Corruption – The disease that kills new business

No Corruption

No Corruption (Photo credit: Ann Douglas)

What is Corruption?

Corruption can defined as “the misuse of entrusted power for personal benefit”. It can also be described as letting personal or family relationships influence economic decision making, be it by private economic agents or by government officials. Corruption is always kept more or less secret and therefore is the individual behavior of corrupt agents almost impossible to observe systematically in real life. You know it when you are subjected to it.

The objectives of government are vital to the understanding of the diverse negative effects of corruption on the public service. Corruption renders governments unable or unwilling to maximize the welfare of the public for personal or the gains of a small group of people.

A corrupt principal creates allocation inefficiencies and cripples its credible commitment to effective policies, and opens the door to opportunism. Because corruption must be hidden from the public and is not enforced by courts it entails transaction costs, which are larger than those from legal exchange. This suggests that corrupt contracts are primarily relational contracts where legal exchange serves as a basis for sealing and enforcing corrupt agreements. Legal exchange not only provides for corrupt opportunities, but for the necessary enforcement mechanisms. Examples of such legal exchange are long-term business exchange, belonging to the same firm or political party or being embedded in social relationships. The latter may even comprise the engagement in charitable institutions. Reform should not only focus on limiting opportunities for corrupt behaviour but also on impeding the enforcement of corrupt agreements.

Two types of Corruption

According to transparenecy International there are two types of corruption that one can encounter “According to the rule”- and “Against the rule”-Corruption.

“According to the rule” constitutes a situation where an individual receives an illegal payment for something he/she is required to do by law – for example when a state official solicit bribes from a company for expediting a routine public service. “Against the rule” refers to a situation where a bribe is paid to obtain a service that the receiver is not authorised to provide but gains access to through a bribe. For example skipping the queue to gain access to a prestigious school or gaining a permit for which would normally would not be granted. Both of which are deemed as counterproductive to positive social and economic development.

There is no way to know how widespread corruption really is and the level of impact on financial and social development. As a Social Risk corruption is properly one of the first things that organisations investigate when investigating possible investments in a region or country primarily because there is a direct link between the perceived level of corrupt behaviour and general social issues like crime, rule of law, healthcare, etc.

When evaluating social risk in a region Transparency International, EBRD, OECD, IMF and the UN good sources for your assessment pared with local sources such as trade groups, the embassy in the region, government business development initiatives, etc.

Links on more information on Corruption and its impact:

http://www.ebrd.com/pages/about/integrity/reports.shtml

http://gateway.transparency.org

http://www.unodc.org/unodc/en/corruption/index.html

http://www.oecd.org/corruption/

http://www.whistleblowers.org

http://www.dfid.gov.uk/R4D/PDF/Outputs/SystematicReviews/Corruption_growth_SR_Report_Final_Revised-v2_SO.pdf

www.u4.no

Articles:

Bishop, T.J. and Hydoski, F.E. (2009), Corporate Resiliency: Man- aging the Growing Risk of Fraud and Corruption. Hoboken, NJ: John Wiley & Sons, 51–208.

Uslaner, E.M. (2008), Corruption, Inequality, and the Rule of Law: The Bulging Pocket Makes the Easy Life. New York: Cambridge University Press, 30–249.

Svensson, J. (2005), “Eight Questions about Corruption,” Journal of Economic Perspectives 19(3): 19–42.

Weitzel, U. and Berns, S. (2006), “Cross-border Takeovers, Corrup- tion, and Related Aspects of Governance,” Journal of International Business Studies 37: 786–806.

Luo, Y. (2006), “Political Behavior, Social Responsibility, and Perceived Corruption: A Structuration Perspective,” Journal of International Business Studies 37, 747–766.

Cuervo-Cazurra, A. (2006), “Who Cares about Corruption?” Journal of International Business Studies 37: 807–822.

Jensen, N. et al. (2010), “Understanding Corruption and Firm Responses in Cross-national Firm-level Surveys,” Journal of International Business Studies 41: 1481–1504.

Removing Cash is effective Anti-Corruption management

scott-schaefer-politics

scott-schaefer-politics (Photo credit: ScottSchaefer)

How do you systematically combat corruption when it seems to be found everywhere? In many countries around the world corruption is part of how business is being done, how you deal with officials and how you get things done. In a lot of places you will hear that it is part of the culture that there is nothing one can do about the phenomenon because the system as a whole would not work if there were no one to skim the cream so to speak.

In my mind there is at least one successful way that will insure the reduction of corruption significantly and that is by removing cash as the main means of payment from society. Cash is the fuel that ensures that corruption can flow freely and if one is able to reduce the amount of cash one can combat the most visible forms of corrupt behaviour and maybe even affect other forms of corrupt behaviour higher up the favours-for-cash food chain.

Corruption is operationally defined as the abuse of entrusted power for private gain (Transparency International) and can be found in two forms:

  • “According to rule” corruption – Which is corrupt behavior that ensures that people of power uphold the laws and rules that they have been entrusted with because to their position in society. F.eks. getting permits within a reasonable timeframe or speeding up bureaucracy.
  • “Against the rule” corruption – Is when a member of the public is able to ensure that a government official does not enforce rules. f.eks. A fine or penalty.

The cost of corruption is four-fold: political, economic, social, and environmental and the more advanced society becomes the more advanced is the corruption that one finds. From police officers taking small bribes to make up of the lack of adequate pay to election fraud through paid ballots.

It is my argument that societies that are not very advanced and therefor have a high degree of cash or natural economy, will be more prone to the two forms of corruption that ones where electronic transfers are more common. Another argument for removing cash in order to reduce corruption is that cash is most common at the bottom of the “food chain”. By cutting off the supply to higher levels in the chain and more damaging types of corruption one is able to reduce the impact as a whole.

We now have low-cost technological systems that can ensure that there is a less of a need for cash in society but more importantly these systems can be made available in developing and emerging markets thanks to telecommunication and improved systems of control. Systems like the ATM or home banking have found its way into the mainstream of all societies around the world and at affordable prices for everybody. Especially if one takes into account that a more transparent system will ensure that the cost of a credit card, interconnection and security systems are covered by the positive impact.

There are of cause challenges to reducing cash and as a technology it cannot be replaced in some parts of the society simply because it is the cheapest alternative. But by strategically targeting government and educational institutions, banking and international business there will be significant gains to be had through relative small investments for all parties involved.

China in for a soft landing

After years of two digit growth figures in China the economy is about to slow a bit down for what IMF believes will be a soft landing. The main drive for this change is the situation in Europe, which does not seem to improve anytime soon. However, the domestic Chinese market seems to be a driver.

Tide is turning for China

China Insurance Building (中国保险大厦), Shanghai

Image by thewamphyri via Flickr

I have touched on the subject of China many times in this blog and have warned about what can be perceived as a growing bubble. The speculation in housing has had many similarities to what we saw in Ireland, Spain and Portugal just on a much much large scale. Driven by large scale growth in the area of 10 % the Chinese economy have been a steam train without breaks or at least nobody was willing to scout for all the dangers that lay on the tracks. But now are the first signs that things are about to change and that we are after all interconnected even if we would like to think it is not the case.

Chinese has the second largest economy the world after the U.S. and in 2011 it expanded by 9.2% a figure that European governments can only dream about, but for China these represent the first figures that points in the direction of a slowdown. The economic growth in 2011 was thus lower than in 2010 and country’s statistical authorities expect a even further slowdown in economic activity.

Economic growth was in the fourth quarter, less intense than in the previous quarter but still a bit higher than economists had predicted. Production from China’s millions of factories rose in 2011 by 13.9 percent compared to 2010 but also the improvement was less than the year before. Retail sales, an important indicator of citizens’ private consumption expanded by 17.1 percent. Again also a bit slower than in 2010.

And despite the general slowdown economists do not expect a catastrophic slowdown as we saw in the US and Europe, But then again so did economists in US and Europe in 2007. As one Li Hiyong from the finance house Shenyin Wanguo in Shangha said “The actual growth in the quarter of 8.9 percent indicates that our economy remains in good condition and stable. The risk of an abrupt slowdown in economic growth is thereby diminished.”

While these figures are quite impressive they are indications that things are changing in the Chinese economy. First of all, China is still heavily relying on exports for their growth and with the slowdown in the economies in general they are vulnerable to changes in consumer behavior. Secondly, a lot of companies are taking production home or closer to their markets reversing the outsourcing flow that we have seen. One of the main reason why is because of the recession and the advantages of mass production in Asia is becoming less attractive. Third, wages in China are rising at an alarming rate some estimates puts the figures at above 20%, which have fueled the housing bubble and will eat up the advantage of producing in china. This should be compared with the 0-2% wage raise that we see in most European countries.

I will not say that the Chinese bubble will burst tomorrow but in my mind there is structural issues in the economy that will lead to a sharp corner and it is closing fast. China has a lot of money in the bank and they just might be able to pull through using their reserves to counter the downturn. However, it is imperative that the country starts to have a more conservative outlook in their economic and development of their social systems if they are not going to end up driving into a very big brick wall.

Chinese tiger is down but far from beaten what will it mean to European business

We have a Chinese economy that might be shaken but far from broken. With an economy that is expanding with nearly 7% in times when most other economies are around 1 or 2% if it is on a expanding curve at all. But while we might fear that the Chinese will come and take over all the business and economies of the western world this is not something that would happen anytime soon simply because it would be bad business. China simply have too much on its own plate for it to be concerned with even more problems, which comes with large accusations.

This interview with Lewis Wan, chief investment officer at Pride Investments Group Ltd. in Hong Kong. Gives some insight into the thinking http://youtu.be/AlkgK8Ky9l8

While the Chinese might be huge in terms of foreign direct investments it is something that they themselves can control and keep within the family so to speak. Doing hostile takeovers of western companies moving control to overseas management will not only be bad for European businesses but also be a poor investment at least for the time being.

Watch out for the Chinese dragon she is about to burst

China, China, China it seems to go on and on but what about the rest of Asia? Research done by the China Briefing found that if you are looking for low labour costs there are actually better places to set up shop in the neighbourhood.

The research was done on 15 countries in the region comparing minimum labour and mandatory welfare costs to business. As the there is no established norm for minimum wage in China the average was calculated using 40 cities across the country.

 Asia_wage_overview

The results are quite surprising as China comes in on third place just after Malaysia and Thailand. It is surprising as the china is a manufacturing country exporting for some 1,58 trillion USD in 2010. (That is 1,580,000,000,000,000,000 USD for those weak on math) and having uncompetitive wages could cause problems for China in the long run, especially if they are unable to control their own growth. The up-side is for the rest of us that Chinese consumers will experience a growth in purchasing power being able to spend more on luxury consumer goods of which some are produced in Europe and the US.

And it is actually the growth issue that I’m concerned about and I see signs that there is a massive bubble building in China which could create problems for the whole world when it bursts.

First, there is massive housing projects going one all over china that are only being build for investment purposes. Whole cities are empty of people even though all the homes have been sold. As we have see in the US and Europe where we had housing bubbles before can investing in a “ever” growing housing market create a house of cards that when they fall take much of the financial institutions with them. One of the questions that they need to be faced is how much of this is real growth due to supply and demand and how much is pure speculation. In Beijing the real-estate price is 22 time the disposable income while it was only 6,4 when the bubble cracked in the US. Furthermore is the lack of transparency in the Chinese financial (because of multiple financial systems working at the same time) making it impossible to know how fare we are from the edge. 

Second, the Chinese have not been able to control growth it seems. Some cities have reported growth as high as 30 %. Especially one thong about this that concerns me is that much of the local economy is being very tight with local business. 

“Many governments are hand in hand with local businesses, especially developers, with both in tandem striving to make large returns,” Chris Devonshire-Ellis, principal of Dezan Shira & Associates, points out. “Much government investment is actually tied up in commercial activities, especially property, and many gains being made are recognizable on paper only. Property prices are being driven up yet many of them still lie empty. Old habits die hard, and while the Central Government has for nearly twenty years focused on GDP growth, an entire mechanism has developed that is only really capable of feeding theoretical growth and lacks any real resale value or flexibility to manage growth in any other way. China is going to have a tough time in taking down a reporting and target structure that is increasingly in part looking to having encouraged the building of castles in the air.”

Third, there is a huge gap between the poor and the extremely wealthy and it is expanding at an explosive rate. At this time there are some 130 billionaires in China compared to the 359 in the US and there are some 825,000 Chinese people who have a net worth of over 1,5 million USD. Compared with the table above they seem to be living in different worlds. When things go from good to worse and finally to “big problems” there will be very strong tensions in the Chinese society that will be released with devastating effects.

A fourth problem is corruption as one commentator, Chen Pokong, put is “Loud words, little action. This is typical of the central government. Not only do they lack the determination, they also have no intention to fight corruption at all. A year ago, a survey showed that 90 percent of the public wanted the government to require officials to publicize their wealth, but 97 percent of the officials were against establishing such a requirement.” Nothing has happened in terms of legislation on corporate and governmental transparency so there is no reason to think that the issue has become even slightly smaller.

With an economy run amok and nothing to stop it, in terms of responsible government at all levels of society the Chinese are in real trouble. There is however no indication that any serious steps are being taken to counter this forth coming disaster.