THE EMPIRICS OF CORRUPTION, INSTITUTIONS AND ECONOMIC DEVELOPMENT

Urska Zagar posted two very interesting empirical articles (here and here) about the connections between corruption, economic freedom and economic welfare. The first two indicators are qualitative while the third one is rather easily measurable. In a sample of 50 advanced, developing and least developed countries, she found a positive and robust correlation between corruption perception and GDP per capita, meaning that higher GDP per capita, on average, reduces the scope of corruption. The relationship between corruption and economic development is in fact even more intriguing than empirical figures suggest.

The impact of corruption on economic growth is an important theoretical and empirical theme in the economic literature. In this theoretical and empirical post, I will briefly review the main literature on corruption and development and discuss the empirical studies.

I would firstly refer to the article by Rodrik, Subramanian and Trebbi (2002) where the authors discuss the primacy of institutions for economic development over the exogenous factors such as geography (link). There has been an extensive amount of literature on the role of geography in economic development. The empirical strategy is quite simple. Usually, the basic equation includes the list of explanatory variables such as distance from equator, the percentage of land used for agricultural production and so forth. For example, the basic equation might take the following form:

log(GDP)=b1+b2(Dist)+b3(Land)+b4(Dummy_SubAfrica)+e

where GDP stands for GDP per capita, Dist for distance from equator, Land for the percentage of fertilized land and Dummy_SubAfrica is a dummy variable, taking the value of 1 if a country is located in the Subsaharan Africa and 0 if otherwise. In addition, e represents stohastic error unexplained by the selected predictors.

However, the basic problem with geographic approach to explaining economic development is that the approach does not, by itself, distinguish between the endogenous features of economic development. In regressing GDP per capita on the distance from equator, the empirical estimates usually result in a modestly negative correlation between the two variables. However, the distance from the equator cannot itself explain the nature of economic development and its significance over time mainly because of its low predictive power in explaining the evolution of institutions and governance.

An interesting approach has been incorporated by Acemoglu, Johnson and Robinson (2001). They incorporate a historical and institutional perspective in the empirical framework of the explanation of economic development. The authors used mortality rates of colonial settlers to explain the institutional quality. They further argue that where settlers encountered few health hazards compared to European settlement, they established solid institutions, strong enforcement of property rights and a robust system of law. In other areas where health hazards frequently occured, colonizers focused on the extraction of natural resources and showed little or no interest in building high-quality institutions. Rodrik, Subramanian and Trebbi (2002) further estimated the impact of geographic variables, institutions and openness on macroeconomic variables.

The main findings in their study were the following. First, each degree distance towards equator, on average, reduces the income per capita by 0.94 percent. The geographical location by the equator is also negatively related to capital per worker (-1.68), human capital per worker (-0.25) and total factor productivity (-0.32). Second, the quality of institutions is a very good measure of the economic welfare. In their panel, the authors found that each additional improvement in the rule of law, on average, leads to 2.22 percent increase in income per capita. The result is statistically significant at 1 percent. The improvement of institutional quality is both positively related and statistically significant when capital per worker, human capital per worker and total factor productivity are regressed on the institutional quality.

Back in 1997, Peterson Institute published an extensive study, searching the causes of corruption (link). The author estimated that the highest cost of corruption in regressing a series of macroeconomic variables on corruption index is lower education expenditure and a decrease in private investment. The estimate of the total macroeconomic cost of corruption is a difficult and daunting empirical task.

The main causes of corruption are mostly endogenous and related to the institutional evolution ranging from legal origins, colonial historical variables to the public sector efficiency variables. In search of the grain of truth, it should be noted that capturing the stylized effect of corruption of economic growth and development requires an interactive empirical approach. In other words, it would be impossible to establish "cause-and-effect" connection between corruption and development indicators without extracting a large amount of historical data and regressing it on the key endogenous variables.

Clearly, the role of geographical characteristics should not be neglected. However, the primacy of institutions in explaining the contemporary patterns of economic development is rather undisputable. Daron Acemoglu recently wrote an in-depth article on the distribution and explanatory factors regarding world poverty (link) where it clearly stressed the lack of institutions of human capital in the evolution of world poverty. When discovering the true causes of corruption, there should nonetheless be a clear and distinct rationale underlined by the evolution of institutional quality over time as the most significant measure in explaining the evolution, causes and effects of corruption on economic development.

WHEN GOVERNMENT ANNOUNCES A STRIKE

In Slovenia, judicial branch of government recently announced a strike, claiming that judges are underpaid and demanding an initial wage increase. The first question to be asked is against whom the judicial branch of government is really demanding a strike? The announcement of the strike is a mark revealing the prevailing corruption in the judicial system, taking place throughtout the process of political transition from socialist system to the system based on market democracy. In Slovenia, generally speaking, private property rights are weakly protected, reflecting slow procedural operations, internal inefficiencies and signs of corruption in Slovenia's judicial system.

Tomaž recently published a beautiful post discussing judicial claims over wage increases:

"The announcement of the strike on behalf of Slovenian Judicial Association is an unusual step, knowing that not all Slovenian judges are not the members of the Slovenian Judicial Association. Even local fireworkers cannot announce a general strike of all fireworkers in Slovenia. That's why, Slovenian Judicial Association does not and cannot have a legitimate right to announce a strike on behalf of all Slovenian judges.

The use of means regarding general strike opens the essential question: against whom shall Slovenian judges announce a strike? From a historical perspective, "strike" has emerged from the individual rather than collective initiative of employees against the employer. By definition, trade unions are workers' associations. Later in the course of time, trade unions launched widespread initiatives as a form of political pressure against government authority as Solidarity did it in Poland in late 1980s."

Source: Tomaž Štih, When Government Announces a Strike (and almost realizes it), Libertarec, January 22, 2008 (link)

DEMOCRACY IN SLOVENIA - A GRAVEYARD SLUT

by Rado PEZDIR

In the fall filled with two national referendas regarding whether Triglav, Slovenia's largest government-owned insurance company should be privatized, and the epilogue of collective bargaining between trade unions and the federation of employers which reminds us on the last sequel of South-American soap-opera, someone could think that Slovenia is a climax of world democracy. It could be thought that this idyllic sub-Alpine landscape is a paradise dreamed by the premise of enlightenment thinkers; a paradise where the wisdom of the citizens tactically paves the road on which society's development takes its own walk. Unfortunately, the reality is completely different and it can be admitted that all sparks of hope for democratization of post-communist society are nothing else but a nostalgic stupidity. In Slovenia, for a long time, the individual does not vote for anything in the elections.

ELECTORAL JUNK

Let's have a look on presidential elections. I think that everyone who wants to explain why we need this junk will face big troubles. Why?

First, in Slovenia, the president has no authorized means of decision-making which would justify the existence of this particular instance. Of course, I assume that institutions are created to have legitimate authorization and not vice-versa.

Second, Slovenia's chaotic institution requires the intersection of legitimacies of democratic institutions, and consequently, there is an inherent probability of institutional conflicts. Mostly because Slovenian policymakers do not actually know which particular legitimacies are ought to be authorized to justify the existence of the institute of the president.

What this means in practical terms, is clearly demonstrated by the latest selection of future governor of the Bank of Slovenia; a situation in which prime minister and the president had an electoral mandate to appoint the governor. At the end, the technical dilemma turned out into an insensible political battle.

Third, some claim that the presidential function is necessary due to its role in representing Slovenia abroad in a remarkable flash. The truth is that the presidential function distorts the other branch of government, the Ministry of Finance, and thus it creates a splash of institutional conflicts. Just think of president Drnovsek's inspirations to solve the Darfur crisis. Was it necessary? At last, if Slovenians want a representative abroad, then gather some money, hire the little boy who knows how to recite the sonnets of William Shakespeare in thirty languages, lock him into the cage, and show him into the international arena. There is no need to waste taxpayers' money.

And at last, a large majority of Slovenians is evinced that the presidential function is necessary because of the need to have a discretionary moral authority such as Plato, Indian gurus, Vatican's cardinal or anti-globalist Joschka Fischer, to morally regulate our lives. Are they serious? Do they suggest voting the highest moral highlight? Excuse me, but this particular construct is a replica of a theocratic state where Ayatollahs are elected and then they submit their opinion on immoral youth and inadequacy of loud music. To exculpate the existence of particular institution with the assistance of an absolute morality is, in a normal democratic state, nothing else but an unrestrained absurdity. In effect, the presidential function is unnecessary and that's why, let's avoid further institutional crash of the splash. My colleague Mićo Mrkaić has thoroughly abstracted the irrelevance of presidential elections in Slovenia: ignorant people need an idol to command from emperor's rooms, the way it was conducted by Kaiser Franz, Maria Theresa, and Josip Broz.

NON-ELECTIONS

The second redundancy is the elections in the State Council this fall. State Council is the remaining creature of fascistic corporate system. Let's summarize how these elections go through. At the end of the mandate, interest groups get together and select a dedicated person who is then authorized to delegate our lives from Ljubljana. Then, the illuminant is sitting in the chamber of State Council by making decisions regarding our everyday lives; without being authorized to do so. How democratically. Suppose that a group of voters proposes a law bill to the parliament and democratically elected parliament passes the bill by a slight margin of votes. In a normal country, this would mean the end of the process, but in Slovenia, the story is going forward. If any of numerous interest groups with representatives in the State Council is not likely to embrace the law bill, it can use the veto and stop the entire process. And then, we're the one who should deal with elections and democratic institutions. The madness such as the undemocratically established body has shown its worth in the initiative of the State Council, suggesting the referendum whether Triglav, the largest asset-holding insurance company in Slovenia, should be privatized or not. Funny; the answer tp the technical question ought to be solved by democratically elected government is proposed by the unelected instance. We already decided to transmit the mandate to solve such a situation to the government, haven't we? I personally think that the State Council exists because a fraction of voters cannot embrace the fact that they're responsible for their lives on their own, while a share of voters would like to regulate the lives of other citizens through the power exercised by the interest groups represented in the fascist-styled State Council.

INTEREST GROUPS CONTROL THE ENTIRE COUNTRY

The fact that interest groups have their own debate luncheons at the expense of taxpayers' money and do whatever they want at any time, is simply a blockade of decisions approved by democratically elected institutions. And even more: it is a blockade that disables the functioning of a democratic system. An ability that interest groups without the approval of taxpayers, are dealing about the way of living that citizens will simply have to embrace and live with it, is coming from the constitutionally approved status of the State Council and collective bargaining. A procedure, in which workers' monthly salary is not determined by his output and productivity, but by the bargaining decisions approved by trade unions; the latter call social justice. As a side-effect, entrepreneurs must give up a fraction of profit due to decisions passed by non-elected institutions, namely trade unions. You're not wrong if you think that such process is a restitution of the situation once common in the Soviet Union. In Soviet Union, wages and salaries had no feedback measures to the output and labor productivity, but instead, salaries were determined collectively subject to central planning. As a matter of fact, what you produce in Slovenia has no effect on your monthly earning but the productivity of labor supply is restricted by the means of collective decisions of trade unions. In addition, there is always no study on how artificially determined salaries affect the economic performance of Slovenian economy. Instead, trade union leaders propagate the ideas that entrepreneurs should give up their own profit. By its means of collective power, trade unions aggressively aim to regulate and flip into the private property of entrepreneurs. It is interesting why trade unions do not invest in particular companies and then give up their profit for the benefit of the labor force. Whether you are asking, when you authorized trade unions to allocate your resources and boost income redistribution, your questioning has no effect since State Council and trade unions collectively make decisions about your lives without a check-up of their proposals in the general elections.

A DEMOCRACY OF WAR MASSACRES

In addition, there are two non-elected representatives in Slovenian parliament approved on the basis of their nationality. What a democracy - a democracy on the basis of Slovenian shame, such as the genocide of Italian, German and Jewish community. Thus, Slovenians have collectively admitted not to aggravate if they have bloody conscience about their own past. Instead, for them it is admirable to have a handicapped democracy which places two non-elected representatives of minorities in the national parliament. If you perceive that as a hang of overdoing, think about suspicious role of those two representatives several times respectively. And if everyone is treated equally, where are the Roma, Serbian and German representatives? Shall we rather dissolve the entire parliament and put in suitable representatives? In case if anyone doesn't know - parliament is a democratic institution whose members are elected on the basis of individual preferences and not on the basis of individual ethical origin. To protect the human rights, there is a judicial system that defends individuals against violations of human rights of all the citizens, including ethnic minorities. It is simply not a seat in the parliament which protects the rights of the minorities.

So if you attend the elections, the impact of your vote will be the same as in the period of socialism - none. That is because of institutional chaos based on Slovenia's constitution. From this point of view, presidential elections are nothing else but a typical junk and wasting of taxpayer's money. In sum, democracy in Slovenia is like a a graveyard slut (also a song sung by Norwegian black-metal band Darkthrone) - it can be bought cheaply by anyone whereas no one cares whether it works or not.

Rado PEZDIR is an economist.

© Copyright 2007 by Rado Pezdir

*An article was translated in English by Rok SPRUK, an economist and the owner of the web log Capitalism & Freedom

POLAND: REFORM OR DIE

In Poland, the liberal Civic Platform won the very recent elections by a narrow margin ahead of socially conservative Law and Justice (here, here, here, here and here).

The current economic and structural picture in Poland is mixed. Despite the great impact of the stabilization and market liberalization on economic performance in the past 17 years, Poland, as well as other Central European countries, maintained a high level of public spending in the share of the GDP. Poland scores low on Corruption Perception Index with a rampant track on the overall corruption. The index is measured on the scale between 0 (highest) and 10 (lowest). Poland slumped from 4,6 in 1998 to 3,4 in 2005.

The reason for such persistent corruption is the fact that Poland's government spending has not fallen below 40 precent of the GDP yet. In turn, higher level of spending and more extensive government and public administration negatively affect the overall capacity of the economy to operate and sustain robust growth subject to convergence process.

As a positive thing, under previous government, the burden of government size and spending was reduced, which was an additional influence on Poland's 6-7 percent economic growth rate, which is still low on Eastern European average. One of numerous disadvantages of the government chaired by Law and Justice was a an assertive foreign policy and a brisk growth of populism, curtailing individual liberties through the coercive dogmas of Catholic values, in addition to the enforcement of protectionism and criticism of free-market views based on the doctrine primarily adopted by socialist movements.

Civic platform's leader Donald Tusk pledged to accelerate the privatization of state-owned assets more rapidly and energetically as previous government did. He also pledged to adopt replace the current progressive income tax with 19 percent flat income tax. Polish economy is doing well at the moment driven by strong foreign direct investment and solid export performance. Mr. Tusk's also promised to reform Poland's wasteful public finance, inefficient and oversized bureaucracy and a lagging infrastructure.

A victory of Poland's now-leading party inspired by liberal political views might play a crucial role in building and implementing a reform agenda as a sign of relief with positive impacts on overall growth foundations such as reduced tax burden and an active fight against corruption through reducing the size of government and improve the inadequte public administration.

THIS IS HOW BELARUS WOULD BE BETTER OFF

Nearly a week ago, I came across an interesting website entitled Economy.by, presenting the project "The Community of Young Economists and Entrepreneurs" which was organized as a reaction to the lowest level of education in Belarus. The project aims to give opportunities to young students in Belarus to support their scientific work. This particular initiative is very ambitious indeed. In fact, Belarus is croaching in Soviet-styled political dictatorship together with poor track on the respect of human rights, civil and personal liberties. Doing business is difficult and the economic environment is embroiled by government involvement, protectionism and widespread corruption. Also, the education system is instilled by staunch ideological propaganda (here and here).

Regarding the practicing of human rights in Belarus, State Department reports:

"Prison conditions remained austere and were marked by occasional shortages of food and medicine and the spread of diseases such as tuberculosis and HIV/AIDS. Leila Zerrougui, chairperson of a UN working group on arbitrary detention who visited the country in 2004, reported that conditions in detention centers were worse than those in prisons because of poor sanitary and living conditions and restrictions on visitation, phone, and mail privileges. According to human rights monitors, conditions in prison hospitals also were poor...The government restricted access to the Internet. Credible reports indicated that the government monitored e-mail and Internet chatrooms. Many individuals and groups could not engage in peaceful expression of views via the Internet, including by electronic mail. During the March 19 presidential election, there were numerous credible reports that the government blocked several opposition campaign and independent media Web sites. Many opposition groups and independent newspapers have switched to Internet domains operated outside the country because of the government's campaign against Internet freedom. There also were credible reports that authorities attempted to block Radio Liberty's Web site in the country during the March presidential elections. On November 7, the NGO Reporters Without Borders again included the country on its annual list of "enemies of the internet," countries that censor independent news sites and opposition publications and monitor the Internet to stifle dissident voices."

Disclaimer: Capitalism & Freedom strongly supports "The Community of Young Economists and Entrepreneurs" in their efforts to pursue the ideas of individual and economic liberty, human rights, international awareness and knowledge development in Belarus.

BELARUSSIAN STATE ECONOMICS

At Economy.by, a Belarussian student explains how Belarussian State University's professor lectures economics to third-year students. During the lectures on Economics of enterprise professor Bainev tells the third-year students of economics faculty that Russians are the superior race, saying that:

"...Russians are the superior race, and the rest of the world in whole, and americans and europeans particularly, are the absolute morons and animals. He insists in a tough way on the fact that the market economy - is an absolute evil with which we should promtly fight. He says that we shouldn’t think about ourselves and our relatives, and should act only in the interests of nation and her the very best child - President of Belarus. He adds that the USSR was the best time, when people were absolutely happy. He alleged that we should do everything to reunite three main countires in the world - Ukraine, Belarus and Russia with a strong leader who will control people’s life."

Source: Lectures in BSU, Economy.by (link)

MEXICO'S ANTI-GROWTH TAX POLICY

The USAToday has published an article describing the populist assertions of Mexican president Felipe Calderon who recently annoucned the launch of aggresive tax hike to raise tax revenue.

Enhanced through the rethorics of populism, Mexian president wants to increase Mexico's tax revenue by one third, roughly $35 billion a year. Among fresh tax policy proposals an extensive corporate income tax based on firm's income from corporate activity can be traced as well as giving tax breaks to state enterprises (Pemex), 5,5 percent gasoline tax and government requirement levied on banks, claiming to deduct 2 percent tax on desposits exceeding the amount of $1,800 USD monthly.

One could claim that despite a relatively low fiscal burden in the share of the GDP and particularly low government spending, Mexico's overall tax revenue equals 10 percent of the GDP, and thus concluding that reducing the aggregate tax burden does not make any sense. However, this particular assertion hardly entails any sufficient arguments and data analysis.

First, corruption in Mexico is perceived as significant. The cost attached to corruptive officials, institutions and politicians negatively affects economic performance and openly enables seeking ways and channels to adopt tax evasion. The negative-side effect of corrupted tax system is that a mantling establishment of the bureaucracy inclines towards seeking additional revenue via loopholes, deductions, exemptions and tax breaks.

Second, despite a moderate degree of economic liberty, Mexico weakly performs in the areas which are essential to sound framework of economic peformance such as the extensive corruption net and discriminatory investment framework. According to World Bank, paying taxes takes 552 hours in Mexico compared to the OECD average of 202,9 hours. This particular indicators purely reflects the complexity and failure of Mexican tax system. Under such conditions, numerous investors prefer to avoid taxes since getting rid of government regulation and directives is less costly than complying with inefficient and onerous tax system.

Here is a brief data on Mexican macroeconomic performance.

The assumption that additional tax revenue measures would induce government's ability to pursue fair redistribution to reduce poverty is false regarding the empirical aspects of income redistribution and research observations on the growth-correlated tax system. Fighting poverty through the prism of government intervention usually returns the opposite results. Instead, there has been much empirical outcome saying that trade liberalization and openness induce poverty reduction. In addition, deregulated labor market and growth-friendly entrepreneurial framework also boost productive behavior which is the ultimate way to avoid and reduce poverty instead of relying on rent-seeking government and tax bureaucracy.

POLITICAL ENTREPRENEURSHIP AND CORRUPTION

Writing for Wall Street Journal, Burt Folsom compares the entrepreneurship in two countries; the U.S. and Mexico.

The discussion in the article is focused on Carlos Slim who supossedly surpassed Bill Gates as the world's richest person. As the article demonstrates, the spread of political entrepreneurship coexists with weak contract security and insecure protection of private property rights. In comparison to market entrepreneurship, political entrepreneurship is costly to growth and does not embrace risk-taking, quality maximization and price minimization as strategic terms. Here is an interesting story:

"Enter Carlos Slim. His father, Julian Slim Haddad, a Lebanese immigrant, made his money as a merchant during the chaos leading up to the Constitution of 1917. Carlos Slim greatly expanded the family fortune by working closely and cleverly with government officials. (In fairness to Mr. Slim, there may not be another avenue to great wealth in a massively interventionist economy.) His major opportunity came when President Carlos Salinas de Gortari decided to privatize some inefficient industries. Mr. Slim bought Telmex, the nation’s phone company, in 1990 in a controversial auction which was decidedly less than transparent. With that purchase came a six-year monopoly guaranteed by the government. Although Mr. Slim was supposed to relinquish the monopoly in 1997, he used a variety of legal and political tools to maintain it, for example filing injunctions in court to block orders from the regulator to provide competitors fair access to his network. According to OECD figures, Mexican consumers and businesses still pay above market telephone rates. Fewer than one-fourth of Mexican homes have telephones. With a near monopoly of fixed-line telephones and data access (the Internet), Mr. Slim has reaped windfall profits which, wisely invested, have propelled him to immense wealth. Meanwhile, Mr. Slim’s newer ventures—his construction company and his oil services company—rely on government contracts for their major business. Recently President Felipe Calderon met with Mr. Slim and urged him to accept greater competition."

Source: Burt Folsom, Slim Pickings, Wall Street Journal, August 29, 2007 (link)