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Wednesday, 23 July 2008

Corruption and Investment

A new paper finds no evidence between corruption and investment in Sub-Saharan Africa. The authors clearly appear shocked by the finding, and try hard to put some political spin on it. Excerpt:

Although a number of studies have examined the impact of corruption on aggregate investments, very few have analyzed the effect of corruption on firm-level investments. This paper analyzes the impact of corruption on firm-level investment growth. We find that the effect of corruption varies significantly across regions: corruption has an adverse effect on investment growth for Transition countries, but has no significant effect for Latin America and the Caribbean and Sub-Saharan Africa. Furthermore, among the variables included in the regressions (firm size, firm ownership, trade orientation, industry, GDP growth, inflation and openness to trade) corruption is the most important determinant of investment growth for Transition countries.

Our finding that corruption has no significant effect on investment in Latin America and Sub Saharan Africa does not imply that corruption is less of a concern in these two regions. A plausible explanation is that corruption provides private rents to some firms. However, these private gains to some firms, do not necessarily translate into social gains. In fact, a number of country-level studies have demonstrated that corruption impedes investments and economic growth (e.g., Mauro, 1995; Pellagrini and Gerlach, 2004), reduces public investments in healthcare, education, and infrastructure (e.g., Tanzi and Davoodi, 1997; Mauro, 1998), and results in large social welfare losses (Bose, 2004; Guriev, 2004). Another important point is that our analysis pertains only to firms that are already operating within the country. It is likely that large levels of corruption may prevent many firms from operating in these regions in the first place. However, this loss of potential investments resulting from corruption is not captured by our model. Thus, although corruption does not have a significant effect on investment growth, it is possible, and indeed likely that it might deter the entry of firms. As a consequence, the overall effect of corruption on investment (which includes the loss of potential investments) may be negative
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13 comments:

  1. Where is the political spin ?

    And intra-firm investment is a little more precise than investment, don't you think ?

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  2. The paper says "Investment Growth"....I simply got rid of the "growth" bit :)

    The political spin is this bit:

    "However, these private gains to some firms, do not necessarily translate into social gains. In fact, a number of country-level studies have demonstrated that corruption impedes investments and economic growth (e.g., Mauro, 1995; Pellagrini and Gerlach, 2004), reduces public investments in healthcare, education, and infrastructure (e.g., Tanzi and Davoodi, 1997; Mauro, 1998), and results in large social welfare losses (Bose, 2004; Guriev, 2004)."

    The first sentence is not proven in the paper. It is not even the subject of the paper. They shown no basis for including that in the conclusion as far as I am concerned.

    Then they go all the way to included a LITERATURE REVIEW in the conclusion, just make the point.

    A poor literature review as well. The review is biased. A number of other studies have shown at COUNTRY and CROSS COUNTRY level evidence that investment and corruption might have minimal effect. They don't mention that.

    Anyway, may be I am being biased. I happen to think corruption is overrated atleast from a macro perspective. I know it has redistribution consquences at the micro level, but at the macro I remain skeptical.

    Here are some two interesting blogs I have written on this:

    Corruption Wars - Part 1 (Corruption & Other Problems)

    Corruption Wars – Part 2 (Corruption & The Poor)

    You can see I am stuck at part 2!
    Still thinking of what Part 3 should be about....

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  3. The paper says "Investment Growth"....I simply got rid of the "growth" bit :)

    INTRA-FIRM investment growth.

    That's exactly the reason their data is as it is.

    The first sentence is not proven in the paper. It is not even the subject of the paper. They shown no basis for including that in the conclusion as far as I am concerned.

    But they sort of do. with this part:

    Another important point is that our analysis pertains only to firms that are already operating within the country. It is likely that large levels of corruption may prevent many firms from operating in these regions in the first place. However, this loss of potential investments resulting from corruption is not captured by our model. Thus, although corruption does not have a significant effect on investment growth, it is possible, and indeed likely that it might deter the entry of firms. As a consequence, the overall effect of corruption on investment (which includes the loss of potential investments) may be negative.

    I mean the first sentence these private gains to some firms, do not necessarily translate into social gains is far from being the kind of definitive conclusion you seem to see.
    The idea that private gains may or may not translate into social gains is just obvious.

    And the litterature review say "in fact, a number of cross-country level studies have demonstrated that..", which doesn't say "it is the case" or "there is a consensus" or whatever.

    A number of other studies have shown at COUNTRY and CROSS COUNTRY level evidence that investment and corruption might have minimal effect. They don't mention that.

    They don't have to.
    They're reminding people that no influence of corruption on intra-firm investment doesn't mean no influence of corruption at all.

    Anyway, may be I am being biased. I happen to think corruption is overrated atleast from a macro perspective. I know it has redistribution consquences at the micro level, but at the macro I remain skeptical.

    See, I tend to think the opposite (influence at the macro but not at the micro level).

    But then again, of course corruption is a weird measure. For one, it tends to be relative and hard to measure, which doesn't lead to the science being any kind of precise. And then, corruption is just too big of an umbrella and it would be nice if the debate was about what kind of corruption produces what kind of results.

    To an extend, that's exactly why corss-country analysis vary so much. Because different types of corruption at different levels in different countries lead to different results.

    But yeah, it seems quite obvious to me that levels of corruption may not affect the decision to invest when it's made by established mines, oil companies or whatever.

    I'll read your entries.

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  4. Ok I've read them (I actually had read part 2 before).

    And if we're talking about how much corruption is part of our national debates, I actually agree with you.. As I wrote in this entry, idiots like Ayittey actually dumb down the debate by focusing on how much Mobutu put in his Swiss bank account. This distracts everybody for asking real questions about the policies.

    After all being ruled by one of the most corrupt self-serving crooks on the continent didn't prevent Gabon from experiencing stronger growth than say its equally small oil-rich neighbourg (Congo-Brazzaville). And Kaunda's or Nyerere's relative integrity didn't do much for the economic performance of Zambia or Tanzania (as compared to crooked Kenya).


    And yes, we agree on how different types of corruption have different effects. But when investment in infrastructure is a someone's top priority, corruption has to be considered a severe problem, don't you think ?

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  5. Relatively most of the "founding fathers" of independent African countries where very corrupt. If they where cousins, they would only vary in intellectual prowess. sorry I had to vere off; but the point had to be stated. Botswana had a very smart and wise man at its inseptual beginning. Wisdom and knowledge are more precious than silver and gold. Thus it is harder to deal with corruption, since it is embedded in quite a good number of Zambians and Africans. and yes, we are dealing with both unit investors and intra-firm heads. Great topic guys, God's blessings.

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  6. The paper says "Investment Growth"....I simply got rid of the "growth" bit :) INTRA-FIRM investment growth. That's exactly the reason their data is as it is.

    The paper title was “investment growth” :)

    ”I mean the first sentence these private gains to some firms, do not necessarily translate into social gains is far from being the kind of definitive conclusion you seem to see. The idea that private gains may or may not translate into social gains is just obvious.”

    My point is that the paper does not really establish this point in detail. To me it just seems they are going all the way to emphasise something in a conclusion. May be its just a stylistic point.

    ”To an extend, that's exactly why corss-country analysis vary so much. Because different types of corruption at different levels in different countries lead to different results.”

    Indeed.

    ”And if we're talking about how much corruption is part of our national debates, I actually agree with you.. As I wrote in this entry, idiots like Ayittey actually dumb down the debate by focusing on how much Mobutu put in his Swiss bank account. This distracts everybody for asking real questions about the policies.”

    My goodness! You had the all Cheetahs on there…after you….lol!
    It’s a fantastic post. I have read your other posts which touches on Ayittey, but for some reason I missed that one! I followed up the links to Bayesian Heresy and so the video as well! The video is very worrying indeed…..very empty and misguided…..

    ”But when investment in infrastructure is a someone's top priority, corruption has to be considered a severe problem, don't you think ?”

    Agreed, and a more cost effective approach is to follow that prioritisation.

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  7. And thinking further about your conclusion in that Ayittey post:

    "But it’s all a waste of time, as constructive and relevant as blaming the West / Colonialism / IMF / Multinationals / Slavery / Racism like so many of his fellows do. May be that’s the real issue, not a failure of leadership but a failure of the intellectual sphere."

    Rodrik's makes quite a simple but very profound statement in his book on page 42 in the last two paras....

    In the search for growth the role for economists with local knowledge is significant...and I think thats where the intellectual capital needs to be spent...not in the noise making...

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  8. May be its just a stylistic point.

    It was. That wasn't the point of the paper and they didn't claim it was.

    When the topic is "relationship between corruption, private gains and social gain", you can complain about such conclusions.
    (and honestly, does the idea that private gains do or do not translate into social gains need detailed argumentation ?)

    My goodness! You had the all Cheetahs on there…after you….lol!
It’s a fantastic post.

    ah ah thanks. I re-read after posting my last reply here and was kinda sad about the spelling and the grammar but I still like the intend.

    The video is very worrying indeed…..very empty and misguided…..

    BTW, what do you think of his insistence on defining pre-colonial African societies as "free-market, small government" societies ?

    Rodrik's makes quite a simple but very profound statement in his book on page 42 in the last two paras....
    In the search for growth the role for economists with local knowledge is significant...and I think thats where the intellectual capital needs to be spent...not in the noise making...


    Yes.
    That said, sometimes I think that you and me don't read Rodrik the same way. That's sort of why I want you to make a post about it.
    In this case, I think there's a danger in respecting local institutions too much. For instance, it's for that reason that someone like Ayittey is unable to even comprehend that a lot (if not most) of the unsecurity of the propriety rights does not come from the state but rather from the private sphere through those semi-recognozed informal (but not regulated) arrangement.

    In the second post, if you remember, I also argued that he was more aware of the political realities than it seems. Focusing on corruption allows him to avoid defending unpopular notions like fiscal restrain or a state that doesn't hire a bunch of people.

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  9. The results of this study are not only misleading but very unhelpful. This may depend probably on the question asked. How can you ask if corruption has a discouraging effect on investment? It encourages it stupid! I see no firm which would not be attracted to go and invest in a country where they do not have to follow laws on environment, labour, use of kids, resource exploitation, air or water control, etc. You make profits by simply ignoring these regulations. You see, through corruption they (firms) can beat all these impediments.

    What needs to be looked at is - what are the impact of corruption on wealth distribution and social-economic impacts? It is unfortunate that many of our young men attach themselves to these useless studies (perhaps only to get paid). Studies which are probably sponsored by the firms or industry itself. Until when we get really inquisitive minds and pro-poor scholars, we'll be getting garbage studies like this one. We do not need that nonsense. Kaela B Mulenga

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  10. Random,

    ”That said, sometimes I think that you and me don't read Rodrik the same way. That's sort of why I want you to make a post about it.”

    If I have understood Rodrik’s approach its quite narrow. To him there are fundamental principles that drive growth, but achieve those principles local economists need to fill the gap on ensuring local economic institutions are suited for that. The key to him is that subtle distinction between institutional function and institutional form.

    In short Rodrik’s approach is a certain view of what drives growth and then imposed with a narrow view of “institutions”.

    I see institutions in the Acemoglu / Robinson framework, where political institutions are at the heart of the problem and if those can be rectified, you would see redistribution of power in society that then lead to emergence of pro-growth economic institutions.

    In short Rodrik does not pay enough attention to political or cultural forces at work.

    I am sure he would disagree….but that’s the conclusion I have reached so far….but I am still reading the book [I am very slow reader..lol!…..coz I read atleast 4 books at a go!!…not very efficient! But it allows me to ponder and contrast :)….]

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  11. Kaela,

    ”How can you ask if corruption has a discouraging effect on investment? It encourages it stupid! I see no firm which would not be attracted to go and invest in a country where they do not have to follow laws on environment, labour, use of kids, resource exploitation, air or water control, etc. You make profits by simply ignoring these regulations. You see, through corruption they (firms) can beat all these impediments.”

    This is an interesting empirical question. A recent paper which I’ll blog shortly actually provides new evidence that shows that private sector investment is negatively related to corruption, but interesting, POSITIVELY related to public sector investment!

    But hold your fire until you see it!

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  12. I think they're complimentary.

    That's probably why "One Economics.." quotes Acemoglu papers on each page.

    Rodrik picks up where Acemoglu/Robinson don't go: application. It's not so much that Rodrik is not interested in cultural and political forces, it's that studying those clauses is not relevant to what he's doing.

    And I guess I like the level of abstraction. Plus, like I said, the idea that everything is culture and politics is just depressing. How does one change that ?

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  13. I should have been more clear in my last post….apart from my quibble on his approach to institutions, “One Economics….” is a FANTASTIC book…
    Certainly probably up there in terms of PRACTICAL application.
    There’s no argument with the growth diagnostic approach. I mean I apply it on the blog all the time, and his previous work in this area as influence my own approach on the need to focus on the biting constraint…clearly in Zambia the main issues we face is weak returns (for example in the areas of education and the brain drain phenomenon, also in general due to weak infrastructure and our “land locked” trap”, poor regulatory environment etc etc etc)…also the high cost of finance which we have discussed many times…

    I guess where I go further than in is that I emphasis more the political institutional setting than he does….I know these can be more challenging to resolve, but I think the Acemoglu / Robinson framework emphasises better how these could be reformed…

    What I am hoping with the series we are doing on Chiefs is later in the posts we’ll discuss to try and apply the Rodrikan “growth constraints” and the “Acemoglu / Robinson” separately and see what they may suggest about how to reform the relationship between Chiefs and the state…..

    So I have not thought through this yet, but the post on the Rodrik approach might for example look at village setting run by a chief and examine the constraints that exists there and see where the binding constraints are in terms of low returns to investment and high costs of finance….and discuss how reform of chieftaincy might help remove those constraints…..

    The Acemoglu / Robinson post…would work the other way and focus more on their power and see how power and land interact and the extent to which it has shaped the distribution of reasons that ultimately prevents / promotes more reforms at the local level….

    So I agree that they are not contradictory…..very complimentary…

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