Economic & Moral Impact Of Corruption

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Business Ethics & Morality Assignment

Mark Regan

Question Bribes to government officials, side payments to sidekicks, facilitation payments, donations to political parties before election…. When is corruption morally corrupt? Analyse the critical meaning of corruption in an international business setting and assess it’s economic and moral impact.

1. What is Morality? Morality is a term used in regular conversation, but it’s true meaning is often misunderstood. Because there are several definitions for the term, there has been much confusion when used in discussions. Many academics believe that a certain amount of time needs be spent dealing with that confusion before one begins to use the term “morality” in discussions. For the purpose of this paper, “morality refers to an ideal code of conduct, one which would be espoused in preference to alternatives by all rational people, under specified conditions”1 . Morality generally refers to a code of conduct which is held to be authoritative in matters of right and wrong. A persons morals are defined by culture, society, philosophy and personal conscience, hence a person’s perception of morality varies greatly. In the domain of corruption, it is important to analyse the situation from the perspective of each of the stakeholders keeping in mind both long and short term affects.

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Wikipedia, Morality, 3rd July 2009, http://en.wikipedia.org/wiki/Morality

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2. What is Corruption The term corruption can be used in a wide variety of contexts, each having different meanings. It is derived from the Latin term corruptio, meaning seduction from loyalty, diseased, corrupt condition and is generally associated with moral decadence2. The concise Oxford Dictionary defines corruption as evil, morally depraved or willing to act dishonestly in return for money or personal gain3. In terms of social science, according to the Collins Dictionary of Sociology (1995), corruption is, “the abandonment of expected standards of behaviour by those in authority for the sake of unsanctioned personal advantage”. (Siergiejew, 2003) The World Bank, an anti-corruption agency, define corruption in more simple terms as the abuse of public office for private gain. The World Bank proceeds to categorise corruption into several categories; Bribery, Theft, Patronage and Influence Peddling. Considering the above categories, one would assume that corruption per se is easy to define and categorise. However, in reality, corruption can manifest itself in many different forms within the aforementioned categories. Depending on the observer’s ethical and moral background, an action may or may not be labelled as corrupt. In China for instance, building relationships with business partners is extremely important and it would be customary for Chinese businessmen to exchange personal gifts or services. The Chinese place significant importance in the concept of 關係 (Guanxi) and would not associate such a gesture with corruption. This concept is central in Chinese society and describes the basic dynamic in the complex nature of personalised networks of influence and social relationships. It is possible that an observer from outside of China would mistake this gesture as corruption. In particular, if the gift is being given to a person in authority, the motives might be seen as dubious. A persons perception of corruption depends almost entirely on their cultural, ethical and moral values. In many cultures, Religion provides the underlying framework behind our ethical, moral and cultural beliefs. In fact, religion and morality have been closely intertwined since the beginning of western thought. The Greeks focused on the concept of homer, “a body of texts transmitted first orally and then written down in the seventh century BCE” (Stanford Encyclopaedia of Philosophy). Morality and religion are connected in the Hebrew Bible primarily by the category of God's command. God issues a series of commands. Firstly, “Let there be light”. Then, after the creation of animals, God gives a second kind of command, “Be fruitful and multiply”. In the second chapter there is a third kind of command. God tells Adam that he is free to eat from any tree in the garden, but he must not eat from the tree of the knowledge of good and evil. When Adam and Eve disobey God, they are expelled from the garden. “God is setting up a kind of covenant by which humans will be blessed if they obey the commands God gives them”. (Stanford Encyclopaedia of Philosophy) 2

Babalon, Latin Dictionary, 1 July 2009, http://www.babylon.com/define/112/Latin-Dictionary.html

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Oxford Dictionary, 1 July 2009, http://www.askoxford.com/concise_oed/corrupt?view=uk

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As we can see, corruption is a highly subjective matter that depends on a person’s ethical, moral, cultural and religious beliefs. Both the extent of corruption and people’s perception of it varies greatly across the world. However, despite the many definitions for corruption and it’s subjective nature, researchers agree that corruption has damaging effects on democracy and economic progress.

3. Why is Corruption Important in an International Business Context? Corruption has a considerable effect on our lives because it is all around us. The emphasis on making money is so great , the emphasis on getting rich, no matter how, is so tremendous, that it influences virtually every aspect of our society. - Lawrence Ritter Corruption has received an enormous amount of attention in recent years. In particular, academics and researchers have analysed the topic in detail. Organisations such as the World Bank are very concerned about corruption and the effect it is having on countries throughout the world. Thankfully, the social science of corruption and it’s effects are better known now than 200 years ago. During this period, the world has changed dramatically and as a result, corruption now poses a far more serious threat. The main reasons for the elevated importance of corruption are inequality and international trade. Over the past 200 years, the world has experienced a dramatic change. Appendix 2 shows that in 1807, that the average life expectancy was less than 40 years for the vast majority of the world. As countries began to develop and prosper, their health systems improved accordingly. The present day reality can be seen in Appendix 1; developed and emerging economies have a life expectancy between 65 and 85, whereas the poorest countries in the world (largely African countries) have only improved marginally. In fact, the discrepancy between the rich and the poor has only widened. It is this disparity that provides corruption with a solid foundation on which to thrive. With this in mind, It is important to consider both globalisation and international trade. Both have caused an increase in foreign direct investment (FDI) in developing countries. This is a natural progression as developed markets become saturated, trade barriers decrease and risks associated with international trade decreases. As FDI is a critical driving factor behind the emergence of developing countries, it is seen as a positive force in development. However, the growth of international trade between countries of disproportionate wealth has presented a serious problem in relation to corruption. Due to the disparity between income levels, foreign investors are particularly susceptible to corruption. Developing countries often have administrative procedures for international companies entering the the host market. The developing country establishes these procedures to ensure that the multinational companies meet

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a set of standards so that the host county is not negatively affected. However, this presents authorities in power with a moral hazard as they can demand additional payments to ensure a successful application. Given the discrepancies in income level, a large demand by the host country official is perceived as an relatively small amount by the multinational company. The company is likely to pay the bribe in the knowledge that market power is secured and that the cost of the bribe can be recouped through higher market prices. Ultimately, the public suffer through higher costs and less efficient systems.

Fig 1 Population Growth (2000 - 2050) Europe

-64

Oceania

+18

North America

+130

Latin America & Caribbean

+246

Africa

+1,177

China, Aisa & India

+1,561 -500

0

500

1000

1500

2000

Source: World Business Council for Sustainable Development

In relation to international business, corruption is more relevant now than ever before. According to The World Business Council for Sustainable Development, the population of the world will double between 2000 and 2050. The majority of this growth will occur in developing countries such as Asia, India, China and Africa (Fig. 1). As businesses turn to developing markets to expand internationally, they will be presented with the threat of corruption. The manner in which they deal with corruption is of significant importance as it will have a profound effect on the host country in question.

4. Economic Impact of Corruption 4.1 External Perspective Considering corruption from a international business perspective, it can be viewed as a risk associated with gaining entry into a foreign market. Business investment decisions are based almost entirely on planning and risk. Companies use various models for assessing the risk associated with gaining entry into a foreign country. One of the basic models is Porter’s 5 Forces, as it describes the competitive forces within the host country. Corruption can be considered part of government and legal barriers that are included in “threat of entry” (Grant, 1998). Deep rooted corruption goes further to affect every

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aspect of Porter’s 5 Forces; Threat of New Entrants, Bargaining Power of Suppliers, Bargaining Power of Buyers, Threat of Substitutes and Industry Rivalry (Siergiejew, 2003). As Porter’s 5 Forces is an indicator of market competitiveness, corruption directly affects a country’s ability to attract FDI (Mauro, 1995). Furthermore, for a single company that wants to expand internationally, corruption is a barrier that also affects entry mode in addition to investment decision. Smarzynska and Wei (2002) showed that a companies choice of entry mode is proportional to the level of corruption and the companies technological sophistication (Appendix 3). When a specific threshold of corruption is reached, the company decides not to enter the market. The impact of corruption on FDI was first performed by Paolo Mauro in 1995. His research analysed a sample of 67 countries and found that corruption negatively affects the ratio of investment to GDP in both developed and developing countries. However, he found that corruption was less evident in wealthy countries. As the majority of developing countries are depending on FDI as a primary driver of future growth, significant efforts need to be made to reduce corruption in developing countries. Multinational companies often justify payoffs as a method of avoiding greater harm. Others argue that corruption helps overcome bureaucratic inefficiencies and helps maintain allocation efficiency. Although these companies believe they need to pay the bribe, they know that they would be better off if nobody paid bribes. It is possible to apply game theory to corruption in a similar manner to the “prisoners dilemma”. The multinational company has two options; to partake in corrupt activities or to report the corruption to local authorities (Siergiejew, 2003). Game theory would suggest that the multinational company will partake in corruption if they cannot determine whether or not competitors are also partaking in it. Furthermore, these companies know that they would be better off if no party participated in corruption. Everyone would benefit in the long run by reduced transaction costs and increased transparency. However, such is the secretive nature of corruption that companies tend to be focused on the short term in corrupt markets.

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Fig 2 Investment Orientation: Market Potential vs Corruption

Market Potential/Attractiveness

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Market Potential/Attractiveness A market’s attractiveness and/or potential is indexed between 0 and 10. Low potential relating to 0, whereas high potential relating to 10.

Long Term Vision

8

6

Medium Term Vision

Transparency Index Transparency International release an annual Transparency Index (TI) on the perceived corruption of 180 countries. A highly corrupt country will score low on the TI whereas an uncorrupt country will score high on the TI.

4

2

0

Short Term Vision 10

8

6

4

2

0

Transparency Index (TI) Source: Author Adaptation of Competitive Strength Matrix (Business Strategy Matrix)

Unfortunately, multinational companies often choose to partake in corruption as it is less risky than confrontation. In doing so, the multinational company has done nothing to improve the underlying situation for the better. In fact, partaking in corruption illustrates the company’s short term orientation and vision. In an attempt to illustrate the effect corruption has on a company’s investment orientation, an adaptation of the “Competitive Strength Matrix” can be seen in Fig 2. Markets that are deemed to have high potential/attractiveness and low corruption (high TI), tend to attract investments with a long term orientation. Conversely, markets that are deemed to have a low potential/attractiveness and high corruption (low TI), tend to attract investments with a short term orientation.

4.2 Internal Perspective From an internal perspective, the economic impact of corruption may not seem obvious to the normal person. However, businesses that operate in corrupt environments are exposed to higher degrees of risk which merit higher rates of return. Companies will often increase prices in order to absorb the cost of bribes and to account for the additional risk. Hence consumers within corrupt countries will experience inflated prices. In addition to this, corruption introduces inefficiency into into a society. When companies can compete in a free market economy, the best or most efficient company generally wins. Referring to Porters 5 Forces, markets that have low barriers to entry, high bargaining power of

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consumers, low bargaining power of suppliers and high threat of new entrants are generally better for consumers. As companies legally compete to win market share, prices fall as companies become more efficient. Similarly, when an employee gets a job because of his family connections rather than ability, the company experiences a loss. In a corrupt environment, businesses rely on paying bribes as their main source of competitive advantage and hence the emphasis of becoming more efficient and innovative is diminished. Ultimately, the market suffers through higher prices, lack of investment and inefficiency.

5. When is Corruption Morally Corrupt? “Morality refers to an ideal code of conduct, one which would be espoused in preference to alternatives by all rational people, under specified conditions”4. However, corruption is a highly subjective matter which depends upon a persons, cultural, ethical, moral and religious backgrounds. A person’s perception of corruption also depends upon their education and understanding of corruption. Hence, it is difficult to define an ideal code of conduct that “all rational people” will abide by, even under “specified conditions”. In many cases, the seemingly black and white scenario has large portions of grey. Despite our diversity, we can take inspiration from each other’s religion and culture. The 10 commandments tells us to love our neighbour, whereas the 5 Pillars of Islam talk about taking care of others less fortunate then you. We can also take inspiration from each other’s cultural beliefs. Indians believe in Karma, such that the effects of all deeds are viewed as actively shaping past, present, and future experiences. Filipinos believe in Utang-na-loob, which transliterates as "a debt of one's inner self ”5. It refers to the manner in which the Filipinos accommodate the demands of the world around them. In terms of morality and corruption, we need to consider the well being of everyone involved - particularly those less educated and less empowered. In an attempt to define “What is Morally Corrupt?”, we can use stake-holder theory as a guiding framework. We can define stake-holders as any person or thing that is directly or indirectly affected by an action. Corruption that disregards the fundamental rights and well beings of it’s stake-holders, is an immoral act. Corruption that takes advantage of people’s venerability's, lack of education or empowerment is the worst kind of corruption and is immoral on every level. In certain countries, entire generations have essentially been wiped out due to corruption in the education system. Children are forced to leave school when parents cannot afford to pay illegal rents. It is immoral at a fundamental human level to deny a child the right to an education through the pursuit of personal gains.

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Wikipedia, Morality, 3rd July 2009, http://en.wikipedia.org/wiki/Morality

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Wikipedia, Utang na loob, 6th July, http://en.wikipedia.org/wiki/Utang_na_loob

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Put simply, corruption is immoral when it disregards the needs of others at the expense of personal gains. Corruption can sometimes act as a market mechanism that helps the efficient allocation of resources. Unfortunately, it is difficult if not impossible to limit corruption to these situations. The vast majority of corruption adds inefficiency, reduces FDI, increases inequality and causes a misallocation of resources. Hence corruption negatively effects all stake-holders; particularly the poor and vulnerable. Based on principals, I consider all forms of corruption to be immoral as it negatively affects it’s stake-holders on certain levels, either immediately in the future. Corruption breeds corruption. In the same way cancer metastasis in it’s hosts body, corruption spreads throughout a society. I accept that sometimes we need to take one step back in order to take two steps forward. When doctors try to kill cancer cells by administrating kemotherapy, the patient suffers by loosing their hair temporarily. In the case of corruption, sometimes we need to partake in corrupt acts, in order to make progress. I believe that we can justify corruption on a moral level provided the end justifies the means; such that a net positive benefit exists for the stake-holders and that progress is being made towards eradicating corruption.

6. Conclusion Morality is a term that spans many meanings. It is shaped by our cultural, moral, ethical and religious backgrounds. Despite religious diversity throughout the world, morality at it’s core is shared by all of human kind. Religious scriptures and ancient philosophy echo similar beliefs; that we should “love our neighbor” and “take care of others less fortunate”. Corruption is also a subjective term, of which our perception is dependent on culture, religion and morals. The World Bank defines it as “the abuse of public office for private gain”. Despite it’s subjectiveness and varying definitions, corruption “of all kinds undermines trust: it inhibits social and economic development and undermines fair competition”6 . Given globalization and the increase in international trade between countries of disproportionate wealth, corruption is posing a far more serious threat than previously before. Developing countries are highly dependent on Foreign Direct Investment (FDI) for economic growth. The increased income disparity between investor and host creates a solid platform for corruption to thrive. Over the next 100 years the majority for future economic growth will come from developing countries, attracting ever more FDI. Caution needs to be given to the threat of corruption under these circumstances. In particular, the disparity between developed and developing countries has widened over the past 200 years. As such, a concerted effort needs to be given toward reducing inequality. As FDI is a primary driver in this effort, corruption needs to be reduced as it is a significant deterrent of FDI (Mauro, 1995) and causes investors to adopt a short term investment orientation. 6

Lord Browne of Madingley, Group Chief Executive, BP plc.

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Ultimately, corruption adds inefficiency into a system and increases the risk for investors. Consequently, market prices are higher due to increased risk and increased transaction costs. Deep rooted corruption causes companies to rely on paying bribes as their main source of competitive advantage. This is opposed to innovating, taking risks and becoming more efficient. Being morally corrupt is the lowest form of existence as the they take advantage of the weak and most vulnerable in society through the pursuit of personal gain. By applying stakeholder theory, morally corrupt people have total disregard for the well being of people, and have no concern for the future well being of society. By applying strict principals, all forms of corruption are immoral as it does not benefit society over the long run. By removing corruption, we are creating value. In reality we sometimes need to partake in corruption in order to make progress. However, this should not be used as an excuse to partake in corruption indefinitely. One can morally partake in corruption provided that there is a net positive benefit for the society, and that the corrupt act is made with the intention of reducing overall corruption.

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References Appendix 1 Life Expectancy vs. Income per Person 2007 (Inflation and Purchasing Power Adjusted)

Source: http://www.Gapminder.org

Note 1: The horizontal axis represents Income per Person and it is adjusted for inflation and purchasing power. Hence comparisons can be made across time and region. Note 2: Each continent is represented by a colour (see map top right) and the size of the bubble represents population.

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Appendix 2 Life Expectancy vs. Income per Person 1807 (Inflation and Purchasing Power Adjusted)

Source: http://www.Gapminder.org

Note 1: The horizontal axis represents Income per Person and it is adjusted for inflation and purchasing power. Hence comparisons can be made across time and region. Note 2: Each continent is represented by a colour (see map top right) and the size of the bubble represents population.

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Appendix 3 FDI Decision as a function of local corruption and firm’s technology

Source: Beata K. Smarzynska and Shang-Jin Wei (2000)

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References World Business Council for Sustainable Development. 2009. Mobility for Development Report. The World Business Council for Sustainable Development. Transparency International. 2008. Global Corruption Report 2008. Cambridge University Press Paolo Mauro. 1995. Corruption and Growth. The MIT Press: The Quarterly Journal of Economics, Vol. 110, No. 3 (Aug., 1995), pp. 681-712 K.I.Golovshinskii, S.A. Parkhomenko, V.L. Rimskii, G.A. Satarov. 2004. Business and Corruption: How To Combat Business Participation In Corruption. Moscow: INDEM Foundation. David Nussbaum. 2006. Money versus Morality: Is corruption just a matter of misaligned incentives? London: London School of Economics. Jakob Svensson. 2005. Eight Questions about Corruption. Journal of Economic Perspectives-Volume 19, Number 3, Pages 19 – 42. Izabela Siergiejew. 2003. Effects of Foreign Direct Investment in Poland. Lund University: School of Economics and Management. Onukwufor, Maxwell Ejikeme. 2006. Political Corruption and Poverty in Nigerian Democratic Stare: Any Grounds for Justification? Linköpings Universitet: Centre for Applied Ethics Tina Søreide. 2004. Corruption in international business transactions: The perspective of Norwegian firms. Chr. Michelsen Institute, Bergen, Norway. Daniel Kaufmann, Aart Kraay, and Massimo Mastruzzi. 2006. Measuring Corruption: Myths and Realities. The World Bank. Unknown Author. 1999. Basic Methodological Aspects of Corruption Measurement: Lessons Learned From The Literature and The Pilot Study. The Hungarian Gallup Institute. Dr. Bruce Buchan. 2004. The Moral Physics of the Body Politic: Changing Contours of Corruption in Western Political Thought. Griffith University Beata K. Smarzynska and Shang-Jin Wei. 2000. Corruption and Composition of Foreign Direct Investment: Firm-Level Evidence. World Bank.

Web Pages Berclo. Corruption. 1 July 2009. http://berclo.net/page97/97en-corruption.html Stanford Encloypedia of Phlosophy. Religion and Morality. 2 Juny 2009. http://plato.stanford.edu/ entries/religion-morality/ Ted. Bill Clinton on Rebuilding Rwanda. 2 July 2009. http://www.ted.com/index.php/talks/ bill_clinton_on_rebuilding_rwanda.html