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V.C. Program Redesign to Limit Corrupt Opportunities

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V.C. Program Redesign to Limit Corrupt Opportunities
One response to corruption is to redesign public programs to reduce the level of rents available to officials and private clients. Rose-Ackerman (1999) provides numerous examples of how this might be done in ways that reduce the discretion and limit the monopoly power of officials. The state can make rules clearer and more transparent; it can increase staffing to reduce delays or increase supply to reduce scarcity. Many such opportunities are likely to exist in any polity that will be relatively inexpensive to implement. The costs are the loss in discretion that might have been used for beneficial purposes to sort out the most deserving beneficiaries or to punish only the most harmful behavior. However, if a system is riddled with corruption then discretion is being misused. Hence the losses are likely to be small when an anti-corruption policy is compared with the status quo, not some ideal state of affairs. Many such reforms are thus socially costless, the only losers are those engaged in the corrupt system, who obviously will resist reform. The explanation for the persistence of many corrupt practices is not the high social cost of reform but rather the political power of those engaged in corrupt networks.
Although we lack systematic evidence of the costs and benefits of most programmatic reforms, there is one area where the benefits are particularly easy to measure and that is tax and customs collection. The evidence suggests that reforms can be very efficacious although maintaining reform momentum over time can be difficult. The best evidence comes from Latin America since 1990 where there are numerous examples of tax and customs reform (Stein et al. 2005, 186). Most of these reforms consist of a mixture of simplified tax schedules that are affordable to taxpayers and importers, automation of operations, better auditing, and improvements in the training, oversight and incentives of officials. For example, in Bolivia, where these reforms were combined with overall civil service reforms, corruption and smuggling declined in the customs service, and the proportion of the VAT lost went from 42% in 2001 to 29% in 2004 after reforms.21 Gómez Sabaini (2006) reports that tax collections as a share of GDP in Bolivia rose from 8.2% in 1990 to 20.5% in 2000 to 23.0% in 2004. In Peru total tax revenues increased from 8.4% of GDP in 1991 to 12.3% in 1998 at the same time as many tax rates were reduced. Taxpayers increased from 895,000 in 1993 to 1,766,000 in 1999. Tariff revenues went from 23% of revenues in 1990 to 35% in 1996 and increased four-fold in dollar terms despite reductions in duties (OECD 2003:9). 22 Peru reduced total staff from 4700 in 1990 to 2540 in 2002 and increased the share of professionals from 2.5 percent to 60 percent (Goorman 2004). The average clearance times fell from 2 days to 2 hours. In Costa Rica times fell from 6 days to 12 minutes (OECD 2003, 22).
A comparison of reforms in Chile and Argentina designed to increase compliance with the VAT shows how similar policies can have different results (Bergman 2003). The average VAT compliance coefficient is 77.6% in Chile and 54.3% in Argentina. After examining and rejecting other explanations, the author concludes that the difference can be explained by the greater credibility of Chile’s reform because the tax agency was stable and had broad autonomy. Hence it was better able to induce voluntary compliance because of its more credible deterrence capacity. However, Chile, with considerable revenue from the copper industry, may simply find tax administration easier because it does not have to tax its citizens as highly. Taxes as a share of GDP were 26.3% in 2004 in Argentina and only 17.3% in Chile (Gómez-Sabaini 2006).
These results are consistent with one specific reform that has received detailed study: the creation of a semi-autonomous revenue authority. Taliercio Jr.’s (2004) study of such authorities in three African and three Latin American countries is broadly favorable. The reforms appear to be very cost-effective. Though some countries had better experiences than others, revenue collection improved. Talierco points to a range of factors that contributed to increased revenue collection for a modest administrative cost. It is not possible to measure the marginal costs of the reform, but they appear low or even negative. Overall, the cost of revenue collection as a share of revenues collected ranges from 1.7% to 2% for the Latin American cases. The best performer was Peru whose agency was the most independent from the executive and whose leaders were most able to motivate employees by creating a professional organizational culture. Talierco does, however, recognize the need for accountability and recommends the Mexican model under which the authority reports to the legislature. Unfortunately, when Talierco checked to see if the reforms had been sustained over time, he found a disappointing pattern of backsliding in all the cases he studied (Talierco 2001).23 He argues that the political coalition in favor of independent revenue authorities is likely to be fragile, and demonstrates that this is so. Officials in the Ministry of Finance oppose revenue authorities especially if the authorities seem competent and professional and, as a consequence, seek to be involved in tax policy, not just tax collection. Furthermore, taxpayers may also object. However, at the time of his study, the one bright spot was Peru where the organized business community supported the independent revenue authority because it was able to collect taxes more evenhandedly from all business and because it promised certainty and limited official extortion.

VI. Solution 4: Controlling “Grand Corruption”
So far, our solutions have concentrated on reforms in monitoring, in transparency and accountability, and in the operation of the bureaucracy. We turn now to the special problems that arise when the state carries out large-scale projects, signs contracts, and sells assets. These are usually special purpose, one-of-a-kind deals so that it is difficult to locate benchmarks to measure excessive costs or to set externally verifiable quality standards. They produce high levels of economic rents (financial gains) that are difficult to monitor. Hence, “grand corruption” may be a serious problem. Although the solutions outlined above have value even here, they are unlikely to be sufficient. They must be supplemented by ex ante polices that limit rents up-front. Because of the special purpose nature of these deals, good statistical evidence is difficult to come by. The broad cross-country indices discussed above go some way to capturing this aspect of corruption because they are largely based on the perceptions of international actors. However, those data do not translate easily into policy recommendations. They highlight interstate differences in perceptions of corruption without providing information on the mechanisms at work.
If the state carries out infrastructure construction projects, privatizes public firms, makes large defense purchases, or allocates concessions to natural resources, these activities are very valuable to the successful private firms and, as one-of-a-kind projects, are difficult to price competitively. Thus, those involved in the government and in the private sector may inflate overall contract values and then struggle over the division of the excess profits. Some of these profits will be provided as bribes or kickbacks; the rest will revert to the contractor with some of the total siphoned off by agents and firm managers. This competition for gains means that the size of the bribe per se is not a good measure of the social harm. A very influential private actor may pay only a small bribe in return for a massive gain because of its overwhelming bargaining power.
If corruption is endemic in large public undertakings, it will give officials incentives to create extra unneeded projects to hide monopoly gains to be split between government officials and their private sector counterparts. These projects may be self-consciously designed as special purpose deals to make monitoring difficult by both insiders and outsiders, such as aid and lending organizations. In such cases the loss to society is not just the bribes paid; it is the total of wasted resources spent on the project.
Corrupt payments and excess profits can be more easily hidden in complex, special purpose deals. This implies that one anti-corruption strategy is to change the types of things the government buys to favor standardized, off-the-shelf products as much as is feasible. The government would go “shopping.” It would, for example, buy standardized fighter jets already in wide use around the world for the air force, purchase ordinary automobiles for the police with special features prices separately and transparently. Government land purchases or sales would be made public and benchmarked in comparison with private sales (Rose-Ackerman 1999).
If the state cannot go shopping but instead needs to sign a special purpose contract, for example, for a major infrastructure project, the nature of the bidding process is a central concern. The World Bank’s most recent standards for International Competitive Bidding, for example, include provisions designed to limit corruption,24 and World Bank has begun a more stringent crackdown on corrupt contractors than at any time in its history (World Bank, 2011). However, it is by no means obvious that the Bank has hit upon the optimal formulation. There needs to be more careful study of the relationship between bidding and auction processes, on the one hand, and results, on the other. Such studies would not need to document corruption itself but would instead ask how different procedures perform in terms of the ultimate outcome of concern, be it efficiently provided infrastructure or a privatization process that enhances competition and increases efficiency while bringing revenue to the state.
VI.A Procurement
Corruption can occur at many different stages in the procurement process. Before the formal process begins, the government must decide what projects it wants to support and must produce preliminary designs and cost estimates to help it set priorities. Even in the absence of kickbacks and bribes, procurement officials have an incentive to underestimate both costs and technical difficulties and to overestimate benefits (Flyvbjerg, Bruzelius, & Rothengatter 2003; Flyvbjerg & Molloy 2011). If they compete with others for scarce public funds, they will seek to make “their” projects look better than the competition. Infrastructure projects are usually de facto irreversible once begun because governments are likely to be punished politically for leaving big holes in the ground and unfinished buildings to blight the landscape. Because everyone expects everyone else to issue overly optimistic projection, even those who would never think of paying or accepting an outright bribe play along or exit the sector. Because there are no good objective measures of costs and benefits, this opens the door to corrupt operatives who exploit the unreliability of the data to enrich themselves and to further the interest of their firms. If officials, both bureaucrats and politicians, are not held responsible ex post for their optimistic projections ex ante, they are likely to continue to act in this fashion. Waste and corruption are facilitated by the lack of clear lines of responsibility.
Over and above inflated net benefit projections, the bidding process itself can be undermined by firms that act as a cartel to share government business. Here too corruption can thrive, but in this case as a counterpart of the collusive behavior of the cartel. Thus Lambert-Mogiliansky (2011) shows how instead of competing with each other in the level of bribe payments, firms may organize a cartel and pay off the procurement official to keep the collusive arrangement operating, giving him a share of the excess profits from the project. If a reform targets kickbacks, the official has less power to extort payoffs, but the firms may still collude to share the market. If corruption is attacked with no concern for collusion, there may be few social benefits from a crackdown. An anti-corruption drive might simply make the cartel cheaper and more lucrative to organize, so that the firms still present a united front that forces the state to continue overpaying for public projects. Therefore, the state must target the risks of corruption and collusion simultaneously—both in the reform of overall procurement procedures and in the implementation of specific procurement projects. This argument exemplifies a general point about anti-corruption policy. It needs to be developed to fit the context in which it occurs with account taken of the ways officials and bribers may seek to compensate for any constraints of corrupt deals.
Modern technology can assist in reducing corruption in procurement although these systems cannot address deeper questions about the type of projects that the state sponsors. A number of countries have experimented with procurement reforms designed to limit corruption, and several have proved quite successful and may provide models for other reformers. However, even the most successful are not a sufficient response. The state also needs to confront the issues outlined above relating to the choice of public projects and the competitiveness of the private contracting market. The most well-documented examples of e-procurement come from South Korea, Mexico, and Chile.25 In South Korea an e-procurement system permits public bodies to shop for standardized goods and services and to manage bidding processes efficiently. The government saved over $2.5 billion in 2002 simply by streamlining bureaucratic procedures. This is lower bound, however, because the government has not measured savings in the lower cost of purchased goods and services. It would be valuable to study the impact of the system on prices paid and the number of bidders participating. Has private cartel behavior fallen? In Mexico the government created an e-procurement system, called CompraNet, to deal with corruption and waste. As in Korea, administrative costs fell, by 20% as a result of reductions in both paperwork and face-to-face interactions. The system is much more transparent and, therefore, is more easily subject to citizen oversight. The government estimated that every dollar invested in an internet procurement system earned a social return of 4 dollars.26 Chile also streamlined its procurement system and put more material on-line. The result was a shorter bid cycle and more competitive processes. The government estimates an annual savings of $70 million both from internal efficiencies and cost savings on contracts. With total procurement totaling about $7 billion per year, however, this is only 1% of the budget.
Beyond efforts to streamline the procurement process and make it more competitive, improvements in ex post oversight are a second option. Two groups with an incentive to monitor corruption are competitors and newly installed political regimes. These groups may seek redress inside the state, but if the domestic legal system has been co-opted by the corrupt elite or is simply weak, international options may have some efficacy as well. The international aid and lending organizations have improved their anti-corruption oversight, and some argue that anti-corruption measures ought to be built into the international arbitration system. We discuss each below although neither seems a panacea. Domestic reform will remain a priority for the foreseeable future.
VI.B. Privatization
Privatization raises some similar concerns. A recent study documents the overall favorable impact of privatization in economic terms at least in Latin America (Chong and López-de-Silanes 2003), but for public utilities, in particular, the experience has been mixed. For example, in telecommunications privatization has eliminated unmet demand by raising prices so that many households still lack service.27 Barrera-Osorio and Olivera (2007) find that privatization of water supply in Columbia was beneficial overall; however, the price rises had a strongly negative effect on poor rural households’ access to water. Some transfers to private ownership are marred by corruption and patronage and impose costs on ordinary citizens. The familiar tradeoff between maximizing the revenue earned by the government from the sale versus creating a competitive market without monopoly profits is evident in many programs and has often been resolved by giving private firms monopoly power (Hoffmann 2007, Manzetti 1999). The most successful cases involved transparent and homogeneous procedures, speed, and limited restructuring prior to privatization (Chong and Lopez-de-Silenes 2003).
Privatization programs and concession agreements are prime locations for corrupt deals (Manzetti, 1999). This means that privatization is not always a move in the direction of efficiency and good service. Some firm might be better off remaining in public hands; some natural resources might be better exploited by public companies. Case studies from World Bank projects in the water, electricity and rails sectors illustrate that, compared to private sector alternatives, the performance of public firms varies widely—from well-run bodies that perform well; to wasteful, inefficient providers (Vagliasindi, 2011). This variation suggests that privatization is not always indicated, but it also suggests that corruption is a likely problem in the poorly managed state firms. According to Vagliasindi, governance reform should involve a combination of internal incentives, coming from incorporation and strong oversight by the firm’s board, and of external checks, such as public stock listing. Such governance mechanisms improve public firms’ performance, in part, by controlling self-dealing by public firm managers and political favoritism. She proposes to align incentives, by publicly monitoring the performance of state enterprises through regulatory contracts that are subject to third party monitoring and scrutiny by the general public.
The privatization process may involve interplay between corruption and competition that can introduce distortions (Auriol & Straub, 2011). First, a corrupt process reduces the price received by the government and leads the privatized firm to set prices and sell quantities that are not socially optimal, perhaps because it has obtained a monopoly franchise. Notice, however, that this monopoly result could arise not only from corruption but also from a revenue maximizing government that does not factor in the social benefits of competition or of effective natural monopoly regulation (Bjorvatn & Søreide, 2005). Second, government officials may privatize the wrong firms, that is, firms that are operating at a high level as state firms and so appear valuable to private bidders. Very inefficient state-owned enterprises do not produce many corrupt rents to share and may stay in public hands, perhaps as a repository for patronage appointments of incompetent but politically connected people.28 Once again, pure revenue maximizers might make the same socially harmful choices as corrupt officials, but the prospect of personal enrichment can be an additional spur to distort the privatization process. Notice that if this dynamic operates, the management problems isolated by Vagliasindi are especially likely to arise. Weak firms stay in state hands because some individuals or groups benefit from their very inefficiency. If an internal reform agenda is pushed too hard, those who benefited from the status quo may switch sides and support privatization because that may allow them to preserve some of their illicit rents.
This discussion suggests that a range of options exist to control corruption but that all of them need to be put in a larger context of state functioning. We have already shown how reducing corruption along one dimension, say by raising salaries, can increase corruption elsewhere, say by leading to the sale of civil service jobs. Here we have seen how reductions in corruption need to be combined with efforts to increase the competitiveness of contracting and privatization processes. Otherwise, the result may just be to increase the monopoly rents available to private firms who obtain contracts and government assets. Furthermore, decisions on what to buy and what assets to sell need to be made with an eye to their overall social benefits, not just their impact on the public budget.
VII. Solution 5: Shifting Service Provision to Private Sector
If government bodies are riddled with corruption and inefficiency, a final drastic remedy is to remove certain tasks from the public sector completely, moving their provision to the private sector.29 Firms have taken over basic service provision in parts of India (Bussell, 2012), tax collection in Uganda (Iversen et al., 2006), transportation in Mexico City (Wirth, 1997), and parts of customs inspection in over fifty developing countries (Yang, 2008). Provided there is some market competition, private actors may have a strong incentive to curb malfeasance and promote cost savings. The risk is that private actors lack a “public service ethos,” and may ultimately become more corrupt and parasitic than the government bureaucrats they replace. The existing record suggests that privatization is a high risk, high reward strategy— some reforms seem to have substantially reduced corruption; others appear to have made the situation worse.
Bussell (2012) studies a unique privatization reform in rural areas of the south Indian state of Karnataka. Starting around 2006, the state government began to create 800 one-stop outsourced service posts called Nemmadi centers in village areas, a substitute for government-run taluk offices. A portion of offices were also computerized, allowing the citizen to interact primarily with a computer program. Because of staggered implementation across the state, Bussell was able simultaneously to evaluate the effects of both privatization and computerization on service delivery. The analysis suggests that privatization reduced corruption— citizens visiting Nemmadi centers reported spending less money overall to access services and faced fewer demands for bribes. Computerization also showed similar positive effects although on a smaller scale than privatization.30
Yang (2008) documents similar success in the introduction of privatization reforms in the customs sector. Over the last twenty years, a number of developing countries have hired private firms to conduct pre-shipment inspections (PSIs) of imports that allow for an independent assessment of the value and tariff classification of incoming goods. The evidence suggests that countries adopting these reforms experience substantial increases in import duty collections, as well as decreased import misclassifications.31 Most importantly, the intervention seems to be cost effective, with the increase in tax collections representing 2.6 times program costs within the first five years.
Governments also sign contracts with private firms to deliver services such as health care. Here the government funds the program and sets eligibility criteria, but it does not provide the service itself. One option is to use not-for-profit firms (NGOs) as service providers. Loevinsohn and Harding (2005) review ten evaluations of contracting out in the delivery of primary health and nutrition services in developing countries. Compared with government provision, most showed positive results from management contracts as measured by coverage of the program. The authors conclude that contracting out should be considered but that rigorous evaluation should go along with experiments. The results suggest the value of combining contracting out with some type of bottom up public accountability as discussed above.
Although these successes are encouraging, there are also prominent privatization horror stories, the most prominent being tax privatization in Uganda (Iversen et. al, 2006). After a fiscal decentralization prompted by the 2001 presidential election, local governments privatized tax collection in hopes of improving both tax yield and efficiency. For a given area, the local government would estimate the revenue potential, otherwise known as the reserve price. Private firms would bid on the right collect this revenue, as well as a 20% margin for cost recovery. Iversen et al. (2006) provide an independent estimate of actual tax collections across six sample markets that could be compared to the agreed reserve price. They found that actual collections greatly exceeded the reserve price, even when the 20% margin was included. Actual gross margins ranged from 71% to 970.1%, resulting in “lost revenue” of 25% to 75% across the different markets. The authors conclude that privatization gave local bureaucrats an incentive to underestimate the reserve price, which would allow firms to collect a larger pool of corrupt rents. The reform merely shifted the locus of corruption from the collection point into the bureaucracy and procurement process.
To summarize, current reform experiences suggest that privatization can improve service delivery and reduce corruption, but reforms must not be implemented without careful planning. Private sector actors engaged in service delivery must be monitored and audited and, in turn, punished for any improprieties. If the threat of losing the public contract is not credible, either because there are no alternative providers or political will, firms once thought to curb corruption may ultimately promote corruption. The privatization process itself also presents opportunities for collusion in procurement, with bureaucrats and firms working together to create a rent-generating situation at the expense of public welfare. Thus, when a service has some public service characteristics simply devolving the service to private firms will not be sufficient. Honest, competent regulation is necessary and should accompany the shift to private firm provision. If such oversight is not possible, it may be better to keep the service inside the public sector.

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