Saturday, October 15, 2011

Corruption and growth

Tim Harford points to this insightful joke which captures the difference between the roving bandit and the stationary bandit, about which I had blogged earlier.

"A bureaucrat from Sani Abacha’s Nigeria visits a bureaucrat in Suharto’s Indonesia and is impressed that his Indonesian counterpart lives in a nice house and drives a Mercedes. "Do you see that road? Ten per cent," the Indonesian explains.

A couple of years later the visit is reciprocated. Suharto’s man finds the Nigerian civil servant in a palace with a pair of Ferraris. "Do you see that road?" says the Nigerian, gesturing at virgin rainforest. "One hundred per cent.""

He explores the challenge of reconciling the incentives of the inevitable corruption among politicians and bureaucrats with those of promoting national economic growth. He points to the success as countries like South Korea, which despite close and corrupt nexus between businessmen and the ruling elite, managed to escape being grid-locked in corruption and stagnation by focusing on export-driven growth. This focus on export markets and the need to be competitive ensured that corruption did not compromise on productivity and quality.

Similarly, the spectacular Chinese economic growth story conceals rampant corruption involving close relationship of politicians, bureaucrats and businessmen. However, certain systemic incentives sought to mitigate the adverse consequences of such corruption and align incentives of all sides towards promoting growth. The export driven growth model, which underpinned the success of town and village enterprises (TVEs), and the informal economic performance based promotions of local party apparatchiks contributed in no small measure to China's success.

In all these models, the ruling establishment, wilfully or otherwise, succeeded in putting in place mechanisms that incentivized economic growth and more critically linked the flow of corruption benefits itself to this growth. In other words, these systems ensured that corruption was sub-ordinated to the achievement of the broader macroeconomic and growth objectives. As the economic growth increased, all stakeholders realized the benefit of nurturing the goose that lays the golden egg, a virtuous cycle of growth and corruption got entrenched. I have two observations about this.

1. Is it possible to replicate this model in countries like India? I am inclined to believe that there are a few ingredients that served to sustain this model, which may be missing in countries like India. The most important ingredient is literacy. I believe that high-levels of literacy exposed all stakeholders to the benefits of sustainable economic growth. Most often, as is evident in the lower level corruption in countries like India, where illiteracy is widespread, the extent of corruption is not dis-similar to Abacha's Nigeria. Though I am not aware of any empirical validation, I believe that there could be a positive correlation between stationary bandits and literacy, and vice-versa between roving bandits and literacy.

Another factor that could possibly come in the way of the formation of such mutually-beneficial coalitions in India may be democracy itself. Does the inevitable lack of discipline of democratic politics erode the stability of such coalitions? Does the lack of continuity in multi-party democracies hamper the establishment of a stable elite?

2. An important point about state-driven industrial policy that is often missed in standard debates about its pros and cons is its role in building and sustaining such coalitions. Supporters point to its role in effective allocation of resources in developing economies. However, they overlook its equally important role in sustaining the careful equilibrium among a set of stationary bandits.

The industrial policies followed by countries like South Korea and China have for long been accused of having engendered a system of crony capitalism. However, the redeeming feature of this capitalism, appears to have been that these capitalists were interested in first expanding the pie and then nibbling the expanded pie!

In other words, East Asian industrial policy not only allocated resources efficiently, but also did so in a manner that reconciled the apparently contradicting need to appease the rent-seeking inclinations of the ruling elites and maintain economic growth.

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