By Leslie Manison*
The phenomenon whereby public funds are misused for projects that benefit corrupt officials rather than serving the public good is generally referred to as corruption, and it has existed for more than 2,000 years. Since the beginning of recorded history, accusations of corruption have led to the downfall of governments, and prominent politicians, including presidents and prime ministers, have lost their positions.
In the modern era, publicity surrounding corruption focuses largely on allegations against politicians and government officials and on the legal outcomes of court cases. However, the public is informed far less about the harmful economic consequences of corruption, a subject that appears to remain largely within the interest of scholars and academics.
The most widely used definition of corruption is “the abuse of public power for private gain”. Based on this definition, it should not be inferred that corruption cannot exist in the private sector. Nevertheless, this article focuses primarily on public corrupt practices that have negative consequences for the economy.
Most scholars conclude that corrupt public practices lead to lower economic growth. It is also argued that corruption, by distorting incentives and market forces, reduces the developmental potential of economies, mainly because of inefficiencies in the allocation of resources.
More specifically, public funds are misdirected towards projects that benefit corrupt officials rather than towards projects that serve the public good, such as vital infrastructure or social services.
Nobel laureate Joseph Stiglitz has written that “American-style corruption” includes, among other things, “the passing of laws that ensure someone is paid excessively for what they sell to the government (arms contractors and pharmaceutical companies), or when someone pays less for natural resources that rightfully belong to the public (oil and mining companies using public lands)”.
Moreover, inefficient allocation of resources may result from bribery and questionable regulations that prevent the entry of new businesses. Competition is significantly undermined by the protection of existing firms, the creation of high levels of concentration and the obstruction of competitive forces that normally reduce prices and promote innovation. These restrictions allow established companies to maintain market power and high profits, often at the expense of consumer welfare and market dynamism.
Institutional effectiveness can be weakened by improper practices in government appointments and promotions within the public sector. Frequently, many government positions are filled by individuals distinguished primarily by their blind loyalty and connections to the governing elite, rather than by those with the competence to provide better services to the public. This appears to occur in many countries where government services, for example, lack appropriately qualified personnel to objectively assess, prepare and effectively implement sustainable infrastructure projects, despite having ample financial resources to do so. Indeed, EU technocrats have complained about the slow progress of Member States in utilising funds allocated for development projects.
In particular, corruption involving bribery, combined with institutional incapacity, increases costs and reduces the quality of public services, especially in health and education, creating informal barriers and discouraging their use, particularly by low-income families.
Money laundering, by definition, involves concealing illicit funds by perpetrators of corruption. Governments in tax haven jurisdictions have been accused of facilitating money laundering by offering property sales and passports in exchange for legitimised funds. Such practices and transactions have in turn led to significant investment in high-end real estate, which tends to exclude many ordinary citizens from securing decent housing and forming families with children.
Tolerance of tax evasion creates unfair competition in the business sector and deprives governments of necessary revenue. Furthermore, tax evasion and tax avoidance, particularly by the wealthy and powerful, combined with the misuse of public resources intended for social benefits, housing and pensions, disproportionately harm lower-income groups.
Widespread corruption also erodes trust in public institutions, such as tax authorities, resulting in reduced government effectiveness.
In essence, corruption obstructs the efficient allocation of resources, discourages innovation and entrepreneurship, widens income and wealth inequalities and undermines the rule of law, while significantly preventing economies from fully realising their potential.
Combating corruption
Even in countries where corruption has serious negative consequences for the economy and society, governments often focus on one or two specific measures, such as increasing penalties for public sector employees or establishing an anti-corruption authority.
Such policies have usually proven unsuccessful, and fiscal experts argue that a multidimensional approach is required to combat corruption. Moreover, Vito Tanzi, former Director of the Fiscal Affairs Department of the International Monetary Fund, has argued that anti-corruption policies cannot be examined independently of the need to reform the role of the state. The reason is that “a certain role of the state almost inevitably creates fertile ground for corruption”.
Tanzi has written that “any realistic strategy (to combat corruption) must begin with the explicit recognition that there are those who demand corruption from public sector officials and there are public officials who are willing to commit such acts in exchange for reward”. He adds that “in the background stands the state, which to a large extent, through its many policies and actions, creates the environment and incentives that influence both those who pay bribes and those who accept or demand them”. Indeed, it is the state that shapes the relationship between bribe givers and bribe takers. Thus, according to Tanzi, combating corruption must be closely linked to state reform, rather than to any single action.
Accordingly, serious measures are recommended to reduce corruption on multiple fronts. First and foremost, there must be a sincere and visible commitment from leadership to combat corruption. Leadership must demonstrate and prove zero tolerance.
Measures should be taken to reduce the demand for corruption by cutting regulations and other policies, such as tax incentives, and by ensuring transparency and limiting discretionary power in the measures that remain. Excessive discretion undeniably allows the abuse of regulations and policy incentives. Strict enforcement of laws and regulations, combined with legal, administrative and technological measures, is necessary to create a system of high risk and low reward for corrupt acts. Effective enforcement also requires strong non-political institutions, such as anti-corruption services, prosecutors and independent courts, as well as effective tax administration.
Furthermore, combating tax evasion as a criminal act requires the use of digital technology for law enforcement, including artificial intelligence to detect tax evasion, clearer distinctions and international cooperation to differentiate between tax evasion and tax avoidance, and the implementation of strict reporting standards. In this context, voluntary tax compliance can also be strengthened by simplifying tax filing procedures in order to reduce compliance costs for taxpayers.
Combating money laundering, which is often linked to tax evasion, should form part of a broader programme to address serious crimes, including corruption. According to an EU directive confirming that “corruption must constitute a predicate offence for money laundering”, enforcement against perpetrators would be far more effective, since money laundering carries severe penalties under anti-money laundering regulations.
Most importantly, to reduce the involvement of public officials in corruption, reforms in the public sector are required. These include merit-based appointments and promotions, maintaining public sector salaries at adequate levels, increasing incentives for honest behaviour, including whistleblower protection, rotating staff in high-risk positions to prevent collusion, enforcing strict codes of conduct and sanctions for public officials, and digitising public services to reduce bribery.
*Leslie Manison is founder and consultant of LG Manison Consulting Services and former adviser to the Minister of Finance of the Republic of Cyprus. The article is republished from the website of the Cyprus Economic Society