Fighting corrupting critical for economic growth- IMF staff paper

It notes that Corruption can undermine the state's ability to deliver inclusive economic growth in a number of different areas.

“When government functions are impaired, it can adversely affect a number of important determinants of economic performance, including macro financial stability, investment, human capital accumulation, and total factor productivity. Moreover, when systemic corruption affects virtually all state functions, distrust of government can become so pervasive that it can lead to violence, civil strife, and conflict, with devastating social and economic implications,” according to the paper.

Commenting on the paper, IMF boss Christine Lagarde said direct costs of corruption is substantial and debilitating, leading to inequality.

“While the direct economic costs of corruption are well known, the indirect costs may be even more substantial and debilitating, leading to low growth and greater income inequality. Corruption also has a broader corrosive impact on society. It undermines trust in government and erodes the ethical standards of private citizens,” said IMF Managing Director Christine Lagarde.

“Given the potential impact of corruption on macroeconomic stability and sustainable economic growth, the IMF has been actively engaged in helping our members design and implement anti-corruption strategies,” she added.

How corruption hampers economic growth

The paper observes that corruption affects economic development in several ways.

First, it weakens the state’s capacity to raise revenue and perform its core functions.By harming the culture of compliance, corruption increases tax evasion. For instance, when tax exemptions are viewed as arbitrary, citizens’ have less incentives to pay taxes. As a result, the state collects less revenue and is unable to provide public services, with potential negative consequences for growth.

Second, by inflating costs in the public procurement process, corruption undermines the quantity and quality of public spending. Funds can also be siphoned off through off-budget transactions. This lowers resources available for public investment and other priority spending, aggravating infrastructure gaps and impacting on growth.

Third, because of lower public revenues, countries tend to rely more on central bank financing, which creates an inflation bias in the country. At the same time, corruption further weakens financial oversight and stability of the financial system. This arises from poor lending and regulatory practices and weak banking supervision.

Finally, corruption can even raise the cost of accessing financial markets as lenders factor in corruption. The private sector is further hurt because it raises uncertainty for firms and act as a barrier to entry for new entrants. Resources are allocated to rent-seeking activities instead of productive activities.

The social and environmental costs can also be significant. Reduced allocations for social programs and the resources lost through corruption limit the build-up of human capital. At the same time, weaker, poorly enforced environmental regulations lead to more pollution and more than desired extraction of natural resources. In the extreme cases, systemic corruption can lead to political instability and conflict. It has been argued that natural resource abundance can accentuate the situation.

Mitigating strategies

While the paper recognizes that there is no common recipe for all countries, it also emphasizes that a comprehensive approach is crucial. Short-term measures with more immediate impact, must be complemented with preventive measures and strict enforcement. The paper offers policymakers practical guidance, drawing on the IMF’s perspective of helping its members design and implement economic reforms, including anti-corruption strategies. The paper identifies four building blocks:

• Transparency is a pre-requisite. Countries need to adopt international standards on fiscal and financial transparency. Because of the relative share of extractives industries in many economies, transparency in this particular sector is crucial. Governments need also to support international standards on transparent corporate ownership. A free press also plays a key role in exposing corrupt practices.

• To enhance the rule of law, a credible threat of prosecution must exist. Enforcement must also target the private sector. In certain cases, new specialized institutions must be set up where existing ones are corrupt. An effective anti-money laundering framework must be in place to minimize the laundering of proceeds of corruption.

• Excessive regulation creates rents which are allocated at the discretion of public officials and must be eliminated. De-regulation and simplification are cornerstones of efficient anti-corruption strategies. However, it is important to have an adequate institutional framework in place first when transitioning from state controlled monopolistic markets (emerging economies in Eastern Europe).

• A clear legal framework is required. However, all of the best frameworks come to nothing, unless they are implemented. And implementation is all about effective institutions. In particular, a key objective is to develop a cadre of competent public officials who are independent of both private influence and political interference—and are proud of this independence. Finally, leadership plays a critical underlying role. Leaders must set a personal example and ensure decisive action is taken when needed.

(Additional files from the paper were added to this report)

Fighting corrupting critical for economic growth- IMF staff paper

A new IMF staff paper has urged countries to fight corruption which is hampering economic growth and stability and development.

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