stemming from corruption with implications for government social expenditure programmes. In addition, the composition and quality of public sector expenditure is often affected with a reduction in productivity and a redirection of spending from ‘less profitable’ areas (eg. health, education and the maintenance of existing infrastructure) to ‘more profitable’ activities (such as military and new investment projects – which more often than not fail to target those at the bottom end of the income scale). Corruption also undermines efforts to improve governance and openness across the public sector. A mistrust of government will have negative consequences for international trade relationships and foreign direct investment, both of which are key drivers of long term economic growth, especially in developing and emerging economies. At the same time corruption within the government sector encourages greater bureaucracy and thus leads to an overall rise in the burden of conducting business – contrary to the view of some commentators that it can serve to ‘grease the wheels of commerce’! This increased burden will push up costs and prices for all consumers. In general, corruption affects business activity in general by creating barriers to entry for smaller businesses, thereby suppressing competition and efficiency. Empirical evidence also indicates that it can lead to financial instability with the danger of capital flight as risks increase. But the removal or reduction of corrupt practices involving dishonesty, fraud, bribery etc must not be confined to the public sector alone. Poor government governance tends to be correlated with poor corporate governance – and may encourage firms (both local and foreign) to illicitly shape laws, policies and regulations for their own benefit. This in turn is likely to further stifle innovation and competition. As noted above, corruption raises the cost of doing business and consequently lowers the effective return on investment projects. The knock-on effect of this is that some much-needed investment programmes will no longer be viable. At the same, lower quality initiatives will be encouraged along with support for companies with lower ethical standards. In the long run, such companies are unlikely to act in the best interest of society – self-interest can be expected to dominate decisions such as those involving large-scale capital investment projects. Corruption can also cause instability of domestic and international banking systems. The recent global financial crisis provides evidence of this. The corrupt activities of a few key players almost led to the total collapse of the world banking system. There has been a significant increase in the risk profile of many countries, both developing and developed. Corruption widens the gap between the rich and the poor in society. For example, tax evasion favours the rich and well-connected. Social programmes to help the most needy tend to get pushed down priority tables while inequities in asset ownership are magnified. At the same time corruption reduces the funding of basic education, health and other government expenditure programmes that help to improve the incomes of the poor – while helping the wealthy to bias public expenditure towards higher education and tertiary health care. Governments must therefore stand up and fight against corruption in order to support sustainable and equitable economic growth in their national economies. # Professor Joe Nellis is the Director of Policy, Strategy and Performance Academic Community, Cranfield School of Management, UK.