The Bad Kind of Corruption

While many corrupt countries have remained mired in poverty, some of the great economic success stories of the past half-century have also been the most corrupt economies on the planet  — to the great discomfort of development economists.

By the end of President Suharto’s 30-year rule in 1998, Indonesia ranked as one of the half-dozen most corrupt economies on the planet, according to Transparency International (TI). Yet in those three decades, the country also experienced growth in per capita income of 6 percent per year, a rate almost unparalleled in recorded human history. The past 30 years have seen comparable economic progress in China: since the 1976 death of Mao Zedong, the Chinese economy has eclipsed even Suharto-level growth rates despite also holding position 79 in TI’s latest ranking, tied with Burkina Faso.

This is not to say that corruption has been good for Indonesian and Chinese incomes (though many would argue it has been) — perhaps they’d be even richer otherwise. But it certainly suggests that not all corruption is created equal. This week’s trial of four Rio Tinto employees on bribery and corruption charges in China may not bode well for the relatively orderly and benign style of corruption that allowed China’s great leap forward into economic progress.

Why might corruption be damaging to economic growth? On some level, it is no different from a tax, albeit one that gets deposited in a bureaucrat’s pocket rather than the state treasury. Just as high tax rates can discourage business entry and growth, so too will a bribe "tax" on business.

Taxes — though subject to the vagaries of politics and populism — are at least in theory codified in law. But in some countries, bribe payments are also common knowledge — a Moscow newspaper, for example, famously published in 2008 the going rates for everything from buying a court verdict to instigating a police raid. In other instances, the requisite payment remains ambiguous, with grasping politicians or bureaucrats trying to squeeze as much out of each individual business as possible. Creating further uncertainty, while tax payments are recorded and required by law, bribes, by definition, happen under the table, so it’s harder to ensure that one’s partner in crime makes good on his commitment to provide a favorable ruling or delivery of a license as promised.

In an orderly, predictable — yet corrupt — system, businesses can at least calculate expected returns and plan accordingly. Paying bribes to an unstable or unpredictable government, on the other hand, requires a leap of faith and a quick exit strategy. This will reduce the overall level of investment and also shift the types of projects toward those that generate a quick buck rather than a long-term payoff.

The most troubling aspect of the recent Rio Tinto case is that it might be signaling to foreigners that they are entering a new era of uncertainty over the rules that govern their interactions with Chinese bureaucrats. It may be that Rio Tinto executives crossed an invisible tripwire that protected the interests of domestic steel firms in paying bribes for preferential market information. If that is well-understood by market participants, then the long-term impact on investment may not be so great: Those that break the rules in a well-enforced and predictable system should indeed be punished.

But this line might not always be visible to the foreign investors whose dollars and expertise have helped fuel China’s explosive growth. While corruption always poses risks for investors, these perils are much greater when the rules of bribery are unclear. If Chinese leaders wish to keep the dollars coming in, they might do well to stamp out the corruption and bribery that keeps some investors away. But failing that, they should at least make sure that grasping bureaucrats take their share in an orderly and predictable manner.