Corruption and business uncertainty in Indonesia.

Publication: ASEAN Economic Bulletin

Publication Date: 01-APR-06

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COPYRIGHT 2006 Institute of Southeast Asian Studies (ISEAS)

I. Introduction

The word corruption has been used in many ways with differing connotations. In the economic context, however, it refers mainly to the use of public office for private gain (Shleifer and Vishny 1993). Even with this "narrow" definition, ambiguities still persist. The distinction between political and economic corruption is also still blurred. In particular, whether striving for private gains also include policies purposely designed to increase the chances of staying in office is still debatable (Bardhan 1997). Given its elusive nature and definitional ambiguities, it has been a challenging task for economists to predict the economic impact of corruption. The debate on corruption has definitely not been settled.

One view suggests that with the prevalence of pervasive and cumbersome regulations, corruption is efficiency-enhancing and may help to boost growth. In this regard, Huntington (1968), for example, asserted that excessive taxes and regulation would remain excessive without bribery, so bribery had, in effect, acted like deregulation. Lui (1985) supported this view by showing that in a queuing model, corruption could be growth-enhancing. In this respect, the differences in the sizes of bribes given by different firms may reflect their different opportunity costs with respect to bureaucratic delay, so buying Iower red tapes could increase efficiency. Lui's model supports the speed or grease money argument in which corruption may improve welfare even if some resources have to be spent in such activities. In line with this argument, Bardhan (1997) pointed out that as part of the Coasian bargaining problem, the corrupt bureaucrats could award the contract to the highest bidder in bribes. Since only the most cost-efficient firm has the ability to pay the largest bribe, an efficient outcome could still be reached.

However, corruption ceases to be welfare-enhancing if the bureaucrat considers other factors besides the bribe size. This could include, for example, nepotism, or a case where the briber is allowed to supply a low quality good at a high price, allowing unqualified applicants with a high willingness to pay or when bribery is used to limit the competition. These are the main arguments rejecting the notion that corruption could be efficiency-enhancing (for example, Rose-Ackerman 1974, 1978, and 1996; Bliss and Di Tella 1997; and Kaufman and Wei 1999). Another crucial argument forwarded by this school of thought is that because the bureaucrats have discretionary power in terms of regulation, regulatory burden or regulation may be designed purposely by governments to extract rents, which can then be used by officials for various purposes including personal benefit. In support of this view, Kaufman and Wei (1999) showed that since officials have monopoly power over regulation, they could customize the nature and amount of bureaucratic harassment or red tape on firms to extract the maximum bribe possible. In other words, the corruption is not exogenous to the system. For example, corruption can be caused and preserved by a patron-client political system where built-in corrupt practices have been present for an extended period of time.

Another important aspect of corruption that works against economic efficiency is its secretive nature. Unlike taxation, corruption is illegal and it avoids detection. This makes corruption less efficient than taxation (Shleifer and Vishny 1993). A bribe as a form of contract cannot be reinforced in courts, and thus, it creates the opportunity for bribe-takers to renege or to demand a higher bribe from buyers. Of course, some officials may have to worry about the reputation problem but many are not concerned about such long-term issues.

Moving from the conceptual debates, economists have been trying to establish some sort of common comparative measurement. Due to its secretive nature, the corruption data are often derived from the perception of businessmen. Certainly, this has its drawbacks. In particular, such perception indices tend to raise concerns about biases. Most empirical works examining the determinants of economic growth employed the framework proposed by Barro in 1991. One early study of the relationship between economic growth and corruption was by Mauro (1995). Employing Business International (BI) data for seventy countries for the period 1980-83, he found a significant negative relationship between corruption and the average annual economic growth rate over the 1960-85 period and also between corruption and the investment-GDP ratio for 1960-85 and 1980-85 as well. Using the same framework as Mauro (1995), Rahman, Kisunko, and Kapoor (2000) used perception-based corruption indicator to investigate the effects of corruption on Bangladesh's economic growth. The estimated equation was used to conduct counter-factual simulation exercises to examine the extent to which Bangladesh had to reduce its level of corruption in order to achieve a level of economic growth comparable to some selected countries. The finding suggested that curtailing corruption would attract more investment, domestic and foreign alike, and thus accelerate economic growth.

II. Corruption and Uncertainty

Despite the apparent negative relationship between economic growth and corruption, many puzzles remain. Perhaps, the most interesting case is Indonesia under the Soeharto regime, where rampant corruption was apparently compatible with very high growth. In most other corrupt countries, this has not been the case. Corruption in Indonesia seemed to inflict very little cost to economic development. It seems that different kinds of corruption have different impacts on efficiency. There are certainly explanations from the point of view of sociology and political science, but few are rooted in the economic theory, among them Shleifer and Vishny (1993). Using an elementary model of industrial organization they attempted to sort out the consequences of corruption in different countries, different places, and also different regimes in the same country.

Shleifer and Vishny (1993) compared a case of independent monopolies where at least two government agencies act independently, each providing one good that is complementary to each other (business and building permits for example), with a case where those two agencies are joint-profit maximizers. In the case of independent monopolies, as in the Cournot model, each agency will perceive the other agency's sales as given. As a result, the bribe-inclusive price is set such that the marginal revenue is equal to the marginal cost. In this setting, the bribe per unit of sale is the difference between the official price of permit supplied and the agencies' marginal costs (both are assumed the same). In the case of joint monopoly, each agency takes into account the effect of an extra unit sold on the sales of the complementary permit, and in so doing the revenue forms the other source as well. In this situation the marginal revenue in the supply of each permit is less than marginal cost. The conclusion is unmistakable, that per unit bribe is higher and the supply of each permit is lower in the independent monopolist setting than in the case of joint monopolists. The total bribe revenue is larger in the joint monopolists but the permit buyers receive a larger supply of both permits. (1)

Shleifer and Vishny (1993) used the change from communist Russia to the post-communist government to illustrate the prediction of this model. The communist party centralized the collection of bribes and established the mechanism to check any deviations from the agreed pattern of corruption. The buyer of government goods (permits) was guaranteed to buy the whole package and not to face any more requests for bribe from various parts of the bureaucracy. Similarly, in Korea the bribes are mostly in the form of lump sum contributions by major business leaders to the President's campaign fund, rather than taxing on economic activities. On the other hand, there are some extreme cases such as in India, in post-Communist Russia and some African countries where different ministries, agencies and different levels of local government all set the bribe rates independently to maximize their own revenues, rather than combined revenue of all bribe takers. During the Soeharto era, the nature of corruption in Indonesia was somewhat similar to that in Communist Russia and Korea. At that time, Indonesia and India were about equally corrupt. The apparent better economic performance for Indonesia might be attributed to the fact that the Indonesian corruption was more centralized, and thus more predictable. The corruption was controlled by the first family and the top military leadership in partnership with ethnic Chinese conglomerates (Bardhan 1997). The reduction of uncertainty due to political stability fostered by such an arrangement was also confirmed by McLeod (2000). Although firms were reported to complain about corruption and bureaucratic harassment, most of the costs associated with corruption and bureaucratic red tape could be predicted and calculated as part of transaction costs. At the national level, the involvement of Soeharto's children in many private businesses was also regarded as efforts on the part of entrepreneurs to reduce business uncertainties that might come from the harassment of lower level bureaucrats. This pattern was often repeated in provinces where families of prominent figures such as governors and local military commanders were asked by businessmen...

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