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Helping Countries Combat Corruption: The Role of the World Bank

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5. Helping Countries Reform Economic and Sector Policies

Economic policy reform should be a main pillar of an anticorruption strategy in many countries. Deregulation and the expansion of markets are powerful tools for controlling corruption, and the Bank will continue to encourage governments to pursue these goals wherever feasible. Where governments must continue to play an active role in the economy, policymakers should carefully consider the demands a new policy might place on institutional capacity.

Deregulation and the expansion of markets

Markets generally discipline participants more effectively than the public sector can, and their power to do so is closely linked to sound economic policy. Enlarging the scope and improving the functioning of markets strengthens competitive forces in the economy and curtails rents, thereby eliminating the bribes public officials may be offered (or may extort) to secure them. There is a strong correlation between policy distortions and corruption.32

Some policy reforms can have quick results, particularly some macroeconomic reforms and deregulation, which do not make heavy demands on institutional capacity. The incentives of economic actors can be changed overnight by the removal of controls and the introduction of market-determined allocation systems in areas like foreign exchange and bank credit. The state's role in supporting rather than supplanting markets is now widely accepted around the world.

Macroeconomic and sector policy reforms that contribute to the expansion of markets and the reduction of rents include:

  • Lowering tariffs and other barriers to international trade.
  • Moving from dual to single exchange rates, with market-determined rates.
  • Introducing competitive credit markets.
  • Eliminating price controls.
  • Cutting subsidies to enterprises.
  • Reducing regulations, licensing requirements, and other barriers to entry for new firms, both domestic and foreign.
  • Privatizing government assets in clearly competitive markets.
  • Abolishing monopoly export marketing boards.

Policy reform has helped reduce opportunities for corruption in many countries. In cases where countries have carried out economic reform programs and corruption persists, part of the answer lies in an unfinished reform agenda. In many countries the benefits of macroeconomic reforms have been blunted by the absence of complementary microeconomic reforms at the sector level. The Bank stands ready to work with governments on macroeconomic and sector policies that not only improve performance but also help to reduce opportunities for corruption.

Policy advice when government continues to play a role

In some areas, advice on policy reform may need to pay more attention to anticorruption goals. Typically, these are areas in which the government must continue to be involved because of market failure but in which public policy can work only if sufficient institutional capacity exists. Without institutional capacity well-intended policies can lead to poor outcomes and even greater corruption. Several examples illustrate the links between design and institutional capacity: infrastructure privatization, environmental regulation, tax reform, and public expenditure reduction. In each of these areas the issue is not that the policies are necessarily misguided but that institutional capacity is crucial to a successful outcome and that policies must be designed in the light of a realistic assessment of this capacity.

Infrastructure privatization.   In the long run privatization should decrease corruption, because it reduces the power and discretion of public managers and bureaucrats and increases competition and transparency. In the short run, however, the complex negotiations required for privatization—usually in a situation of shifting policies and regulations—create temptation and opportunity. Weak institutions are unlikely to resist temptation. If corruption becomes evident, a negative image of privatization builds in the public's eye—even though the transactions themselves still make good economic and financial sense.

The dangers are particularly acute in infrastructure privatization, in which, in most cases, the stakes are large, the negotiations before the sale are elaborate, and continued government oversight is justified. When a firm is divested into a competitive market, the opportunities for corruption more or less end. In the case of a natural monopoly, corruption can continue indefinitely in the regulatory system.

Governments embarking on privatization of state enterprises need to reinforce institutional capacity so that clear rules can be impartially applied, both before and after sale. In the case of infrastructure, privatization should not be undertaken without also establishing a minimum regulatory capacity. It has proven costly to privatize first and try to install a regulatory regime later. Corruption is not an argument for not proceeding but for better design and implementation of privatization programs.33

Environmental regulation.   The environment is a sector in which governments have tended not to be involved enough in the past and are now seeking greater involvement through regulation. But tighter regulation without strong institutions is likely to lead to more corruption, because it creates rents and gives the government more coercive powers. A careful balance between policy and institutional capability is crucial but is easily overlooked.

Some countries are testing new and innovative ways to use market mechanisms for environmental control. These include, for example, auctions of tradable permits to pollute and negotiated contracts with industry groups on acceptable pollution levels in a particular watershed basin. In each case the level of acceptable pollution is set by the government but how that level is reached is ultimately decided by the market or the private sector. The Bank can help strengthen governments' capacity to design and implement such decentralized, market-based approaches to pollution control.

Tax reform.   In most cases tax reforms that eliminate multiple rates and exemptions and limit the discretionary powers of tax officials help reduce corruption and enhance economic efficiency. However, tax rates that exceed what taxpayers view as legitimate or what tax offices can administer encourage the informalization of the economy and induce tax evasion and the corruption of tax officials.34 High tax rates coupled with weak collection arrangements simply inflate the gains from corruption without increasing the risk of detection. Where this is the case, efforts should be made to design tax structures and rates that better match institutional capacity and to strengthen that capacity over time (and adjust policy accordingly).

Public expenditure reduction.  Corruption may also increase when governments are under pressure to reduce the public wage bill's share in the budget but find it politically difficult to do so. In such circumstances a mandated reduction in the wage bill translates into yet lower real pay for government employees. Pay cuts can have devastating effects on government performance, through the loss of skilled professionals, demotivation of those who remain, and lowered resistance to corruption. When the erosion of pay makes it impossible for staff to maintain basic living standards, the government can quickly lose its capacity to control fraud, and even the honest can be driven to absenteeism and moonlighting activities that may conflict with their roles as public servants. On the surface the formal processes of government may be maintained, while underneath an alternative set of informal rules operates to the detriment of public welfare.

Large public sector wage bills are fiscally unsustainable and must be addressed. But this should happen within an integrated framework of public sector and governance reform (see chapter 6). The Bank's ability to help with this, as with other policy areas discussed above, will continue to increase as it learns more about the important links between policy design and institutional capacity.


Notes

32. See Figure 2-2 in World Development Report 1997: The State in a Changing World, New York: Oxford University Press, 1997.

33. Daniel Kaufmann and Paul Siegelbaum, "Privatization and Corruption in Transition Economies," Journal of International Affairs, 1997. 50(2), 419Ð58.

34. For example, in a number of transition economies in which government revenue accounts for less than 10 percent of GDP, value-added tax rates are 20 percent or higher. Rates this high are not widely enforceable in such an environment and create incentives for bribery.

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