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Corporate Corruption Matters for Public Governance:

Empirical Evidence and Implications for Anti-Corruption Strategies

Daniel Kaufmann, World Bank Institutewww.worldbank.org/wbi/governance

Keynote Presentation at the 3rd ICAC Symposium on Anti-Corruption,

Hong Kong, May 9th, 2006

"If you cannot measure it, you cannot improve it."-- Lord Kelvin

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Challenging ‘Popular Notions’ on Private Sector Corruption

1. Governance & Corruption Measurement: Useless?

2. Evidence: Has Corruption declined globally?3. Controlling of Corruption: an outcome of development?

4. Problem is solely with Public Sector/Officials in LDCs

5. Public Sector: sole shaper of the Investment Climate6. ACCs universal approach to private sector corruption?

7. No Innovations in addressing private sector corruption

8. Investigate & Punish: the only effective tool of A-C

9. Corruption: Cultural & Historical Determinism

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Tenet # 10: Challenging the previous 9 ‘popular notions’

1. Data Matters -- on Governance & Institutions: data can be gathered, analyzed, & used – including by ACCs

2. Corruption Matters: US $1 trillion;& 300% ‘dividend’

3. Worldwide: Corruption stagnation, yet variance

4. Private Sector Corruption: Underemphasized

5. Private sector: also an Investment Climate ‘Maker’

6. Implications for institutions fighting corruption

7. Innovations: Transparency & Incentives

Data Partnership Illustration: ICAC – World Bank Mini-Survey

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Six Dimensions of Governance

• The process by which those in authority are selected and replaced – VOICE AND ACCOUNTABILITY – POLITICAL STABILITY & ABSENCE OF

VIOLENCE/TERRORISM• The capacity of government to formulate and

implement policies– GOVERNMENT EFFECTIVENESS– REGULATORY QUALITY

• The respect of citizens and state for institutions that govern interactions among them – RULE OF LAW – CONTROL OF CORRUPTION

Governance as the set of traditions and institutions by which authority in a country is exercised -- specifically:

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Governance Data• Data on governance from 37 different sources

constructed by 31 different organizations• Data sources include cross-country surveys of

firms, commercial risk-rating agencies, think-tanks, government agencies, international organizations, etc.

• 352 proxies for all dimensions of governance • Organize these measures into six clusters

corresponding to definition of governance, for five periods: 1996, 1998, 2000, 2002, 2004

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Control of Corruption: one Aggregate Indicator (selected countries from 204 worldwide, for illustration, based on 2004 research data)

-2.5

0

2.5EQ

UA

TOR

IAL

GU

INEA

KO

REA

, NO

RTH

TUR

KM

ENIS

TAN

UZB

EKIS

TAN

TAJI

KIS

TAN

BA

NG

LAD

ESH

VEN

EZU

ELA

ZAM

BIA

RU

SSIA

KO

REA

, SO

UTH

MA

UR

ITIU

S

SOU

TH A

FRIC

A

GR

EEC

E

ITA

LY

BO

TSW

AN

A

SLO

VEN

IA

CH

ILE

FRA

NC

E

SPA

IN

UN

ITED

KIN

GD

OM

NET

HER

LAN

DS

NO

RW

AY

NEW

ZEA

LAN

D

FIN

LAN

DPoor Governance

Governance Level

Margins of ErrorGood

Governance

Source for data: : 'Governance Matters IV: Governance Indicators for 1996-2004’, D. Kaufmann, A. Kraay and M. Mastruzzi, (http://www.worldbank.org/wbi/governance/govdata/); Colors are assigned according to the following criteria: Dark Red, bottom 10th percentile rank; Light Red between 10th and 25th ; Orange, between 25th and 50th ; Yellow, between 50th and 75th ; Light Green between 75th and 90th ; Dark Green above 90th.

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Control of Corruption, 2004: World Map

Source for data: : 'Governance Matters IV: Governance Indicators for 1996-2004’, D. Kaufmann, A. Kraay and M. Mastruzzi, (http://www.worldbank.org/wbi/governance/govdata/); Colors are assigned according to the following criteria: Dark Red, bottom 10th percentile rank; Light Red between 10th and 25th ; Orange, between 25th and 50th ; Yellow, between 50th and 75th ; Light Green between 75th and 90th ; Dark Green above 90th.

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Governance Matters: The 300% ‘Dividend’

1. Large Development Dividend of Good Governance: a one-standard-deviation improvement in governance raise incomes per capita in a country by about 300% in long-run

2. But is such a decline in corruption unrealistically large?: NO -- One S.D. is the difference from: Angola → Brazil → Estonia or Botswana → US, Canada or Germany, or, the difference from Equatorial Guinea → Cuba or Uganda →Mauritius → Portugal → Finland or New Zealand

3. The impact is from governance to incomes, and not viceversa -- higher incomes alone will not do

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Development Dividend From Controlling Corruption

Low Governance Medium Governance High Governance

Control of Corruption

$300

$3,000

$30,000

Data Source for calculations: KK 2004. Y-axis measures predicted GDP per capita on the basis of Instrumental Variable (IV) results for each of the 3 categories. Estimations based on various authors’ studies, including Kaufmann and Kraay.

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Good Governance associated Country’s Competitiveness

ZWE

VNMVEN

URY

USA

GBRARE

UKR

UGA

TUR

TUN

TTO

THA

TZA

TJK

TWNCHE

SWE

LKA

ESP

ZAF

SVN

SVK

SGP

YUG

RUS

ROM

QATPRT

POL

PHLPER

PRY

PAN

PAK

NOR

NGA

NIC

NZLNLD

NAM

MOZ

MAR

MNGMDA

MEXMUS

MLT

MLI

MYS

MWI MDG

MKD

LUX

LTULVA

KGZ

KWT

KOR

KEN

KAZ

JOR

JPN

JAM

ITA

ISR IRL

IDN

IND

ISL

HUN

HKG

HND

GUY

GTM

GRC

GHA

DEU

GEOGMB

FRA

FIN

ETH

SLVEGY

ECU TMPDOM

DNK

CZECYP

HRV CRICOL

CHN

CHL

TCD

CAN

CMRKHM

BGR

BRA

BWA

BIHBOL

BEN

BEL

BGD

BHR

AZE

AUT

AUS

ARGDZA

ALB

2

4

6

-1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0KK Control of Corruption

Gro

wth

Com

petit

iven

ess

Inde

x (E

OS)

LowLow High

High

r = 0.90

Sources: GCI drawn from EOS firm survey, WEF 2005 – 117 countries; Control of Corruption from Kaufmann, Kraay and Mastruzzi, ‘Governance Matters IV: Governance Indicators for 1996-2004’.

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Measurable Worldwide Trends in Governance

• Through new method, we showed that it is possible to identify significant changes over time

• It is found that changes can take place in the short-term: in 6-to-8 years, some deteriorations as well as some significant improvements as well

• Yet the world on average has not improved• Good News: Some countries are improving

(while others deteriorate) in governance

12

0

1.5

3

1984-1988 1989-1993 1994-1998 1999-2001

TRANSITION

EMERGING

OECD+NIC

Source: ‘Rethinking Governance’, based on calculations from WDI. Y-axis measures the log value of the average inflation for each region across each period

Significant Decline in Inflation Rates WorldwideHighInflation

Low

(avg. inlogs)

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Quality of Infrastructure

1.5

4

6.5

1997 1998 1999 2000 2001 2002 2003

High

Low

East AsiaIndustrialized

OECD

Transition

Emerging

Source: EOS 1997-2003 (Quasi-balanced panel). Question 6.01: General infrastructure in your country is among the best in the world?

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Judiciary Independence (EOS survey resuls 1998-2004)

1

4

7

1998 1999 2000 2001 2002 2003 2004

Inde

pend

enci

a de

la J

udic

atur

a

OECD

East Asian NICs

Latin America

NON OECD

HighIndependence

No Independence

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No Significant Trend in Control of Corruption Worldwide Averages

0.2

0.5

0.8

1996 1998 2000 2002 2004

EIU

PRS

QLM

Poor

Good

PRS country coverage in 1996: 129, all other periods 140; QLM and EIU country coverage: 115 for all periods.

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Control of Corruption: East Asia 2004 vs. 2000

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The ‘Mezzo’ Level of Governance Measurement• Based on cross-country surveys, mainly of enterprises –

(such as the EOS of WEF, BEEPS/WBES of WB, etc.)

• Thousands of firms interviewed on a range of issues; focus on governance, specialized questions

• More detailed unbundling of governance and corruption phenomena than aggregate indicators

• Relatively broad country coverage, but less than aggregate governance indicators

• Measuring what is taking place De Facto matters: it uncovers stark realities masked in De Jure indicators

• Addresses empirically: ‘It takes two to “tango”’

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On Specifics – the perspective of the firm

• Corruption is highly detrimental for the growth

and competitiveness of a dynamic private sector

• ‘It takes 2 to tango’: firms bribe, various patterns

• Unbundling Corruption: different manifestations

• The behavior of some Powerful Firms and MNCs

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0

20

40

60

80

East Asia NICs East Asia dev. South Asia Sub-saharanAfrica

Eastern Europe Latin America

Foreign Currency Infrastructure Bureaucracy

Corruption Tax Regulations Inflation

% firms reporting constraint among top 3:

Top Constraints to Business vary across regions (responses from the Firm in EOS 2005)

Source: EOS 2005. The question posed to the firm was: Select among the above 14 constraints the five most problematic factors for doing business in your country. Note that the overall EOS sample covers 117 countries, and in some regions –particularly in the Middle East, Africa and the FSU, many countries are not surveyed. Thus, regional averages need to be interpreted with caution, since typically countries not surveyed tend to rate lower in governance than those surveyed.

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Corporate Corruption, 2004

0

20

40

60

80

Corporate Bribery

% F

irm

s re

port

'cor

rupt

ion'

Nordic Countries

G-7

Southern Europe

East Asia NICs

Non-OECD

Source: Author’s calculations based on EOS 2004.

% Firms report existence of bribery (avg across types)

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0

20

40

60

80

OECD East AsiaNICs

East Asiadev.

Sub-saharanAfrica

FormerSoviet Union

EasternEurope

LatinAmerica

Freq

uenc

y of

Bri

bery

Connection to Utilities TaxationProcurement Judiciary

State Capture

Unbundling Corruption: Different types of Bribery(responses by firms 2005)

% Firm Report High Bribery (1-3)

Source: EOS firm survey, WEF2005 – 117 countries. Question: In your industry, how commonly firms make undocumented extra payments or bribes connected with permits / utilities / taxation / awarding of public contracts / judiciary? (common…never occurs).

Bribery in:

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Multinationals Bribe Abroad?% Firms Reporting Frequent Procurement Bribery, EOS 2005

0

20

40

60

80

100

Procurement Bribery is prevalent (% Firms Report)% F

irm

s Rep

ortin

g Pr

ocur

emen

t Bri

bery

is P

reva

len Domestic Firm in OECD Country

OECD Multinational in another OECD country

OECD Multinational in Non-OECD country

Domestic Firm in Non-OECD Country

Source: EOS, preliminary. Question: In your industry, how commonly would you estimate that firms make undocumented extra payments or bribes connected with the following: permits, public utilities, tax payments, loan applications, awarding of public contracts, influencing of laws, policies, regulations and decrees to favor selected business interest, and judicial decisions. Any firms reporting answers 1 through 3 were considered to be reporting at least high frequency of bribery, while answers 4 through 7 were not.

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State CaptureFirms shape the legal, policy and regulatory

environment through illicit, non-transparentprovision of private gains to public officials

• Examples include:– private purchase of legislative votes– private purchase of executive decrees– private purchase of court decisions– illicit political party financing

Finding: Countries subject to Capture of the State (or Undue Influence) by powerful firms exhibit much lower private sector growth than countries that avoid State Capture

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Economic Cost of Capture for Growth

0

5

10

15

20

25

Firms' Output Growth (3 yrs)

Low captureeconomies

High captureeconomies

Based on survey of transition economies, 2000

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Addressing Capture: Economic Reform, Political Competition & Voice/Civil Liberties Matter

0

0.1

0.2

0.3

0.4

Stat

e C

aptu

re I

ndex

Partial Civil Libs High Civil Libs

Advanced

Partial

Slow

Pace of Econ Reform

Political/Civil Liberties Reforms

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Stock Market Volatility vs. Control of Corruption

ARG

BRA

CHL

CHN

COLCZE

EGYFRA

GRC

HKG

HUN

IND

IDN

ISRITA JPN

JOR

KORMYS

MEX

MAR

NGA

PERPHL

POL

PRT

RUS

SAU

SVKZAF

ESP

LKA

TWN

THA

TUR

USA

VEN

ZWE

0

10

20

30

-1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0Control of Corruption

Stoc

k M

arke

t Vol

atili

ty

LowLow High

High

r = -0.56

Sources: KK 1998 and Morgan Stanley Capital International Dataset and Emerging Markets Database (1998). Stock volatility defined as the standard deviation of monthly returns over December 1984 to December 1998, multiplied by 100.

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Extent of Insider Trading vs. Control of Corruption

FINAUSGBR DNKLUX SGP

NZLAGO ETHMWI

DZA MLT BELISR IRL SWEJPN AUT NLDFRA DEU CHECANPRY USAMLI URYESTTUN

NAM ISLHTI GMB LVA HKGDOM SENTZA BGR PRTMKD MARJAM CRIGTM MYSYUG MDGJOR ZAFZMB NIC TWNHUNSLVBOL CHLMOZUGA BWAHND KORLTUROMPAN SVKVNM HRV ESPGHA NORITACMR ARG BRAMEX POLEGYKEN THARUSECU INDCOL MUSLKAPERIDN CZENGA PAK

TTO GRCUKRTUR

SVNVEN

PHLZWE BGD

1

4

6

-2.0 -0.5 1.0 2.5Control of Corruption

Insi

der T

radi

ng

Low

Low High

High

r = -0.55

Source: EOS firm survey, WEF2003, and KK 2002. Question to firms on insider trading: “Insider trading is not common in domestic stock markets”, 1=strongly disagree, 7=strongly agree.”

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Stock Market Volatility vs. Extent of Insider Trading

ZWE

VEN

USA

GBR

TUR

THA

TWN

CHESWE

ESP

ZAFSVK

SGP

RUS

PRT

POL

PHLPER

NORNZL

NLD

MEX

MYSKOR

JOR

JPN ITAISRIRL

IDN

IND

HUN

HKG

GRC

DEU FRA

FIN EGY

DNK

CZECOL

CHN

CHL

CAN

BRA

AUTAUS

ARG

0

10

20

30

2 4 6Extent of Insider Trading

Stoc

k m

arke

t Vol

atili

ty

LowLow High

High

r = 0.55

Sources: EOS firm survey, WEF (1998) and Morgan Stanley Capital International Dataset and Emerging Markets Database (1998). Question for insider trading: “Insider trading is not common in domestic stock markets”, 1=strongly disagree, 7=strongly agree. Stock volatility defined as the standard deviation of monthly returns over December 1984 to December 1998, multiplied by 100. Based on Du and Wei (2004)

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Insider Trading Significantly Affects Stock Market Volatility: An Example from Du and Wei (2004)

US (1)

China(2)

Difference(3)=(2)-(1)

Increase in mkt Volatility

Insider Trading

2.62

4.62

2.00

245 bp

Output Volatility

1.7%

3.0%

1.3%

103 bp

More volatility effect from an ↑ in insider trading

>

The volatility effect from an ↑ in output volatility

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Findings on Governance & Emerging Financial Markets

Du and Wei (2004): Insider trading higher market volatility

Gelos and Wei (2005) find that in opaque countries:FDI, herding intensity, &, capital flight during a crisis

Wei (2000): short term flows ‘intensity’ in corrupt countriesMehrez and Kaufmann (1999): financial crisis more likely

in less transparent countries (liberalizing)Acemoglu & Johnson (2004): property rights institutions

matter for growth, I, Financial Market DevelopmentKaufmann, Mehrez & Schmuckler (1999): Listening to

data from firms matters for predicting crises

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Misgovernance Higher Fragility of Financial Sector Soundness of Banks vs. Control of Corruption

(View of the firm, GCS 2001)

3

5

7

Poor Control ofCorruption

Average Control ofCorruption

Good Control ofCorruption

Average Uncontrolled Rating

Predicted Controlled Value

Soundness of Banks

Low

Source: Global Competitiveness Survey, 2001, KK Governance Indicators

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General Implications -- departing from convention?Challenging popular tenets:

• Governance measurement skepticism challenged• Beyond corruption: also governance & transparency• Not only administrative corruption -- influence

peddling and state capture by firms is also key• Private sector not merely the ‘investment climate

taker’; while public sector not alone as ‘investment climate maker’

• Governance Matters for country growth prospects, and for its financial markets

• Capital Market Development as Disciplining for Governance

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Towards Larger Role of Private Sector in Anti-Corruption

1. Address Undue Influence, Monopolies & State Capture2. ‘Data Power’, Voice & Freedom of the Press 3. Transparency Reforms--substitute to over-regulating4. Engage Bussiness Associations & Multinationals5. Money in Politics: Political & Campaign Finance Reform

6. Focus on Incentives & Prevention: raising the cost7. Corporate Social Responsibility reconsidered8. Capital Markets Development – as ‘market-disciplining’9. Addressing Financial/Banking sector challenges10. ACCs, IFIs: To do more in engaging the Private Sector

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Specific Innovations, Initiatives, & ACCs• Data & Indicators on private sector corruption• Public Delisting of Companies engaged in corruption• Voluntary Disclosure Programs (VDPs)• Outreach: Transparency/Integrity Standards for Firms• Need to strengthen ACCs to fulfill its role:

-- Independence from Political Interference-- Political Commitment to Independence, Resources-- Strengthen Investigative Functions-- Outreach, & Incentives-Based Prevention--Advocacy for key Reforms-- Legitimacy in the eyes of the corporates & citizens

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10 Transparency Reform Components for a Scorecard

1. Public Disclosure of Assets & Incomes of Candidates, Public Officials, Politicians, Legislators - & dependents

2. Public Disclosure of Political Campaign contributions by individuals and firms, and of campaign expenditures

3. Public Disclosure of Parliamentary Votes, w/out exceptions4. Effective Implementation of Conflict of Interest Laws,

separating business, politics, legislation, & government5. Publicly blacklisting firms bribing in public procurement6. Effective Implementation of Freedom of Information Law,

with easy access to all to government information7. Fiscal/Financial transparency: central/local budgets; EITI8. E*procurement: transparency (web) and competition9. Transparent, Streamlined Regulatory Framework- ‘0-based’10. Corruption Diagnostic Surveys, Governance Monitoring-- Data

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Data for Analysis and Informing Policy Advice, Not for Precise Rankings

Any data on Governance, Institutions, and Investment Climate is subject to a margin of error. It is not intended for precise country rankings, but to highlight relative strengths and weaknesses and

draw analytical and policy lessons. The data and indicators do not necessarily reflect official views on rankings by the World Bank or

its Board of Directors. Errors are responsibility of the authors.

Further materials & access to interactive data: General: www.worldbank.org/wbi/governance

Data: www.worldbank.org/wbi/governance/govdata/Governance Matters IV Report and Materials:

www.worldbank.org/wbi/governance/pubs/govmatters4.htmlSynthesis Article about ‘Myths’ on Governance in F&D:

http://www.imf.org/pubs/ft/fandd/2005/09/basics.htm